Student Loan Bill Caught in a Web of Politics
Business + Economy

Student Loan Bill Caught in a Web of Politics

iStockphoto/The Fiscal Times

Senate Republicans on Tuesday blocked Democrats from acting on a bill aimed at preventing a doubling of interest rates on federal student loans this summer. While both sides and the Obama administration insist they favor legislation that would spare millions of students and graduates a huge boost in their college debt, a festering feud over how to offset cost of holding the interest rate at 3.4 percent is threatening to scuttle the efforts.

The Senate voted 52 to 45 along party lines to move ahead with the legislation, but the majority Democrats came up eight votes shy of the  60-vote super majority  needed to proceed with debate and a final vote. “The very last thing our students right now need is for interest on this critical loan program to double,” said Sen. Patty Murray, D-Wash., a chief sponsor of the legislation. “We cannot afford to allow that to happen. At a time when mortgage rates are under 4 percent, we should be doing everything possible to keep interest rates low for students today.”

House Republicans on April 27 passed a version that would cut into preventive care funds for women and children in the Obama health care reform program to offset the projected $7 billion of income the Treasury would forego if the interest rate on Stafford student loans remained the same for another year instead of shooting up to 6.8 percent. Obama threatened to veto that legislation. Senate Democrats are proposing to offset the cost of holding the interest rate steady by closing a tax loophole used by some wealthy individuals to avoid Medicare payroll taxes.

The election year dispute highlights a major philosophical and political divide between the two parties, with Democrats insisting that wealthier Americans be required to pay more in taxes to cover necessary spending and to help reduce the deficit, while Republicans insist that any tax increase would hurt the economic recovery  and should be avoided at all costs.

Professionals such as  lawyers and doctors can avoid payroll taxes by first organizing their business as an S-corporation under the federal tax code and then characterizing most of their income as business profits rather than as wages or salaries. The U.S. Treasury’s inspector general for tax enforcement once called this  a “multibillion dollar employment tax shelter.”

Democrats say that repealing the loophole  would do little harm other than forcing wealthy people  --  including former Republican House Speaker Newt Gingrich and disgraced  former Democratic senator John Edwards of North Carolina -- to meet their full tax obligation. “This is so obviously a wrong-headed loophole,”  Sen. Al Franken, D-Minn., said during a debate today before  the vote. “It’s a loophole that  I don’t think anyone can really defend."

But Republicans claim it was the Democrats who were  being wrongheaded by pressing for passage of a bill that would raise taxes on professionals and small businesses and discourage them from creating jobs, just when college graduates  are most in need of work to help pay off their loans. The Democratic proposal would apply to S-corporations with incomes exceeding $250,000 and whose revenues come primarily from the work of three or fewer owners. Some law firms, doctors' practices and other professional services partnerships would be affected as well.

The Heritage Foundation argues that if the tax loophole was eliminated, people would reincorporate as sole proprietorships, LLCs or  partnerships, which are not subject to the double tax. The result would be less tax income and would add to the deficit.

“Taxing job creators has a chilling effect on hiring,” said Sen. Mike Johanns, R-Neb. ,  “It really isn’t straight forward to promise students the American Dream while making it harder for them to get a job – often the first step towards realizing their dream."

It was unclear how the two parties intend to break the deadlock. Sen. Lamar Alexander, R-Tenn., has introduced a bill nearly identical to the House-passed measure  that would underwrite the cost of holding down the interest rate by dipping into the remaining funds in the preventative care fund. Alexander noted that all but six Senate Democrats voted with Republicans last February to dip into that fund to help pay for a jobs and middle-class relief bill, and that President Obama has previously proposed using the fund for other purposes. 

However, Senate Majority Leader Harry Reid, D-Nev., has said repeatedly that Democrats are opposed to short changing a program that prevents disease and protects against public health emergencies “just so Republicans can continue protecting millionaire tax dodgers."

It’s one measure of how far John Edwards has fallen that his former Senate Democratic colleagues have  named  a detested  tax loophole after him and Gingrich. A background memo  circulated by the Democrats refers to it as the “Newt Gingrich/John Edwards Loophole.” The former presidential candidate is standing trial in North Carolina for using his campaign donations to hide his affair with his mistress, Rielle Hunter and her subsequent pregnancy.

 “I just think we feel that rich folks should pay their fair share of payroll taxes,” said a senior Senate Democratic aide today  when asked about the swipe at Edwards. The former senator earned $26.9 million from his work as a trial lawyer in 1995, according to The New York Times. He paid himself a salary of $360,000 each year for four years and took the rest as distributions from his S corp. That  saved Edwards an estimated $600,000 in payroll taxes.

The burgeoning problem of student debt has received extraordinary attention from President Obama on the campaign trail, as he has  attempted  to recreate the excitement he generated on college campuses four years ago. College seniors who took out loans to fund their college education owed an average of $25,250 in 2010, or five percent more than the class of 2009 owed, according to a report from the Institute for College Access & Success' Project on Student Debt.

Former Massachusetts governor Mitt Romney, the presumptive GOP presidential nominee, also wants to  prevent the interest rate from doubling. He said on Monday, “Given the bleak job prospects that young Americans coming out of college face today, I encourage the Congress to temporarily extend the current low rate on subsidized undergraduate Stafford loans. I also hope the president and Congress can pass the extension responsibly, that offsets its cost in a way that doesn’t harm the job prospects of young Americans.”

The maneuvering underscored the intense rivalry between Democrats and Republicans over appealing to college students and voters with college degrees, who overwhelmingly went for Obama over Republican Senator John McCain in the 2008 presidential election. The skyrocketing costs of a college education and the unprecedented levels of outstanding  college debt – now estimated at $1 trillion, or more than the total credit-card debt -- are also part of a larger discussion about the financial pressures Americans are facing as the economic recovery continues to sputter.

Senate Minority Leader Mitch McConnell, R-Ky., said Democrats were forcing the vote today as "a way to drive a wedge between Republicans and a constituency that they're looking to court ahead of November's elections. That's what today's vote is all about for them." McConnell said the Senate "has ceased to be a place where problems are resolved. It's become, instead, a place where Democrats produce campaign material."

Reid said he might be willing to allow a vote on the GOP bill. But he also criticized Republicans for opposing the Democratic plan. "They're sending a clear message that they'd rather protect wealthy tax dodgers, and that's what they are, than help promising students achieve their dreams of higher education." Still, both leaders acknowledged that Congress and the White House will have to come to terms on a bipartisan agreement to avert the scheduled doubling of interest rates on future college loans beginning this summer.

Subsidized Stafford loans are for low- and middle-income students.  Democrats who controlled Congress in 2007 and wrote the student loan law allowed the lower interest rates to rise again this summer because they felt it would have been too expensive to permanently reduce those rates. The Education Department estimates 7.4 million students will borrow $31.6 billion in such loans in the year beginning July 1, averaging $4,226 for each student.