Student Loan Forgiveness: Why Economists Say Income-Driven Plans Are Always Superior

The Clinton Administration’s introduction of the first income-driven repayment (IDR) plan for student loan borrowers in the early 1990s was a milestone in the history of higher education finance in the United States. For the first time, borrowers struggling with high loan balances and limited earnings could elect a payment option that provided relief from the burden of what were, in many cases, unaffordable monthly payments required by the standard plan at that time.

Because IDR plans tailor payments to income and family size and eventually offer student loan forgiveness, these plans have gained a certain level of popularity in the United States as a way to ease the financial burden of student loan borrowing. Nevertheless, U.S. IDR plans remain vastly underutilized, especially among those who might benefit the most from them. In spite of a growing international consensus among economists that IDR plans are always superior to standard repayment programs—and despite IDR programs in nations like Australia that dramatically reduced loan defaults while improving access to higher education—about half of the 43.6 million student loan borrowers in the United States still remain stuck in standard plans.

It’s not difficult to see why. The bewildering complexity of America’s four IDR programs, combined with their rapidly shifting regulations, has created confusion among borrowers. As a result, IDR plans in the United States remain largely misunderstood, with significant proportions of borrowers missing opportunities to reduce their payments and receive student loan forgiveness because they didn’t fully appreciate the advantages of these plans.

To help borrowers better understand their options, this article provides a brief overview of the history of income-driven repayment programs, along with the economic theories that justify their continued implementation. We also compare the U.S. IDR programs with IDR programs offered by other nations that arguably seem more effective. With the U.S. Department of Education’s April 2025 launch of a negotiated rulemaking process that seeks public comments on potential reforms to two IDR plans along with the Public Service Loan Forgiveness (PLSF) program that roughly serve a combined 20 million borrowers, our analysis is relevant to the current public discussion and debate over student loan finance.

Federal student loans are not new. The National Defense Education Act introduced federal student loans in 1958, and the Higher Education Act of 1965 established indirect federal funding through guaranteed loans. However, both these initiatives required a traditional, time-based repayment (TBR) plan: a fixed rate with regular payments over a specific time interval that would repay the loan’s principal plus interest. Essentially, this was a mortgage repurposed to fund higher education.

But what’s relatively new is the concept of an income-based or income-contingent student loan repayment plan. Invented in 1955 at the University of Chicago by the Nobel Prize-winning economist Milton Friedman, this innovation replaces the fixed payments with flexible payments as a percentage of income above a certain threshold.

Australia first introduced this type of plan nationwide in 1989. President Bill Clinton’s 1992 campaign stump speech then promised to deliver flexible loan repayment to college student voters. He signed America’s first income-based plan into law with the 1993 federal budget, with payments as a percentage of income, followed by student loan forgiveness after 25 years.

Today’s Income-Contingent Repayment program offered by the Education Department is an updated version of the Clinton plan. Here’s how IDR plans like this one work, and why it was so popular with President Clinton’s millions of student voters.

Studies show that some student loan borrowers experience challenges with repaying during low-income periods. Among traditional-age college graduates, these periods most frequently occur between the ages of 23 and 31 because early-career employment can sometimes be unpredictable. This potential combination of varying income with fixed bills for loan payments can be risky.

Under a time-based repayment plan with fixed payments, borrowers with low earnings during these early-career years often face substantial financial hardships. At these times, their repayment burden—the percentage of their income required to repay student loans—will be large. If the situation doesn’t resolve, they can eventually face elevated probabilities of student loan defaults.

By contrast, an income-driven repayment system guards against a large repayment burden because it sets a maximum monthly payment at a low level. For example, in England, the maximum monthly repayment obligation never exceeds nine percent of income, and in Australia, that obligation never exceeds 10 percent. Borrowers with high incomes stay in the plan for shorter periods than borrowers with lower incomes, who stay in the plan for longer intervals. This structure means that repayment hardships are largely eliminated, with defaults extremely rare or nonexistent.

In other words, standard fixed repayment, mortgage-style plans carry major repayment risks and the possibility of default, while the income-driven approach is safer because it provides insurance against financial adversity. In the United States, we have about 12 million individuals who have defaulted on student loans, many of which were issued under the standard TBR plan. In other nations with fixed payment plans, the default rates can range as high as 40 to 70 percent.

But in nations that adopted universal income-driven student loan systems like the United Kingdom, Australia, New Zealand, and Hungary, repayment burden hardships and defaults rarely exist. This is why leading economists argue that time-based repayment plans are always inferior to income-driven repayment plans.

There’s another huge benefit to income-driven repayment: governments receive larger revenue streams in the long run compared with the income streams produced by time-based repayment plans. A 2022 simulation applying data from Columbia demonstrated this effect by showing that, in the long run, the aggregate repayment streams of borrowers who paid according to an income-driven plan were much greater than the income streams of those who paid under a fixed-payment plan.

Although the United States has struggled to balance simplicity, fairness, and cost in its income-driven repayment programs, several other countries have operated successful IDR systems for decades. Two leading economists with direct experience in designing these programs outside the U.S. offer valuable insights into what’s working abroad—and where the U.S. falls short.

They are two economics professors, Dr. Bruce Chapman at the Australian National University in Canberra, and Dr. Lorraine Dearden at University College London. In Australia, Dr. Chapman was the architect of the world’s first IDR program, and Dr. Dearden served as a consultant to the British government on the recent expansion of that nation’s student loan system. Their research on student loans has yielded more than 200 publications.

Concurring with Dr. Chapman and Dr. Dearden are several other economics professors who’ve collaborated with them on research focusing on IDR plans. For example, another recipient of the Nobel Prize in Economics—Columbia University’s Dr. Joseph Stiglitz—co-edited a 2014 book on income-contingent repayment plans with Dr. Chapman. For many years, Dr. Stiglitz has been a strong supporter of a comprehensive income-driven repayment program for borrowers in the United States, and he wrote several New York Times op-eds arguing in favor of this type of policy reform. In addition, a 2019 paper by Dr. Chapman and Dr. Dearden, “The US College Loans System: Lessons from Australia and England,” was co-written with Dr. Susan Dynarski of Harvard University and Dr. Nicholas Barr of the London School of Economics.

Dr. Chapman and Dr. Dearden first recommend that the U.S. consolidate its plans into a single IDR system required of all borrowers that’s simple to understand, which is how the plans in their two nations operate. By contrast, currently in America, we have a ridiculously complicated system offering four IDR program options with varying monthly payments and levels of student loan forgiveness at the end of the payment periods—and a fifth plan if one counts the PSLF program, which requires enrollment in one of the IDR plans. They warn that this wide variety of plans encourages adverse selection: borrowers who anticipate receiving the largest subsidies are most likely to enroll in the most generous plans.

Second, they argue that the U.S. IDR plans aren’t really “income-driven” because the borrowers’ income data relies on income tax returns that are filed as long as a full year in advance. Especially with borrowers in their 20’s who change jobs frequently, there’s often little relationship between their year-old tax return data and current earnings. In Australia and the United Kingdom, IDR plans are based on more current payroll data, which employers share electronically with the government.

Third, the economists recommend that the U.S. should preclude “unsatisfactory quality” institutions from enrolling students who finance their educations under IDR plans. “This often means for students that there is little value added from such college experiences,” they write, “and has resulted, and continues to result, in many loan borrowers accumulating debt that is difficult to repay—and for many leads to loan defaults.” They continue:

When all the fiscal risk of poorly functioning loan arrangements is being taken by US taxpayers, why is it the case that higher education institutions with dubious credentials and low graduation rates qualify for all US college loans?

When considered in an international context the US higher education system is quite strange to us, given the apparent lack of consideration of the costs involved with respect to non-payment of debts given the fact that all student loan costs are ultimately financed by the government; our view is that there just has to be due care given to eligibility for student loan coverage with respect to the credentials of private providers.

Fourth, Dr. Chapman and Dr. Dearden warned the Biden Administration in February 2023 testimony before the Secretary of Education and the Council of Economic Advisors that the subsidies in the SAVE Plan—the Biden plan currently suspended by a court order—were set at levels that were much more generous than successful IDR plans in other nations.

They agreed with an Urban Institute study which concluded “The Biden plan will transform IDR from a safety net that supports borrowers with low incomes into a substantial subsidy for most undergraduate students who take on debt. . .If the Biden plan is implemented as proposed, fully repaying a student loan will be the exception, rather than the rule.”

In short, the SAVE Plan’s generosity could make unpaid balances the norm—not the exception—and overwhelm the system’s long-term fiscal sustainability. Here’s a key excerpt from the professors’ testimony:

Several loan parameter choices determine total subsidies and we note that one of them, the collection rate, is to be set at of 5 percent of discretionary income, which is a far lower rate than that operating in the UK and New Zealand of 9 and 12 percent respectively.

As well, the forgiveness periods suggested for the new [IDR plan], in some instances of the order of 10 years, are very short indeed. In the UK the forgiveness period now occurs after 40 years, which essentially means there is no forgiveness period in the UK, as is the case in both the Australian and New Zealand ICLs.

In reviewing the global evidence, the case for income-driven repayment becomes overwhelming. As leading economists like Dr. Dearden and Dr. Chapman emphasize, student loan systems that link repayments to real-time income not only protect borrowers from financial hardship but also deliver better outcomes for governments. Their 2023 Brookings Institution article put it plainly:

For both borrowers and governments, income-driven repayment is a more efficient and equitable approach to student loans, and time-based repayment plans everywhere should be assigned to the wastebasket of higher education financing history.

With the U.S. Department of Education now revisiting its IDR and PSLF programs, policymakers have a critical opportunity to heed these lessons—and to finally modernize America’s approach to student loan repayment.