Financing higher education: What’s
right, what’s wrong, what next?
Nicholas Barr and Alison Johnston
European Institute Lunchtime Seminar
LSE, 12 May 2009
Financing higher education: What’s
right, what’s wrong, what next?
1 What’s right?
2 What’s wrong?
3 Fixing the problem
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1 What’s right?
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1.1 Lessons from economic theory
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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
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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
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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
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Loan repayments in the UK (2006
scheme)
Annual earnings
Income tax (monthly)
NI contributions (monthly)
Loan repayments (monthly)
Bill
Tariq
Tim
Jane
£15,000
£161.19
£91.26
£0.00
£20,000
£252.86
£137.10
£37.50
£30,000
£436.19
£228.76
£112.50
£50,000
£945.58
£274.93
£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
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1.2 A strategy for financing
universities and students
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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
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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
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Leg 3: active measures to
promote access
• Widening participation
• Raising attainment
• Improving information/raising aspirations
• Money measures
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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.
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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
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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
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Who benefits from interest
subsidies?
• Students?
• Low-earning graduates?
• High earning graduates with low earlycareer earnings?
• High earning graduates?
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3 Fixing the problem
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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
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Specific policies to increase
repayments
• Higher monthly repayments
• Increased duration of repayments
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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
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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
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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
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Interest Subsidy Per Average
Graduate (% of Total Loan)
1% real
interest
Rate
2% real
interest
rate
3% real
interest
rate
9% repayment
Rate
20
(£5,030)
11
(£2,760)
2
(£500)
10% repayment
Rate
19
(£4,770)
10
(£2,610)
1
(£330)
11% repayment
Rate
18
(£4,520)
10
(£2,450)
1
(£230)
12% repayment
rate
17
(£4,270)
9
(£2,260)
1
(£180)
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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
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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.
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