President Obama’s expansion of student loan forgiveness programs may be popular with millennials, but there’s no such thing as a free lunch. The Government Accountability Office (GAO) just told Congress to expect a price tag in the ballpark of $108 billion in “the coming years” because many of the borrowers utilizing income-based repayment programs receive debt forgiveness after 10, 20, or 25 years (depending on the program). With a national debt load just shy of twenty trillion dollars — a figure that’s doubled in the last decade — the expense associated with these programs is noteworthy. Moreover, the GAO noted that this $108 billion figure is “more than double what was originally expected for loans made in fiscal years 2009 through 2016.”

The idea of adjusting a borrower’s payments with his income over time is not new. Milton Friedman suggested it in the 1950s, along with the idea of loan forgiveness on any remaining balance after several decades. William Bennett, Secretary of Education under President Reagan, argued in a 1987 New York Times op-ed that repayment schedules should be tailored to a student’s income. So what went wrong?

A Closer Look at Obama’s Loan Forgiveness Programs

Kevin James of the American Enterprise Institute argues that the U.S. has been “prodding borrowers to use income-contingent options with increasingly generous terms, all the while making the system significantly more complex and bureaucratic.” Income-contingent repayment (ICR) was first enacted by Congress in 1993 as an option for repayment in the Stafford Loan program. Payments were set at 20 percent of a borrower’s discretionary income (defined as adjusted gross income above 150 percent of the poverty level). Any remaining debt after 25 years would be forgiven.

Conservatives and progressives should find common cause in streamlining and revising the implementation of these programs to ensure both an adequate safety net for unsuccessful college students and the avoidance of needless loan forgiveness for high wage earners.

But from the beginning it was bureaucratic — one repayment option among others — but one that required annual documentation, possibly resulting in less-informed distressed borrowers missing out on the program’s benefits. In 2007 Congress enacted an income-based repayment (IBR) program, with more simplified and generous terms: Payments would be set at 15 percent of discretionary income, with the remaining balance forgiven after 25 years. At this time Congress also enacted the Public Service Loan Forgiveness (PSLF) program: If the borrower works for a government organization (local, tribal, state, or federal), a 501(c)3 tax-exempt organization, or if they provide certain kinds of qualifying public service (e.g., AmeriCorps or Peace Corps), their payments are also set at 15 percent of discretionary income, but they only have to make payments for 10 years. Any remaining balance is not only forgiven, the amount forgiven is tax-free. (For those in the private, for-profit sector, any student debt forgiven is taxed as ordinary income.)

In 2010, President Obama worked with Congress to make the programs even more generous: For those who qualify, monthly payments would only be 10 percent of a borrower’s discretionary income and loan forgiveness would occur after just 20 years (or 10 years for those in the public sector). This was the “Pay As You Earn” (PAYE) option. President Obama later made PAYE retroactively available to many more borrowers via executive actions. 

The More Help You Need, The Less You Receive

Who is being helped by these increasingly generous programs? A 2012 study from the New America Foundation analyzed hundreds of scenarios for different borrower profiles based on the 2010 legislation (which would go into effect in 2014). They found that most of the benefits would accrue to middle and high-wage earning borrowers who completed graduate or professional programs. Those with the least need of a subsidy — because they command high salaries — stood to receive the most help.

How could this be? Wouldn’t 10 percent of a large monthly salary still be a large payment? Yes, but PAYE allows borrowers whose salaries dramatically increase during the 20 year repayment window to (after becoming high earners) make payments that are less than 10 percent of their discretionary income. If these borrowers also have high debt loads from their graduate studies (and many do), they stand to receive generous loan forgiveness after 20 years. Note also that the generosity of PAYE’s terms renders graduate and professional students less sensitive to tuition costs (lowering the incentive for universities to pursue efficiency and affordability in those academic programs).   

Lower income earners (e.g., those only completing a bachelor’s degree) can also come out on the losing end: By making lower payments over 20 years with PAYE instead of 10 years (under the traditional repayment option), they could easily end up paying more than twice as much interest on their principle — and still wind up with at least a few thousand dollars in loan forgives after 20 years.

Meanwhile, student default rates are actually highest among students with relatively low debt ($15,000 or less). These are often college drop-outs who are worse off financially than if they never went to college. Because of the complexity associated with PAYE, and the dizzying array of repayment options, these individuals often get lost in the bureaucracy, defaulting in the process.

So while income-based repayment programs were intended to help struggling low wage earners, conservatives and progressives should find common cause in streamlining and revising the implementation of these programs to ensure both an adequate safety net for unsuccessful college students and the avoidance of needless loan forgiveness for high wage earners. New America Foundations recommendations include maintaining the lower payment calculation (10 percent of discretionary income) only for borrowers with incomes at or below 300 percent of federal poverty guidelines, requiring high-debt borrowers to make payments for 25 years (rather than 20 years) before qualifying for loan forgiveness, and removing the maximum payment cap that allows high-earning borrowers to make lower payments than they can afford (sticking the taxpayers with the bill for the rest).  

Dr. Alex Chediak (Ph.D., U.C. Berkeley) is a professor at California Baptist University and the author of Thriving at College (Tyndale House, 2011), a road map for how students can best navigate the challenges of their college years. His latest book is Beating the College Debt Trap. Learn more about him at www.alexchediak.com or follow him on Twitter (@chediak).