Home > #OWS, finance > Student loans are a regressive tax

Student loans are a regressive tax

October 2, 2012

I don’t think this approach of looking at student loans is new, but it’s new to me. A friend of mine mentioned this to me over the weekend.

For simplicity, assume everyone goes to college. Next, assume they all go to similar colleges – similar in cost and in quality. We will revisit these assumptions later. Finally, assume that costs of college keep going up the way they’re going and that student loan interest rates stay high.

What this means when you put it all together is that sufficiently rich people, or more likely their parents, will pay a one-time very large fee to attend college, but then they’ll be done with it. The rest of the people will be stuck paying monthly fees that will never go away. Moreover, because the interest rates are pretty high, the total amount non-rich people pay over their lifetime is substantially more than what rich people pay.

This is essentially a regressive tax, whereby poor people pay more than rich people.

Other points:

  1. The government student loans don’t have interest rates that are extremely high, but there’s a limit of how much you can borrow with that program, which leads many people even now to borrow privately at much higher rates.
  2. In the case of government-backed student loans this “tax” is essentially going to the government. In the case of private student loans, the private creditors are receiving the tax.
  3. Since you can’t discharge student debt via bankruptcy, even private student debt, it really is a life-long tax. It’s even true that if you haven’t paid off your student debt by the time you retire, your social security payments get cut.
  4. What about our assumptions that all schools have the same quality? Not true. Rich people tend to go to better schools. This means the poor are paying a tax for an inferior service. Of course, it’s also true that truly elite schools like Harvard have excellent financial support for their poorer students. This means there’s a two-tier school system if you’re poor: you can go to a normal school and pay tax, or you can excel and get into an elite school and it will be free.
  5. What about our assumption that all schools have the same cost? Of course not true; we can look for better quality education for a reasonable price.
  6. What about our assumption that everyone goes to college? Not true, but it’s still true that going to college and finishing sets you up for far better wage earning than if you only have a high school diploma. And although going to college and not finishing may not, nobody think they’re the ones who won’t finish.

Conclusion: Either we have to keep costs down or we have to make college government-subsidized or we have to make student loan interest rates really low or we have to offset this regressive tax with a highly progressive income tax.

Categories: #OWS, finance
  1. Justin
    October 2, 2012 at 9:07 am

    I agree very much with the spirit of this post. But calling student loans a “regressive tax” because only the poor need the loans, while the rich pay in full is stretching it. Just about every personal loan product, from mortgages to car loans has the same feature. Would you argue we should subsidize car loans? I agree we should hold down college cost and subsidize loans for the poor, because there are huge social and personal benefits to that. I doubt, though, that the “regressive tax” rhetoric is going to help win that argument.

    • Dan L
      October 2, 2012 at 11:00 am

      I agree with the main point here that calling it a “regressive tax” is just rhetoric without any real substance. I prefer to save the word “tax” for things that are actually taxes or are essentially equivalent to them.

  2. Jonathan
    October 2, 2012 at 9:37 am

    I agree with much of this. But:
    “2) Since student debt is government-backed, this “tax” is essentially going to the government” Huh???

    Just because government is insuring it doesn’t mean the revenues are going to the government. You know better than that.

    • October 2, 2012 at 9:38 am

      Sorry, you’re right. The proceeds of the private loans are certainly going to the private creditors. I will correct this. Thanks!

      Cathy

  3. Eugene O'Neil
    October 2, 2012 at 11:37 am

    College probably does prepare people to succeed to some extent, but before we overstate the significance of statistics, how many people who are talented and ambitious enough to get an all-expense-paid scholarship to Harvard turn it down just because they’re curious to see if they can succeed with only talent and ambition? And how many high school dropouts had the untapped potential to be a more EXPENSIVE disappointment to their parents, if only they went through the half-hearted motions of being a student long enough to get a degree in art history?

  4. Gary
    October 2, 2012 at 12:47 pm

    While I agree with you, I’m not sure I’d call this a regressive tax as much as a mechanism by which inequality is perpetuated by the “investment” aspects of higher education. The notion would be that higher education improves an individual’s stock of “human capital” (however nebulously defined) – and this asset reaps dividends (in the form of higher pay, for one) throughout one’s life. Then the question is how to fund investments in that stock of human capital.

    When rich parents pay for their children’s education, they’ve received an interest-free investment in their human capital. And in most cases these family loans are forgiven (for example, I’ve never paid my parents back for my tuition, even as I’ve eliminated my real student loans). There’s no debt overhang for these folks; one might even say that they have a full equity stake in their human capital.

    People who take out loans to pay for their education, however, get a loan that carries interest and can NEVER be forgiven even in the case of bankruptcy, as you point out. So an individual in this situation has a very different, highly leveraged, “human capital structure” as opposed to the equity stake described above.

    On the asset side, I would also emphasize that rich, even middle-class folks come into the process with additional human capital (e.g., parental connections) as well as working capital that allows them to leverage their education and withstand shocks better than poorer folks.

    And as you point out, the education asset itself is not uniform in value. More shocking than the differences between, say, Princeton and Podunk State, are the differences between ANY of these institutions and the for-profit education industry.

    For the highly leveraged indebted college graduate, there’s a lot of risk in here. For the grad with an equity stake in his or her human capital (and perhaps a working capital) – there’s less risk. So even if their overall risk appetites are similar, the latter is going to have more capacity to absorb risk (and reap higher returns) – magnified by the likely higher return on their human capital asset in the first place.

    My conclusion is similar: level the playing field through a combination of subsidized education (via more fully funding public universities, or through low- or no-coast loans/grants for college education) and progressive taxation. Or a rigorous program of Trading Places-style human-capital redistribution. And for god’s sake stop subsidizing for-profit institutions this way.

  5. None
    October 2, 2012 at 1:04 pm

    It’s amazing to see a post like this from such a competent mathematician.

    If you are going to factor in as cost to the poor student including total debt repayment, then you ALSO have to factor in the cost to the rich student for loss of interest payments or investment returns on the money which would otherwise have been deposited.

    • Bobito
      October 4, 2012 at 4:54 am

      The two cases are not exactly parallel. In the case of the poor student the payment (the interest on the loan) goes to the government. In the case of the rich student, the cost (= negative payment) does not come from the government – rather from the private lenders who the student has not chosen to use.

      • Bobito
        October 4, 2012 at 4:56 am

        From reading other comments, it sound like that in fact the interest on student loans does not go to the government, in which case I retract my previous comment.

  6. P
    October 2, 2012 at 4:32 pm

    The rich person has the option to take on the student loan as well. Assuming they pay with no loan, it’s because they deem the loan to be more of a burden than the up front-cost. The poor person has no such option. The difference between these values is the regressive tax.

    The progressive part of university education is that a lot of schools do actually reduce tuition for needy students, acting as a counterbalance to the tax.

  7. None
    October 2, 2012 at 5:11 pm

    “The rich person has the option to take on the student loan as well. Assuming they pay with no loan, it’s because they deem the loan to be more of a burden than the up front-cost.”

    According to:

    http://www.direct.ed.gov/applying.html

    “The Direct Loan Program offers the following types of loans:
    Subsidized: for students with demonstrated financial need, as determined by federal regulations. No interest is charged while a student is in school at least half-time, during the grace period, and during deferment periods.
    Unsubsidized: not based on financial need; interest is charged during all periods, even during the time a student is in school and during grace and deferment periods.”

    So two different types of loan. Satisfied ?
    I suspect rich people don’t generally take out loans for things they can afford because of administrative hassle rather than any conceived monetary saving. Being conceited and very stupid if the rich thought about it they’d probably think they could make a better return on the money themselves.

    [sorry for all these posts. am now attempting to go cold turkey :-) ]

  8. Bindicap
    October 2, 2012 at 7:52 pm

    I agree with those who understand the sentiment but don’t think “regressive tax” is very meaningful or even just useful for pushing appropriate reform.

    I’d like to see bankruptcy rules changed to make student loans much easier to discharge or modify. The NYT article from a while back really pointed to how senseless the current harsh hopelessness test is. There would be costs to bear for this.

    I haven’t sorted out a clear view about what makes sense for changes to origination. More grants would be nice, or ways to discharge loans through public service. On the other hand, there is a strong case that bigger loans or more generous terms largely feed into higher education costs and the actual benefit that students realize is not so great. On top of difficult budget conditions, it’s a challenge.

  9. David N
    October 3, 2012 at 1:09 pm

    All consumption is “regressive.” A poor person pays a greater precentage of their income than a rich person for anything they buy. It’s beyond absurd to call this a tax. You can’t compare the total amount the poor student pays over the life of the loan unless you also include the lost interest to the rich student who pays up front. If either student finds less value in the diploma than the net present value of the affected future cash flows, then attending the college was an unwise investment, but perhaps still a desirable purchase. If I had my way, kids would learn about the time value of money in high school and use college costs as a learning example, and society would tell kids that the Honda education is fine, you don’t have to ruin your finances stretching for the Cadillac.

  10. October 3, 2012 at 7:19 pm

    This is an interesting point that I’ve been thinking about a lot recently, and I just wanted to add a few things to this discussion.

    First, I think student loans, especially the non-subsidized ones with high interest rates, probably mostly go to fairly well off families, who are sending their children to some of the better schools. (A bit more on this below)

    Second, less than 70% of kids who graduate high school enroll in college, and many kids don’t graduate high school. (Some data on enrollment rates are here: http://nces.ed.gov/programs/digest/d11/tables/dt11_209.asp). So costs of college are not that regressive in the sense that the perhaps 30-40% of people who are going to have the lowest educational attainment when they grow up don’t pay the costs.

    Third, only about 30% of people in the US end up getting college degrees (http://www.census.gov/hhes/socdemo/education/data/cps/2011/Table1-01.xls). So to the extent that these people are in college for longer, they have higher costs of loans. People who graduate from college make, on average, a lot more money than those who don’t. So subsidizing college costs subsidizes perhaps some of the richer 30%.

    Fourth, I don’t think “college” is nearly as elite an experience as those posting here think. Less than 20% of people enrolled in college were enrolled in a 4 year non-profit school. (http://nces.ed.gov/programs/digest/d11/tables/dt11_196.asp) The other half of students are roughly equally split between 4 year and 2 year public schools. Table 1 (on page 41) of this paper: http://econweb.umd.edu/~turner/LTurner_FedAid_Apr2012.pdf. Suggests that less than 40% of students attend a “selective” school, which in the paper is defined as accepting less than 75% of applicants.

    Fifth, a lot of the schools that a lot of people go to end up being just not that expensive, once you take into account federal grants and tax credits (but not looking at loans). The average net price that people who attend community colleges pay, before room and board, which you kind of have to pay at home or at school either way, was actually negative in 2011-2012 (http://trends.collegeboard.org/college_pricing/report_findings/indicator/Average_Net_Price) This is where 40% of college students are going. If these students are taking out loans, it is on average to pay for room and board. But even students from modest backgrounds are likely able to receive parental support in the form of “free” room and board by living at home. The same chart shows that the average tuition and fees, before grants, that students at 4 year schools face is around $8,000, but after grants this drops down to under $3,000. So another 40% of students only needs loans for $3,000/year above room and board.

    I realize that averages mask variation here. But people who go to more expensive schools (and hence get bigger loans and pay more) are PROBABLY going to better schools and so will be more able to afford them. And students who get lower grants than these averages (and so pay more) are likely the ones whose parents are better able to afford college,

  11. October 4, 2012 at 3:04 am

    My say is that, these loans/grants should be priced lower than the current price. Since Its main aim is to help students pursue college, and to have a brighter career ahead of them and not just to make money out of them.

  12. A. Wells
    October 8, 2012 at 12:19 pm

    … or we have to offset this regressive tax with a highly progressive income tax.
    How does that work? Almost half of households pay no federal income tax. How does highly progressive income tax actually help to pay the loan for someone who doesn’t make enough money to pay for the loan in the first place?

  1. October 2, 2012 at 1:44 pm
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