Biden's Misfire on Student Loans
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Biden’s Misfire on Student Loans

Yann Coatanlem,

NEW YORK – The student debt forgiveness scheme announced by US President Joe Biden last month can certainly alleviate many of the desperate conditions some borrowers face.

But it will do so at a disproportionately high cost. Much of the money spent will go to people who do not really need it.

Given that a college degree already confers a significant wage premium, those who never went to college and pay taxes may well perceive this aid as unfair. And in today’s inflationary environment, the timing is less than optimal.

Two other flaws in the program are the lack of predictability and the intergenerational inequality it will bring about.

People who have already paid back their loans are excluded, while future students won’t know for certain whether their debts will be forgiven.

This could create a type of moral hazard, encouraging borrowers to max out their student loans in the hope that someone will one day pay for them.

A better policy would create a system that rewards human capital formation – learning skills but also improving health – throughout a person’s lifetime.

Biden’s plan won’t solve the student debt crisis, nor will it reduce the cost of college and health care.

Moreover, most of the truly dire debt burdens could probably be ameliorated by retraining students who have seen very poor returns on their investments in higher education.

As Antonio de Lecea and I explain in our recent book Le Capitalisme contre les inégalités (“Capitalism against inequalities”), we need to de-emphasize the concept of schooling and higher education in the early years of a person’s life in favor of lifelong acquisition of knowledge and expertise.

Numerous studies have shown that continuous education and job training will be crucial for creating greater equality of opportunity in a world where skills become obsolete at an accelerating rate.

In addition, we need to ensure that our tax and welfare systems don’t impede human capital and labor supply – in other words, that taxes don’t create unnecessary distortions – and can provide some insurance against adverse returns on productivity.

The focus should be on policies that integrate long-term horizons, the element of uncertainty, and the relationship between welfare and tax dynamics.

What is needed are “human capital” subsidies (or tax deductions) that make it easier for individuals to improve themselves throughout their lives.

Harvard University economist Stefanie Stantcheva has designed a theoretical model of human capital development that does just that.

By considering the complicated process by which workers acquire human capital – investing time and money while dealing with uncertainty and other risks – her “life cycle” model enables policymakers to devise “optimal income tax and human capital policies.”

Stantcheva examines two such optimal policies: “income contingent” loans that calculate loan repayments based on individuals’ human capital expenditures and earnings history, and a “deferred deductibility” scheme that accounts for risk by allowing people to deduct some human capital expenses from future income.

As ambitious as this model may seem, more has to be done to modernize our tax and welfare systems. Stantcheva’s approach must be extended to behavioral factors as well.

A 2020 paper by Emmanuel Farhi and Xavier Gabaix, for example, shows that introducing a negative marginal tax rate for low incomes could incentivize people who may not “fully recognize the future benefits of work” to participate in the workforce.

Behavioral nudges can be helpful in other areas, too. As individuals, we don’t always consider the long-term cost of consuming harmful goods like tobacco or fatty foods.

These long-term costs are what economists call “internalities.” Farhi and Gabaix show that because internalities tend to be more prevalent among low-income people, attempting to mitigate these behaviors through “sin taxes” might have the unintended effect of making the poor poorer.

Nudges are an attractive tool in this regard because they can alleviate internalities without deepening inequality.

Such measures, ranging from simple informative warnings on goods packaging and shocking pictures of cancerous lungs on cigarette packs, to different default options (such as the size and content of sugary beverages), modify consumption without affecting income.

Governments must also make sure they don’t keep their citizens in the dark. They should provide easy access to simulations that are tailored to each individual and allow taxpayers to use relevant past data as a way to improve their decisions, bearing in mind the need to provide minimal guidance and explanations that are easy to understand.

By estimating the long-term effects of the tax and welfare systems on decision-making, we can promote policies that motivate individuals and companies to make productivity-enhancing investments.

While we would need to collect and analyze more data to make the models more robust, it is clear that a student-debt jubilee will not help us achieve a more equitable and efficient level of social development. That would require a far more holistic and refined approach to human capital.

Yann Coatanlem, an economist and fintech executive, is President of Club Praxis and the co-author (with Antonio de Lecea) of Le Capitalisme contre les inégalités (Presses Universitaires de France, 2022).

Copyright: Project Syndicate, 2022.
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