January 11, 2023

Next month the U.S. Supreme Court will hear the case of Biden, President of U.S., v. Nebraska et al. This case, which was brought by six Republican States (Arkansas, Iowa, Kansas, Missouri, Nebraska, and South Carolina), challenges the constitutionality of the Biden administration’s Student-Loan Forgiveness Program. In response to this lawsuit, the Biden Administration suspended loan payments until June 30, 2023.

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The Biden Administration’s loan-forgiveness proposal calls for the cancellation of up to $20,000 in student debt for eligible borrowers that receive federal aid (Pell grant recipients) and up to $10,000 for other borrowers. More than 26 million borrowers have already applied for student-loan forgiveness. That number is expected climb given that 43 million borrowers collectively owe about $1.6 trillion. The nonpartisan Congressional Budget Office estimates that the student-loan forgiveness program will cost taxpayers $400 billion.

The proposal to cancel student-loan debt raises a number of basic fairness questions. For example, why should those who attended less-prestigious schools or decided to forego discretionary purchases to pay off their loans be forced to pay off the loans of those students that made less-prudent choices? Why should those who chose not to attend college or attended a trade school be forced to pay off the loans of those who attended college?

The Department of Education’s statement that “90 percent of relief dollars will go to those earning less than $75,000 per year” is misleading. The financial benefits from a college degree accrue over the course of the graduate’s professional career. The relevant metric is not the relatively low income of a college graduate early on in his career, but his lifetime cumulative earnings. To wit, the income of new physicians and attorneys is a fraction of what they can expect to earn once they become partners in their practices. The student-loan forgiveness program is regressive because the financial burden is expected to fall disproportionately on individuals in the lower income strata.   

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According to one study, the cost of attending college has risen nearly five times faster than (economy-wide) inflation over the last half-century. The average annual cost of tuition at a public four-year college is now 37 times what it was in 1963. There are myriad explanations for this phenomenon, but these runaway tuition increases coincide with the government’s takeover of the student-loan program. This has precipitated an administrative surge throughout academia. The number of managerial and professional staff that Yale employs has risen three times faster than the undergraduate student body over the last two decades.

Student-loan forgiveness fuels these inflationary pressures. Universities have incentives to raise tuition in direct proportion to the degree to which tuition is subsidized. This is the case because the demand for college is determined not by tuition, but by tuition net of government subsidies. This is a financial boon for universities because the student-loan forgiveness program enables them to increase tuition virtually without limit.

While tuition continues to spiral out of control, the evidence is mounting that teaching standards and academic rigor have declined. The average college student in the United States today puts in less than 60 percent of the study time per week that his counterparts did in 1961 (14 hours versus 24 hours). Employers are forced to compensate for these declining academic standards with increased skills training for newly minted college graduates.

As the economics Nobel laureate Milton Friedman famously quipped, “there is no such thing as a free lunch.” This means that salaries for new college graduates will be reduced to reflect the costs of the supplemental training that employers must now provide. These lower salaries will make it even more difficult to pay back college loans. Attending college now costs more and delivers less — an unambiguous decrease in the value proposition. This may explain why undergraduate enrollment has declined by 14 percent over the last decade in the U.S. while the population increases by about two million people per year.

A moral hazard is a type of incentive problem that arises when an economic agent does not bear the full costs of a loss and, as a result, fails to put forth the efficient level of effort (which cannot be observed directly) to avoid that loss. For example, an individual may not take adequate precautions in locking the doors on his rental car or parking the rental car so as to avoid parking-lot damage because he does not pay the full cost in the event of theft or damage. Moral hazard explains why most insurance policies require co-payments or deductibles (i.e., to ensure there is “skin in the game”).

How does the moral hazard problem manifest itself in the case of student-debt cancellation? A student who is not required to actually pay the full freight for his college education may not invest the effort necessary to earn his degree or may be less than judicious in selecting a major. The major that is chosen may not be financially remunerative (e.g., African American Studies, Women Studies, Art History and Theatre).