On March 28, a bipartisan group of senators who don’t often agree on tax and economic policy introduced legislation that would eliminate origination fees charged to current borrowers under the federal student loan program. Led by Sen. Mike Braun (R-IN) and cosponsored by Sens. Kyrsten Sinema (I-AZ), Elizabeth Warren (D-MA), Josh Hawley (R-MO), Tim Kaine (D-VA), Chris Coons (D-DE), and Chris Van Hollen (D-MD), the “Student Loan Tax Elimination Act” was introduced last week in the Senate, with Rep. Lloyd Smucker (R-PA) proposing identical legislation in the House.
The bill’s authors argue that origination fees are a “hidden tax” on federal student loan borrowers. According to Sen. Braun’s office:
“Federal student loans currently contain a hidden tax called an ‘origination fee.’ Origination fees historically existed to offset the costs of private-sector partners that, in the current federal student loan program, no longer originate federal student loans. Before a federal student loan is disbursed, an origination fee is calculated as a tax to the borrower, increasing the overall borrower loan cost. The origination fee is subsequently deducted from the amount actually received by borrower. While a student borrower is given less than their guaranteed loan amount, they are still expected to pay that dollar amount back—with interest. Since private sector partners no longer originate loans, there are not costs to offset, as there were when the fee was established—and this fee is no longer necessary.”
The National Association of Student Financial Aid Administrators (NASFAA), which supports eliminating origination fees in federal student loans, estimated in April 2021 that origination fees generated $1.7 billion in revenues for the federal government in the 2019-2020 school year.
There are technical quirks with federal student loan origination fees that deserve scrutiny.
The origination fee was historically used to offset the costs for private sector partners that used their own resources to process these loans, however those private sector partners no longer process loans under the current federal program.
The fee is also duplicative. Under current law, borrowers have the origination fee taken out of their loan for processing at the beginning and have to pay back the processing fee (plus interest) when they are repaying their loan. Before a federal student loan is disbursed, an origination fee is calculated as an additional fee to the borrower, reducing the take-home value of their loan. The origination fee is deducted from the amount received by the borrower. While a student borrower is given less than their ‘sticker’ loan amount, they are still expected to pay the higher dollar amount (the loan plus the fee) back, plus interest. Effectively, the federal government is charging borrowers the origination fee twice – plus additional interest.
This double charging of the origination fee is an accepted practice in the private sector, but for federal loans being processed by the government, it may be confusing and unnecessary. The government should exercise caution when issuing loans and should adequately account for the risk it takes on by lending money. This can be accomplished through interest rates instead of a duplicative, obsolete fee.
Another technical issue involves the effect of government spending sequestration orders on origination fee amounts each year.
Under the Balanced Budget and Emergency Deficit Control Act of 1985, subsequently amended by several laws enacted by Congress – most notably the Budget Control Act of 2011 – any sequestration (i.e., across-the-board spending cut) order from the Office of Management and Budget required by law results in student loan origination fees “increas[ing] by the same uniform percentage.”
Sequestration orders take effect on October 1 of the calendar year, when a new fiscal year begins for the federal government. The practical effect of sequestration, per NASFAA, is that:
“...colleges and universities must change fees in the middle of fall enrollment. When the rate changes, a school must cancel all loans that have not yet been disbursed and re-award the loans with the updated origination fee.”
If Congress stops short of eliminating origination fees, they should still consider reforms that reduce the administrative burdens faced by higher education institutions around the country as a result of federal loan origination fees being adjusted on October 1 of each year with a sequestration order. One potential fix could be to require the higher fee to take effect on loans originating in January 1 of the calendar year following a sequestration order. This could give colleges and universities two extra months to adjust to the new origination fees set by sequestration, and would potentially avoid mid-enrollment changes to loans.
Regardless of how far the Student Loan Tax Elimination Act advances in Congress, lawmakers and policymakers at the Education Department should give careful consideration to how they can fully cover the costs the federal government bears in administering student loans and the risks the government takes when loaning out amounts borrowers may not pay back. This issue has been in the political and policy discourse for some time, but especially since President Biden announced expensive student debt cancellation executive actions in the summer of 2022.
In 2022, the nonpartisan Government Accountability Office estimated that the federal student loan program had cost the federal government nearly $200 billion over 25 years, from fiscal years 1997 through 2021. This was a “swing of $311 billion” from prior Department of Education estimates, that the federal student loan program would “generate $114 billion in income for the government” (emphasis ours).
Most policymakers would agree that the federal government should control for both the costs of administering the federal student loan program and the risk of borrower default through some combination of interest rates and fees. Policymakers will likely disagree, on the other hand, over how much federal taxpayers or creditors writ large should subsidize the federal student loan program. Eliminating the origination fee would, on the whole, make the federal student loan program slightly more costly for federal taxpayers. How would lawmakers respond? Would they authorize increases in interest rates on federal student loans to make up the difference? Would they decrease spending or raise taxes elsewhere to offset the cost of eliminating origination fees? Or would they borrow more? Congress should proceed with caution.