President Obama has proposed legislation that will give tax exemptions to student-loan borrowers who complete income-based repayment programs and whose loan balances are forgiven at the end of the repayment period. This is a good idea.
As is well known, the Obama administration is encouraging more student-loan borrowers to switch from standard 10-year repayment plans to income-based repayment plans (IBRPs) that will stretch the repayment period out to 20 or 25 years. The advantage of these plans is that monthly loan payments are based on a percentage of the borrowers' income, which means most monthly payments will go down. People who are unemployed will not be required to make any monthly payments.
All well and good except that student-loan balances will actually grow for borrowers who are not making loan payments or are making payments that are not large enough to cover accruing interest on their loans. Thus, many student-loan borrowers who elect IBRPs will find they still have a loan balance at the end of their 20- to 25-year repayment periods.
The New York Times carried a story recently that illustrates this point. A woman who borrowed around $300,000 to attend veterinary school obtained a job in her field but the job did not pay enough to allow her to pay off her loan in 10 years and still maintain a reasonable standard of living. The veterinarian elected a long-term repayment plan, which lowered her monthly payments to a percentage of her income; but these payments did not cover accruing interest on her loans. The New York Times, figuring her likely income trajectory, estimated she would owe a total of $600,000 on her student loans at the end of her 25-year repayment period--double the amount she originally borrowed!
Under the terms of the veterinarian's IBRP, the federal government will forgive this loan --all $600,000 of it; but under current IRS regulations, the forgiven amount is taxable income to her. Thus, at the end of her 25-year repayment period, she faces a sizable tax bill.
President Obama's proposal would exempt her from this tax, which is a good thing.
Nevertheless, I don't agree with the Obama administration's push to get more student-loan borrowers to sign up for IBRPs. Nor do I agree with proposals to make long-term income-based repayment plans the default option for students who borrow money to attend college, which several commentators have suggested.
Look where we are headed--toward a higher education landscape in which millions of people will be paying on their student loans for the majority of their working lives. And for many of these people, their loan payments will not be large enough to cover the accumulating interest, which means the federal government will be forgiving massive amounts of student-loan indebtedness.
And of course IBRPS do nothing to reign in the ever-growing cost of attending college.
Forcing people to pay a portion of their income to the government for a quarter of a century is imposing too high a price for the privilege of attending college. As I have said before, we need to allow distressed student-loan debtors reasonable access to bankruptcy.
Michael Stratford. Tax Breaks for Students. Inside Higher Education, March 4, 2014. Available at: http://www.insidehighered.com/news/2014/03/04/obama-budget-calls-changes-education-tax-benefits