Unlike free college, discharging student loans in bankruptcy is a great idea

Unlike free college, discharging student loans in bankruptcy is a great idea
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Sens. Dick DurbinDick DurbinSchumer sets Monday showdown on debt ceiling-government funding bill Democrats surprised, caught off guard by 'framework' deal Senate panel advances antitrust bill that eyes Google, Facebook MORE (D-Ill.) and John CornynJohn CornynSenate panel advances antitrust bill that eyes Google, Facebook Democrats up ante in risky debt ceiling fight Senate parliamentarian nixes Democrats' immigration plan MORE (R-Texas) recently introduced a bipartisan bill aimed at restoring the way that student loans are handled in bankruptcy.

In contrast to other recent proposals, such as free college and a student loan jubilee, this legislation isn’t a flashy proposition — it’s a great idea, one that enjoys support from both sides of the aisle among policymakers and some experts. 

Over the past 30 years, a series of policy changes have made it more difficult for borrowers to have their student loans discharged in bankruptcy. These policy changes were driven by the idea that investments in education could not be transferred, because the borrower would always retain the benefits acquired from their education. This would make sense if degrees paid off uniformly with large dividends, but the reality is that some investments in education fall short of that mark — unpredictably offering little or no value to the borrower. 

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In theory, income-driven repayment (IDR) programs were supposed to offset the financial burdens faced by struggling borrowers when Congress made it more difficult to discharge student loans in bankruptcy. However, in practice, IDR programs are falling short of providing an adequate safety net for borrowers and are in need of serious reform. 

In the meantime, reinstating the option to have student loans, both federal and private, discharged in bankruptcy under certain conditions would create an effective patch to the well-intentioned, but inadequate, IDR system. 

To be clear, reforming bankruptcy laws is not a silver bullet and would have its own drawbacks. Some borrowers might use this option strategically, borrowing to pay for school and then entering bankruptcy as a less costly option than repaying their loans. The introduction of this moral hazard is inevitable, but could be mitigated through restrictions. For example, requiring a borrower to be in repayment for a number of years before the loan becomes eligible for bankruptcy would reduce the financial reward of bankruptcy while increasing the costs. It would also be reasonable to require borrowers with larger balances, such as those from professional and graduate programs, to pay for a longer period of time before their loans would become eligible for discharge.

In an economy that relies on largely self-financed investments in education as the primary mechanism for social mobility, it is untenable for students to risk their financial well-being without a robust safety net. Lawmakers are right to consider restoring the option of “dischargeability” for student loans after a waiting period of 10 years. At the same time, it is imperative that Congress simplify the current ill-functioning IDR safety net into one program and automatically enroll all borrowers when they enter repayment.  

“Dischargeability” in bankruptcy, coupled with significant reforms to the IDR system, are good first steps toward reforming our faulty system of higher education financing. Although these tweaks may not be as flashy as other proposals on the table, they have the potential to substantially improve our system of higher education finance without exorbitant expense. We are glad to see that policymakers, on both sides, are seemingly in harmony on this issue. 

Beth Akers is a resident scholar at the American Enterprise Institute (AEI). She is the author of “Making College Pay: An Economist Explains How to Make a Smart Bet on Higher Education.” AEI research associate Olivia Shaw contributed to this article.