The highly-anticipated tax reform legislation introduced by GOP leaders this week included bad news for student loan borrowers.
If passed, the bill would eliminate a deduction on interest paid on student loans, a move that has borrowers up in arms. And while the student loan interest deduction could certainly stand to be improved, eliminating it entirely is the wrong approach.
Over the years, more students have been borrowing increasing sums of money to pay for college, making student debt a more salient problem than ever before. What’s more, those with the most debt tend to be highly educated, a group with high levels of political engagement. Because debt is widespread and borrowers are politically engaged, it’s no surprise that student debt has become a huge political issue.
Putting things in context, the GOP tax plan cuts a wide array of other higher education benefits as well. The plan includes major reductions in the tax credits for tuition that help students and their families offset college costs, moves to treat employer-provided tuition payments as taxable income, and proposes taxing endowment income at prestigious private universities.
The student loan interest deduction allows borrowers to reduce taxable income by up to $2,500 to offset interest payments on student loans. As an “above-the-line” deduction, taxpayers can claim the benefit even if they do not itemize deductions, making it available to anyone who pays interest on student loans.
Since only payments that go toward interest can be deducted, the student loan interest deduction is most valuable for borrowers with high loan balances because they make higher interest payments. But because people take on student loans to pay for higher education, more debt often indicates higher educational attainment. More education, in turn, leads to higher earnings.
In other words, someone who took on large debts to pay for an advanced degree is likely making much better money than a person who never enrolled in college at all, and the student loan interest deduction benefits only the former.
By contrast, people who took out loans for just a few semesters but left school without finishing their degree might have smaller loan balances, but on average also have much lower earnings. In these situations, borrowers often turn to a variety of federal protections in order to lower their payments, or simply stop paying altogether. Because low-balance borrowers pay less interest each month and in some cases have lower incomes (and a lower effective tax rate), the deduction is less valuable to them.
These differences are not just theoretical: Despite income limits on who can claim the student loan interest deduction, actual tax claims support the idea that high-income borrowers benefit more.
The Joint Committee on Taxation estimates that 3.5 million borrowers with incomes above $100,000 per year claim the deduction, approximately equal to the 3.4 million borrowers with incomes below $50,000. But the amount claimed is where these groups diverge: High-income borrowers are estimated to save $860 million on their taxes as a result of the deduction, while the low-income group saves only $538 million.
It’s clear the deduction could do much more for low-income families. But that’s not what the GOP has proposed.
Rather than improve the existing program, the GOP plan scraps it entirely, along with several other provisions that make higher education more affordable for students and their families. Worse, instead of using the savings to support students in other ways, the GOP bill would enable corporate tax cuts and a phased-in repeal of the estate tax, among other changes.
Some of these are indeed aimed at middle-class taxpayers, including an increase in the standard deduction, but the combined changes make it hard for the average Americans to fully understand how their net tax liability will change if the GOP bill becomes law.
That said, while the tax code’s treatment of higher education has substantial room for improvement, slashing the higher education benefits risks further limiting economic mobility in the US, because it will make higher education less affordable for many families.