Redesigning Education Finance: How Student Loans Outgrew the “Debt” Paradigm

This Article argues that the student loan crisis is due not to the scale of student loan debt, but to the federal education finance system’s failure to utilize its existing mechanisms for progressive, income-based payments and debt cancellation. These mechanisms can make investment in higher education affordable to both individuals and the government, but they have not been fully utilized because of the mismatch between the current system’s economic reality and its legal, financial, and institutional apparatus.The current economic structure of federal student loans does not resemble a true credit product, but a government grant program coupled with a progressive, income-based tax on recipients. For example, federal direct loans do not require the full repayment of all principal and accrued interest. Instead, borrowers have the contractual right to satisfy their obligations by paying only a percentage of their income for a fixed period of time. Debt forgiveness is contractually baked into the federal student loan product.The education finance system, however, still relies on a legal, financial, and institutional apparatus based on “debt,” developed under the pre-2010 system, which was based on private loans backed by federal government guarantees, rather than the post-2010 system of direct federal lending with income-driven repayment. The frictions between the legacy legal, financial, and institutional “debt” apparatus and the economic reality of subsidized finance; progressive, income-driven repayment; and debt forgiveness are the source of nearly all of the problems in education finance, including high levels of default, abusive servicing, and even the very idea of a student debt crisis.It’s time to call federal student loans what they really are—a tuition grant plus an income surtax on students. To this end, this Article proposes a set of targeted reforms: automatic income-based payments using a graduated rate schedule; collection through tax withholding and return filing; and replacement of interest accrual with an inflation adjustment. Moving toward a grant-and-tax framework would facilitate substantial reforms to the financing of higher education and help ensure that instead of being a debt trap, federal financing facilitates affordable higher education