If you have ever made payments on student loans, how would you feel if the government forgave the debt of others who had not paid? Effectively, you would have paid for student debt twice–first for your own, then second, as a taxpayer, for those who had their loans erased.

Last week, a group of economists released a 66-page study which argues the government should forgive and eliminate the current $1.4 trillion of outstanding student debt.

The report, from the Levy Economics Institute of Bard College, titled “The Macroeconomic Effects of Student Debt Cancellation” provides forecasting models to show how a “one-time policy” of debt forgiveness “could be undertaken without doing economic harm—in fact, to moderate macroeconomic benefit.”

At the same time, the report reflects tortuous, Keynesian thinking which grants little attention to matters of fairness and responsibility. It also contradicts common sense.

Although the study’s authors acknowledge their proposal is “radical,” their analysis was picked up by major media outlets and presented favorably by CBS, CNN, Fast Company and New York magazine.

Current outstanding student debt amounts to roughly $1.4 trillion–about $1 trillion in federal loans, with the remainder in the form of private loans. The study’s authors review the unfortunate, current trends of rising tuition costs and the corresponding increase in students’ dependence on loans to finance their education. Moreover, the authors describe the lingering “social costs” of this exposure: debt-laden graduates are less likely to purchase houses and start businesses, and they will generally spend and consume less. All of this creates a negative macroeconomic effect.

The Levy Economics Institute released its study last week

The solution? If the government were to make all of that debt burden go away, the authors say, a remarkable stimulus effect would arise:

“By reversing the drag imposed by $1.35 trillion in outstanding student loans, we expect a net stimulus to the economy through housing markets, small business formation, growth in consumer spending, and the feedback effects these changes create. These directly measurable effects of student debt cancellation would be complemented by unmeasured social benefits like greater social mobility and quality of life. Based on this research, student debt cancellation presents a significant economic opportunity not only for the households burdened by debt but for the entire US economy.”

The report’s various forecasts demonstrate how this policy would boost GDP, employment, and consumption, among other good things. And just like that, the huge financial burden of $1.4 trillion in liabilities becomes an “economic opportunity.”

The authors dedicate many pages of their study to consider the “mechanics” of debt cancellation–namely the various ways in which the government might wave its magic wand to make this burden disappear. For example, the government might erase outstanding loans all at once, or pace out the relief and cancel each as it comes due.

The study also considers whether the financial black holes within the Federal Reserve might be used to vaporize the debt (they cannot–the authors note there is “no free lunch.”) Plus, there’s the matter of outstanding private loans. The authors conclude it would be better for the government to purchase those loans and then cancel them, rather than simply cancel the loans by decree and leave the private lenders holding the bag. Presumably that would be bad because the private sector is funded by real people (unlike the government?)

Readers of the report might find it strange that the study provides sixteen pages of ideas on how the government could execute these mechanics. It soon becomes clear, however, that the financial devil lives in the details of the balance-sheet contortions which are needed to present this policy as a financial boon.

A table from the study, addressing mechanics of debt forgiveness

For example, imagine the government forgives $1 trilllion of loans owed to it. How much does this cost the government? You might say, “A trillion dollars,” or if you’re really paying attention, you might say, “A trillion dollars plus interest.” But those answers would indicate you do not think like a think tank economist.

In their preferred view, because the government already budgeted for the loans when they were dispersed, if the loans were cancelled, the government would really only lose the interest proceeds on the loans. Thus the authors downplay the reality of receivables–actual money which is due to the US Treasury–and try to frame the question as one of sunk costs.

Appendix B in the report attempts to justify this reasoning:

“[The Department of Education’s] loans were previously funded via issuance of government securities; as a result, only the interest due on these securities is financed by new increases in government securities outstanding. There is no increase in government liabilities from cancellation of the principal on the ED’s loans. Rather, the principal amount of the loans, funded originally by previously issued securities, is rolled over.”

Based on this helpful accounting–which would make an Enron executive blush–the study concludes that “the cancellation’s impact on the federal government’s budget is, on average, modest, with a deficit impact of 0.65 to 0.75 percent of GDP.” In other words, because of the “balance sheet effects” of the financial engineering of the program, combined with all the secondary stimulus effects to the economy, the actual net costs can be scored at just $700 billion or so over ten years.

Imagine you run an ice cream stand, and one of your customers, Johnny, has run up a $10 tab over time. He has promised he will pay you back $11 by the end of the month, to cover his debt plus interest. Now imagine you tell Johnny he doesn’t need to pay you anything. How much does this cost you? Presumably the Levy economists would say $1, because you’ve already spent the other ten.

But your net costs are really even less than that, because you’ve stimulated Johnny. He now has more money to buy a home, start a business, and make real contributions to society, from which you will benefit secondarily. Plus, he now has more money to spend on ice cream at your store! Why didn’t you think of this sooner?

This silly example captures the silly, circular logic of Keynesian economic thinking–the notion that somehow society can ultimately profit by giving away money to consumers, who can then spend and consume more. We should note the ice cream analogy isn’t quite accurate, though, because the store owner would be forgiving debt on his own accord, rather than transferring the outstanding liability to taxpayers.

We do not have economics PhD’s, but we did generate our own sophisticated forecasting model on this topic, which is summarized in the figure below.

An alternative model of debt forgiveness

However, let’s assume the Levy economists are correct with their models and with the notion that erasing debt has a postive macroeconomic effect. By their reasoning, this group should also get started planning “mechanics” for additional types of debt forgiveness:

  • Total outstanding auto loans: $1.2 trillion
  • Total outstanding home mortgages: $10 trillion

With more car ownership, consumers are able to acquire and drive to better jobs, and their greater mobility will promote increased spending. With more debt-free home ownership, consumers will have more disposable income, plus they’ll be more likely to start families and grow the tax base. Et cetera.

But getting back to student loan debt: What about concerns of moral hazard–the disturbing precedent this relief would set for debt markets in the future, combined with the sheer unfairness to those who have already paid back responsibly? The authors are less concerned with this issue than with another inequity, specifically that rich student loan debtors would benefit disproportionately from loan forgiveness.

As the authors explain, “Those with the largest amount of debt outstanding tend to have the highest incomes, and those who spend the most on college come from the highest earning families.” While the authors grant there is some truth in this, they maintain that universal debt forgiveness is still justified because lower-income borrowers suffer disproportionately.

The authors do address the moral hazard question on page 49 of the report, just before the conclusion:

“In combination with debt cancellation, publicly funded free or debt-free college would provide the institutional reform necessary to avert the problem of moral hazard.”

So, as we dismiss all student debt, we can avoid any related problems with unfairness or inconsistency by making all future college free, too. Don’t worry–it pays for itself!