We’ve been talking about student loans, and the fact that the federal government is turning a multi-billion dollar profit on them (especially law-school and other graduate loans). These profits may be the equivalent of a progressive tax on borrowers. Is that a reason to support the current design of the program? Assuming that the program actually is progressive (admittedly, an unanswered question, as we saw last time), I would say yes. I’ll argue co-blogger David Gamage should say yes, too, but that many other folks would disagree.
Standard public finance economics analysis would suggest that government shouldn’t use its own market participation as a way of redistributing wealth. The reasoning is what I’ll call the “heavy buckets” theory, but most people follow Kaplow & Shavell in terming it a “double distortion” argument. Let’s say you have to schlep some water from the river to your house. Would you rather use a heavy steel bucket or a nice light plastic one, assuming both hold the same amount of water? That’s a no-brainer.
The double-distortion argument is roughly the same. The claim is that any time we redistribute income, we will change people’s incentives to work, as the expected after-tax returns for earning more are diminishing. So whether government imposes a pure transfer, or just charges more for the brownies at its bake sale, either way the after-transfer value of my salary is lower. That’s the water in the bucket. The bake sale, though, is the heavy bucket, because it has a second drag on the economy: it also discourages me from eating brownies.
Anyway, that’s the standard story, but Gamage has a different one.