The murky world of student loans, the national debt and a fiscal illusion

Published on 19 February 2018

IFS Director Paul Johnson writes in The Times.

Today we are promised (yet another) review of university tuition fees. Yesterday the Treasury select committee launched its own report on student loans. As a cross-party committee, it shies away from the high politics, but it still makes important recommendations, including reducing the interest rates charged on loans and looking again at the funding of part-time degrees after a collapse in the number of part-time students.

The most interesting part of the report, though, explores the weird and wonderful world of government accounting for student loans. Believe me, this really is fascinating and important stuff. In fact, it is genuinely bizarre. And it may well explain more of current policy than is sensible. So please bear with me.

The first thing you need to understand . . . no, understand isn’t the right word, there is not enough logic here to allow understanding . . . the first thing you need to know is that when the government spends about £14 billion this year on loans to students, government debt rises by £14 billion but government borrowing does not. That £14 billion does not count against the deficit. That’s because the national accounts treat student loans as financial transactions. A loan is issued. It is due to be paid back in the future. There is no impact on the deficit unless and until the borrower fails to pay back.

But wait a minute. The student loan system is not devised even on the basis that all these loans will be paid back. The whole point of the system is that if you don’t earn very much, you won’t pay back very much. It is designed that way for a reason: it helps to ensure that people are not put off attending university. They don’t bear the risk of having to make large repayments from small amounts of earnings. Perhaps 80 per cent of graduates will not repay in full, given existing rules. Jo Johnson, minister for higher education until the recent reshuffle, thinks that under present rules between 40 per cent and 45 per cent of the value of loans will not be repaid.

This is, in fact, reflected in the Department for Education’s own accounts, which are likely this year to write off more than £6 billion of the loans that it makes to students. It is, nevertheless, not reflected at all in government borrowing figures.

In principle, this would all wash out in 30 years’ time when the unpaid loans are finally written off. That is when, formally, any unpaid student debt would be added to the government deficit. Of course, few governments care much about deficits 30 years hence. As the Treasury select committee says, “policy decisions taken today will have no impact on the public finances for the next 30 years . . . £6 billion to £7 billion of annual write-offs are missing from the deficit”.

Yet that’s just the beginning of the story. Things get quite a lot stranger and murkier than that. The government is not actually holding on to the loans; it is selling them. Private investors pay the government for the right to receive the loan repayments. If, perhaps because graduates end up earning more than expected, repayments are higher than expected, then those purchasing the loan book will do well; conversely if graduates have a bad 30 years. Note that this is a purely financial transaction. The repayments are still made through Revenue and Customs in exactly the same way. There is no additional debt collection going on. There is no pretence of gaining any private sector expertise here.

There are two curious aspects to this financial transaction.

First, when this happens, any impact on the deficit simply disappears altogether. The process of selling off student loans, before they are written off, means that the losses are never recognised in the deficit. Magic or what?

Second, this happens despite the fact that the loan book is sold off at way below its value, as recognised in the Department for Education’s accounts. When the first tranche of the present loan book was sold off, at the end of last year, it was sold at a discount of 50 per cent on its face value. An asset valued at £3.5 billion on the Department for Education’s books was sold for £1.7 billion. The main reason for this difference is that government uses a very low discount rate in valuing future repayments, in large part because it can borrow so cheaply. The private sector applies a higher discount rate. But that is just another way of saying that this asset is worth more to the government than it is to the private sector.

So why sell at all? The explanation may well lie with our old friend the national accounting rules. Selling the loans, even for less than they are worth, reduces the national debt as measured in the accounts. That’s because while the value of the loan book is not netted off against the national debt, any cash for which it is sold is netted off. Not surprisingly, both the International Monetary Fund and the Office for Budget Responsibility have described this sort of thing as a fiscal illusion.

In one sense this is all just a bunch of numbers. Who cares what the accounts say? The problem is that this bunch of numbers, rather than underlying economic considerations, can drive policy decisions. We’ve been here before. Both the Private Finance Initiative and the structuring of Network Rail were to a large degree driven by accounting rules. It may be pure happenstance that current policy on student loans minimises their impact on recorded borrowing. Maybe this has had nothing to do with decisions to turn maintenance grants and nurse bursaries into loans. But who could be blamed for wondering whether the accounting rules tail is wagging the policy dog?

Paul Johnson is director of the Institute for Fiscal Studies. Follow him on @PJTheEconomist.

This article was first published by The Times and is reproduced here in full with permission.