Deficit Reduction Hits Home

Congress' latest bill shores up Medicaid but hurts students.
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Every year Congress passes a budget for the federal government. And every year the government doesn't stick to it, so the deficit keeps growing and increasing the national debt.

Late Wednesday, Congress narrowly passed the Deficit Reduction Act, or DRA, which is intended to reduce the still-growing budget deficit by about $40 billion over the next five years -- about 2.5% of the projected $1.6

trillion

in deficits over that same period.

The DRA calls for cuts to many areas, ranging from welfare to crop subsidies. There are two moves in particular that could affect many Americans, and these changes demonstrate both the good and the bad of the bill.

Student Loan Consolidations

Federal spending on student loans represents about one-half of 1% of the federal budget, but proposed cuts to the student loan program equal 30% -- roughly $12.7 billion -- of the proposed budget cuts.

Buried in the DRA is a section of the law that will make it illegal to consolidate student loans while students are still in school -- a provision that currently enables students to lock in current low fixed rates. And even more deeply buried in the bill is a provision that prevents borrowers from using a clever strategy that currently gives those who have already consolidated their loans a chance to reconsolidate.

It's unfortunate that these provisions passed. If you can refinance your mortgage to take advantage of lower rates, why not your student loan?

Some would argue that mortgages aren't being subsidized by the government, so refinancing is appropriate. But the existing student loan refinancing program really doesn't cost the government any money. Most refinancing is done by private banks. They simply agree to pay off the initial student loan and accept a lower rate of interest.

If refinancing to a lower rate doesn't cost the government any money, why object? One of the largest holders of student loans is Sallie Mae, a formerly federally chartered organization that is now privatized. Allowing easier consolidations and reconsolidations by competing organizations could cut into Sallie Mae's profits, so it lobbied strongly for this bill.

It's important to know that in addition to the changes created by DRA, there are several rate increases scheduled for existing student loans starting July 1 this year. The rate for new Stafford Loans for students will jump from 4.7% to 6.8%, and the rate on new PLUS loans made to parents will jump from 6.1% to 8.5%. That increase was built into existing legislation.

Current borrowers also will have to deal with the annual adjustments on existing loans. Those are based on the 90-day Treasury bill auction held at the end of May. If those auction rates increase over the previous year, then rates on existing student loans also will go up on July 1. Given the trend in short-term interest rates and recent Fed rate increases, you should immediately start the process of consolidating existing loans.

Medicaid and Long-Term Care

The DRA also makes changes to Medicaid as it applies to long-term care, making it more difficult to qualify for federally paid nursing home care.

The new act is intended to strengthen the Medicaid program in the long run by making it harder for middle-income families to shift assets to their children so the parents can qualify for federally paid nursing home care.

The DRA provides a five-year look back on such transfers and closes abusive loopholes such as certain annuities or "life estates" techniques designed to get countable assets out of the individual's control. This change makes sense; if federal financial aid for long-term nursing care were limited to those truly in need, the program wouldn't be swamped by baby boomers trying to qualify for this benefit.

The bill also includes provisions that make the purchase of long-term care insurance more attractive -- including state partnerships that allow people who have purchased, say, $100,000 in LTC insurance benefits, to exclude that amount from their Medicaid spend-down if they ultimately run out of insurance benefits and need state care.

Many senior advocate groups, including the AARP, which actually has a very good program of LTC insurance for its members, believe this is an attack on seniors instead of a way to preserve Medicaid for needy members of the boomer generation. If boomers don't face up to the need to plan in advance for their future care and instead depend on taxpayer funding, we'll transfer a huge tax burden to our children -- and create generation warfare.

Overall, I personally think it's a shame they tampered with student loan refinancing provisions. But I'm glad Congress is encouraging responsible long-term care planning. And we can only hope that the deficit will actually be reduced, or at least grow at a slower rate. That's the Savage Truth.

Terry Savage is an expert on personal finance and also appears as a commentator on national television on issues related to investing and the financial markets. Savage's personal finance column by the Chicago Sun-Times is nationally syndicated, and she released her fourth book, The Savage Number: How Much Money Do You Need? in June 2005. Savage also was the first woman trader on the Chicago Board Options Exchange and is a registered investment adviser for stocks and futures. A Phi Beta Kappa graduate of the University of Michigan, Savage currently serves as a director of the Chicago Mercantile Exchange Corp. She also has served on the boards of the McDonald's and Pennzoil corporations.