It does not require a great deal of imagination to picture the conversation that must take place in living rooms up and down the country. A budding young sixth-former contemplating the merits of a higher education; circumspect parents prophesying the impending financial doom of amassing such large debts at so young an age – ‘Son, university’s all well and good, but is it really worth over fifty grand of debt?!’. How can the thrust of someone’s desire to attend higher education slip unnoticed through the psychological drag elicited by the prospect of such severe indebtedness?
However, student finance is nothing like a conventional loan. And yet, the rather insidious consequence of calling such finance ‘a loan’ is, not surprisingly, that this is exactly how people will think of it. Specifically, they’ll consider their personal liability to be the (often worrying) amount they have borrowed. But this is not their liability. Their liability is nothing other than to pay a fixed proportion of their income, in much the same as income tax, for a period of up to, but not exceeding, 30 years. The misnomer of the student loan has been able to persist for too long.
When most people think of a loan, they undoubtedly have, at the front of their minds, the notion of a common bank loan. The type of arrangement whereby the provider advances you a sum of money and in return you agree to pay a series of fixed repayments for a specified period of time. The size of each repayment varies depending on the amount borrowed, the term of the loan, and the interest rate charged. For a given term, the greater the amount borrowed or the interest rate charged, the higher each repayment.
However, the repayment on a student loan is based purely on a graduate’s income. More precisely, graduates pay 9% of their earnings above the repayment threshold (currently £25,000). A basic rate taxpayer pays income tax of 20% on earnings above the personal allowance (currently £11,850). We can therefore think of the loan repayment as an additional chunk of income tax that all qualifying graduates have to pay. This effective rate of income tax is progressive. Anyone on a salary up to £25,000 pays no additional income tax, someone earning £35,000 pays an additional 3.9%, someone on £45,000 pays 5.4%, and so on. Before we get carried away this interpretation of student finance we have to consider its other defining characteristic, a feature which makes it stand out like a sore thumb against conventional loans – after 30 years, any outstanding balance is written off by the taxpayer. Our mid-earner on £35,000, in real terms, will pay their additional 3.9% for a maximum of 30 years. If the repayment is to be regarded as a tax, then it must be seen as a temporary tax (despite 30 years spanning the majority of working life).
If the repayment amount is only calculated with reference to earnings, where does the original amount borrowed by the student come into the equation? At first sight, it doesn’t seem to matter if our mid-earner took out a loan of £25,000 or £50,000, they make exactly the same repayments (3.9%) for a maximum of 30 years. However, the system is fair to the extent that once the cumulative repayments have offset the original loan (with the addition of any interest) the repayments cease. Therefore, the amount of the original loan serves only to affect the term of the repayments. What is perhaps surprising about this design is that about 80% of loans issued are expected to have a true repayment term of greater than 30 years and will not be repaid in their entirety within three decades. Only comparatively high-earners will pay their loans off in time. For 80% of borrowers then, the student loan is just a graduate tax that is paid for 30 years.
Everyone other than high-earners are expected to default. Viewed in terms of a conventional loan, you’d therefore expect high-earners to pay a lower interest rate. This is not the case. The rate charged actually increases with earnings (from RPI+0% for someone earning £25,000 to RPI+3% for someone on £45,000 or more). The interest rate charged on student loans cannot be interpreted as a conventional interest rate, which represents the cost of lending money to people of a given credit repute.
Given that the student loan repayments are purely income-contingent, the interest rate serves only to increase the term of the repayments. A high-earner repays for a longer period than would be required in the absence of a (real) interest rate being charged. These extra payments can be used to subsidise the repayments of the lower earners. The interest rate on student loans is purely a mathematical device for a progressive redistribution of repayments.
I wonder whether it would not just be far simpler and, more importantly, less artificial just to extend every graduate’s repayments to 30 years, and perhaps beyond, and do away with the entire loan apparatus altogether? But of course, the government would then have to strip the student finance system of all its vesture and expose it for what it really is – a graduate tax. Revisiting our provident parent from earlier, perhaps the advice best served is not the pernicious psychological blow of inflicting their child’s awareness with the potential for amassing huge debts, but phrasing the question as follows - ‘Son, university’s all well and good but do you really want to saddle yourself with a few extra percent of income tax for the rest of your working life?’. This is a far more instructive and, in my opinion, encouraging piece of advice that takes the focus away from the largely irrelevant magnitude of any potential loan balance and puts the emphasis back on the real debate – is an additional tax aimed purely at graduates a fair way to meet the increasing demands of higher education funding?