Forgiving student loans would pass risks of higher-education costs to taxpayers

There are more bailouts in the making. But it’s not big corporations this time.

Congress previously passed legislation that made it easier to buy health care and educational services. New proposals are now being discussed that will pass the risks of these purchases on to taxpayers.

Economic theory and history show that when a good or service is subsidized, consumers buy too much of it and prices rise faster than average. Such has been the case in the United States for health care and higher education.

But the higher prices are not the only problem. Both of these industries are subject to an economic problem called moral hazard — the adverse outcome that occurs when individuals, firms, or other organizations take on too much risk because they have little or no incentive to concern themselves with potential losses.

In the health care market, insurance companies take a number of actions to avoid moral hazard, such as deductibles and screenings. These actions provide individuals an incentive to take care of themselves. But since current law doesn’t allow for much screening, insurance companies cover this cost with higher rates, and if we now increase the insurance subsidies, the moral hazard problem will only get worse.

In lending markets, the moral hazard problem rears its ugly head when financial institutions receive guarantees against loss. Consider the crisis a decade ago when the government covered bad loans and helped struggling banks consolidate. Competition among banks is now lower than before, and the resulting large financial institutions will likely be bailed out in the future no matter how badly their managers behave.

If student loan debt is forgiven, we can expect much of the same. More students will enroll in college — increasing demand and therefore prices for everyone — without much concern as to how well they perform in their classes. This policy move encourages young people to “gamble” on degrees that have little chance to pay off in the job market, or to simply not study much.

Nineteenth century French economist Frédéric Bastiat noted that a “bad economist pursues a small present good, which will be followed by a great evil to come.” No matter how good it may feel to help people buy health care or education today, policymakers must concern themselves with the evil incentives such moves create for tomorrow.

Peter Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. prcrabb@nnu.edu

This story was originally published February 16, 2021 at 11:44 AM.