To cancel debt or not to cancel debt: Evaluation of debt cancellation or provide a tax credit

Abstract

U.S. students are facing unprecedented student loan debt levels, roughly $1.75 trillion. The Biden Administration is proposing a debt relief program that will cancel student loan debt up to $20,000 for Pell Granted individuals. However, the current plan has faced substantial legal challenges and political pressure, and as suggested, it could increase the current inflation crisis. However, the size of the inflation effect is subject to debate. On the lower end, student debt relief may add only about 0.2% points to annual inflation. Proponents have also circulated linking student loan repayment to income levels. We propose an alternative approach to handle the current student loan debt crisis using a non-refundable tax credit. We provide theoretical support that individuals receive higher utility with a college degree, can pay off student loan debt faster, and that the U.S. government may obtain higher tax revenue from college graduates in the long run. We argue that individuals will seek higher-paying jobs, work longer hours, and accept promotions not only based on the increased salary but also because it would reduce taxes.