Income-Based Repayment Will Bankrupt America

Student loan debt has become a common topic of conversation recently, mainly due to the presidential election. One party says “free college for all” while the other says “better repayment plans for graduates.” Frankly, neither of those will affect the millions of us who have already taken out mortgage-sized loans to fund our studies.

Student loans in America total nearly $1.3 trillion, spread across 43 million Americans. (source https://studentaid.ed.gov/sa/about/data-center/student/portfolio) Nearly 40% of that financing graduate or professional degrees. Many of us high earners have some sort of advanced degree, so student loans are clearly a burden we carry on the path to higher incomes.

Of the $1.3 trillion loaned out, approximately $270 billion is currently in some form of income-driven repayment plan. These are confusingly known as Income-Based repayment (IRB), Income-Contingent repayment (someone in the government was using their thesaurus to find a synonym), Pay-as-you-earn, and Revised Pay-as-you-earn.

All of these offer lower payments to borrowers who are not making a lot right out of college, and all have time frames (usually 20-25 years) for repayment. Any remaining balance at the end of the repayment period will be forgiven.

This forgiveness is what will bankrupt America.

Say, for example, Hank graduates with $85,000 in graduate student loan debt. He finds a great job making $70,000, and he is married with 2 kids. His adjusted gross income (without any fancy tax planning) is closer to $50k, so his loans qualify for IBR. Using the repayment estimator found on studentloans.gov, Hank’s monthly payment starts at $113 and increases over 20 years to $582 per month. After 20 years of faithful payments, the remaining balance is ‘forgiven.’ The remaining balance on his $85k loan is $126,000. It grew quite a bit since his monthly payments weren’t even enough to cover the accruing interest.

I said ‘forgiven’ because when a debt is wiped clean, the government sends you a nice 1099 for the amount forgiven, and it is treated as normal income. So on your tax return in 20 years, you get to claim an additional $126,000 of income, which likely puts you in a higher tax bracket, and you now owe taxes on the whole of it. That could be upwards of 30-40% taxes on the $126,000! (That’s assuming the tax rates don’t keep creeping up higher) Conservatively, Hank will owe $40,000 in taxes in one year if he follows this plan.  That may lead him to bankruptcy, or at very least lead him to dip heavily into his savings and investments.

The numbers I used for Hank are obviously made up, but with so many people acquiring so much student loan debt, in 20 years time, tens of millions of people are going to owe tens of thousands of dollars each in taxes that they can’t pay, which may lead many to evade their taxes or file for Chapter 7. Trillions of dollars in loans will be forgiven, leading to hundreds of billions of dollars in taxes being levied.

America may go bankrupt.

 

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