What would happen if the US allowed citizens to deduct 100% of cost of school loans?

Ask an Economist

During a discussion with some friends on the whole "free college tuition" debate, along with the trillions of dollars currently owed on student loans, I began to wonder about a solution that would be somewhat liberal, but not so far to the left that it would be completely dismissed.

My question is: would it be economically feasible if the United States changed its tax code to allow all citizens to deduct 100% of all monies paid towards student loan lenders (interest AND principle)?

Responsible tax payers could see a lower tax bill (something we all know conservatives AND most liberals love), or most likely a refund (even better!, and the American public would have a greater incentive to pay down the trillions in student loan debt we currently owe.

I am what people are calling a millennial. I am a liberal. However, I do believe that nothing is free. But after graduating in 2008, my loans quickly rent into repayment long before I earned the chance to pay them off. Almost a decade later, my wife and I have a combined student loan debt of just about $100,000. And that WITH going to a cheaper public in-state school!

Anyways, I digress. I just had this notion, and since my education is more in marketing, I felt I could let the economists tell me if I'm flat out crazy, or if it was a viable plan.


This is a great question. Currently interest (but not principal) on student loans is deductible within certain limits. The maximum deduction is $2,500 and the amount of the deduction begins to diminish once your Modified Adjusted Gross Income reaches $65,000 ($130,000 if you file jointly). It is a simplification, but let’s treat your question as being what would happen if repayments of the principal outstanding were made deductible?

Current estimates (http://tinyurl.com/gvlrjv4) are that there is about $1.2 trillion in outstanding student loans, and that this number has roughly doubled since 2007. Making these payments tax-deductible would reduce federal tax revenues every year. A back-of-the-envelope calculation suggests that this loss in revenues (called a tax expenditure) would be on the order of $22 billion per year (this is based on principal payments of $120 billion and assuming a marginal tax rate of 18.5%).

Is this feasible? In a $4 trillion budget it is, but it would either require raising other taxes, cutting spending, or increasing the federal deficit, which we all have to pay back eventually. As economists like to say, there is “no free lunch.” One can also ask whether alternative uses of this sum might be more effective in addressing the cost of education or helping former students get out of debt.

In addition to these “first-order” effects, it is important to think about how increasing tax deductibility would affect future behavior. The plan you propose would in effect lower the cost of college, and economic models would predict that, other things equal, people would spend more when the price falls. The end result might just be even more debt, and a bigger reduction in tax payments.