Student debt figures are mere artifacts of a series of policy and modeling choices, with little basis in the reality of personal or public finance.
Therefore, the government would immediately record $38,000 as revenue in the first year of the loan (the difference between $188,000 and the original loan amount)
Not only is the stated interest rate arbitrary; it’s also unlikely to be the interest Mark actually pays. There are many ways for interest to be tweaked, subsidized, and waived on federal student loans, particularly through any of the income-driven repayment (IDR) programs. These complex and opaque rules mean that it is impossible for a borrower or the government to know how much interest will actually be paid, which underscores the arbitrariness of statutory interest rates.
Because of Mark’s high debt, he’s likely to enter one of the IDR programs, which generally require borrowers to pay 10 percent of their discretionary income for 20 years, at which time any remaining debt is canceled. As Mark goes on in life, he’ll pay the Education Department that fixed 10 percent of his discretionary income, and his total debt will grow or shrink based on those payments and the complicated interest rules. Under this system, it’s likely that some of what Mark owes the government is already being canceled, on a monthly basis, under current law-a fact that raises barely an eyebrow, compared to the heated debates around a one-time cancellation of debt principal.
First of all, it does not simply count the dollars actually repaid annually as revenue. (In federal credit parlance, this is known as the loan’s subsidy rate. Loans that are estimated to earn a profit-like many student loans-are deemed to have a negative subsidy rate.)
Instead, at the time each loan is made, the government executes a complicated calculation that balances the amount loaned against how much the government expects to get repaid, including interest, and books all of that expected profit (or loss) as revenue (or outlay) immediately
Because student loan payments take place over years if not decades, the government discounts future payments to present value. But it does so using a discount rate that is much less than the loan interest rate. The effect of all this is that the government’s expected 4.6 percent annual profit over the full life of a student loan-the statutory spread above its borrowing rate-gets entirely booked as revenue in the first year of the loan. In each subsequent year, the government revises its estimate of the subsidy rate, and books additional revenue or outlays as its estimate of profit goes up or down. If in a future year, loan repayment estimates are lowered, because of new repayment plans or partial loan cancellation, that would show up as a new government outlay in that future year.
This is confusing stuff, so let’s put some numbers to it. Imagining this as a single $150,000 loan, this methodology would mean that if the government expected Mark to fully repay his loan over the standard ten-year repayment term, it would estimate receiving, in discounted present value, about $188,000. Then suppose next year Mark signs up for IDR. Now the government anticipates lower monthly revenue and some chance of ultimate forgiveness. (To be clear, these annual re-estimates are done at the loan portfolio level based on the Education Department’s model, not at the individual borrower level-but choices like Mark’s will affect the variables used in the model.) Let’s say Mark entering IDR lowers the present value estimate of the loan to $160,000 (it may not; extending loan payments for 20 years with high interest could increase the government’s profit if Mark is likely to be a high earner in future years). Federal credit rules would then treat this as a budgetary outlay of $28,000 in the second year of the loan-a cost. But all we’ve really done is lower an estimate of government profit.