The Student Loan Repayment System Needs a Radical Overhaul

The hot mess that is the federal student loan program is about to get hotter and messier. This month, repayments started for more than 43 million student loan borrowers who had benefited from a pandemic-driven moratorium that began during the Trump administration in March 2020. With an average monthly payment of $503, the household budget for these borrowers is taking another hit, on top of inflation and the elimination of other pandemic subsidy programs. 

While this phenomenon was predictable, the circumstances were not what the Biden administration anticipated. In August 2022, the administration announced a debt-forgiveness plan for all borrowers with individual incomes below $125,000 or household incomes below $250,000. The plan would have eradicated $20,000 of debt for each student loan taken out by Pell Grant recipients and $10,000 for non-Pell recipients, thus attempting to make good on a promise made during the 2020 presidential election. This plan was challenged in court, and rose to the Supreme Court, which decided in June 2023 that the Biden plan was not legally authorized. 

The administration quickly moved to Plan B, announcing a new Saving on a Valuable Education (SAVE) program in August 2023. This program was based on a broad interpretation of existing authority given by Congress to the Secretary of Education — thus, presumably, avoiding another Supreme Court case. Key elements of the SAVE plan include that it:

The SAVE plan, which required that a borrower file an application, reduced or eliminated student loan debt for more than 3 million borrowers.

With the date arriving for repayments to resume, the administration announced on Oct. 4 the results to date of its new plan. Overall, some $127 billion in debt has been forgiven for 3.6 million borrowers since the inception of the SAVE program. This includes public service loan forgiveness, the new rules for income-driven repayments, and debt forgiveness for some 22,000 borrowers with total or permanent disability.

While critics of student loan debt forgiveness remain skeptical about the new Biden initiatives, they seem to be well-researched, with some limited precedents to support the specifics.  Nevertheless, the 3.6 million borrowers affected by the SAVE initiatives are less than 1% of all student loan borrowers in repayment. Thus, the big impact for more than 40 million borrowers is just ahead.

Some critics on the left argue for an extension of the moratorium. Nineteen state attorneys general have taken this view, noting that contractual loan servicers have sharply reduced staff since the onset of the moratorium, because there were simply no loans to be collected. They point to overloaded customer service lines with wait times of two hours or more and dropped calls. They also note confusion on the part of borrowers whose loans have been transferred from one servicer to another. The advocacy organization Student Borrower Protection Center calls the customer service wait times a “nightmare.” 

Nonetheless, it is most likely that the resumption of repayments will move forward. The Biden administration anticipated some glitches in readjusting to normal payments by making it easier to cure defaults and absolving borrowers who miss a payment from having their delinquency reported to a consumer credit bureau. Republicans and some Democrats believe that those who take out student loans have an obligation to repay them. Among other things, they fear that widespread debt forgiveness will create the expectation among new borrowers that they have no responsibility to repay their loans.

On a long-term basis, the entire system of student loan collections needs to be radically overhauled. The first reform is to make income-contingent repayment (ICR) universal and automatic. We’ve known for decades that income rises considerably during the 10 years after college graduation. A system that starts with lower payments that rise over time, as income levels increase, will result in more successful collections. 

Instead of the current system of well-compensated private collectors, student loan repayment could be effectively managed by the IRS. An income-contingent tax surcharge could be levied to pay back student loans. Those who have lower marginal tax rates would pay a lower rate than those in higher tax brackets. Implementation of such a system would be relatively easy, especially since the Department of Education uses IRS information to calculate borrowers’ income for the ICR program.

Using the IRS for student loan collection would eliminate a number of regulations and bureaucratic procedures that complicate the present system. For example, borrowers who are unemployed no longer would need to apply for forbearance. Someone who files a tax return with zero adjusted gross income would pay nothing for their student loan that year. Additionally, there would be no such a thing as a loan default. The bureaucracy tied to the calculation and administration of cohort default rates would disappear into the ash bin of history. 

It is time that the Congress and administration face up to the failures of the current system of collecting student loan debt. The policy foundation for student loans dates back nearly 70 years to Nobel Prize-winning economist Milton Friedman, who observed that the market dysfunction for students is that they have no assets or credit history to justify an extension of credit to them.  They have only their future earning potential. Friedman advocated income-sharing agreements, but his ideas could be practically implemented by tying repayment to income through the IRS system, a more economical and efficient system than the one we have now.

C. Ronald Kimberling, a former president or chancellor at several colleges, is a research fellow at the Independent Institute and consultant for the Gerson Lehrman Group.