John Brooks, Professor of Law at Georgetown University Law Center joins Yahoo Finance’s Kristin Myers and Aarthi Swaminathan to discuss how taxes could change under President-elect Joe Biden’s student loan forgiveness plan.
KRISTIN MYERS: Welcome back to "Yahoo Finance Live." I want to jump straight into our discussion on the more than $1.6 trillion student debt crisis. We have John Brooks here with us. He's a law professor at the Georgetown University Law Center.
And we also have Yahoo Finance's Aarthi Swaminathan joining us for this conversation. Thanks to you both for being here. John, I want to start with you here about how feasible it is for President-elect Biden to essentially cancel student loan debt, either all of it, or even partially, on day one.
JOHN BROOKS: Yeah, the Higher Education Act, which governs student loans, says that the Education Secretary has the power to compromise, waive, or otherwise change or negotiate the amount of the debt that anybody owes. So that should be sufficient for legal authority for Biden and his Education Secretary to cancel just about any amount of debt for borrowers that they think is appropriate.
KRISTIN MYERS: John, I'm wondering if you think that this might impact taxes, if it's viewed as a as an economic benefit that then has to be accounted for at tax time.
JOHN BROOKS: Yeah, the traditional tax treatment of cancellation of debt, of any debt, is that it should be taxable, because it sort of is a benefit that's come to you. Imagine you winning a lottery and using that to pay off your debt, for example. That's what's the classic treatment for mortgage debt, or credit card debt, or something like that.
But student loans are very different, partly because this is really a massive government program. Most of the lending is from the federal government. So if it was to be taxable, the federal government would be simultaneously with one hand canceling debts, and then on the other, asking to collect a portion of that in tax revenue immediately.
So you would essentially cancel only some debt and then accelerate the rest. And I think that that's going to have potential policy implications. Fortunately, I think it's actually is a fixable problem.
AARTHI SWAMINATHAN: How is it fixable, John, just to follow up on that. And also we have some forgiveness programs that don't hit you with a tax bill. That's PSLF. Is that sort of the ideal scenario that we're trying to work towards?
JOHN BROOKS: Yeah, Public Service Loan Forgiveness, for some sort of historically quirky reasons, has a particular exclusion in the tax code that doesn't apply to some other forms of debt, particularly if there is a one-time cancellation now and also to the cancellation's under income-driven programs, which it covers now a huge amount of borrowers in debt.
And so there's been a sort of a overly simplistic view of some of the other debt cancellation that they say, well, if it's not a Public Service Loan Forgiveness, then it must be taxable, because I don't see a separate exclusion in the tax code. But I think that ignores a more important view about the history of this.
And importantly, for decades, the IRS treated student loan forgiveness as a nontaxable scholarship. As anybody who's gotten a scholarship or a grant knows, those are not taxable. And canceled student debt was for years treated the same way. That's, as best I can tell, also the reason why we don't tax interest subsidies now, such as under the subsidized direct loans or under some of the income driven repayment programs.
So there still is good law out there that it could be treated like a scholarship. There is also a ability to exclude certain government payments for the general welfare. This is why we don't tax, say, housing subsidies or disaster related payments.
So if any cancellation was made in the context of the economic devastation around COVID, for example, I think it would pretty clearly qualify as a sort of disaster relief payment that wouldn't be taxable. So those are just a couple of the tools that the IRS has in its tool chest to try to solve this tax problem.
KRISTIN MYERS: John, you know, every time we talk about canceling student loan debt, I become increasingly concerned that in some ways we're not doing enough to address the real problem, which is the cost of education in the first place and making sure that all folks have access to any kind of funds to achieve higher education. I mean, do you see it the same way, that perhaps we're not focusing enough on a really holistic solution to this problem?
JOHN BROOKS: I think that's right, yeah. I think the student loan issue is really more a symptom, in some ways, than the underlying disease. And I guess there's two things I would say.
One is that if we only cancel student debt, but without addressing any of the underlying causes of student debt, particularly in the funding of higher education and the cost of higher education, we're just going to have this same debate over again in a few years and maybe even more so, as people, you know, students learn that they should load up with debt because it's all going to be canceled later anyway, we could even make the problem worse.
So it's really important that we fix the underlying causes of cost of higher education. Some of that is probably figuring out ways for schools to contain costs. Some of that is also recognizing that the other forms of public funding have drastically reduced over the years, particularly state support of state public universities and also the Pell Grant program. Pell Grants used to be sufficient to fund a full tuition and fees for most students and has not kept up with the cost of higher ed.
The other thing, though, that I think is important to say is that the student loan program itself has, over the years, become a little bit of a Frankenstein's monster in terms of how many different programs there are, how many different people and institutions that a borrower has to deal with in order to effectuate all the rights that they get under the student loan program, that it's made it really difficult to really serve its original purpose of trying to provide affordable access to higher education.
So there are reforms, both on the cost side of higher ed and also making the student loan program work better that I think are really important to not leave out of this overall debate.
KRISTIN MYERS: All right, John Brooks, Law Professor at Georgetown University Law Center and Yahoo Finance's Aarthi Swaminathan. Thank you both so much for joining us for this incredibly important and nuanced conversation.