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

1. Financing higher education: What’s right, what’s wrong, what next? Nicholas Barr and Alison Johnston European Institute Lunchtime Seminar LSE, 12 May 2009

2. Financing higher education: What’s right, what’s wrong, what next? • What’s right? • What’s wrong? • Fixing the problem Nicholas Barr May 2009

3. 1 What’s right? Nicholas Barr May 2009

4. 1.1 Lessons from economic theory Nicholas Barr May 2009

5. 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 Nicholas Barr May 2009

6. 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 Nicholas Barr May 2009

7. 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 Nicholas Barr May 2009

8. Loan repayments in the UK (2006 scheme) Bill Tariq Tim Jane Annual earnings £15,000 £20,000 £30,000 £50,000 Income tax (monthly) £161.19 £252.86 £436.19 £945.58 NI contributions (monthly) £91.26 £137.10 £228.76 £274.93 Loan 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 Nicholas Barr May 2009

9. 1.2 A strategy for financing universities and students Nicholas Barr May 2009

10. 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 Nicholas Barr May 2009

11. 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 Nicholas Barr May 2009

12. Leg 3: active measures to promote access • Widening participation • Raising attainment • Improving information/raising aspirations • Money measures Nicholas Barr May 2009

13. 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. Nicholas Barr May 2009

14. 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 Nicholas Barr May 2009

15. 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 Nicholas Barr May 2009

16. Who benefits from interest subsidies? • Students? • Low-earning graduates? • High earning graduates with low early-career earnings? • High earning graduates? Nicholas Barr May 2009

17. 3 Fixing the problem Nicholas Barr May 2009

18. 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 Nicholas Barr May 2009

19. Specific policies to increase repayments • Higher monthly repayments • Increased duration of repayments Nicholas Barr May 2009

20. 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 Nicholas Barr May 2009

21. 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 Nicholas Barr May 2009

22. 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 Nicholas Barr May 2009

23. Interest Subsidy Per Average Graduate (% of Total Loan) Nicholas Barr May 2009

24. 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 Nicholas Barr May 2009

25. References Vidha 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/nb Nicholas 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 progress OECD (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. Nicholas Barr May 2009