The current student loan repayment system has lost its purpose, one expert said, and cancelling it doesn’t have to be that complicated.
“The student loan program itself has, over the years, become a little bit of a Frankenstein's monster,” John R. Brooks, professor of law at Georgetown University Law Center, told Yahoo Finance Live (video above). “It's made it really difficult to really serve its original purpose of trying to provide affordable access to higher education.”
Two main issues need to be addressed if we were to fix the underlying problem, according to Brooks: The cost of higher education and states’ declining support of higher educational institutions. While some schools, like Purdue University, have managed to keep tuition flat for a decade, others have had to make major cuts to faculty and even tenure to stay afloat.
Meanwhile, preliminary data from the National Student Clearinghouse Research Center of 2,300 high schools revealed a 21.7% drop in students attending college immediately after the fall this year, as compared to the last.
These multiple financial pressures — declining enrollment, declining state funding, rising expenses and an uncertain future — need to be addressed now, Brooks stressed, because if not, “we're just going to have this same debate [over cancellation] over again in a few years.”
How cancellation can be tax-free
Some experts argue that cancellation of student debt doesn’t make sense since borrowers will be hit with a massive tax bill.
As “it currently stands, debt forgiven through a broad federal forgiveness program would be taxable to the borrower,” Goldman Sachs economists stated in a recent note.
But Brooks, who is also an expert on the matter, said that interpretation was wrong.
“Student loans are very different, partly because this is really a massive government program,” he said. “Most of the lending is from the federal government.”
That means the government has the power to treat cancelled loans the same way it treats scholarships and grants, which are not taxable. Otherwise, a tax bill would just end up hurting the struggling borrowers a cancellation was meant to help.
“So you would essentially cancel only some debt and then accelerate the rest,” Brooks said.
“There is no good logic for such a policy — it undermines the whole purpose of student loan cancellation and causes hardship at exactly the time that the law is trying to provide relief,” Brooks stated in a recent report published on the same topic.
For years, canceled student debt was for was treated like a grants and scholarships, Brooks pointed out. Additionally, just how tax housing subsidies or disaster-related payments are not taxed, the government can also consider student debt in this bucket.
“So if any cancellation was made in the context of the economic devastation around COVID, for example, I think it would pretty clearly qualify as a sort of disaster relief payment that wouldn't be taxable,” said Brooks.
The Goldman note also recognized Treasury’s authority to exempt student debt without Congressional action, but concluded “whether this could or would happen is hard to predict.”
Aarthi Swaminathan is a senior reporter at Yahoo Finance. Write to her at firstname.lastname@example.org, or follow her on Twitter @aarthiswami