Financing higher education: What’s right, what’s wrong, what next?

Financing higher education: What’s right, what’s wrong, what next?

Nicholas Barr and Alison Johnston

European Institute Lunchtime Seminar

LSE, 12 May 2009

Nicholas Barr May 2009 2

Financing higher education: What’s right, what’s wrong, what next?

1 What’s right?2 What’s wrong?3 Fixing the problem


1 What’s right?


1.1 Lessons from economic theory


Lesson 1: Competition between universities helps students

• Does competition work? Yes when consumers are well informed

• Are consumers well informed?– Students mostly a savvy, streetwise bunch– Much information is available and more can and should be made

available– Good information is a central source of quality assurance:

• On the student experience• On teaching• On employment outcomes

• Are all students well informed? No. Information problems for students from poorer backgrounds contribute to debt aversion

• The same body of theory leads to a very different conclusion for school education


Lesson 2: Graduates (not students) should share in the costs

of their degree• Higher education creates external benefits:

• Growth, social participation• Thus right that society (aka taxpayer) should contribute

• But also significant private benefits in financial terms, but also in nonmonetary terms, e.g. job satisfaction

• Thus right that beneficiaries should share some of the costs• BUT students generally cannot afford to pay• Thus need a way that students can get it free, but graduates

repay – loans


Lesson 3: Well-designed loans have core characteristics

• Income-contingent repayments, i.e. calculated as x% of graduate’s earnings

• For efficiency reasons, to reduce uncertainty

• For equity reasons, to promote access, since loans have built-in insurance against inability to repay

• A genuine loan

• Large enough to cover all fees and realistic living costs; thus higher education free at the point of use

• An interest rate related to government’s cost of borrowing


Loan repayments in the UK (2006 scheme)

Bill Tariq Tim Jane

Annual earnings £15,000 £20,000 £30,000 £50,000Income tax (monthly) £161.19 £252.86 £436.19 £945.58NI contributions (monthly) £91.26 £137.10 £228.76 £274.93Loan repayments (monthly) £0.00 £37.50 £112.50 £262.50

• Low earners make low or no repayments• Repayments automatically and instantly track changes in

earnings, exactly like income tax and national insurance contributions

• Loan repayments are generally much smaller than income tax or national insurance contributions


1.2 A strategy for financing universities and students


Leg 1: paying for universities: deferred variable fees

Variable fees

• Promote quality• by bringing in more resources, and

• by strengthening competition, creating incentives to use those resources efficiently

• Are fairer than any other method


Leg 2: student support: free at the point of use

• Loans should be• Adequate, i.e. large enough to cover all fees and all living

costs

• Universal: all students should be entitled to the full loan

• As a result• Higher education is free at the point of use

• Students are no longer poor

• Students are not forced to rely on parental contributions, extensive paid work or expensive credit card debt


Leg 3: active measures to promote access

• Widening participation• Raising attainment• Improving information/raising aspirations• Money measures


2 What’s wrong?

Two wrong interest rates• Zero real rate

• I.e. interest rate equal to the inflation rate, lower than the rate at which the government borrows

• This is the rate on UK student loans

• ‘Commercial’ rate• I.e. the rate on individual unsecured loans• This is the rate charged on credit cards, bank

overdrafts, etc.


What is wrong with a blanket interest subsidy?

A zero real interest rate• Is enormously expensive, at least £1.2 bn per year

(roughly 10% of total higher education budget of £12bn)

• Impedes quality. Student support, being politically salient, crowds out the funding of universities

• Impedes access. Loans are expensive, therefore rationed and therefore too small

• Is deeply regressive, the main beneficiaries being successful professionals in mid career


Why interest subsidies are regressive

• An interest subsidy in a conventional loan helps people with low earnings

• But in the UK student loan scheme• Loans have income-contingent repayments

• There is forgiveness after 25 years

• These 2 features turn the conventional argument upside down


Who benefits from interest subsidies?

• Students?

• Low-earning graduates?

• High earning graduates with low early-career earnings?

• High earning graduates?


3 Fixing the problem


What should be done?• The blanket interest subsidy should be replaced by

targeted interest subsidies• The default interest rate should be related to the

government’s cost of borrowing• Targeted interest subsidies should prevent real debt

rising for• People with low earnings

• People with caring responsibilities

• Use at least part of the savings for policies that really widen participation


Specific policies to increase repayments

• Higher monthly repayments

• Increased duration of repayments


Specific policies to increase repayments

• Option 1: Higher monthly repayments• Repayment rate: 10%, 11% and 12%

• Repayment threshold: £13,000 and £10,000

• Option 2: Longer repayment 1: charge a real rate of interest equal to the government borrowing rate

• New Zealand variant system: annual unpaid interest is forgiven

• Option 3: Hybrid system • 1%, 2% and 3% interest rate coupled with 10%, 11% and 12%

repayment rates

• Option 4: Longer repayment 2: an extra n years


Calculation of interest subsidies

• Use an average graduate real salary path, calculated from the Institute of Fiscal Studies

• Starting salary £20,000• Assume that the Government borrows at a 3% real

interest rate• Students graduate with SLC debt of £25,126• Based on these assumptions, we estimate the

current interest subsidy to be 28% of the loan, or £7,040 per average graduate


Results: Options 1-3

• Higher monthly repayments by changing the repayment formula is not highly effective (20% of the subsidy remains even under the most stringent conditions modeled)

• Combining higher monthly repayments (changed repayment formula) with longer duration (charging a positive real interest rate) provides more significant reductions


Interest Subsidy Per Average Graduate (% of Total Loan)

1% realinterest

Rate

2% realinterest

rate

3% realinterest

rate

9% repaymentRate

20

(£5,030) 11

(£2,760)2

(£500)

10% repaymentRate

19(£4,770)

10(£2,610)

1(£330)

11% repaymentRate

18(£4,520)

10(£2,450)

1(£230)

12% repaymentrate

17(£4,270)

9(£2,260)

1(£180)


Results: Option 4• Progressive repayment extension: individuals who

repay their loan in less than 10, 15 or 20 years, have an additional 3, 2, 1 years of repayment, respectively

• Has political and administrative advantages not present in other options

• Reduces the interest subsidy to approximately 7% of the original loan (for the average graduate)

• If the average graduate pays an additional 3 years instead of 2, the loan subsidy is completely eliminated


ReferencesVidha Alakeson (2005) , Too Much, Too Late: Life chances and spending on

education and training, London: Social Market Foundation. Nicholas Barr (2002), ‘A way to make universities universal’, Financial Times,

22 November 2002, p. 21, downloadable from www.econ.lse.ac.uk/staff/nbNicholas Barr (2004),‘Variable fees are the fairer route to quality’, Financial

Times, 30 March 2004, p. 21 downloadable from www.econ.lse.ac.uk/staff/nb

Nicholas Barr (2004), The Economics of the Welfare State, 4th edn, OUP Nicholas Barr (2004), ‘Higher education funding’, Oxford Review of Economic

Policy, Vol. 20, No. 2, Summer, pp. 264-283.Nicholas Barr and Iain Crawford (2003), ‘Myth or magic’, Guardian, 2

December 2003, pp. 20-21, downloadable from www.econ.lse.ac.uk/staff/nb Nicholas Barr and Iain Crawford, Financing Higher Education: Answers from

the UK, Routledge, 2005.Nicholas Barr and Alison Johnston (2009), ‘Interest subsidies on student loans’,

in progressOECD (2008), Tertiary Education for the Knowledge Society, Volume 1:

Special Features: Governance, Funding, Quality and Volume 2: Special Features: Equity, Innovation, Labour Market, Internationalisation, Paris: OECD.

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Financing higher education: What’s right, what’s wrong, what next?