Thursday, April 16, 2015

Marriage or joint filing penalty in student loan repayment plans

I heard about something interesting this week, from students in my Tax Policy Colloquium and brought to their minds by Larry Zelenak's paper on marriage penalties and bonuses.  It was news to me, but apparently is common and perhaps well-known in the demographic of near-graduates from college or professional school who have huge student loans to pay and are making use of the federal income-conditioned repayment program.

Under this program, of course, the more one earns after graduating, the more one may have to pay annually.  Obviously this functions like a marginal tax on earning more, but what I hadn't known about was the interaction with marriage and filing status.

Apparently, the program relies on adjusted gross income (AGI) from borrowers' tax returns to determine how much one needs to pay in a given year.  First point, don't get married and file a joint return, so far as the program's incentives are concerned, if, say, you are both going to be lawyers earning junior attorney salaries.  (Actually, the examples I heard about may have concerned a student borrower marrying someone else, as opposed to two student borrowers getting married.)

Second point, you can get married after all, so long as you use the "married filing separately" category.  Since the program looks at AGI, doing this keeps your spouse's earnings out of the AGI on your tax return.  And apparently the loan repayment benefits from doing this may significantly outweigh the general disadvantageousness, within the income tax, of married-filing-separately status.

But apparently that comes at a further tax cost, since I am told (though I have not independently checked this) that those who select the married-filing-separately status are barred from taking advantage of special income tax deductions, subject to an income phase-out, for student loan interest.  To beat that as well as the loan program, you have to not get married.

It's obviously preposterous to have the application of the student loan repayment program turn on whether married individuals select "married filing jointly" or "married filing separately."  But is the question of how the loan repayment program operates, with respect to household or marital status, any different from that regarding tax and transfer rules generally?

One difference might be that, depending on the numbers and also on responsiveness in the affected population, marriage penalties here may simply be "too large," even if one is not wholly averse to them in all circumstances given the broader issues raised by household status.

A second difference is that we might need to think more about the purposes being served by the income-conditioned loan repayment program.  Suppose that it is rationalized, not just as tailoring loan repayments to ability to pay (and thus generally offering income insurance to participants), but also as specifically addressing the payoff that the borrower has derived from the education that triggered all those student loans.  The idea might be: We're sharing the risk by making you pay more if the educational loans really pay off big-time (at least, ignoring the point that correlation needn't imply causation - I may not make it big BECAUSE what I learned or my degree helped me so much).

Insofar as that is the rationale, one might conclude that purely individual rather than household "taxation" should apply here.

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