A fairer way to fund higher education

Nicholas Barr dispels some common myths about higher education funding and describes the main elements of a funding system based on equity and efficiency.

This post originally appeared on the LSE British Politics and Policy blog.

Everyone knows that the welfare state exists to alleviate poverty (the “Robin Hood” element). Less well known is that it also exists so that people can be redistributed during their life cycle (the piggy bank element). Estimates show that anywhere from two-thirds to three-quarters of welfare state spending is of the second type – for example, pensions are redistributed from younger people to their older ones. The NHS is similar in that older people are significantly more likely to use health and social care services than younger people.

Student loans are a form of reverse pension: they redistribute a person’s years of earnings onto themselves in previous years to invest in their skills. Many years ago, I advocated loan repayment by adding graduates to National Insurance contributions, and I continue to think that this is the right basis for thinking about student loans as part of broader higher education funding.

Basic Rules for Fair and Efficient Financing

A well-functioning and fair financial system has four starting points. First, cost-sharing is necessary because mainstream higher education is losing out to other public services like the NHS, and desirable because universities continue to attract students from more affluent backgrounds.

Second, risk sharing. Higher education should be free for students, and graduates should pay for their education. Because borrowing to finance qualifications involves risk, the loan should protect the borrower from excessive risk.

Third, equal participation. The argument that fees hurt access is an example of what I call the “pub economy” – something that everyone knows but isn’t. Strong evidence shows that resources from antenatal education to primary and secondary school are major determinants of participation.

Fourth, a holistic approach to higher education. Policy should be considered higher education in general, breaking down the wall between university education and further education.

Policy should consider higher education as a whole, breaking down the wall between university education and further education.

How did we get into this mess

A loan to cover an annual tuition fee of £9,250 for three years plus living expenses could amount to £58,000 for a student living away from home outside London. Graduates pay 9% of their income over £27,295; any outstanding balance after age 40 is forgiven.

It’s natural to think of this figure in terms of credit card debt, which is very scary. But few people repay the loan in full. in jargon RAB fee is a measure of how much will not be returned, i.e. leaks in loans. In 2021-22, the RAB fee was 57 percent, although reforms are currently underway that are projected to bring it down to 37 percent. Moreover, the central feature of the design—payments based on income—is deducted from wages along with income tax and national insurance contributions, so that the low-paid worker pays little or no payouts. Unlike ordinary debt, non-payment does not lead to bankruptcy.

So we have a system with high label prices and leaky loans, but the subsidy goes unnoticed, spontaneous and has been heavily criticized hurt. The reason loans are so unreliable is the coalition government’s reforms in 2012 that eliminated the support for teaching by most taxpayers, raised interest rates, and raised the income level at which graduates start paying back loans. These changes dramatically increased the size of student loans and the rate of default. Why these changes? Mainly for exploit a loophole in how student loans go into government accounts, a practice for which a leading supermarket was fined £235m.

Why does leakage matter? Large loan subsidies, while intuitively appealing, are a crude tool for achieving equity goals. By making credits less leaky, resources are freed up for policies that do more for access.

In general, taxpayer support for education is too little, fees are too high, interest rates are too high, and repayment thresholds are too high—correct system, incorrect parameters.(1)

Why not just abolish tuition fees?

The argument for “free”—that is, taxpayer-funded—higher education is misleading but misleading. Over-reliance on public finances means that lower-earning taxes benefit mainly students from better-off families and thus hurt participation by crowding out access policies earlier in the system, which the data strongly suggests are the main the driving force behind improvement is participation. To make matters worse, higher education regularly loses out to more politically relevant pressures on public spending, such as nursing pay and social assistance in the face of an aging population, resulting in reduced funding per student (compromising quality) or quantity limits, which are even more damaging access.

The argument for “free”—that is, taxpayer-funded—higher education is misleading but misleading.

Where We Should Be: Lower List Price and Less Loans with Less Losses

A higher education funding strategy that follows the basic rules outlined above has three complementary elements: first, funding institutions primarily through tuition and taxpayers (with some funding from employers). Second, fund students primarily through well-designed loans that protect the underprivileged. And thirdly, to increase participation through policies aimed primarily at interfering with the earlier stages of the system.

This, in general, was the strategy of the 2006 reforms, which led to an increase in income from tuition fees for universities, the number of grants and loans, the number of students and – mainly due to the policies started earlier in the system in earlier years, such as SureStart. which contributed to the development of preschool education – the number of applicants from the most disadvantaged families increased by 53%.

What will the resulting system look like?

If such a system were implemented to fund educational institutions, it would rebalance finances between taxpayers and alumni by restoring some tuition grant (Grant T) and reducing (or at least not increasing) tuition fees. The reinstatement of some T-grants is part of a cost-sharing and also gives the government political leverage that allows it to provide additional funding in areas it wants to encourage, such as certain subjects, certain types of students, or certain institutions.

Credit reforms would lower the interest rate from its current level (for most students, 3 percent real, i.e. 3 percent above the rate of inflation); instead, the interest rate must be equal to or close to the government’s cost of borrowing, giving students access to the government’s risk-free interest rate. The second reform is to lower the threshold at which repayments begin, but with a repayment rate starting at, say, 3 percent and gradually increasing to 9 percent at higher incomes. The basic idea is that loans should be designed in such a way that graduates with good earnings must repay them in full, and defaults are limited to graduates with low incomes.

To increase access, reforms should restore or improve the provision of policy resources (some of which were withdrawn in 2012), including pre-primary education (quantity, quality, price, accessibility), literacy and numeracy hours, and policies that replaced benefits content education (which offered income verification support between GCSE and A level) and AimHigher (which sought to improve information and raise aspirations).

How long should payments continue?

In a net loan, repayments continue until the borrower repays in full or becomes eligible for forgiveness. In equity funding, payments continue for life or until retirement, commonly referred to as the alumni tax. In this scheme, high earners return more, and some even more, than they borrowed (I call this the Mick Jagger problem, given his time as a student at the London School of Economics).

The third option is a hybrid where repayments stop when the borrower repays, say, 120 percent of the loan. Thus, persons with higher incomes partially or completely cover the losses of persons with low incomes. This is the purest manifestation of student loans as social insurance, just as the London School of Economics professor’s national insurance contributions contribute to the cost of unemployment benefits for workers with less job security. The additional 20% can be seen as similar to the mortgage insurance normally required to cover a mortgage.

Because loans protect the poor, they are inherently unprofitable, so the second question is where the resulting costs should fall. They can fall entirely on the taxpayers (as they are now); distributed between taxpayers and borrowers (social insurance scheme) and/or distributed among taxpayersborrowers and educational institutions.

Finally, any of the options described above can be combined with stepped repayment rates, starting at a lower threshold than currently and starting at a lower rate.

Beyond higher education

While the discussion of finance has mostly focused on higher education, the government is rightly moving towards a more comprehensive approach covering both higher and further education. This policy direction, however, requires careful planning to provide a flexible system in which people can acquire skills in different ways, in different combinations, at different speeds. This will require a granular supply supported by granular funding that is fair to all higher education institutions. The current debate tends to focus on distributional effects for tertiary students, ignoring the fact that subsidies for the 50 percent who attend university are much larger than subsidies for the 50 percent who do not. They should not be forgotten.

(1) Sound fragment stolen from Anna Vignoles.

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