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Making Education More Expensive Through Subsidies

students dressed for graduation, standing together facing away from the camera
photo by Alan Light

One of the cardinal rules of economics is that if you tax something, people consume less of it, and if you subsidize something, people consume more of it.

Another cardinal rule of economics is the basic law of supply and demand: When people consume more of something, the price increases. The converse is also true.

When you put these two rules together, it is easy to understand why things like health care, housing and education tend to increase in price faster than things like chocolate bars and snow tires. The tax code offers a big subsidy toward the consumption of health care, because employer-paid insurance is not taxable to the employee actually consuming that care. The law does the same for housing by making mortgage interest deductible.

The price of a college education could not have increased nearly as fast as it did over the past few decades had the government not stepped in, first to back and then to directly issue vast amounts of student debt at interest rates that do not reflect the reality that many borrowers will never be able to satisfy their obligations.

Now some lawmakers want to prescribe yet another stimulant to the cost of education. Two bills currently in Congress have the same objective: to expand a section of the tax code to treat up to $5,250 per year in employer contributions toward employees’ education debt as nontaxable income.

If this policy became law, it would serve as a further tax subsidy to both the borrower, who could pay back a portion of the debt with tax-free dollars, and the borrower’s employer, who could avoid paying both Social Security and Medicare taxes on such debt payments.

Incidentally, who would make up for those lost Social Security and Medicare taxes? All the rest of us.

Legislators did not pull this idea out of thin air. Even without the suggested tax benefits, some employers have begun offering educational loan repayment as a fringe benefit. PricewaterhouseCoopers was one of the first major employers to offer such a perk, and Fidelity launched its own version in January. These programs have proven popular when available, and many young adult workers have said such a benefit would attract them to a potential employer. Yet only 3 percent of companies currently offer this perk, according to the Society for Human Resource Management.

Congressional backers want to increase that number substantially. The plan to offer a subsidy is politically attractive, especially if you are trying to lure young adult voters to your camp. But unfortunately, it makes no economic sense. Americans are already wringing our hands over the difficulty of weaning people off existing subsidies for mortgage debt and health insurance. Now backers of this ill-conceived idea would create a new iteration of the same problem.

Moreover, the proposal could turn out to be highly unfair to different groups of borrowers. Unless Congress is careful, graduates who pursue self-employment after completing their education might not get the same break as their traditionally employed peers. Students who work for firms that do not offer this benefit will also find themselves at a disadvantage, paying their debts with after-tax dollars while their classmates, doing the same work at other firms, will pay their debts on a pretax basis.

We have tax-favored alternatives for workers who don’t have access to a 401(k) through an employer, but what would such an alternative look like in this scenario? And what about parents or grandparents who choose to relieve their young adult family members of some of the burden by paying educational loans on their behalf?

Like much of the debate supporting the Affordable Care Act, the arguments in favor of this plan are confused. Legislation that truly aimed to make care affordable would have driven down the cost of providing health services instead of driving it up by subsidizing additional consumption. Making education affordable is not a matter of funneling more tax dollars to indebted graduates; it is a matter of bringing the cost of education into line with its realistic economic benefits.

The student loan proposal would be a large step away from its own stated goal.

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