Student loan debt forgiveness could juice the US economy, but create potential problems, too

Democratic presidential candidates Elizabeth Warren and Bernie Sanders have both proposed eliminating either most – or all – of Americas’ student loan debt burdens, proposals that have been met with some criticism over potential costs.

But how would the policy actually impact the U.S. economy?

According to researchers from Moody’s Investors Service, the proposals would have both positive and negative effects on the economy – the scopes of which would largely depend on the specifics of the plan enacted, including how it is funded.

On the plus side, researchers expect eliminating student loan debt to provide a similar boost to economic activity as a tax cut, producing a near-term, modest increase in household consumption and investment since people may have more disposable income.

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However, the effects of totally canceling student debt – as proposed by Sanders – will be “partially diluted” since those with higher debt burdens tend to have higher household incomes. These people are more likely to stash away their savings than spend it, according to the study.

Researchers note other positive, longer-term effects could be higher levels of both household and small business formation.

On the flip side, a one-time forgiveness act could create a “moral hazard,” causing future borrowers to take on more debt because they expect it to be canceled.

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Universal student debt forgiveness would increase the U.S. government’s debt burden by about 0.4 percent of GDP without offsets for lost revenue, according to Moody’s. Debt would also be increased if the U.S. purchased the roughly $402 billion worth of privately held student loans.

The fiscal deficit could widen to 6.7 percent of GDP by 2029 due to annual net losses in revenue as it foregoes debt service on outstanding federal loans.

Outstanding student loan debt has doubled over the past decade to more than $1.5 trillion in 2018 and is now second only to the amount of mortgage debt held by Americans. Delinquency rates are the highest of any form of household debt.

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Sanders has estimated this his complete student loan cancellation and free public college plan would cost about $2.2 trillion. He plans to use a Wall Street transaction tax to finance the proposal.

A similar plan put forth by Warren carried an estimated price tag of $.125 trillion. Her plan involves the cancellation of $50,000 in student debt for individuals with household incomes below $100,000 – or about 42 million people. American households with higher incomes, up to $250,000, would also see some of their debt written off. The $50,000 cancellation amount would phase out by $1 for every $3 in income above $100,000. She said her plan could be paid for through her “ultra-millionaire tax,” or a tax equal to 2 percent for those with more than $50 million in assets, or 3 percent for those who have assets valued at more than $1 billion.