What is to be done about England’s student debt storm?

Private passage

No doubt hampered by the parlous state of public finances, the present government has allowed a well-thought-through tertiary education strategy to become mired in a debate about how it is funded. It is in a jam, the getting out of which will not be easy.

This is because the entire post-16 education and skills strategy as set out in last autumn’s White Paper is underpinned by a reduction in the taxpayer subsidy for student loans.

This is to be achieved by freezing for three years the repayment and interest rate thresholds on Plan 2 loans: those taken out between 2012 and 2022. A campaign led by the consumer champion Martin Lewis and other pressure groups has real traction and the Treasury Committee has started its own inquiry.

Unpicking the settlement would not be easy. The sums are enormous. Reversing the latest changes would cost £1.3 billion for 2022 starters alone, according to the IfS. Rival proposals from the Conservatives and Liberal Democrats, the thinktank calculates, would come at a long-run cost to the Exchequer of £3-4 billion for the same cohort.

And public finances have deteriorated since the spending review and the Budget, when these terms were agreed between the Treasury and the Department for Education. With defence spending now even higher up the agenda as a result of the Gulf war, it is hard to see any extra money coming the way of post-16 education. Nor will the DfE be ready to reallocate funds from elsewhere in its carefully constructed strategy. Cutting the repayment rate and extending the repayment period on Plan 2 loans from 30 to 40 years could be cost-neutral in the long run but would be a screeching U-turn and politically difficult.

It may well be, then, that presentational tweaks aside – for example, concessions for priority occupations – the current system will remain in place. But that is extremely painful for existing Plan 2 borrowers, who are now repaying their loans on terms they didn’t expect. At the very least, we need to avoid this happening again for future generations.

The starting point has to be setting the balance between the public and private funding of higher education. The latest changes, on top of those of predecessor governments, shift the balance almost entirely to private funding. The IfS expects that only £0.7 billion (3 per cent) of the total cost of financing higher education for 2022’s starters will be met by the taxpayer, leaving £23.1 billion (97 per cent) to be met by graduates (2023 starters on Plan 5 will still repay 83 per cent of the corresponding total).

This is a significant change to what had gone before. Before 2012, graduate repayments were expected to cover just 40 per cent of the total cost of higher education, rising to 65 per cent after fees were trebled in 2012. In 2019, the government-commissioned panel that I chaired recommended a 50-50 public-private split as a fair reflection of the benefits to the individual and the state.

The subsequent shift to mainly private funding by successive governments happened under the radar without any public discussion of the right mix. The forthcoming Treasury Committee inquiry is an opportunity to have just such a debate. Costed manifesto commitments to whatever the respective parties judge to be the appropriate state share of spending are required. This would enable prospective students and parents to judge for themselves what to expect and hold politicians to account if they departed from script. If funding a degree is to be students’ responsibility, they should be told so, upfront and clearly.  

We also need a statement to clarify the basis for future changes to terms and conditions. Real-time fluctuations in the interest rates, reflecting market conditions and the inflation rate, are inevitable, but after-the-event changes to repayment and interest rate thresholds for existing borrowers are not.

These thresholds need to be set by principle, not by whim. The panel that I chaired recommended that the contribution threshold be set at the level of median non-graduate earnings – currently around £30,000 – so that graduates start contributing towards the cost of their higher education as soon as they experience a financial benefit from it. We are a long way from that today: the repayment threshold for new Plan 5 borrowers is £25,000. Closing the gap would cost too many billions to contemplate in the current environment, but a binding commitment to permanently index-link thresholds in future is the least borrowers can expect.

The state’s retreat from funding higher education changes the relationship between students and providers. Universities need to acknowledge that they have an increased duty of consumer care to those who are, in effect, private buyers of their product, and this should be monitored by the Office for Students.

Moreover, in a privatised sector, prospective students, their families and their careers advisers need to appreciate that paying for tertiary education is a lifetime commitment, not a free gift. Deciding what, where and whether to study requires careful consideration and transparent information. They must try to anticipate a fast-changing labour market, be familiar with course-specific graduate outcomes and be aware of modular alternatives to a full bachelor’s degree. An urgent requirement is that, as the White Paper promises, the Discover Uni website, which allows university applicants to compare undergraduate courses, be modernised and incorporated into the Ucas platform.

Privatising higher education is a long way from the free tuition and means-tested grants enjoyed by the lucky few before higher education went mass market. But like it or not, if private funding is what we are going to have, all stakeholders need to be aware and adapt.

Philip Augar chaired an independent panel reviewing post-18 education and funding in 2018-19.

Losing balance

The recent furore around student loans took many by surprise – not least the chancellor.

The actual changes in the loan terms Rachel Reeves made at the November Budget were far from unprecedented. The repayment and interest rate thresholds on Plan 2 loans will be frozen for three years from April 2027; the same thresholds have been frozen in five of the past 10 years. Changes announced in 2022 – which included a change to the default indexation from average earnings to RPI, as well as a one-year freeze – will have a much larger impact on graduates over the longer term but prompted far less outcry.

What is different this time? The several million graduates with Plan 2 loans now constitute a sizeable – and vocal – block of voters, and the first students with these loans are now in their early thirties and making sometimes-hefty repayments. This has raised the political stakes of changing the loan terms.

Income tax thresholds have been frozen since 2022 and are set to remain so until 2031, making “fiscal drag” – increasing tax receipts by pulling more people into higher tax brackets – more salient. This has made it harder for the government to raise revenues quietly by freezing other thresholds, such as those for student loan repayments. And a period of high inflation since 2022 has led to much higher nominal interest rates on these loans. An interest rate cap limited the maximum rate applied when RPI was at its peak at few years ago but meant that for two years all Plan 2 borrowers were subject to the maximum interest rate, rather than only higher earners.

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Bob Thomas/Popperfoto/Getty Images

Even now that interest rates have come down, the vast majority of those with average-sized loans and on typical graduate salaries will be seeing their outstanding loan balances grow year-on-year. Someone with an outstanding loan of £50,000 would need to earn around £63,000 (and repay £260 each month) to see their loan balance stay the same – and would need to earn more than this to see it start to come down.

That many borrowers would have ever-rising loan balances was entirely foreseeable. It follows from the fact that graduates’ repayments depend on their earnings, not on their balance or the interest rate. This means that, by design, actual repayments of these loans should never be unaffordable.

Any outstanding debt is written off after 30 years, of course, but policymakers may have underestimated how much graduates would care about the balance on their statement from the Student Loans Company – even if, for many, it will bear little relation to how much they actually go on to repay.

A plethora of potential reforms to Plan 2 student loans have now been suggested. These target different features of the current loan system that some people dislike – and would have very different consequences.

The Conservative proposal to reduce interest rates to RPI, for instance, would benefit middle and (particularly) high earners, who are most likely to eventually repay their loans with above-inflation interest. It would mean more graduates seeing their balances fall rather than rise year-on-year but would only reduce actual repayments many years in the future.

Proposals focused on increasing the repayment threshold – either cancelling the planned freezes or going further to undo the impact of earlier policy changes – would reduce monthly repayments from all those making repayments in the short term. The lifetime gains would be much larger for lower-earning graduates – although the reverse is true for higher earners, who might repay for longer and save very little overall.

Reprofiling repayments such that more is paid back later in graduates’ working lives, as some Labour backbenchers have suggested, could reduce short-term repayments from those trying to get on the housing ladder or struggling with childcare costs. But it is not clear that graduates would be appeased by reforms that asked them to make repayments for even longer.

Of course, new students since 2023 are subject to the 40-year repayment terms of the new Plan 5 loans. The lower interest rate (RPI) means no one will repay more than they borrowed in real terms, making these new loans a substantially better deal for high earners; the DfE estimates that the top-earning fifth with Plan 2 loans can expect to repay nearly 40 per cent more than they borrowed in real terms.

But Plan 5 loans provide less protection to low earners, who can expect to repay more each month (owing to the lower £25,000 earnings threshold) and to repay for longer. Hence, shifting Plan 2 repayment terms in the direction of Plan 5 would be a substantial redistribution from lower- to higher-earning graduates – something that is unlikely to appeal to the current government.

More radical combinations of changes could reduce repayments in both the short and long term from almost all graduates – but would inevitably be much more costly for taxpayers. The proposals from Rethink Repayment, a graduate campaign group, would roughly halve repayments. Given the “fair value” of Plan 2 loans – the amount government expects to actually be paid back – was £129 billion this time last year, the one-off cost of such a reform would be well into the tens of billions.

Spending billions on student loan reform or forgiveness is unlikely to be the government’s priority. But one change that would cost very little to implement would be a redesign of student loan statements. These could explain the unusual terms of the loans and give graduates more sense of how much they might actually expect to repay, reducing the unhelpful over-focus on outstanding balances.

Some called for this back in 2019, and it received a sympathetic hearing from the Augar Review. Now may be a good time for government to look again at this proposal – although it is unlikely to quieten calls for substantive loan reforms from many quarters.

Kate Ogden is a senior research economist at the Institute for Fiscal Studies.

Rearranging the deckchairs

The current problems with English higher education finance go back to an original sin: the abolition in 2012 of the teaching grant for most subjects.

The reasons for that change were, first, austerity, whereby all unprotected government departments were dealt swingeing cuts by the newly elected Coalition government in its 2010 spending review. That included the Department for Business, Innovation and Skills, where higher education and research were then housed.

Rather than slash research, ministers chose instead to replace what remained of the teaching grant with tripled student fees – public spending on the loans for which had the great virtue to Treasury officials of not counting as public spending. Of course, a sizeable chunk of that spending was expected ultimately to be written off – but that write-off would not hit the books for over 30 years.

That accounting fiddle was rectified by the Office for National Statistics in 2019, prompting Rishi Sunak’s Conservative government to replace Plan 2 loans in England with Plan 5 loans in 2023, whose lower repayment threshold and decade-longer repayment period – albeit with lower interest rates – were expected to lower write-offs.

But unless and until we atone for the original sin, policy changes are in the category of moving around the deckchairs on the Titanic.

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Ralph White/Corbis via Getty Images

There is nothing wrong with the principle of student loans. Sharing the cost of higher education between student and taxpayer is necessary because mass tertiary education would otherwise lose out to other public spending priorities, such as the NHS. It is also desirable because it is still mainly students from better-off backgrounds who go to university. As for the argument that fees harm access, this is an example of what I call “pub economics” – something that everyone knows is true but, actually, is not – the main barriers to access occur much earlier in the system.

It is also right that loans should be income-contingent, so that failure to repay does not lead to bankruptcy. However, the high post-2012 tuition fee means that the write-off (the so-called RAB charge) is large, estimated in 2021-22 at a startling 57 per cent. This figure was expected by the Office for Budget Responsibility to fall to 37 per cent for Plan 5 loans. The accuracy of that projection is open to question but, either way, the public subsidy is large.

At the same time, the subsidy goes unnoticed. This is a self-inflicted political wound that is starting to fester in the current fevered media environment – even though the current government was not responsible for the system it inherited.

Moreover, large loan subsidies are a blunt instrument for achieving equity objectives. A less leaky loan system frees resources for policies that do more for access, starting with nursery education and continuing through school. Of course, reduced reliance on loans means more taxpayer support for teaching, but that has the attraction to the government of allowing it to direct extra funding towards its own priorities in terms of subjects, types of students or institutions.

One of the features of Plan 2 loans is that higher earners can end up repaying much more than they borrowed. Overpayment is not wrong in principle, but excessive overpayment – what I call the Mick Jagger problem, given his time as an LSE student – is why student loans are a better solution than a lifetime graduate tax. Better to cap loan repayments when the borrower has repaid (say) 120 per cent of the loan.

That way, higher earners cover some of the loss on low earners. This is the purest manifestation of student loans as social insurance, in the same way as the national insurance contributions of a professor contribute to the cost of unemployment benefit for workers with less job security. And this design could be combined with stepped repayment rates, starting from a lower repayment threshold and lower repayment rate than currently, with the rate rising for higher earners until they hit the total repayment cap.

This would be good policy. Whether it stands a chance of being adopted is more a question of whether it is good politics. Abolishing the teaching grant was seen that way in 2012. So was Theresa May’s raising of the repayment threshold on the fly from £21,000 to £25,000 at the Conservative Party Conference in 2017, at a long-run cost, according to the IFS, of £2.3 billion per year.

Of course, May was spooked by Jeremy Corbyn’s unexpectedly strong showing in that year’s general election, widely attributed to the popularity among young people of his pledge to abolish tuition fees. That would have been a terrible policy. Over-reliance on public finance means that the taxes of lower earners benefit mainly students from better-off backgrounds and, in doing so, harm participation by crowding out pro-access policies earlier in the system that evidence overwhelmingly shows are the main drivers of improved participation.

There is clearly no prospect of the modern Labour Party going down such a ruinously expensive road. But a few steps down it, by restoring some teaching grant, could take it a long way, in terms of both policy and politics.

Nicholas Barr is professor of public economics at the London School of Economics’ European Institute and School of Public Policy. This article is based on his 2023 blog, “A fairer way to finance tertiary education”, published on the LSE’s British Politics Blog.