The future of student loans

Paul Johnson:

Hello and welcome to this episode of the IFS Zooms In. I'm Paul Johnson, Director of the Institute for Fiscal Studies, and today, I'm delighted to be joined by, first of all my colleague Ben Waltmann and also by Professor Ivor Crewe from the Master of University College, Oxford. One of our leading thinkers on all things political and author of one of my favourite books of all time, The Blunders of Our Governments. That's a real delight, Ivor, to have you here.

But the particular reason that we have Ivor Crewe with us today and Ben Waltmann is their work on higher education and the funding of higher education. Ben leads on that work at the IFS and Ivor Crewe was a member of a panel for the Augar Review Post-18 Education, which was reported a couple of years ago.

I got a whole slew of huge issues to talk about when we think about the student funding system, how many people we think should be going to university, how higher education funding fits together with further education funding and so on. But let's start by getting for each of them an overview, from their point of view of how the system as a whole for higher education works.

Ivor Crewe:

Well, the higher education funding system was really revolutionised, certainly very radically changed. Not only were tuition fees introduced by the new Labour government under Tony Blair, but when what is now referred to as the income-contingent loan system was established to support students who were charged fees. Initially, the tuition fee as it's called, it should really be called a ‘university fee’, but it's called a ‘tuition fee’ because it covers all university costs. Initially, the fee for UK undergraduate, full-time undergraduates, was £3,000 and then under the coalition government it was increased to £9,000, and that was in 2012.  

What's essential to understand about this system is that the provision of loans for undergraduates meant that they did not have to pay at the point of initial consumption when they started off as students, and it directly provided a much larger amount of money for universities. The year after it was introduced in 2013, George Osborne, Chancellor of the Exchequer at the time, lifted the cap on student numbers. Until that time, the treasury, through the Department for Education, had put a limit on the total number of undergraduates in, well, I should now say English universities, not UK universities - that was lifted in 2013.  

So this combination of a loan system to pay the fees and the lifting of the cap led to a very significant expansion of university numbers; the provision of adequate resources for universities; and in my view, it was responsible for the widening of participation in higher education - particularly amongst those from low income households, particularly from ethnic minorities and particularly for women and in that sense, democratised higher education in this country.

Paul Johnson:

You've run through some of the really important aspects of the system there. Ben perhaps you could put some numbers on some of those things, the scale of the student loans, how student loan system works from the point of view of the student.

Ben Waltmann:

Sure, Paul. Let me just run through some specifics here. So what happens at the moment is that students typically take up government loans for both their tuition fees and living costs, and that for a three year degree can easily run up to £50,000 in loans at the time of graduation. And then once these students graduate, they start paying back these loans if their income rises above a certain threshold, so that's currently around £27,000. Of all the income above that threshold, nine percent goes towards the student loan. These repayments go on until the end of what's called the repayment period which is currently thirty years. So, thirty years after students start repaying, they stop and the remaining loan balance is cancelled.

And the important thing to understand about the system as it currently works, is that most graduates will actually never clear their loans. So it won't pay off their balance within those thirty years, mainly because they were not earning enough to make sufficient repayments. But that's not a problem for them, after thirty years, the loans just get cancelled with no harm done for the student. So that means that for most graduates, the student loan system effectively just creates an additional tax. So, what matters for students is this repayment threshold, and the repayment rate rather than the loan balance, which for most students, won't matter at all.

Paul Johnson:

So, we think something like the highest earning twenty percent of students will pay back, is that right?

Ben Waltmann:

Yes. So, as we’ll get into, the government is reforming the system and has announced reforms also for existing borrowers from the 2012 university entry cohort onwards. And so if we think about these existing borrowers, we now estimate that it might be more like a third of students who fully repay.        

Paul Johnson:

That's because they're reducing the repayment threshold.

Ben Waltmann:

Exactly. Because effectively, the repayment threshold is going to be reduced broadly speaking, between a quarter and a third, I think it's a realistic estimate, certainly a minority.

Paul Johnson:

Ivor, Ben has described the system as it stands, and you told us a bit about how we got there. Can you tell us a bit about what you recommended after, I know, the huge amount of work that went into the Augar Review that published, I think, three years ago or so now, what your thinking was behind recommendations for change?

Ivor Crewe

Yes, I mean The Augar Review, first of all, looked at the principles of an income-contingent loan system, and looked at the relative advantages and disadvantages of that compared with other ways of funding universities and supporting students; such as a graduate tax by which I mean a premium tax that is paid by those who have graduated, or the old system of university education that's free, where there are no fees at all and all of the costs of university are paid for by the central government out of taxation. We looked at those, we looked at also the possibility of having a free market for universities in which they charge whatever fees they think they can, a bit like the American system and students just have to find the money one way or another. And we, first of all, came to the view that the loan system which is based on the capacity of graduates to repay that loan according to their income was the fairest. And we thought it was the fairest because what it recognised in a way that none of the other systems recognised is that, students do derive some individual benefit from having gone to university. It does, in most cases, enhance their lifetime earnings. On the other hand, society and the economy also benefits from having a well-educated population. There are undoubtedly public benefits and it is reasonable for those public benefits to be supported by the taxpayer rather than by the individual student. And whilst recognising that the specific parameters of an income-contingent loan system or as I would call it, a graduate contribution system, can be changed and can alter the balance of contributions made by the student as distinct from the taxpayer, nonetheless, this was the appropriate framework in which to design a system for both funding universities and for supporting students. So that was the first position that the Augar Review came to.

Paul Johnson:

Ivor, before you go on, can I just ask why you came out against a graduate tax, which I suspect a lot of listeners will be wondering at this stage, because that achieves quite a lot of what you were just describing?

Ivor Crewe:

Well, in one very significant respect, it does not. The problem with a graduate tax is that it provides no guarantee that the funds raised by the graduate tax, that that money will actually go towards higher education. That is the main objection to a graduate tax. We do not have hypothecated public expenditure in this country, the treasury has always very strongly resisted it. There would be no guarantee that the additional tax charged to graduates would find its way into the higher education system. It would simply go into the treasury coffers and would be spent on whatever the government regarded as a public expenditure priority at any particular time. I should add that although it was not the business of the Augar panel to think about the political or the electoral implications of a graduate tax, we were well aware that it would be very unlikely that a government would take the political and electoral risks of charging a graduate tax.

Paul Johnson:

Sorry, carry on with where you were going with your previous discussion.

Ivor Crewe:

Yes, well, so that was the first position taken by the Augar Review. We then looked at the cost to the taxpayer of the system as it existed when we were undertaking our deliberations. It was clear that the cost to the taxpayer was going up, the size of the loan book was going up inexorably each year. The proportion of graduates who, best as models could estimate this, were likely to repay their loans in full, was quite a small minority and a declining minority. And we knew that the government was looking for ways in which it could reduce or at least put a halt to the rising cost to the taxpayer of a student loan system, where the majority of students were not fully repaying the loan.

So we looked at various ways in which the details of the loan system might be tweaked in a way that would restore the balance of contributions between graduates and the taxpayer, and also, meet the general conceptions of fairness and equity. That meant looking at the interest rate that's charged on loans, that meant looking at the period of repayment after graduation, and it meant looking at the salary threshold beyond which graduates were required to start repaying the loan. And we made a number of recommendations for changes which were not wholly accepted in the end by the government, but the government came quite close to meeting the recommendations that were made.

The one very important recommendation that the Augar Review made, which the government has not accepted, in my view, regrettably, is the restoration of maintenance grants as distinct from maintenance loans for students from low-income households. This has been ignored by the government and I'm sorry about that - maintenance grants are paid in the other nations of the United Kingdom, in Wales and Scotland, and Northern Ireland, but not in England.

The panel proposed an extension of the repayment period on the grounds that graduates should go on repaying their loans for as long as they were benefiting from having a degree and as a result, in most cases, having better jobs and better paid jobs and given the lengthening period at which people work, we thought it was reasonable to extend the repayment period from thirty years to forty years before a loan is forgiven. We did recommend that the threshold at which graduates start to repay their loan should no longer be an arbitrary figure selected by the government, but should be pegged to median graduate earnings. The government has not quite accepted that recommendation, but they have taken down the threshold from a bit over £27,000 at the moment to £25,000 starting, I think, in the 2023. But that means it won't start to be paid until something like 2026, 2027. So, they are taking it down, it'll probably come slightly below the median graduate earnings.

And we also recommended that the interest rate paid by graduates should only start to be paid after they've graduated and not right at the beginning of the loan once they are students. The one, and I was slightly surprised at this, although I think I understand the political reasons for it, the one initiative that the government took, which we did not recommend but which is to the advantage certainly of some students, is that the interest rate will now be a zero real interest rate. It will be an interest rate that merely reflects inflations defined by RPI. At the moment, the interest paid is three percent above RPI, once graduate earnings reach a certain salary threshold. This is extremely unpopular amongst graduates and graduates' parents as well and I think the government was aware that this was a potential vote loser, so they scrapped it.

Paul Johnson:

Wow, there's a lot in that. I think there's a couple of points that's worth pulling out. I think it's really important to point you make about the maintenance loan. We talked very little about that, actually, most of the discussion about graduate finance, graduate loans, and so on is focused on the tuition fee element. But actually what really matters, certainly in terms of young people from less well-off backgrounds going to university is the upfront cost of that and the amount that is provided by government has in real terms have been going down over time.  

But Ben, let's look a bit at some of the elements of where we've actually ended up in terms of the consequences of the changes that happened. So broadly speaking, as Ivor just said, we're moving from an interest rate of up to RPI plus three, to just RPI - that's still a very high number at the moment. The repayment threshold is coming down to £25,000 and the repayment period is being extended for forty years, those are the big changes that we've got. Is there any more there from the government and what are the impacts of those changes?

Ben Waltmann:

So, these three elements that you just mentioned are definitely key planks for the system from the 2023 university entry cohort onwards. So, the repayment threshold is going to be £25,000 as Ivor said, and it will be frozen until 2026/ '27, so in real terms, we're going to end up a bit below that. The repayment period is going to be extended to forty years, and interest rates are going to decrease from up to RPI plus three forty percent to just RPI.

In addition, there's a fourth, kind of, major change, which is that the repayment threshold above which students have to make repayments, after it's been frozen until 2026/ '27, it's going to increase with RPI inflation rather than with average earnings as had been the previous policy, and as the Augar Review recommended. So, if the government actually follows through with that, in the long run that will mean that the threshold is going to be much lower in some decades time than it would otherwise have been because average earnings are predicted to rise faster than RPI inflation, so that's one major thing.

The second major thing is that the reforms that have been announced aren't just about the 2023 cohort onwards. As I briefly mentioned earlier, some parts of the reform, or some elements, also affect the 2012-2022 cohorts, so that includes many students who have already graduated. And for them, these reforms are all about the repayment threshold. Right now, the repayment threshold for them is around £27,000 and it has been frozen for one year, and it's going to be frozen for another two years until the '24/'25 fiscal year. That means a decline of the repayment threshold in real terms and relative to earnings. And for these cohorts as well, and that's really significant, the repayment threshold will in the future be increased in line with RPI inflation rather than in line with average earnings growth.

Paul Johnson:

You're focusing, quite rightly, a lot on the way that things are indexed, the role of indexing the threshold in particular, and that really matters, doesn't it? Because if you increase that threshold in line with prices as opposed to earnings and then the incomes that you end up getting repayments on grow over time, at least they do if earnings grow as they should do more quickly than prices. We've also talked a little bit about the maintenance loan aspect of this. And you’ve also shown, haven’t you Ben, that what's happened to that because of the lack of indexation over a long period is that its real value has fallen significantly.

Ben Waltmann:

Maintenance loans in the coming academic year are going to be around ten percent less in real terms compared to maintenance loans in the 2020/21 academic year. All of that is actually not due to explicit government policy, it's due to a forecast error - Inflation has surprised on the upside, it's going to be bigger than what's forecast and the actual maintenance loan increase is based on these outdated forecasts. So, that means just because of a sort of technical problem, students from the poorest families are going to be a £100 a month, roughly, worse off than they would have been had the forecasts been correct. So, actually, these are quite substantial cuts.

Paul Johnson:

Those really are substantial changes. So broadly speaking, we've got a set of changes coming which, for one reason or other, reduce the incomes of students as they're in university, and then going forward, on average higher repayments because the threshold is coming down and the period of repayment is being pushed out and indeed, the rate at which that threshold is increased is being reduced relative to what was intended.  

There's one group who are going to win from this, though, isn't there? Which are those on the very highest incomes, who would have repaid anyway, and they're going to benefit from this reduction in the interest rate. But I want to come on to Ivor and ask you about the other end of this formula, which is what's happening to university funding because the tuition fee, the tuition loan has been stuck at - was introduced at £9,000 a decade ago now, has increased to £9,250 and has been frozen ever since and is now due to be frozen for several more years. What's your view Ivor, about the adequacy of that as far as universities are concerned?

Ivor Crewe:

Clearly, if you freeze the tuition fees, then this is essentially, particularly in a period of our significant inflation, is a real cut in the funding of universities, to the extent that universities depend for their finances on the tuition fee of home full-time undergraduates. The Augar Review looked very hard at the case for, in fact, cutting the maximum tuition fee from £9,250 to something like £7,500. Which was, in fact, what was recommended, but on the assumption that there would be compensatory funding of universities from central government for teaching. The government has ignored that recommendation, I think partly because it doesn't really need to implement it. The rate of inflation is such that the real value of the tuition fee at the end of its period of freezing will be, in fact, probably less than £7,500, somewhat less than £7,500, in real terms. And there's no doubt that this is going to put a significant number of universities under real financial pressure and they're going to have to change their business models. Some universities will seek to compensate for this loss by recruiting even more students from overseas, universities are free to charge whatever fee they like to students from outside the UK. I think other universities, those that will struggle most under the frozen tuition fee, would probably try to increase their revenues by pushing further into education for part-time students, education for mature students, and probably try to do this in partnership with local further education colleges and institutes.

Paul Johnson:

Which I guess maybe no bad thing if it results in some change in some entrepreneurial activity you might say, in the university sector. But it’s very striking that again, their just allowing, or the government's just allowing inflation to do a job for it in a rather unplanned and unintended way. The amount we're giving to universities in real terms is just going down year on year and the amount it goes down depends on the level of inflation in that year and as you say, that's a big cut this year with inflation at eight percent or so.

Coming onto the student loans, you wrote that the reforms you just described as a leap into the unknown. In what sense are they a leap into the unknown?

Ben Waltmann:

There's various incidences in which that's the case. I think the first one I'd want to highlight is that this is really quite a radical reform. There are big changes, and those changes actually make England more of an outlier internationally because other countries tend to rely more on direct taxpayer funding rather than on a loan system. We just don't know what that will do in terms of affecting participation of students, especially students with lower earnings expectations.

Paul Johnson:

But the key point here is that these changes reduce the taxpayer subsidy because more students will be paying back their loans in full.

Ben Waltmann:

That's correct. The lower middling earners are the ones who are going to be most affected, certainly by the reforms that take effect from the 2023 cohort onwards because they are going to have to payback in full or nearly in full, whereas before they would have paid back relatively little. So, we don't know to what extent prospective students are going to react to that. So, in that sense, it's a leap into the unknown.  

It's also a leap into the unknown for the taxpayer, because even more than before the reform, the cost of the system is going to depend on what will happen in many decades time. That's the result of policy choices the government has made. So, one reason is the forty year repayment period, and graduate earnings are going to matter even further into the future. Another aspect is the threshold indexing change. This way of indexing the threshold through RPI inflation rather than average earnings means that how much the government gets back depends more on how the economy develops in the future. There's also a sort of, a very nerdy way in which this makes the taxpayer cost more uncertain, which is that for the public finances, the way future repayments get valued actually depends on the student loan interest rate. And so a lower interest rate means that predicted repayments far in the future are now valued more, and those are more uncertain when it comes to accounting for student loans that feeds into things like the deficit.

Ivor Crewe:

I mean, if I could just add something to that, it's absolutely true that this is a leap into the unknown. I think this is quite inevitable if one is modelling the impact of changes to the loan system than it is unavoidable that you make assumptions about such things as the future trend in earnings or changes in government policy. But one of the things I think we've discovered from this system of income-contingent loans is that it is always open to the government to tweak the system if it finds that predicted returns are different from those that had initially assumed. This is what the government has done ever since the new system was introduced in 2012 when fees went up to to £9,000. So if, for example, the taxpayer subsidy of the loan system continues to go up, or if it doesn't go down as much as the government wants, it's open to the government to reintroduce interest rates or to lower the threshold at which loans start to be repaid, or indeed to extend the repayment throughout the life of a graduate.

But equally, if the government finds, as I think a future government might find, that there starts to be voter resistance amongst the very large number of graduates who are having to repay their loans to the size of those loans, it's open to the government to cut those loan repayments in various ways. And I can quite envisage in the future that just as currently the political parties engage in competitive bribery of voters on income tax, they might start trying to bribe voters competitively on student loan repayments

Paul Johnson:

Absolutely. It seems to be two really important points in here, as one thinks about the student loan system. The first is just this new structure, which is supposed to involve students repaying over forty years and it came alongside some very precise numbers about what that would do to the public finances and how much it would cost the government and so on. I mean who knows what's going to be happening in forty years? I mean, we could have another pandemic and other financial crash or more likely some other series of catastrophes to follow on those that we've had over the last decade. Or maybe earnings will zip along in the way that they did in the forty years before the financial crisis. The honest truth is, we have absolutely no idea, so basing policy on the expectation of where the world will be in forty years is at best a leap of faith.      

And then there's that second point, which both Ben and Ivor are making, which is that even if the world pans out as planned, the government certainly won't. I mean, we've had three, four or more significant changes to the system that was introduced in 2012. The idea that the system that has just been legislated will still be in place unchanged in the early 2060s, is completely and utterly for the birds, and that's one of the many ways in which it strikes me that this system does not bear much resemblance to what we normally understand as a loan system because the government can and indeed does simply change the rules retrospectively at whatever point it feels like doing so.  

Before we finish, it will be good to start talk a little bit about the broader issues around higher education finance. And in particular this question of whether we have the right number of young people going to university at the moment, should we have fewer, should we have more, and how that relates to other parts of the post compulsory education system in the UK. Now we don't have time to talk about that in any detail, but it was an important part of the Augar Review. So, Ivor, just if I can ask the crass question as it were, should we have more or fewer people going to university?

Ivor Crewe:

Well, if you'll forgive me, it is a slightly crass question or as philosophers would put it, I think it involves what they call a category mistake in this sense. But the right question to ask, I think, is should we have more or fewer people engaged in post-eighteen education, high quality post-eighteen advanced education, either when they leave school, or college at the age of typically eighteen or at a later stage in their life. And if that's the question that's asked, then to me, I think it's very clear that both the economy and society as well as people themselves, would benefit from there being greater access to post-eighteen education. Whether that takes the form of the traditional full-time, undergraduate degree at university, or whether it takes the form of advanced technical qualifications which perhaps are not taken at university that are taken in further education colleges, or takes the form of graduate apprenticeships. There is pretty convincing and consistent evidence now that the better educated a society is, the higher the productivity in that country and also the greater social solidarity. That is it is good for the economy, and it is good for society to have a better educated workforce.

There's a separate question as to whether the standard three year university degree taken by people aged between eighteen-twenty-one is the best form of that education and it clearly isn't for quite a large number of people. The Augar Review was very clear that the fifty percent approximately of the young population who didn't go to university were being short changed, they didn't have enough opportunities for training and for technical education. They were not incentivised to do anything other than go to university, too many of them were leaving a school without adequate qualifications for the labour market, and this was both to their detriment and to the detriment of the country as a whole. I don't think we have yet cracked the problem of how we can persuade many more people both on leaving their school education or at a later stage in life, how they can be persuaded and supported to continue with an advanced education, even if that doesn't involve degree level subjects. I don't think the government has yet really found the right policies to do that, and I think they need to.

Paul Johnson:

We can spend a lot of time on that particular issue and it's one that I'm quite passionate about, not least because one of my, as regular listeners to this series will know, one of my sons didn't go to university, did an apprenticeship and is doing extraordinarily well as a result of doing that.

But just to round off, Ben, on this question of the numbers going to university, can you just summarise very, very quickly some of the key findings from your work on the extent to which actually it looks like quite a number of people don't, at least in earnings terms, benefit enormously from going to university at the moment.

Ben Waltmann:

On the whole, university is financially a good investment for most students. Around eighty percent of students, we think, do benefit financially from the undergraduate degrees and that's all things considered, including the student loan system and the tax system. That being said, some don't and they are especially concentrated in certain subjects. There are a few subjects, such as most importantly, creative arts degrees, which don't tend to have a large financial payoff and for many students might even reduce their earnings going forward all things considered.  

On the other end of the scale, there are a lot of subjects where the financial payoff is very large indeed, such as economics or medicine or things like law and business. And what we found is that it is not - you know, subject seems to be the most important element here, and it's importantly not background of people that place such a big role. So, university can be right for people from all backgrounds and can pay off financially for people from all backgrounds. If you do creative arts, don't expect a big earnings return but of course, that doesn't mean it's not worth doing, and there are many other reasons other than earnings to get a university education.

Paul Johnson:

Absolutely. I really wish I was somewhat more creative and artistic than I am. Well, look, thank you both for that. I mean, that was a remarkable run down of some of the changes we have to the higher education finance system over the last decade, some of the proposals and reasons for proposals to reform that Ivor and his colleagues put forward and what's actually happened as a result of government response to that. All of which boils down to a squeeze on university funding for sure, because the tuition fees are not being changed, are not going to be changed for a long time. More repayments from middle income graduates into the medium run and over a long period. And what I think we can all agree is a great deal of remaining uncertainty, and that despite the government's claims that this is setting out the policy for the next forty years, I would put literally zero probability on that, actually turning out to be the case. If there are any actual potential students listening, hopefully that gives you some sense of how things are working, but also actually the huge differences between different graduates. We talk about the graduate loan system, we talk about universities, but the courses on offer and the returns in terms of earnings to those and indeed the types of people going are all very, very different. And maybe we'll come back to explore some of those differences in the future edition.  

If you did enjoy this one, do go back and listen to a previous episode of the podcast where we talked to Alison Wolf, the government's advisor for a long time, on all things further and higher education, and Jack Britton, who has led work on higher education at IFS for a long time. You can find a link to that in this episode description.

Thank you so much for listening. To find out more do visit www.ifs.org.uk, and please consider donating to the IFS by heading to that website forward slash donate. You can find further information again in the episode prescription.

Thank you and stay well.