Smoke, mirrors and the scandal of student debt

Student finance is a difficult subject for progressives.  On the one hand it seems outrageous that our young people should enter adult life burdened by debts of some £40 – £50,000   – the highest level of student debt in the world. On the other hand, fixing the crisis in social care and raising our shamefully low levels of welfare benefits must be a higher priority than helping relatively wealthy graduates. After all, as defenders of the status quo correctly state, students only make repayments if their earnings prove to be above average.

 It seems a real dilemma; but what if the whole system of student finance were based on smoke and mirrors, voodoo economics or a financial conjuring trick?

Astonishingly, it really is. 

Don’t just take my word for it; listen to the OBR (Office for Budgetary Responsibility.)

Student finance they state has been based on a huge “fiscal illusion

Student fee loans were introduced at a low level in 1998 but only reached their current scale in 2012 under the coalition.  One of the attractions for politicians of transferring most of the cost of undergraduate courses from the state to students, (with loan support) was that grants to universities count as public expenditure.  Loans to students do not.  At a stroke a government obsessed with reducing public sector borrowing could ‘achieve’ a cut of £7 billion per year in the so-called ‘deficit’. The cumulative effect would, by 2023/24 make £128 billion of public expenditure seem to disappear.

If it were just a question of relabelling government debt as private debt in order to keep deficit obsessives happy it wouldn’t be so bad. But it gets worse. Over half of student debt will never be repaid and is therefore a real cost to the taxpayer. The cost arises because the loans are ‘income contingent’ – that is graduates only begin to repay if and when their income crosses a threshold (currently £25,000 per year) – and any outstanding debt is written off after 30 years.

The real scandal is that the national accounts pretended that the debt would be repaid in full and with interest so that any shortfall would only register when the debt matured.  In other words, they kicked the can thirty years down the road.

At the very time George Osborne and his pals were preaching about not burdening future generations with debt their student loan policy did precisely that. Indeed, the very generation they burdened with private debt would, after 30 years, then face the burden of extra public debt!

Embedding the fiction that student loans cost the taxpayer nothing into the national accounts was not the only deceit. Although the loans themselves do not increase the deficit, the interest charged on the outstanding debt is treated as income which reduces it! This sleight of hand could be one reason why students are charged a rate of interest well above that at which the government can borrow – 3 per cent over RPI (the retail price index)

A final twist is that some of the loans have been sold off to the private sector at well below their face value. This in part is an honest reflection of the fact that they won’t be repaid in full, and that the purchasers take the risk that repayments may be even lower than current estimates.  In part, however, it is just plain bad value for the taxpayer as the private purchaser adds nothing – the calculation and collection of repayments is still all handled by HMRC. The reason for the sales is almost certainly the accounting trick that, unfathomably, says if the debt is sold before it matures any loss just disappears.

If you are having difficulty understanding all of this don’t worry.  As Paul Johnson, respected head of the Institute of Fiscal Studies (IFS) says “understand isn’t the right word, there is not enough logic here to allow understanding”  What we do need to worry about however is that the tricksters have been found out and the chickens are coming home to roost.

At the end of 2018 the Office for National Statistics (ONS) , prompted by both the OBR and the International Monetary Fund, announced that it would change the way student loans are treated in the national accounts better to reflect the reality of their costs.  It makes sense but adds around £12 billion per year to the government deficit raising fears that deficit fetishists will look for a similar level of real savings to balance it.  It’s a serious risk, but before looking at how to mitigate it there is one more aspect of the Alice-through-the-looking-glass world of student finance to consider.

For a student who graduates and enters a low paid profession the current system represents a very good deal.  As long as their income remains below average they will pay nothing; if they strike lucky and pay improves they will only ever pay an extra 9 per cent on income above the threshold; and any balance remaining after 30 years will be wholly written off. 

That’s not how it feels however to someone with £50,000 of debt hanging over them and increasing by 3 per cent plus RPI every year. There is also a real fear that a government that threatens to break international treaties might not think too hard about retrospectively breaking faith with students.

So a bad deal for the taxpayer is made to feel good and a good deal for the student feels bad.  What a mess!

What then should be done?

The most important step is to get rid of the language of debt.  After all, as the ONS change recognises, student debt is not proper debt since it is known up front that most of it will not be repaid.

Some would argue that higher education should be wholly funded out of general taxation. Given the alternative candidates for increased public spending such as the NHS, social care and welfare that seems unlikely.  Most people now accept that students, who clearly benefit from their higher education experience, should bear part of the cost.

 A widely-touted alternative is a graduate tax which might be configured to have the same rates and thresholds as the current loans but avoid the negative connotations of a debt burden. As Vince Cable has argued “most of us don’t think about our future tax obligations as debt”.  The big objection to a graduate tax however is that governments shy away from any suggestion of tax increases. An equally large problem is that there is no reliable record of who is and isn’t a graduate.

For those reasons there is increased interest in the idea of a graduate contribution scheme, a version of which was clearly set out in a recent paper from the Higher Education Policy Institute (HEPI) The argument is that it is both more honest and more palatable to ask those who have benefited from higher education to make a contribution to the costs of its provision.  If contributions were calculated in broadly the same way as current loan repayments the exchequer would not lose out; but there would be several benefits.

No graduate would have to worry about living in the shadow of a crushing load of personal debt. 

Students would carry on paying after the specific costs of their course had been covered so the richer would pay more – perversely the present system ensures the richest students pay least since the faster the debt is paid down the less interest is charged.

There would probably be no need for the student loan company to keep detailed records of individual debts and repayments, therefore saving administration costs.

Most importantly perhaps, it recasts student contributions in an ethical rather than transactional frame. Making a contribution appeals to ideas of social solidarity and a shared enterprise, of giving back something to benefit future generations. It has, interestingly, been considered by government as the basis for a sharia compliant alternative to student loans for Islamic students whose religion bans usury.   It seems altogether a more honest basis for higher education finance than the perverted logic of the current scheme.