Higher Education Financing – lessons from the past, options for the future

Dr Matt Dickson is Reader in Public Policy at the University of Bath's Institute for Policy Research, and leads the Institute's work on widening participation into higher education.

Last week Theresa May announced the Government’s long-anticipated review into post-18 education and funding, pledging to make the system fairer and create a tertiary education system that works for all young people. Importantly, the remit of the review is not limited to just University-based higher education but covers the entire post-18 system, including the full range of further education routes available and taken by more than 50% of young people.

Despite this wide remit, perhaps unsurprisingly so far most of the focus has been on the potential implications for future financing of higher education. Tuition fees, grants and loans have been the focus of much political debate in recent years with first the Liberal Democrats (2010) and then Labour (2015, 2017) putting forward manifesto proposals to radically alter the funding system for higher education in England. The political fallout of the Liberal Democrats’ failure to deliver on their tuition fee pledge in the coalition government undoubtedly made the issue a key policy area and since then this salience has been heightened first by the cap on fees being raised to £9,000 in 2012, and in the last couple of years by the steep increase in inflation and the implications this has had for student debts. For much of the last three years inflation has been low even on the RPI measure which the Government uses to calculate inflation for student loans (in March 2015 it was only 0.9%). But during 2016 inflation started to climb steeply and by March 2017 was 3.1% which is the rate currently being used to determine the student loan interest rate. It’s on course to be around 4% this March when the rate for the year from September 2018 will be determined, the highest level it’s been for five years.

As a result of this level of inflation, student debts are currently growing at between 3.1% and 6.1%. The latest research for England shows that the average debt that students in England will graduate with is around £50,000, and for those from lower income backgrounds who have more loans available to them, the figure is as high as £57,000. The average student will incur £5,800 of interest charges before they have even left university. It is these sorts of headlines and this broader political context that has fed a narrative that the system is unfair and something needs to change, putting pressure on the government to re-open the question of HE financing.

Lessons from the past

It is worth at this point rewinding the clock and reminding ourselves of how we got to a situation in which fees were raised to the level of £9,000 per year in 2012/13 (now £9,250). The Higher Education Initial Participation Rate (HEIPR), capturing the proportion of 17-20 year olds starting in HE for the first time, was 37% in 2010 when the Lord Browne undertook his independent review of fees policy and financial support for undergraduate students. Funding per student had recovered from the historic low in 1997 that prompted the introduction of tuition fees in the first place, but Browne concluded that funding was still low relative to comparator countries and recommended lifting the cap on tuition fees. The government accepted the majority of Browne’s recommendations and the fee cap was raised to its current level with the accompanying repayment mechanisms, interest rates and term.

The main aims of these reforms were two-fold. Firstly, finance: increase investment in higher education, improving funding per student and reversing the decline in the quality of provision that had resulted from increasing student numbers even after the introduction of tuition fees. Secondly, equity: widen participation so that able students from disadvantaged backgrounds have the same opportunities to access higher education, based on the Robbins principle that “courses of higher education should be available for all those who are qualified by ability and attainment to pursue them and who wish to do so”.

Did the previous reforms meet their aims and what are the options for this review?

The post-Browne period has seen a continuation of the pattern of increasing numbers of young people participating in higher education, with the HEIPR up to 42% in 2016. At times since 2012/13 the rate of increase amongst those from less advantaged backgrounds has been higher than amongst the better off, but by 2016 the gap in HE entry rates between those eligible for free school meals and those ineligible remains 16 percentage points, exactly what it was in 2010. Almost all of this persistent gap is due to prior attainment. Amongst those with the same prior attainment and who apply to University, there is almost no family income gradient in who attends University – a reminder that widening participation policy at the University level is always going to be limited in what it can achieve given the attainment gaps between better off and poorer students that emerge early and persist throughout schooling. There is a family income gradient in application to University amongst those with the same prior attainment and here there is scope for policy to address the gap and where the fee regime and repayment architecture does matter, more on this below.

What about Browne’s aim regarding the financing of HE? Funding per student has increased – by around 25% compared to the pre-2012 system and this has had positive impacts on teaching quality. The abolition of maintenance grants and huge reduction in teaching grants has also had a dramatic impact on public finances. Unlike grants, loans do not appear as current government expenditure (until the point in 30 years when the proportion outstanding is written off), which means the system change has removed £5.7 billion per year from the deficit (approximately 10% of the entire deficit). In the long-run the taxpayer contribution has not fallen by the same amount, since although the graduate contribution is much higher than before it is not sufficient to fully finance the increase in HE funding. As such, in the long-run the taxpayer contribution is estimated to be only around 5% lower than under the old system, despite the large increase in fees. This owes in large part to the substantial amount of student debt that is never repaid and has to be written off.

Under the current system, it is forecast that for every £1 the government lends, 31p is never repaid, based on the current forecasts of graduate earnings growth. (A recent change in the government’s own accounting rules means that they now value future repayments higher than previously; otherwise the figure would be 43p in the pound, only 5p less than under the 2011 regime.) For while the movement of student financing from grants to loans is good for the deficit, it changes the funding from a certain cost of teaching and maintenance grants paid now, to an uncertain loan subsidy cost that will depend on graduate earnings over the next 30 years. If graduate earnings growth is just two percentage points lower than the 2.3% per annum forecast then the long-run taxpayer contribution to HE funding increases by 50% (to be around £9 billion per cohort rather than the currently estimated £6 billion). Similarly, a two percentage point increase in the government’s discount rate (which is related to their cost of borrowing) has almost exactly the same impact, increasing costs by £3 billion per cohort. Given the uncertainties of the post-Brexit economy these are potentially dangerous exposures to risk and could see more and more of student debt effectively transferred to the taxpayer.

Options for the future

The forthcoming review will consider different funding options against the criteria of providing equal opportunities of access to students from all backgrounds and value for money (both for graduates and the taxpayer).

So what are the options?

The Corbyn option – eliminate fees

The most radical proposal put forward is the Labour pledge to get rid of tuition fees altogether. This would cost approximately £7.5 billion per cohort of students, plus another £1.5 billion if maintenance grants were reintroduced at their previous levels, a total of around £9 billion per cohort. This assumes that the government would replace the funding directly associated with the tuition fees with money from the Exchequer. This policy would increase the value for money for the graduate but would radically increase the government costs per degree for the same return with respect to graduates entering the labour market and contributing to the economy. Students from poorer backgrounds in particular may welcome the proposal, removing as it does the burden of future debts in the £50,000+ range.

However, this would be a hugely inefficient system. All students would benefit from the reduction in fees, including all the students from better-off families, who make up the vast majority of the student population. The bill would be picked up by all taxpayers, which would be extremely regressive – essentially a system in which everyone in the country is paying for the children of the better off to go to university. Moreover, the impact on the public finances – the addition of £7 to £9 billion to the deficit – would put huge pressure on the government to reduce the amount paid to the HE sector which could see a fall in funding per student, one of the things tuition fees were brought in to address. Universities would have to reduce the number of places available which would be likely to disproportionately affect the access for those students from non-traditional university backgrounds, with lower levels of the sorts of social and cultural capital that improve chances of getting one of the dwindling number of places available. Far from helping social mobility, a return to the taxation funded HE system that prevailed until the late 1990s would likely turn the clock back for social mobility too.

The Miliband option – reduce fees to a maximum of £6,000

The 2015 general election saw Ed Miliband’s Labour party proposing to reduce the cap on tuition fees to £6,000. Again, the impact of the policy in terms of value for money for the government and the graduate would depend on whether the fee income was replaced directly by tax funded government teaching grants to the HE institutions. Assuming the government did replace the lost fee income, the impact on public finances would be to increase the immediate deficit (by around £3 billion per year) and increase the long-run taxpayer contribution to each degree. For students, the impact would only be felt by those who currently pay off their student debt in total (23% of students at present), and the group who currently do not but would do under the proposed lower fee. These are the highest earning graduates, who would see their debt cleared earlier and would therefore have lower total repayments. The only group not to benefit would be lower earning graduates who would not pay off their debt even with fees reduced to £6,000. As the cost of this policy would be borne by the general taxpayer and the beneficiaries would be the highest and mid-earning graduates, this would be a regressive move. And again, considering the socio-economic mix of the student population, this would represent a backward step with regard to equity in the system and the same dangers of places being cut and social mobility stymied would be apparent should the government fail to replace the tuition fee income and thus cut funding to universities.

Variable fees

One idea that has gained traction in the debate and was a motivating factor behind the decision to raise the fee cap in 2012, is that of variable fees for different courses, creating a more flexible ‘market’ for higher education. Pricing courses according to the cost of providing them, the likely earnings return over the career or using price to steer students towards courses that would support labour market shortages are all ideas that have been proposed. However, as has been pointed out in numerous places, none of these ideas stand up to scrutiny when it comes to considerations of value for money and fairness. For example, pricing according to the cost of providing a course runs into trouble on equity grounds when we find courses with low costs but high returns – Economics, Politics, and History for example have relatively low costs but relatively high returns. Some courses that have high costs to deliver perform relatively poorly in the earnings returns – Creative Arts, Media, Veterinary Sciences and Agriculture for example – and so it would seem unfair to charge students a relatively high price on these courses.

The reality is that the ‘market’ for higher education courses cannot function like other markets in which price is a signal reflecting the scarcity value of the good. Earnings returns are realised over a long time-horizon in the future and will vary according to numerous factors not all of which can be predicted. Though we can do the best we can to estimate the wage returns to different degree courses, pricing on this basis would have to consider both the subject and institution of the course. Basing a price on either in isolation would lead to some obvious iniquities – if all Russell Group university degrees demanded a high fee this would seem unfair on those studying subjects that have low earnings returns no matter where you study (Creative Arts, for example). Similarly, if courses were priced solely on the basis of subject it would seem unfair that those studying Economics at a post-92 institution would pay the same as those studying at LSE where average earnings are significantly higher for Economics graduates than the average. Another risk with pricing on the basis of subject and institution is that students from poorer backgrounds will be put off taking subjects that lead to higher average earnings because of the higher price and higher associated debt taken on. If young people from disadvantaged backgrounds are less willing to take risk then this will exacerbate the problem for high average earning courses that also have high variability in returns (Engineering, Law and Languages courses fall into this category). The risks are clear for social mobility if the pricing system channels poorer young people away from the higher earning pathways.

Moreover, pricing like this on the basis of subject and institution does not take any account of the social returns to different degrees, only the private earnings returns. Why not price then on the basis of what the economy needs? The skills that the economy requires at the moment may be reasonably clear but forecasting over a 30-year horizon what the economy will need and therefore what fee reduction should support would be prone to a great deal of error – whilst encouraging students into courses that they may or may not have wanted to do in the first place. In addition, the economic needs argument runs the risk of perverse outcomes with regard to fairness. At present we are short of doctors and this is only likely to be exacerbated whatever the post-Brexit immigration system entails. Offering low fees for medical students could be a way to address this but given that medics are by far the highest earning graduates on average, it would not seem an equitable way forward to offer them lower fees.

The strongest argument against trying to artificially create a menu of prices for higher education courses is the reality that in effect a variable fee system is exactly what we currently have. Graduates pay back a variable amount of their total loans and interest based on earnings over their career – only 23% are forecast to repay in total, whereas the remaining 77% pay a proportion between zero and the full amount. The income contingent nature of repayments insures against poor returns on the investment, and more importantly the variable costs are based on the realised earnings rather than having to be set based on either the perceived likely benefits or the demands of the economy – both of which are uncertain and variable over future decades.

Amending the current system?

At present students repay at a rate of 9% on all earnings above £21,000 (though this is increasing to £25,000 in April) and any debt remaining after 30 years is written off. Changing the threshold (up or down) mainly affects the middle earning graduates and shifts the balance of contributions between the government and the graduate. Those earning less than the threshold, whatever it is, are unaffected when it rises while lowering it will bring in more contributors amongst the lowest earners and may put off those on the margins of applying. Changing the repayment rate would affect the payments of every graduate earning above the threshold and have the greatest impact on the middle earning graduates, increasing their payments and reducing the government contribution. For high earners the impact would be a reduction in the time taken to pay-off the debt but a similar total amount repaid. Similarly, reducing the interest rate applied to student debt will not affect low earning graduates, who typically do not earn enough over their lifetime to pay off both the loans and the interest accrued. Higher-earners would be affected by a lower interest rate, paying off their debt earlier and reducing their total payments, shifting more of the costs onto the taxpayer. Increasing the number of years before the debt is written off would have an impact on the majority of graduates since 77% will not have paid off their debt in full after 30 years under the current system. These graduates in the middle especially and the low earning range would end up paying off more of their debts and it would reduce the long-term government contribution, though these additional payments would not accrue to the Exchequer until decades from now.

So what should the government do?

The current system broadly delivers on the aims of providing enough income to enable Universities to continue to provide high quality teaching and research, producing graduates with the skills that the economy requires. The evidence to date suggests that in the vast majority of cases a degree continues to confer an earnings premium compared to not going to University, even after taking fees into account £9,250 per year tuition fees. The fees and loans structure protects the public finances in the short-term but does expose the government to risk since the long-term costs are contingent on graduate earnings over the coming decades. What about equity? Though the changes in 2012 have not deterred low-income students from applying to university, the removal of maintenance grants and replacement with loans, coupled with the social gradient in debt aversion, has the potential to see real declines in applications from disadvantaged young people, especially given the way rising inflation has increased the headline debt level. The evidence that we have suggests that increasing maintenance grants to poorer students has sizeable effects on participation.

For this reason reintroducing maintenance grants, at the cost of £1.5 billion per cohort, feels like an important potential policy move. It would reduce debt related aversion to university for those from the poorest backgrounds, and whilst it would increase the current deficit it would at least hedge the government against the risk of future increases in their cost of borrowing or poorer than anticipated graduate earnings growth.

One thing that is definitely needed is a better public understanding of the student finance system. The impact of student loan debt is more of a psychological issue than a financial one – repayments are contingent on income not on debt level, and so the actual value of the debt affects how long the student is repaying rather than how much is paid each month. It does not affect credit score and so does not impede graduates in that way, though it will affect the affordability calculation for mortgage repayments which is an important consideration in the current climate where getting onto the property ladder is increasingly difficult for Millennials.

The government is already doing a good job through the Office for Fair Access and now the Office for Students, in ensuring that universities are meeting their obligations in terms of bursaries and additional support for students from under-represented groups, and pursuing widening participation activities. Continuing to hold feet to the fire in these areas is hugely important if we are to see improvement in the applications to university and successful graduation of students from non-traditional university backgrounds.

In terms of value for money and considerations for social mobility it is tweaks to the system that are required rather than a complete overhaul – but a radical improvement in public understanding of the system would go a long way towards reassuring prospective students of the value in their investment and reducing fear of debt, whilst ensuring a more intelligent debate on the necessary trade-offs for government, young people and society in funding a world-leading HE sector.