IBR: the trench

I suggested in an earlier post that the Income Based Repayment program is digging a trench under our economic future. Here's why:

Degree holders make up our middle and upper-middle classes. They are the consumers who renovate houses, buy hybrid cars, wait in line for the latest iPad, and pay for their kids' orthodontic work. That demand powers the U.S. economy. When the middle and upper-middle classes have less to spend, the economy suffers.

Our economy is already suffering from a serious shortfall in jobs: Grads in every field are going without the jobs they trained for. That's catastrophic for the individuals, but it's also a serious threat to the economy. People without jobs can't buy the goods and services that create jobs; without new jobs, they won't get hired. It's a vicious economic cycle, one that both economists and policymakers worry about.

Now, though, we have another problem: The escalating cost of higher education, combined with IBR, is intensifying that cycle. Even the grads who find jobs have significantly less of their income to spend. IBR currently takes 15% of a debtor's discretionary income; if current reforms take effect, the percentage will fall to 10%. Grads paying IBR may feel lucky: They, at least, have jobs--and they're able to support a modest lifestyle. They may pack their own lunches rather than eating out; use older model laptops and cell phones; put off thoughts of buying a house; and wear their old suits for a few more years. It's not what they hoped for in college or graduate school, but they're holding on. 

Meanwhile, what are all of those empty restaurant seats and houses, as well as those unsold laptops and dress suits, doing to the economy? A 10% cut to middle-class discretionary spending has serious economic impact. To see how significant that 10% could be, consider the huge furor over extending the Bush tax cuts for middle-class taxpayers. If those cuts expire at the end of this year, tax rates will rise 3% in the middle brackets. People who currently pay 25% will pay 28%; those who are now paying 28% will pay 31%, and those who are paying 33% will pay 36%.

Almost everyone agrees that those increases would cause significant economic damage. When taxpayers send 3% more of their marginal income to the government, they reduce other spending. The resulting decline in consumption would leave lots of goods and services on the shelf. Businesses would close or contract; jobs would disappear; families would spend even less...the whole ugly cycle would accelerate. 

For just this reason, both Republicans and Democrats oppose increasing tax rates for the middle brackets; the only dispute centers on how to treat the top income bracket. But while we're all swooning over 3% decreases in discretionary middle-class spending, we're blithely ignoring a system that will take up to 10% out of middle-class incomes for years to come.

Some money paid through IBR is tax deductible, but the amounts are limited. Most grads will feel some IBR bite on top of their tax bite. The economy will feel that same bite, in the shape of reduced discretionary spending by graduates. The money you send to the Dept of Ed won't buy new furniture or running shoes.

The IBR bite wouldn't matter if graduates were earning significantly more due to their degrees. If college graduates today were earning 10% more than they did ten or fifteen years ago, then they could afford to pay off their loans while still spending as much in the marketplace as earlier grads did. Unfortunately, though, degree holders are not earning significantly more today than they did ten or fifteen years ago. The National Center for Education Statistics, a division of the federal Dept of Education, reports that young adults with a college degree earned a median income of $45,000 in 2010. In 1995, they earned about the same amount ($44,300) in inflation-adjusted, constant 2010 dollars. The numbers for graduates with an MA or higher are even worse: Those incomes declined from $56,700 in 1995 (using constant 2010 dollars) to $54,700 in 2010. 

Nor would the IBR bite matter much if educational loans were limited to a small percentage of the workforce; our economy could continue to prosper based on spending by other middle-class consumers. But a recent study by the Pew Research Center shows that 19% of all US households held student loan debt in 2010. A whopping 40% of under-35 househelds held that debt. And average debt amounts are increasing each year.

All of this paints a grim picture: Degree-holders are earning no more than they did in the past, but they are significantly more likely to hold student loan debt--and to owe more of that debt. Under IBR, graduates will pay off that debt as a percentage of discretionary income every year for the forseeable future. The impact will be close to a 10% increase in the marginal tax rate for each of those debtors. That's got to hurt the economy, impeding creation of the very jobs that these graduates need to pay off their debt. 

The primary flaw doesn't lie in IBR itself; the problem stems from the ready availability of guaranteed loans and from the extravagant rises in the cost of higher education. But IBR is lulling more students into assuming this debt--and allowing educators to tout loans as an affordable way to earn costly degrees.

Affordable today, perhaps, but we're siphoning that money directly from tomorrow's economy. IBR lets us see just how damaging this debt will be to the future: It will affect consumer spending as much as a major tax increase. Let's hold the next Presidential debate on that issue.