Is a Student Loan Bill Ready to Graduate?

In recent weeks, a number of competing proposals from the parties in each chamber of Congress to reform the interest rates charged on student loans have come to the forefront. CBO has scored four of them, including one from President Obama, so let's take a look at each one. You can also see some of the other proposals in a New America Foundation blog post here.

First, a little background. There are four main different types of student loans that these proposals deal with. Subsidized Stafford loans are the loans that currently are set at 3.4 percent and are set to go back to 6.8 percent on July 1. Unsubsidized Stafford loans are currently 6.8 percent and are not scheduled to change. GradPLUS and parent loans are set at a rate of 7.9 percent.

The proposals generally deal with Stafford loans but may make changes to the others. Many of them encouragingly deal with the interest rate permanently by pegging the rate to the ten-year Treasury note rate, which currently sits at two percent, an approach that would generally keep rates lower in the short term and higher in the long term. Here's what each plan does:

  • President's Budget: The President's budget sets the subsidized loan rate at the ten-year Treasury note rate plus 0.93 percent, thus likely making the rate lower than 3.4 percent upfront. The unsubsidized loan rate would be two percentage points higher than that. There is no cap on how high either interest rate could go. CBO scored this provision as saving $6.7 billion over ten years, with $30 billion of costs through 2018 and $36.5 billion of savings in the next five years. Also see our discussion of this provision here.
  • House Republicans: The House Republicans' plan, which just passed the House on a party line vote, would adjust all four types of loans to be linked to the ten-year Treasury rate. They would equal the ten-year Treasury rate plus 2.5 percentage points with a cap of 8.5 percent for subsidized and unsubsidized loans and a 10.5 percent cap for GradPLUS and parent loans. This would likely mean that the subsidized loan rate for the upcoming year would be somewhere between 3.4 percent and 6.8 percent. This is the only proposal that would have variable-rate loans as opposed to fixed-rate loans, meaning that each loan's rate would vary from year to year, rather than the rates being set in stone once the loan is issued. This reform would save $3.7 billion over ten years.
  • Senate Democrats: In contrast to other proposals which set a permanent rate for subsidized loans, the Senate Democrats' plan would extend the 3.4 percent subsidized loan rate for two years. The plan would pay for this extension, which costs $8 billion, with three tax changes. One would change the tax treatment of tax-exempt pension plans, the second would further limit the deductibility of interest for expatriated businesses, and the final one would expand the definition of "crude oil" for the excise tax that funds the Oil Spill Liability Trust Fund. Overall, the bill slightly reduces deficits by $330 million over ten years.
  • Senate Republican: The Senate minority's bill would result in the highest interest rates of the three proposals that link student loan rates to the ten-year Treasury rate. It would set the rate for all four types of loans to the ten-year rate plus three percent, which would likely put the rate about halfway between 3.4 percent and 6.8 percent for next year. The proposal would save about $16 billion over ten years.

The chart below shows how each plan would affect the deficit. Each plan has an upfront cost since it reduces rates relative to the current law rates on student loans but raises them later on or makes up the money elsewhere in the budget.

Source: CBO, CRFB calculations
Note: Year refers to second year of academic year. CBO interest rates are calendar year rates.

There are a number of other proposals outside of these ones, such as:

  • The "Bipartisan Path Forward" plan to peg interest rates for student loans to an unspecified market-based rate
  • Rep. Joe Courtney's (D-CT) plan to also extend the 3.4 percent rate for two years
  • Sen. Elizabeth Warren's (D-MA) plan to set the subsidized loan rate for the next year equal to the Federal Reserve's discount rate
  • Sen. Jack Reed's (D-RI) plan to have the Secretary of Education set a rate annually that cannot exceed the cost of administering the loans

Encouragingly, the four major proposals described in the first part of this blog (along with the Bipartisan Path Forward proposal) would all prevent the sharp student loan increase in a fiscally responsible way which would not add to the deficit over the next decade. However, the Senate Democrat approach represents a band-aid solution to a problem in need of something more permanant. Under that solution, interest rates would be scheduled to double in July 2015, and the issue would need to be re-visited. The better approach is to permanantly peg student loan rates to market rates, so that they stay low now but gradually rise as interest rates grow in order to avoid future cliffs and help reduce long-term deficits.

Ideally, policymakers would follow the example of the Bipartisan Path Forward and also use this opportunity to make further reforms to the entire higher education funding system. Permanantly addressing the interest rates issue, though, would represent a good start.