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What you need you have to borrow


The DOE’s proposed budget for FY2014 extends the benefits of the Pay As You Earn (PAYE) plan to everyone’s eligible Income-Based Repayment (IBR) loans. As of now only people who hadn’t taken out any federal educational loans prior to October 2007 are eligible for PAYE.

These plans work like this: if the federal government (or, prior to 2010, private lenders participating in the FFEL program, but not other private loans) lends you money to go to school, and you suffer a “partial financial hardship,” you can pay a reduced amount on your loans as long as the hardship exists. The definition of a partial financial hardship is that the portion of someone’s adjusted gross income that doesn’t exceed 150% of the federal poverty line isn’t subject to debt repayment as long as the hardship exists. So if you don’t make more than 150% of the federal poverty line you don’t have to make any payments on your eligible educational loans. As for AGI 150% above the poverty line, you have to pay 15% of that under IBR, and 10% under PAYE, toward your loans as long as you’re eligible (eligibility gradually decreases and can eventually disappear to the extent that someone’s AGI increases faster than inflation).

Here’s a concrete example, using the more generous PAYE provisions, rather than the original IBR system. Suppose Bill takes out $100,000 in federal educational loans while going to undergrad and law school, and graduates with $100,000 in principal debt (Bill’s total debt will be higher, since interest will have already accrued on all of the loans that are unsubsidized, which at the post-graduate level is now all of them, but let’s stipulate that Bill paid the interest on the loans while in school to keep this simple). Bill gets a job that gives him an AGI of $40,000 (this is probably about the median for current law school graduates), and he gets raises that outstrip inflation by 25% each year for 20 years. At the end of that period, Bill will have made $74,000 in payments — an amount which will have covered just slightly over half of the interest that accumulated on the loans over this time (interest on federal government loans in income contingent repayment plans does not capitalize, but it does accrue).

Bill will at this point still owe $100,000 in principal and $73,000 in unpaid interest. This combined amount is then forgiven, and the sum of $173,000 is imputed to Bill as income.

Now one one level this is a “good” deal for Bill, who has not been tossed in debtor’s prison, or had his wages garnished (technically speaking anyway), or had liens placed on his property should he have acquired some, etc. In addition, using a standard discount rate Bill has made $44,000 in payments, reduced to net present value, so in terms of NPV he only paid back 44% of a $100K interest-free loan, which is certainly a better deal than he would have gotten from Tony Soprano or Chase. (Depending on his current economic circumstances he may have a big tax bill though. The good news is that if he and his loved ones are still broke he won’t).

On the other hand, what this “deal” adds up to is, under current tax law, a 23% annual hike in what would otherwise be Bill’s effective tax rate, for each year over the next two decades.

IBR and PAYE, in other words, constitute a gigantic functional backdoor tax hike on (primarily) the middle class and striving working class and poor youth of America, by a political establishment that would rather allow higher education to feed unmolested at the trough of government loans, while passing the costs of doing so onto college attenders and taxpayers via the kind of massively regressive and grotesquely generationally-skewed tax hike that could lead to actual social unrest in even this sleepy republic, if it were not so cleverly disguised.

Is it better than nothing? Absolutely. Is it in anyway an acceptable alternative to returning to a system of higher education that allows those who had the poor judgment not to be born to the Quality to pursue that education at a price that won’t require them to indenture themselves to the government? Absolutely not.

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