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The Short Answer

5 Questions About Student Loan Forgiveness

We examine the impact of President Biden’s plan on both individual households and the larger economy.

Editor's Note
A version of this article was published on Feb. 18, 2021.

Could your student loans really just … go away? For many, that’s what last week’s news could mean.

On Aug. 24, President Joe Biden announced new strides to forgive student loan debt: Individuals who earn less than $125,000 annually will have $10,000 of student debt forgiven; individuals who received Pell Grants will have an additional $10,000 forgiven (for a total of $20,000). Biden also announced that the pause on student loan repayments will be extended through the end of the year.

Supporters of the plan say it will deliver real relief to debt-burdened households, lift the economy, and help narrow the racial wealth gap. Critics, however, say it’s unfair to those who have avoided debt or sacrificed to repay their loans.

So, how much good can we really expect to come from this plan? And who will benefit most?

We took a closer look at the numbers to determine the impact of canceling student loans at different levels on both individual households and the larger economy.

1) Will Loan Cancellation Help Narrow the Racial Wealth Gap?

According to data from the Survey of Consumer Finances, nearly one fourth of households have student loan debt.

When you take a look at the demographic details of who holds that debt, some clear patterns emerge. One is that Black/African American households are more likely to have student loan debt and hold much more than borrowers of other races.

Bar chart showing the median student loan debt of Black, Hispanic, White, and other households.As Black households hold more student debt than white households, they could see an outsize impact from student loan forgiveness.

The graph below shows how many households in different racial groups have student debt (in any amount) and how the numbers would change with loan forgiveness of $10,000 for households below the income thresholds announced by President Biden.

As we do not have a reliable indicator for whether anyone in the households in the dataset has previously received a Pell Grant, we don’t extend the forgiveness to $20,000 for any households.

Bar chart showing the percentage of Black, Hispanic, White, and other households holding student debt and how forgiveness will benefit them.A greater percentage of Black households have student loan debt than white households and could benefit from student loan forgiveness.

It’s clear that fewer people will owe money after loan forgiveness takes effect, but will the policy really help level economic inequality among races?

Possibly. According to an analysis by the Roosevelt Institute, the total percentage of Black households that would benefit would be greater than white households. Not only that, the researchers found that the relative gains for those households’ net worth are far larger.

But will the policy really deliver relief to the borrowers that need it most? Sort of. We looked at the breakdown of households with student loan debt by income quartile now, as well as these breakdowns after $10,000 of loan forgiveness.

Looking at the changes in the lowest and highest income quartiles, the $10,000 forgiveness removes student debt for 32% of households in the lowest quartile and 18% of households in the highest quartile.

Table showing percentage of households that will have debt partially and fully forgiven, by quartile.The $10,000 forgiveness removes student debt for 32% of households in the lowest quartile and 18% of households in the highest quartile.

In actuality, a large percentage of the money will go to households with relatively higher incomes, because a higher percentage of these households have student loan debt to begin with. But the forgiveness programs will also direct a significant amount of money to more lower-income families to help them overcome their debt burdens.

2) Will Loan Cancellation Help Boost Retirement Savings?

This may seem obvious to say, but canceling debt frees up money in people’s budgets that they can spend in other ways. One of the things people can do with this money is invest it for retirement.

An analysis by Brandeis University also mentions saving and investing as a benefit of student loan cancellation: “The greater ability to save and build assets entailed by a lower debt load would generate additional wealth and would be significant in the lives of debtors.”

And according to Survey of Consumer Finances data, only half of all U.S. households have any money saved for retirement at all.

An obvious counterpoint is that we don’t actually know what people will do with the extra money in their budgets from the canceled loans. Maybe they will save it, maybe they won’t.

The other argument is that the extra money is already there: The suspension on loan payments and interest on all federal student loans has been in place since March 2020.

3) Will Loan Cancellation Benefit the Economy?

It may be optimistic to assume that canceling student loan debt will be the solution to closing the retirement savings gap in this country. Surely, not everyone will prudently invest this extra cash flow in a retirement savings account. They’ll just spend more.

But guess what? Consumer spending is 70% of our economy. So, money that is spent is actually far more “stimulating” to the economy than money saved.

Still, Morningstar’s head of U.S. economics Preston Caldwell notes that it won’t mean the average household has an extra $10,000 to spend. Rather, it relieves borrowers of their monthly interest and principal payments, which normally total $200 to $300 per month. “The macroeconomic impact won’t be large,” Caldwell says.

Caldwell explains that even if individuals increased their consumer spending by the forgiven amount over the next 10 years, the impact would total approximately 0.2% of consumer spending per year. And he adds that the actual impact would probably be smaller for various reasons, such as people choosing to save some of it.

And, as mentioned earlier, thanks to the extension on student loan payment relief, that money is already in people’s budgets.

4) Will You Have to Pay Taxes on the Debt Canceled?

No—at least not federal taxes.

According to Biden’s statement, “Thanks to the American Rescue Plan, this debt relief will not be treated as taxable income for the federal income tax purposes.”

However, depending on your state of residency, you may still need to pay state taxes. CNBC reported that some states “automatically conform to federal rules, but others may count the forgiven balance as income, meaning it’s still possible you’ll have a bill.”

5) What Other Policies Would Help Low-Income Students?

Not everyone agrees that eliminating student debt up to a certain cap—$10,000 or $20,000—provides meaningful relief to those who need it most.

A study by a Wharton finance professor and a professor from the University of Chicago’s Booth School of Business suggests that directly canceling student loans would actually increase economic inequality because most of the benefits will accrue to upper-income borrowers.

The authors’ argument is that for low-income earners, balance forgiveness (and particularly partial forgiveness up to a cap) erases debt that was already scheduled for cancellation under existing income-driven repayment rules. For high-income earners, however, it’s a real gift.

An alternative to student loan forgiveness that would benefit more lower- and middle-class borrowers would be an extension of the government’s income-driven repayment program, they posit.

Another criticism of student loan cancellation is that it picks winners and losers: In other words, it does nothing to eliminate the debt burdens of past and future borrowers. Researchers at the University of California argue that increasing the amount of the Pell Grant, from $6,495 to $13,000, would be a more equitable way the government could help low-income students afford college with no obligation to repay debt.

In the end, the issue of student loan cancellation comes down to values, says Morningstar’s head of retirement studies and public policy Aron Szapiro: “Some people feel that it is fundamentally unfair to pay off debt for some while doing little for those that avoided it or did not have the benefit of a college education. Others see a moral issue with letting millions of mostly young people struggle to pay for an education that is a prerequisite for many careers and opportunities.”