The Secret Taxes On The Young: Health Insurance And Student Loan Interest

On this Tax Day, columnist Shannon Achimalbe looks at two payments that are not called taxes but feel like and have the effect of a tax.

Today is the deadline to file income tax returns. For many solo practitioners and small business owners, today is the day to mail the filing extension and pay whatever money is in the bank account that day.

Most people only know about income taxes and sales taxes. But taxes come in other forms. Politicians just don’t call it a tax or don’t realize it’s a tax. It does not mean that every payment to the government is a tax, such as paying an admission fee to a public park or golf course.

Today, let’s look at two payments that are not called taxes but feel like and have the effect of a tax: health insurance and student loan interest.

Health Insurance

Beginning in 2014, the Affordable Care Act (or “Obamacare”) required Americans to purchase health insurance. If they don’t, they must pay a “shared responsibility” penalty to the IRS (well… not really). For those with low to moderate incomes that meet certain criteria, the government provides a tax credit to fully or partially subsidize the cost.

The basic economic theory of Obamacare is that it will lower health care costs for consumers because insurance companies will be motivated to reduce monthly premiums and deductibles to compete for market share. But that didn’t happen, at least not yet. Prior insurance coverage was canceled and premiums went up. When people went into an uproar, the insurance companies blamed everyone but themselves: government mandates, the recession, divided public opinion, and uncertainty about whether Obamacare will be repealed or survive judicial review. Young people have been hit with the steepest increases in insurance premiums. This was the goal because their participation is needed to subsidize the elderly and those with preexisting conditions.

Young people are going to have a hard time paying for health insurance on their own. Most are paid non-Biglaw entry-level salaries and have to pay living expenses and student loans. This leaves them with little disposable income to pay for health insurance. Others are unemployed, underemployed, or worst of all, work for a cheap, shady solo practitioner. These people will have to rely on government subsidies and tax credits or go without insurance and risk paying the tax penalty.

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Those who can afford to pay will feel resentful being forced to pay for something that they do not need. When their premium money is used to subsidize others, even though the goals are for the greater good, it feels like paying a secret tax.

Student Loan Interest

Until recently, I was under the impression that the government provided student loans to help people of modest means get an education. While not perfect, it’s supposed to be a win-win policy. Graduates will increase their earnings potential and chances at a better quality of life. The government will get its return on investment mainly through higher income tax payments. Also, there are other positive effects on society, such as reduction in crime and violence.

Federal student loans have scary legal provisions to maximize the chances of getting paid back as agreed or as soon as possible. They are almost nondischargeable in bankruptcy. Federal preemption trumps any state consumer protection laws favoring debtors. Social Security payments and tax refunds can be intercepted. The government can also take collection action without having to go through the usual court processes that private creditors do.

Since student loans have broad economic and policy goals with legal protections and collection powers that would make a mob boss envious, federal student loan interest rates should be lower relative to other loans. But they’re not. As of 2013, federal student loan interest rates are tied to market rates. As of the day of this writing, mortgage interest rates are lower than student loan interest rates.

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While the numbers vary, the federal government will make a pretty penny from student loan interest income. The Congressional Budget Office projects that the government will receive about $127 billion in the next ten years, mostly from graduate and professional students. The Government Accounting Office projects that the government will generate $66 billion in profit on the $454 billion in loans it originated between 2007 and 2012. While the accounting methods used to come up with these numbers are questionable, the government intends to make a profit even taking potential defaults into consideration.

Few would argue that reasonable interest should be paid when a loan is disbursed. But the federal government should charge lower interest rates for education loans and instead rely on future income taxes for the return on investment. Otherwise, the interest income acts as an alternative source of tax revenue.

These Secret Taxes Will Create A Disincentive To Work And Make Money

I assume that most young graduates will apply for alternative student loan repayment programs such as IBR, PAYE and PSLF in order to reduce their monthly payments and start the loan forgiveness countdown.

Some will be able to pay off their loans. But others will pay little to nothing for years and watch the interest accumulate to astronomical levels. At some point, it will be in their overall best interest to “PAYE” off their loans instead. If it comes to this, there is little incentive to earn a lot of money.

Think about it. Earning more money means you will lose tax benefits and get placed in a higher tax bracket. You also lose or limit Obamacare health care subsidies, which might be a dealbreaker if you have children. Finally, you will have to make higher student loan payments, most of which will apply to all of the accumulated interest that you didn’t pay at the beginning. Now I don’t think people will deliberately live on poverty level income just to avoid making student loan payments. But this may make people think twice before accepting higher paying jobs, especially if it requires additional time in the office or if they are at the final years of IBR/PAYE before loans are forgiven. This means the government loses potential income tax revenue and student loan interest revenue.

Speaking of loan forgiveness, some people are concerned that when the debt is forgiven, the amount will be included in taxable income, creating a huge tax bill for some. While there are ways to deal with cancellation of debt income, I wouldn’t worry too much about this. When debt affects a large enough group of people, Congress will act. Eight years ago, when the housing market crashed on an epic scale, many mortgage debts were forgiven and former homeowners faced a potentially huge cancellation of debt income tax bill. In response, the Mortgage Forgiveness Debt Relief Act was passed, which allowed taxpayers to exclude income from the discharge of debt on their foreclosed homes. Also, unless the current student loan lending system changes dramatically within the next few years, a large percentage of voters will be IBR/PAYE lifers. These people will not hesitate to vote for a party running on a student loan forgiveness ticket.

With the exception of the very rich, student loans and health insurance are secret taxes imposed on the young. Many will barely be able to pay both and some will rely on alternative repayment programs, thus putting them deeper into debt. At some point, it would not make economic sense to make more than a certain amount of money because most of the extra income would go towards taxes, student loan interest and higher health insurance premiums to subsidize others. Not only will this create a moral hazard, this is also poor government fiscal policy.


Shannon Achimalbe was a former solo practitioner for five years before deciding to sell out and get back on the corporate ladder. Shannon can be reached at sachimalbe@excite.com.