Wharton’s Sylvain Catherine and University of Chicago’s Constantine Yannelis talk with Wharton Business Daily on SiriusXM about their research on student loan forgiveness.

Forgiveness of outstanding student loans has been a recurring theme in policy debates on the roughly $1.6 trillion in such debt that the U.S. government and private lenders hold. Calls for such forgiveness have increased now as the Joe Biden administration prepares to assume office.

However, partial or full student loan forgiveness is “regressive,” according to a recent working paper, titled “The Distributional Effects of Student Loan Forgiveness,” by Wharton finance professor Sylvain Catherine and Constantine Yannelis, professor of finance at the University of Chicago’s Booth School of Business. The paper’s findings are being actively discussed on Twitter.

“Any policy that is a universal loan forgiveness policy or a capped forgiveness policy — say forgiving debt up to $50,000 — is going to give most of the dollars in forgiveness to upper-income individuals,” said Yannelis, who was interviewed along with Catherine on the Wharton Business Daily radio show on SiriusXM. (Listen to the podcast above.) “That problem is compounded if you look at the present value of the loan and account for the fact that people at the bottom of the distribution aren’t going to pay much of their loans anyway, or they’re going to pay them later than wealthier people.”

The paper studied the distributional effects of student loan forgiveness policies. It also presents a framework for computing the present value of student loans and uses it to present new results on the progressivity of loan forgiveness options.

Essentially, the research finds that forgiveness would benefit wealthier borrowers more than low- and middle-income borrowers. The authors stated that forgiveness outcomes would be uneven because “high earners took larger loans, but also because, for low earners, balances greatly overstate present values.”

“Basically, most of the benefits will end up accruing to upper-income individuals.” –Constantine Yannelis

Under a universal loan forgiveness policy, in present value terms, the average individual in the top earnings decile would receive $6,021 in forgiveness, compared to $1,085 for those in the bottom earnings decile, the paper stated. In fact, households in the top 30% of the earnings distribution receive almost half of all dollars forgiven. The patterns are similar under policies forgiving debt up to $10,000 or $50,000, with higher-income households seeing significantly more loan forgiveness, the researchers write.

The benefits of student loan forgiveness are unevenly distributed also by race and ethnicity, Catherine and Yannelis found. The average loan balances are the highest among blacks at $10,630, while those for whites are $6,157, and for Hispanics and others they are $3,996. After adjusting for the present value of those loans, universal loan forgiveness would lead to roughly equal average benefits for whites and blacks, but would yield significantly lower average benefits for Hispanics and other groups, the researchers noted.

Loan Balances Are Misleading

According to Catherine, student loan balances are not the right measure to look at. “Instead, we compute present values based on what people are actually repaying, which depends very much on their earnings,” he said.

People with student debt can enroll in the government’s income-driven repayment (IDR) program, in which they pay at most 15% of their “discretionary income,” which is the part of their earnings above 150% of the poverty line. After 20 or 25 years, their loan is forgiven. “As a result, under current law, the value of their loan can be much lower than what balances suggest,” Catherine pointed out.

“Overall, we find balance forgiveness to be a highly regressive policy; the top decile would receive as much as the bottom three deciles combined,” said Catherine. “Instead, we propose to enroll more people in IDR, which is an option people do not use enough.” A “more progressive” policy — where more of the benefits of loan forgiveness accrue to the middle class — would be to expand income-driven repayment (IDR) plans that link payments to income, the authors stated.

A Route to More Equitable Gains

The researchers studied the likely outcomes of three scenarios where all borrowers are enrolled in IDR plans. In the first, borrowers begin paying on income above 150% of the federal poverty line and pay 10% of this income. In the second scenario, remaining balances are forgiven after 10 years. In the third, the repayment threshold is raised to 300% of the federal poverty line, as opposed to 150% under current plans.

The study finds that putting all borrowers in IDR leads to significant forgiveness for middle-income borrowers, in contrast to universal or capped forgiveness policies that disproportionately benefit high income borrowers. Individuals in the third through seventh deciles receive 61% of the total forgiveness, and people in the bottom half of the earnings distribution receive more than half of the gains. In terms of the racial and ethnic effects, “forgiveness amounts are twice as high for blacks relative to whites and the general population,” the researchers found. Hispanics and others see lower loan forgiveness amounts relative to other groups.

“Expanding the generosity of income-driven repayment plans, or enrolling more people in these plans, leads to the benefits of forgiveness going to the lower middle and the middle class, rather than the top percentiles of income distribution,” said Yannelis.

“It’s not just about emotion. We need to look at the numbers to do some types of policy evaluation.” –Sylvain Catherine

Raising the income threshold above which borrowers repay loans from 150% of the poverty line to 300% dramatically expands the gains to low-income borrowers. “Having an income-driven repayment program that only is garnishing wages above three times the poverty line means that someone who earns $40,000 a year and is single is not going to pay anything — or very little — and then their balance is going to be forgiven after 20 years,” said Catherine. However, making that IDR policy more liberal makes little difference to someone who earns $100,000 or $150,000, he added.

In most cases, people who spent more time in school are in professions like medicine or law, are earning well and are able to pay down their student debt, Yannelis said. But that is not true for all people who went to graduate school, he added. “Some people struggle for whatever reason. And that’s one of the strengths of these income-driven repayment plans. If somebody has a high debt balance, they went to law or medical school and for whatever reason things didn’t work out, they don’t have to make those very high payments. So, there’s insurance built in for borrowers.”

The top takeaway from their research is that policymakers have to be “very careful” in shaping policies to deal with student loans, “because they might sound progressive on paper, but they are very regressive,” said Catherine. “We need to do some qualitative exercises. It’s not just about emotion. We need to look at the numbers to do some types of policy evaluation.”

An Unwieldy Problem

According to an internal analysis the U.S. Department of Education conducted, the government faces losses of $435 billion on the $1.35 trillion in student loans it holds, The Wall Street Journal reported in November. The analysis didn’t include roughly $150 billion in loans originated by private lenders and backed by the government, it noted.

However, the student loans market apparently lacks the rigor that one sees with typical bank lending. The government lends more than $100 billion each year to students to cover tuition at more than 6,000 colleges and universities, the Journal report stated. “It ignores factors such as credit scores and field of study, and it doesn’t analyze whether students will earn enough after graduating to cover their debt,” it added.

The incoming administration has proposed a series of changes that could affect more than 42 million student loan borrowers, The New York Times reported last month. Significant student debt forgiveness also exists under current programs for public sector employees, teachers and for borrowers in income-driven repayment plans for more than 20 years, Catherine and Yannelis note in their paper.

Meanwhile, the U.S. Department of Education last week extended the student loan forbearance period through January 31, 2021, in response to the pandemic. That extension applies also to loan repayments, and a freeze on interest accruals and collections activity, including wage garnishment against defaulters, according to a CNBC report. Student loan borrowers could get more relief that could extend to April 2021 from the proposed $908 billion bipartisan coronavirus stimulus bill, as Forbes reported.