The case for curbing student debt

The student debt burden is increasingly a hot topic in US politics. It generates less mainstream attention in the UK but the Covid crisis, in which many students questioned whether they were receiving value for money from the system, has thrown the issue into sharp relief. Over the last decade, the UK government has slashed university funding in a bid to shift risk off the state balance sheet and force individuals to bear more of the costs. As a result students have had to shell out a lot more to fund their university education and have acquired large amounts of debt in the process. This contrasts with much of the rest of Europe where university education is viewed as a public good and the state contribution is far higher. But with UK student debt levels continuing to spiral higher, there is increasingly a case for reforming the funding system.

Counting the cost

A plan for student debt forgiveness was one of Joe Biden’s campaign promises. Self-funding has traditionally played a big role in the US system in which students take out loans, primarily from Federal government, and pay it back over time. There is a range of payback options depending on the type of loan taken out, but the general idea is that loans are repaid over 20 years for undergraduate degrees or 25 years for graduate programmes and any outstanding balance after this point is written off. As education costs have risen in recent years, there has been a huge increase in the amount of outstanding debt. In 2006 the volume of outstanding debt stood at $481 bn (3.5% of GDP). By the end of 2020 this had ballooned to $1.7 trillion (7.9% of GDP, chart 1).

Similar trends are evident in the UK - indeed are even more pronounced. But whereas the US has traditionally relied on students funding their own way through college, it is only in the last decade that this has gained momentum in the UK. Between 1962 and the 1990s higher education in Britain was effectively free and student debt was correspondingly low. In fiscal 1995-96 total outstanding student debt amounted to just 0.2% of GDP. Latest figures to FY 2019-20 put the figure at 6.3% (since 2006, the data have referred only to students domiciled in England so we should use GDP for England as the denominator which takes the ratio to 7.3%, chart 2). The rise in the UK is primarily attributable to the strategy introduced in 2012 to cut government funding for tuition and force students to bear these costs up to a maximum of £9250 per annum (this is not the case in Scotland where tuition is free). Once borrowing to fund living costs is taken into account, UK students graduate from university after three years with debts averaging £47,000 which compares with an average starting salary of £29,000.

Payback terms are also onerous. The interest rate on debt is benchmarked against the discredited RPI measure of inflation, which on average runs around 0.5 percentage points above the CPI rate which the BoE targets for monetary policy purposes. Those earning less than £26,568 per annum pay an interest rate equal to RPI inflation (in fiscal 2020-21 this was set at 2.6%). Above this threshold, students are charged a mark-up over RPI which rises as high as 300 bps for annual salaries of £47,835 or above. This currently implies a sliding scale for debt interest charges between 2.6% and 5.6% versus a current BoE policy rate of 0.1%. Moreover, British students (or more accurately those in England) have to keep paying for 30 years after graduation before they are eligible for debt forgiveness, compared to 20 years in the US.

The extent to which debt is paid down over the first 30 years of employment depends on salary and the rate of inflation. Debt principal payments are charged at a rate of 9% of gross salary above the lower threshold. Thus, if a student takes a job paying the average salary (£29,000) they pay £219 (.09*(29000-26568)) in the first year. But if inflation is greater than zero the interest on the debt will exceed this figure so the total value of outstanding debt rises. We can roll the analysis forward, changing the inflation and wage growth assumptions to derive a range of scenarios (chart 3). In the best case the student debt repayment schedule looks like a mortgage curve, with little movement over the first half of the period followed by a sharp reduction over the second half. In many instances, however, the accumulated debt is not repaid after 30 years and it ends up being written off.

This model stands in stark contrast to most parts of Europe where student fees are negligible – in Germany tuition is free whilst French universities levy a peppercorn charge averaging €170 per year for most undergraduate programmes. They can afford to do so because the government provides a huge amount of support to higher education establishments. An international comparison is provided by OECD data which shows that as of 2017 the public sector accounted for 77% and 83% of spending on tertiary education institutions in France and Germany respectively, with the private sector providing 21% and 15%. In the UK the position is reversed with the private sector accounting for a whopping 71% and the state just 25%. Indeed, the UK’s share of funding derived from the private sector is the highest in the OECD – even higher than the US at 65%. 

Reforming the system

There are major question marks against a policy which essentially entails a transfer of risk from the public sector to the private sector but from which the public sector expects to benefit. In both the US and UK, generations of people have been told that a university education is the pathway to financial security and upward mobility but this assumption is increasingly being called into question. For one thing the cost of education has risen more rapidly than prices and wages over recent years. Since the turn of the century UK average wages have increased by 75% (annual average increase of 2.8%) but education costs, as measured by the CPI component, have risen by 290% (7%). It is thus becoming ever more expensive to gain a foot on the ladder. An associated problem is credential inflation in which workers have to attain a higher educational standard to access jobs compared to previous generations. This breeds a self-perpetuating cycle in which individuals have to pay more to buy an education for jobs which do not require the level of qualifications which they have so expensively obtained.

Reform is clearly required – a point acknowledged by the government which commissioned the Augar Review to consider changes to the system. Amongst the recommendations were:

• Reducing higher education tuition fees to £7,500 per year
• Increasing the university teaching grant to compensate for the lost revenue
• Extending the student loan repayment period from 30 years to 40 years
• Capping the overall amount of repayments on student loans to 1.2 times their loan 

In my view, there are a couple of other options worth considering: 

• Make the loan interest-free or at least change the interest rate to something closer to the market rate (e.g. targeting a markup over Bank Rate). There is no justifiable reason why the spread between the cost of government borrowing and student loans should be so high
• Offer a tax break on student debt. Students graduating with £47,000 of debt pay an additional 3% of their income towards their student loan once their salary reaches £40,000. At a salary of £60,000 the graduate tax rises to 5%. On the basis that graduates earn more than their non-university educated counterparts, the progressive nature of the tax system ensures they already pay a higher tax rate. Additional taxes eliminate a large part of the graduate earnings premium and the issue needs to be addressed (in fairness, adopting the option above would resolve it).
  

When I looked at this issue in September 2019,  I concluded that there are positive social externalities associated with higher education that ought to be encouraged. Other European countries recognise this by bearing a large part of the costs of provision. But the British system in effect allows the government a free ride on these benefits. The Covid crisis, in which the younger generation has been asked to make sacrifices to shield the older, more vulnerable, members of society has highlighted inter-generational fairness issues (particularly since anyone aged over 50 has benefited from free university tuition). It really is time that the inequalities in the funding of higher education are addressed.