From Volume 77, Number 4 (May 2004)
The design of the tax system and substance of tax laws have an effect on nearly every economic decision made by individuals. Whether to invest or consume, buy or sell, and what forms of consumption or savings in which to engage are all issues that are influenced by the design of the tax system and the substance of tax laws. The tax treatment of debt in the U.S. hybrid-based income tax system generates inequities and inefficiencies that result from both an inconsistent base and failures in timing. Americans with high net wealth and sophisticated tax advisors can strategically use the inconsistent base and timing problems associated with debt to avoid, delay, or shift tax burdens. Unfortunately, for lower- and middle-class Americans without the benefit of tax advisors, the inconsistent base and timing problems associated with debt in our tax system can be economically detrimental.
One major type of debt that is disproportionately held by lower- and middle-class Americans under thirty-five years of age is debt accumulated to finance post-secondary education and other similar personal investments in their human capital. The unfair and inefficient tax treatment of debt that is acquired to finance post-secondary education is the focus of this Note. These inequities and inefficiencies can be resolved, in whole or in part, by tax reform. This Note discusses three alternative tax reform proposals, focusing on how each may impact the tax treatment of student loan debt. One of these reform proposals functions within the context of a hybrid-based tax, defining debt accumulated to finance post-secondary education as an amortizable investment and generating deductions for taxpayers in later years when their investments provide a higher salary than they would have had without this additional education. The other two reform proposals require fundamentally redefining the tax base and moving toward a pure, consistent income tax or a pure, consistent consumption tax.