Last week, the US House of Representatives passed a $1.9 trillion coronavirus relief bill. President Joe Biden is expected to sign the bill on Friday. The bill’s significant proposals include jobless aid support, direct payments, child tax credit, rental and utility assistance, and more.
The bill includes a provision that exempts student loan forgiveness from federal taxation. This bill will primarily affect students borrowing under income-driven repayment plans.
How Do Student Loan Payments Work?
Income-Based Repayment Plans
Under income-driven repayment plans, the borrower’s monthly payments are set at a percentage of their discretionary income. This is meant to make the loan affordable by allowing the borrower to pay what their income will enable them to.
After a loan repayment period of generally 20 or 25 years, all remaining debt is canceled. Common examples of such plans include Income-Based Repayment (IBR), Income-Contingent Repayment (ICR), Pay As You Earn (PAYE), and Revised Pay As You Earn (REPAYE).
Cancelled Debt is Treated as Taxable Income
The “catch” of these plans is that when student loans are canceled at the end of the repayment period, the borrower may have to pay income taxes on the balance of their canceled debt. This is because the cancelled debt is essentially treated as taxable income.
Borrowers still pay less than they would if they followed through with full repayment of the initial loan. However, canceled debt can end in a “tax bomb” at the end of the repayment period. This may be incredibly costly for those whose monthly payments under the plan did not cover their accrued interest. They may face a tax liability greater than their principal loan.
Currently, there are 8 million people enrolled in income-based repayment plans, and we are just about to see borrowers end their repayment period and face the resulting tax.
Some students can get their loans forgiven through avenues that are not taxed, such as public service loan forgiveness, disability loan forgiveness, or profession-based loan forgiveness.
How Does the Stimulus Bill Impact Student Loans?
Biden’s bill contains a provision that would exempt all debt cancellation from taxes, including direct federal loans, federally guaranteed FFEL loans, and private student loans. This means that there will be no federal income tax at the end of the loan repayment period.
The coverage of this relief provision lasts until January 1, 2026. This means that a relatively low number of income-driven repayment borrowers will get this tax relief, as many income-driven repayment plans are less than 25 years old. Therefore, it is expected that there will be a push for the provision to be permanent.
Will Biden Cancel Student Loans?
This bill has inspired many to hope that Biden eventually plans to cancel student loans.
Supporters of the provision, such as Senator Elisabeth Warren, have suggested that its presence in the stimulus bill removes obstacles to student debt cancellation.
Warren tweeted, “I’m happy that my bill with @SenatorMenendez to make any student loan forgiveness tax-free was included in the COVID relief bill. This clears the way for President Biden to #CancelStudentDebt without burdening student borrowers with thousands of dollars in unexpected taxes.”The logic behind this argument is that due to the bill, should student loans be forgiven, borrowers needn’t fear the resulting taxation.
Senator Martinez, who also supported the provision, said in a press relief that “I’m hopeful this will pave the way for President Biden to provide real debt relief so many student borrowers need and give a boost to our economy that benefits everyone.”
Biden’s Stance on Cancelling Student Loans
However, Biden has made it clear that while he supports canceling $10,000 in federal student debt per borrower, the president does not believe it is within his authority to cancel student debt of $50,000 or more by executive order. He would rather wait for congress to enact relief.
In the interim, Biden has asked the justice department to review whether it is legal to executively cancel student debt. Biden has also extended the pause on many federal student loan payments, interest, and collections until September 30, 2021.
Should Student Loans Be Forgiven?
Critics of unilateral debt forgiveness argue that cancellation of loans would be unfair for those who either already paid off their student loans or didn’t attend college in order to avoid them. Or, it would send out the wrong message, suggesting that it is acceptable for people not to pay their debts.
Student Loan Cancellation Could Only Benefit the Wealthy
Mass loan forgiveness could be regressive and mostly benefit the wealthy, as wealthier students tend to attend more expensive universities and borrow more than lower-income students. It could also be argued that such relief is poorly targeted, as only Americans with student loans would receive this form of assistance.
Additionally, one view posits that in light of the current suspension of student loan payments, debt forgiveness would create no instant economic stimulus.
Student Loan Cancellation Could Boost the Economy
On the flip side, canceling student debt would mean borrowers could use the money they would spend on that loan for savings and other spending, or even starting a small business, which would create jobs and give the economy a boost. For lower-income borrowers, a $10,000 debt forgiveness would have an enormous impact.
Student Loan Cancellation is Likely to Benefit People of Color
It is the lowest-income households, and especially people of color, who have the most to gain from debt forgiveness. Black students are the most burdened by student loans, with 86.6% of Black students taking out federal student loans, compared to 59.9% of white students. Even more concerning: Black students are five times more likely to default on these loans than white students. Debt forgiveness would free up a significant portion of income for these borrowers.
It remains to be seen whether Biden or Congress will broadly cancel student loans. In the meantime, however, the stimulus bill allows borrowers to take a momentary sigh of relief.