Unlike free college, canceling student loans in bankruptcy is a great idea
Meaning. Dick durbinDick DurbinSenate Democrats to Garland: “It’s time to end the federal death penalty” Overnight Defense: COVID-19 vaccine mandate for troops to come by mid-September (D-Ill.) And John cornynJohn Cornyn Unlike free college, canceling student loans in bankruptcy is a great idea. The budget includes a plan for the path to citizenship, green cards for millions of people. (R-Texas) recently introduced a bipartisan bill aimed at restoring the way student loans are handled in bankruptcy.
Unlike other recent proposals, such as the free university and a student loan jubilee, this legislation is not a flashy proposal – it is a great idea, which enjoys the support of both. sides of the aisle among policymakers and some experts.
Over the past 30 years, a series of policy changes have made it more difficult for borrowers to discharge their student loans in bankruptcy. These policy changes were driven by the idea that investments in education could not be transferred, as the borrower would always retain the benefits of his studies. It would make sense if degrees were to consistently pay off with large dividends, but the reality is that some investments in education fall short of this level – unpredictably providing little or no value to the borrower.
In theory, income-tested reimbursement programs (IDRs) were supposed to offset the financial burdens faced by distressed borrowers when Congress made it harder to release student loans in bankruptcy. However, in practice, IDR programs fail to provide an adequate safety net for borrowers and need serious reform.
In the meantime, restoring the ability to discharge student loans, both federal and private, in bankruptcy under certain conditions, would create an effective fix to the well-intentioned, but inadequate, IDR system.
To be clear, reforming bankruptcy laws is not a quick fix and would have its own drawbacks. Some borrowers may use this option strategically, borrowing to pay for their education and then going bankrupt as a less expensive option than paying off their loans. The introduction of this moral hazard is inevitable, but could be mitigated by restrictions. For example, requiring a borrower to repay a certain number of years before the loan becomes eligible for bankruptcy would reduce the financial reward of bankruptcy while increasing costs. It would also be reasonable to require borrowers with larger balances, such as those in professional and graduate programs, to pay for a longer period before their loans become eligible for release.
In an economy that relies heavily on self-funded investments in education as the primary mechanism for social mobility, it is untenable for students to risk their financial well-being without a strong safety net. Lawmakers are right to consider reinstating the “availability” option for student loans after a 10-year waiting period. At the same time, it is imperative that Congress simplify the currently flawed IDR safety net into one program and automatically enroll all borrowers when they start repaying.
Bankruptcy “acquittal”, coupled with significant reforms to the IDR system, are good first steps towards reforming our failing higher education funding system. While these adjustments may not be as flashy as the other proposals on the table, they have the potential to dramatically improve our system of funding higher education without exorbitant spending. We are happy to see that policy makers on both sides seem to be in harmony on this issue.
Beth Akers is a resident researcher at the American Institute of Business (AEI). She is the author of “Charging college: economist explains how to make a smart bet on higher education. AEI Research Associate Olivia Shaw contributed to this article.