Student Loans

by George Hatjoullis

Being of a generation for whom higher education was free, the student loan situation has passed me by somewhat. Far fewer people went university in my generation so the cost of providing it free was less onerous and justified on the basis of efficiency and social justice. The desire to expose many more to higher education led to constant debates about how to fund and I gave some suggestions in a letter to the FT published 12/12/1984. The  ideas that I espoused there may well have led to the present situation.

My proposal was for a graduate tax to finance higher education but still provide it free to those that might be deemed capable of benefitting. The student loan structure now in place (from 2012) may well amount to the same thing but with the tax rate somewhat obscured and collected in such a way as to confuse and disincentivize. The logic of my argument was that, since we are used to the notion of progressive taxation, a hypothecated tax related to higher education would not affect willingness to attend university. The education would be free and repayment proportionate to income, so why not? The present system amounts to the same thing but takes the form of a massive debt up front which varies with a visibly high interest rate. This is quite off-putting.

The present system collects loan repayments at the rate of 9% per annum of all income above £21k per annum. The interest rate is RPI plus 3%. It is odd that the government chooses RPI as the index has been discontinued. Moreover, it is typically about 1% higher than CPI, the government preferred inflation index. So in reality the interest is inflation plus 4%. Well I would like some of that! A 4% real interest rate. Nothing offers 4% real interest on such a quality of loan and indeed has not done so for decades. Is the marginal rate of return on university qualifications higher than 4% real?

If you never earn much then the real interest rate may not matter because after 30 years the loan is cancelled. Your repayments are based on income not the amount outstanding. You pay 9% of income over £21k until the loan is repaid or cancelled. At RPI + 3% this means the loan may be growing. If you owe 20k and earn 30k you will repay £804 in a year. The loan interest at 6.1% (latest RPI 3.1%) is £1220. If you earn £50k you will repay £2610. The high real rate has thus introduced a very regressive element in what was meant to be a progressive tax. High earners can pay down quicker.

Indeed the whole system now discriminates against poorer students. It is possible for wealthier families to borrow for much less than 4% real from the private sector. It is only those that have no other means (or very low-income expectations) that will resort immediately to student loans. It may also be those that do not explore their options carefully. Let’s face it, financial illiteracy is rife and the student loan structure is not the least complex system available!

The student loan repayment calculator provides some guidance. If you expect to earn little then a student loan makes sense because it will be cancelled before you pay it all back. If you expect to earn a lot it is not so bad because you will pay down quickly. It is the medium earners that suffer most and are most vulnerable to the high interest rates because it extends the amount and duration of the loan. For example for an initial loan of £40136 someone starting on an income of 25k and finishing on 50k will pay a total of £56065 over 24 years. Someone starting on 19k and ending on 30k will pay £23563 over 30 years and the loan is then cancelled. Importantly, someone starting on 36k and ending on 80k will pay back £50062 over 14 years. Even the least numerate can use this calculator.

The student loan system is an implicit graduate tax system. However the incidence of tax falls on the most vulnerable. Those that have no other means of finance and have only intermediate income expectations are penalised by the system. The high real interest rate effectively acts as an additional tax on this group. This is not a fair system.