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.

Caution: Data in use

Data are the lifeblood of analytical research. If it were not for people willing to go out and track the positions of the stars in the sky, the theories of Nicolaus Copernicus would remain unproven and we would be operating on the misconception that the Earth was the centre of the universe. Albert Einstein would just be another clever theorist with some whacky ideas unless people were able to validate his theories by observation and measurement. On a more prosaic level, data matters hugely for modern policy issues as we need some form of benchmark against which to judge whether a policy is working.

As an economist I spend my professional life assessing economic issues on the basis of the evidence in front of me. I may not always be able to foretell the future but I can make a pretty good fist of understanding what is going on based on the data at my disposal. The data may not always be accurate or may be distorted by factors which hide the true message and one of the keys to decision-making is to understand how the evidence is compiled upon which decisions are based. This matters because decisions taken on the basis of faulty data risk making outcomes even worse. Two pieces of evidence released this week highlight the problems inherent in making policy based on uncertain data. 

(i) Covid data

The first instance is the measurement of Covid-19 deaths in England. It is well known that the UK has reported the highest number of deaths in Europe. But what is less well known to the casual observer is the figures assume that once a person is diagnosed as Covid-19 positive, their eventual death will be attributed to Covid-19, irrespective of the manner of their demise and how long after the initial diagnosis. For example, if a person was diagnosed as Covid-19 positive this year but dies a year later as a result of a grand piano landing on their head, they will technically still be classified as a Covid death. The rationale for this approach was that the authorities did not know much about the incubation period of the disease and did not want to be accused of under-reporting mortality figures in the early stages of the pandemic. Incidentally, this explains why, in contrast to many other countries, the UK did not report figures on recoveries. Once you have had the disease, that’s it – you are marked for life.

Obviously this is not particularly sensible. Consequently Public Health England this week imposed a limit of 28 days from diagnosis as the basis for measuring Covid-19 mortality, bringing it into line with Scotland, Wales and Northern Ireland – and indeed the international consensus. This makes a lot of sense: Broadly speaking, if you have not died 28 days after diagnosis, the odds are very much in favour of you remaining alive. This also changes the UK’s position in an international comparison. By my reckoning, the mortality rate is reduced from 70 per 100,000 of population to 62, which is much closer to the figures for Italy, Sweden and Spain. The UK still has the fifth highest global number of deaths but it no longer looks quite the outlier that it did earlier this week. Not that this is to excuse the government’s many failings in the way it handled the Covid pandemic, but by treating the figures on the same basis as other countries we have a more fair picture of how the UK stacks up in an international context.

(ii) Assessing exam data

The second data issue concerns the way in which school leavers’ ‘A’ level results were graded following the cancellation of this year’s exams. For those readers outside the UK, I should point out that the reporting ritual of exam results has become a staple of August news bulletins when there is nothing else for the media to focus on. Until recent years, the cry was that exams were becoming too easy and too many students were achieving top grades. In response to this media outcry, the marking was toughened up. So you can imagine the field day the media have had when it was impossible to hold exams at all.

There was never a satisfactory way to go about assessing what grades students would have achieved in the absence of exams. The starting point was to ask teachers to predict grades, but as Ofqual (The Office of Qualifications and Examinations Regulation) pointed out  teachers tend to offer optimistic predictions of their students’ ability. Teachers were thus also asked to provide “a rank order of students for each grade for each subject” on the basis that empirical evidence suggests people are better at making relative judgements than absolute judgements. Having collated all the evidence, Ofqual concluded that this would “likely to lead to overall national results that were implausibly high.” Accordingly, it had to find a way of normalising the results.

Unfortunately the model it chose is primarily based “on the historical performance of the school or college in that subject.” Even allowing for numerous tweaks, the system contains built-in discrimination against bright students from schools which in the past may not have delivered great exam results and is particularly biased towards independent schools which have a tendency to deliver above-average results. Ofqual argues there is “no evidence that this year’s process of awarding grades has introduced bias.” The data suggest otherwise: The number of A and A* grades awarded to independent schools increased by 4.7% compared to 2019, whereas the increases awarded to sixth form colleges, which tend to be attended by more disadvantaged students, was just 0.3% (chart). The data also show that the most disadvantaged students were more likely to have their predicted grades marked down: The proportion of pupils achieving a C or above fell by 10.4 percentage points among the most deprived third of pupils, compared to 8.3 percentage points among the wealthiest third. For anyone interested in an expert view of the problem, this series of Tweets is worth a read.

For a government that is trying to level up the life chances of those outside the south east of England (if you recall that was the promise in the 2019 election campaign) the 2020 exam process seems to be an odd way to go about it. Moreover, to the extent that young people’s exam results are one of the benchmarks which determine which university they attend, which in turn has a bearing on their future employment prospects, the importance of their exam results matters. Unfortunately, it is difficult to justify the rationale behind the algorithm which predicts exam grades thus devaluing their usefulness as a predictor of student ability. This in turn means that the data generation process becomes more important than the data which it turns out and is an example of why we should not always take data used to feed into policy decisions at face value.

As for the students, it is hard not to feel sympathy for them. They may or may not have gone on to achieve the grades predicted for them. But had they fallen short during the exams, they would at least have done so on their own terms. As it is, they have had grades imposed upon them by what appears to be a flawed data generation process, and judging by the popular outcry, it is not a decision that has played well with the public.

Education: Assessing the costs and benefits

The provision of education services, like health, is one of the things that the state does well. Never mind the fact that both are available in the private sector: The vast majority of us at some point or another rely on the state provision of both. But as is usually the case with such services they have also been used as footballs to satisfy various political ends. Since spending on the NHS is such a large part of government outlays, representing around 16% of total outlays, it is a subject I have covered on previous occasions (here, for example). Education also accounts for a not-insignificant proportion of spending – around 7.5% – and it is thus worth looking at some of the issues surrounding it.

My curiosity in this area was piqued by the announcement last December that the ONS is to apply a new treatment of student loans in the national accounts and public finance statistics which will have some profound effects on the data when the figures are rolled out later this month. The reason for the change is a sensible approach to tackle the fiscal illusions caused by their treatment in the accounts. But first, a bit of explanation is in order.  Student loans were first introduced in 1990 as a means of allowing students to cover their living costs. In 1998, they were extended to include loans to pay tuition fees, but in 2012 universities were permitted to increase the cap on tuition fees from £3,000 per year to £9,000 which raised the amount that students were permitted (required) to borrow. Many students can be expected to graduate with debts of around £50,000. They are expected to repay these loans over the first 30 years of their working lifetime, so long as their annual income exceeds £25,000, with interest charged at a rate of 5.4% (down from 6.3%).

As one who is old enough to have received a public grant to study at university, it strikes me as an egregious example of intergenerational unfairness and is a clear example of the law of unintended consequences. One of the reasons why the cap on tuition fees was bumped up in 2012 was to create a market amongst universities in which they could compete for students on price grounds. However, all universities decided to charge the maximum amount in order that their offerings were not perceived as inferior goods. It thus costs the same to study at Oxford or Cambridge as at Bucks New University.  The model has thus failed. It also does not make sense to me why today’s graduates, who still enjoy a wage premium over their non-university educated peers, should not simply pay higher tax generated by their well-paid jobs to repay the costs of their education as my generation did. I will accept that there may be fewer well-paid jobs about today, but the point still stands. Today’s students are being taxed twice: Once for the direct costs of tuition, where loans are charged at an interest rate 465 points above Bank Rate, and once for the higher wages which a university education (theoretically) generates.

Before coming back to the issue of student loans and public finances, an excellent article in The New Statesman questioned the impact of grade inflation on university education. This is, of course, not to denigrate the hard work that a lot of people put in to obtain their degree. But when 24% of students obtain the highest classification compared to around 7% in the mid-1990s, it is difficult not to be struck by the conclusion that there is some correlation between the need to give the customers what they want (good grades) and the increasingly extortionate amount that they pay (more on this another time). Education has thus become commoditised in a way that was previously unthinkable.

So what does all this have to do with public finances? As it currently stands, student loans are recorded as conventional loans in the national accounts – in other words, they are a public sector asset. But given the amount that students are forced to borrow and the almost usurious interest rate, coupled with the salary threshold, a large proportion of the loans will never be repaid within the 30-year timeframe. The Department of Education reckons that between 60% and 65% of the amount outstanding will have to be written off (other estimates suggest this figure could rise to 80%). Since it was never intended that the full amount of loans be repaid, it is therefore nonsensical to treat them in the public accounts as though they will be.

Accordingly, the statisticians will in future treat part of the amount outstanding as genuine loans whilst the rest will be classified as government expenditure. This will raise annual public borrowing by around £10.5 billion (~0.5% of GDP) and add almost £60 billion, or 4%, to national debt (2.7% of GDP) – see chart. It will therefore be interesting to watch out for comments around 24 September when the new data are released, arguing that the government has somehow been massaging the figures (it hasn't, but the accounting treatment has left something to be desired). However, at a time when the government has recently announced a big increase in public spending, it is clear that forecasts of UK government borrowing will be revised sharply higher in the months ahead. 

Nor is the student debt issue confined only to the UK. A VOX blog post looked at the situation in the US, where the market is far less forgiving, and concluded that high student debt burdens have a major impact on the behaviour of the debtors. Borrowers’ are constrained in their ability to take high-risk/high pay jobs “because they need to pay these loans and prefer more stable income” and find that their mobility is constrained as a result. The research also finds that “borrowers benefiting from debt relief … are also significantly less likely to default on their accounts, above and beyond their student loan accounts.”

The build-up of student debt has major implications for the wider economy and public finances. But to the extent that there are significant social externalities associated with education that have long been recognised but are difficult to measure (better heath, reduced tendency towards crime etc.), there is an argument that the government has an incentive to bear at least part of the costs of provision. In the current system where the cost burden is placed squarely on the consumer of education services, this in effect allows governments a free ride on the positive benefits it generates which is something else today's generation of students have a right to feel aggrieved about.

Universities challenged

Concerns over ‘fat cat’ salaries have been a recurrent feature in the UK over the years and the issue has been raised again in the context of the earnings of university vice-chancellors. Although it has been going for a long time, my first recollection of the popular outrage associated with excessive pay was in the mid-1990s when Cedric Brown, chief executive of the formerly state-owned British Gas, was criticised for his £500k annual pay packet (equivalent to £900k today). The outrage was not so much the amount he was paid – after all, he was ranked in the middle of the range for FTSE 100 CEOs of the time – as the fact that senior managers in formerly state-owned utilities enjoyed massive increases in pay following privatisation. 

Nonetheless, it struck at the heart of the debate over the nature of market economics. The Conservative government of 1979-1997 turned state monopolies over to the market and a lot of UK households, which bought British Gas shares following its 1986 privatisation, benefited handsomely from the surge in share prices that followed. Yet still there was outrage (manufactured or otherwise) over the fact that world class companies competing in a tough global market should have the temerity to pay their management salaries commensurate with that position.

Fast forward more than 20 years and elements of the same debate are evident in the current furore regarding the salaries paid to vice-chancellors at British universities. These are very senior management positions, equivalent to the post of chief executive who essentially oversee the management of the institution. According to a survey by the University and College Union published in February, university bosses received an average salary package of £278k in the academic year 2015/16 which is “an increase of 2% on the previous year and 6.5 times the average pay of their staff.” Whilst a 2% rise sounds modest, it is double the rate of the average university employee and comes after several years of faster increases: In 2014-15, for instance, average remuneration including pensions jumped by 5.4%.

Some universities rewarded their chief executives exceptionally well: The best paid vice-chancellor was at the University of Bath who received a compensation package of £451k (an 11% increase on the previous year). Even more rapid rates of increase were reported elsewhere, with the vice-chancellor at Bournemouth University getting a 19.6% pay rise whilst Ulster University raised the value of total compensation by 16.6%. Pay increases of this magnitude have raised a lot of political eyebrows. But as has been pointed out in a number of quarters, the current government has gone a long way towards creating a market for education so should they be surprised when market forces operate in the market for talent capable of managing in the cut-throat university sector?

What has changed in UK universities in recent years is that the state provides far less direct funding than previously, with only around a quarter coming from the public purse. University managers have to rely far more heavily on private sector sources to drum up business – in other words, they have to be far more commercially minded than previously. But the main source of funds comes from tuition fees which account for around 45% of university income. UK students now have to pay up to £9,000 per year for tuition, which for most is funded via a student loan. Once we add living costs such as food and accommodation, many students can expect to graduate with up to £50,000 of debt. As monopoly suppliers of higher education, there are those who argue that universities are exploiting their clients and paying their senior management handsomely into the bargain. It certainly is not a satisfactory situation when viewed from the position of a young student who will struggle to get a well-paid job on graduation which comfortably covers their living costs and repayment of student debt (let alone some form of long-term savings plan).

Another often overlooked fact is that UK universities enjoy charitable status. Indeed, English institutions are even exempt from registration with the Charity Commission because “they were considered to be adequately supervised by, or accountable to, some other body or authority, such as Parliament.” Scottish and Welsh universities are required to register for some reason. Nonetheless, all of them are designated as non-profit organisations whose primary purpose is to promote social well-being and serve the common good. This means that the vast majority of university income is exempt from corporation tax though they do pay VAT on certain items and are liable for payroll taxes. To give some perspective, Cambridge University paid £3 million of tax in fiscal 2015-16 on profits of £287 million (including investments) and the University of Manchester paid £2 million on earnings of £61 million, both of which are lower tax rates than paid by the much-maligned Google (20%) and Amazon (41%).

The vice-chancellor of Oxford University recently expressed the view that university managers deserve their pay packages because they operate in the “global marketplace” for talent. I have no doubt that they are good at their job, but given the tax status under which universities operate and the fact that in effect these big packages are being funded by students, this came across as a very self-serving statement (and was indeed disowned by many of her Oxford colleagues).

Nobody denies that the challenges of running a university are far greater today than even ten years ago. But academic institutions are not private sector profit maximising organisations – they are non-profit organisations which still rely on the state for part of their revenue – and to argue that university bosses are poorly paid compared with footballers may be true, but the only way to earn a footballer’s obscenely high salary is to be good at football. Indeed, perhaps universities are just the latest in a line of businesses to demonstrate that the pure application of market forces can result in perverse outcomes which benefit managers at the expense of customers.