Student loan forgiveness advocates attend a press conference in front of the White House, Aug. 25.
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President Biden’s decision to cancel billions of dollars in student debt is unfair to responsible Americans and will feed inflation. But state lawmakers can do something about it: tax the windfall. It’s a longstanding principle that the discharge of debt is a taxable event. It could provide revenue for broad-based, economically stimulative tax relief to all of a state’s residents.
Debt forgiveness, like income, is an accession of wealth and so taxing discharges of debt has been a feature of the U.S. tax code since the adoption of the first income tax in 1861. The Supreme Court upheld the validity of taxing forgiven debt in U.S. v. Kirby Lumber (1931). Last year, however, the American Rescue Plan precluded any federal taxation of student-loan cancellation through 2025.
But not all states followed Washington’s lead. New York, for one, chose to continue to tax student-loan forgiveness. All in all, it appears 13 states have gone their own way on taxing debt relief. Normally, it’s better policy simply to conform to federal tax rules because it reduces filing costs and saves the state legislative and judicial resources. In this case, however, other states should follow New York’s example.
The added revenue would give states an opportunity to mitigate some of the unfairness of Mr. Biden’s handout. States often struggle to cut taxes because strict balanced-budget rules in their constitutions don’t allow them to run deficits. The revenue generated by taxing student-loan forgiveness may grant states the room they need to give residents a little relief in these tough economic times.
States could reduce the tax burden on all residents, for instance by raising the state’s standard deduction. Alternatively, they could balance Mr. Biden’s unfair stimulus by using the revenue for one-time tax rebates to residents who…
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