• Bernhardt Wealth Management

Student Loan Forgiveness Is Good News for Borrowers, but What about the Economy?

You may have read that the Biden Administration issued an executive order canceling up to $10,000 of student loan debt for borrowers. The program extends to the remaining balance on all so-called federal “direct loans,” the now-defunct Perkins Loans taken out directly from colleges, and any non-direct loans held by the federal government. There are some 43 million individuals in America who are carrying the burden of these debt obligations, and for an estimated 15-20 million of them, the executive action would entirely eliminate their loan balances.

However, this cancellation would only be available to people with income under $125,000 for single individuals ($250,000 for married couples). Current students with debt are eligible for relief if the student is currently claimed as a dependent on the parents’ income tax return, in which case the parents’ income would be used to determine eligibility. Additionally, up to $20,000 in student debt would be forgiven for Pell Grant recipients (a program designed for students “with exceptional financial need”), with the same income thresholds. “Parent-Plus” loans, which are federal student loans taken out by parents to help their students, also qualify for relief, subject to the income thresholds mentioned above. The executive order also specifies that all federal student loan payments (and accrued interest) would be delayed once again, through December 31, 2022. This is likely the final moratorium, which would end the COVID-driven pause in student loan payments that began in 2020.

Under normal circumstances, forgiven debt is taxable as ordinary income. But that is not likely the case with the Biden student loan forgiveness program. The American Rescue Plan Act of 2021 provided that most student debt discharged through 2025 (which, of course, includes the Biden Administration’s current proposal) would be tax-free at the federal level. It is uncertain whether those states that collect state income tax would consider the debt cancellation to be taxable income.

Without question, students, graduates, and their parents who meet the specified requirements are pleased by the prospect of having $10-20,000 of debt wiped off the books. But what about the economy? With financial markets alternatively diving and soaring based on the latest readings for inflation and other economic indicators, what is the likely effect when the federal government deletes an estimated $300 billion in debt—and its accompanying interest payments—from the balance sheet? According to the Tax Foundation, a Washington, DC-based nonprofit, the president’s order, in decreasing the government’s “accounts receivable” by such a large amount, would be inflationary, largely negating the deficit reduction benefits of the recently enacted Inflation Reduction Act (IRA) of 2022. Some sources counter that the practical effect will involve only the amount of payments and interest that would have been collected in a single year, and will thus spread the effect of the cancellation over the entire term of the original repayment plan, producing a net effect of a much smaller amount each year, with a correspondingly negligible impact on inflation.

It is also worth noting that the Department of Education makes roughly $90 billion in new student loans every year—and there is currently no discussion about whether or how any of those loans might, in the future, be forgiven.

Bernhardt Wealth Management is committed to providing up-to-date, authoritative information and research in order to help our clients make well-informed decisions for their financial futures. To learn more, click here to read our latest newsletter, “The Inflation Reduction Act of 2022: What’s in It for You—And What’s Not.”

Buen Camino!

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