Select Committee on Education and Skills Minutes of Evidence

Supplementary memorandum from Margaret Hodge MBE, MP (SS 26)

  At the end of our discussion about higher education and student support, I agree to provide the committee with a few more pieces of information. Since the meeting, I have also seen the paper from professor Barr commenting on my evidence.

  Can I start by clearing up a few points about Professor Barr's proposal? As I repeatedly said at the hearing, nothing has been ruled out of the Review of student finance and there is much in what he said that I am in complete agreement with. It is true that the loans are heavily subsidised at present, so that they represent probably the best financial deal that students will get, and that there is more that could be done to educate potential students about the benefits of income-contingent loans. It is also true that charging a real rate of interest would generate some savings that could be recycled into other measures. We feel, however, that he has overestimated the amount of savings that might be available for redeployment.

  The costs of issuing the loans under Government resource accounting and budgeting (RAB) are made up of the interest subsidy (by far the largest part at present), and charges arising from defaults on the loans and write-offs which occur when graduates reach the age of 65, die or become permanently disabled. The interest subsidy element represents the difference between the interest charged on the loans to maintain this real value and the Treasury's real discount rate, which is 6 per cent. The Government's "cost of borrowing" is not relevant to the costs of the interest subsidy in the Government's accounts.

  To eliminate the interest subsidy completely we would therefore need to charge a real rate of interest of 6 per cent (ie 6 per cent above inflation). If we were to charge a nominal interest rate of 4% as Professor Barr suggests, the savings made would be considerably lower than the figure of £700-800 million he mentions since there would still be an interest subsidy in the Government's accounts. In addition, if we were to dampen the effects of charging the high interest rate by, for example, waiving the interest in certian circumstances or for certain groups of graduates, or cancelling the loans after 25 years, the savings would come down still further.

  Charging a real rate of interest also has a knock-on effect on the other elements of the RAB charge. It would significantly increase the amount of time that students would take to pay off the loans, and would therefore increase the likelihood of the loans having to be written off (we estimate that charging 6 per cent on top of inflation would mean that some 14 per cent of graduates would have their debt hanging over them for the whole of their working life).

  There is another important point about charging a real rate of interest. As I said at the hearing, if we were to charge a real rate of interest (even if it is not a commercial rate), the loans would come under the Consumer Credit Act which requires the lender, for example, to provide speedy information to borrowers about their debt. We could not meet those requirements if we were to continue to use the Inland Revenue to collect the loan repayments. Our advice at this stage is that it would not be as simple as Professor Barr suggests to legislate to disapply all consumer credit provisions for student loans since European law impacts on this area too. Establishing a new collection agent would have significant costs and the default rate on the loans would increase substantially if we cannot deduct the repayments from salaries.

  As I said on the 13th, it is easy to come to a quick answer without having thought through all the implications properly, and these are all issues which the Review needs carefully to consider and resolve before reaching conclusions.

  I agreed to send to the Committee some "case studies" that we have done illustrating the effects on some hypothetical graduates of charging a real rate of interest on Government loans. The illustrations—which are attached—are based on real rates of interest of 3.5 per cent or 6 per cent and assume that there are no exemptions from the interest. They therefore represent a base case before any necessary safeguards are introduced.

  I would like to correct something that I suggested at the hearing about the case studies. I said, for example, that the earnings progression for the "low income" graduate was in the second decile of graduate earnings. In fact, the earnings used for the "low income" example are higher than those of someone in that decile. The effects of charging a real rate of interest on a graduate in the second earnings decile would be even more pronounced: the overall amounts that he or she would pay back and the number of years in repayment would be higher than in the "low income" illustrations.

  A further exemplification of the effects of charging a real rate of interest—from the New Zealand student loan website (www.winz.govt.nz)—is also attached. The message from this is clear: if you are wealthy enough to pay the debt off quickly then the interest is comparatively marginal; if you are not, then the costs can be great.

  One final point, you asked about the costs of implementing the Scottish endowment model of student support in England and Wales. When Baroness Blackstone gave evidence to the then Select Committee for Education and Employment back in April 2000, she said that a broad-brush estimate of the costs of implementing the Scottish system in England and Wales would be around £500 million in the first full year of the system. You may wish to be aware that my officials will be meeting with Andrew Cubie in the near future to discuss student support issues and his experiences.

  I trust that this additonal information will assist you in your consideration of this issue.

Margaret Hodge MBE MP

27 May 2002

CASE STUDIES

  Set out below are some case studies based on students who graduate with Government student loan debts of £10,000 and who enter either a "low", "medum" or "high" paid job. The income progressions—as set out in table 1 below—are at the high end of what might be usually implied by those terms so that, for example, the repayments for the low income graduate are not at the ceiling of what graduates might pay.

  The case studies show the effects of charging real rates of interest of 3.5 per cent or 6 per cent for all graduates (ie there are no exemptions). Those amounts are on top of inflation and the total interest rates are therefore 6 per cent and 8.5 per cent (assuming inflation at 2.5 per cent). A real rate of interest of 6 per cent is needed in order to eliminate the interest subsidy on the loans, because Government accounting applies a real terms discount factor of 6 per cent.

  The repayment system is assumed to be the same as under the current system ie graduates pay 9 per cent of their salary above a threshold of £10,000, which for the purposes of these examples is assumed to rise each year with inflation.

Table 1a:

THE INCOMES ASSUMED FOR THE LOW, MEDIUM AND HIGH INCOME GRADUATES IN CASH TERMS:

Annual income in	Years after graduation
£k (cash)	0	5	10	15	20
Low	8	18	29	44	64
Medium	11	27	49	80	120
High	16	40	77	126	192

Table 1b:

INCOME IN REAL TERMS (ADJUSTED FOR INFLATION): 2001 PRICES

Annual income in £k (real terms)	Years after graduation
	0	5	10	15	20
Low	8	16	22	30	39
Medium	11	24	38	55	73
High	16	36	60	88	117

A: No career breaks

  Table 2 below shows the effects of charging a real rate of interest on the repayment of a £10,000 debt when the graduate enters a low, medium or high paid job and does not take any career breaks.

Table 2:

REPAYMENTS ON A LOAN OF £10,000 (ASSUMING NO CAREER BREAKS)

	Amount of cash repaid £k			No of years taken to repay
	Current policy	3.5% RRI	6% RRI	Current policy	3.5% RRI	6% PPI
Low	13	19	28	14	16	19
Medium	12	15	18	9	10	11
High	11	13	14	6	7	7
1A total interest rate of 6 per cent, assuming inflation at 2.5 per cent. 2A total interest rate of 8.5 per cent, assuming inflation at 2.5 per cent.

  The graphs below illustrate that the data above.

  Commentary on charging 6 per cent real rate of interest:

NO CAREER BREAKS

  The low income graduate does not make sufficient payments in the early years to pay off all of the interest on the debts and, after 10 years, he or she has paid around £6,000 in repayments but seen the debt grow from £10,000 to over £14,000. The high-income graduate pays enough each year to cover the interest and reduce the principal of the loan.

  The graphs below shows the level of debt in each year after the student graduates (after payments have been netted off) and illustrates the time taken to pay off the £10,000 loan.

B: Five year career break

  Table 3 shows the same information as table 2, but the data assume that the graduates take a five year career break in their late twenties/early thirties, with their income on return to work being at around the same level as when they left employment and then resuming the same, but interrupted, upward profile.

Table 3:

REPAYMENTS ON A LOAN OF £10,000 (ASSUMING FIVE YEAR CAREER BREAKS)

	Amount of cash repaid £k			No of years taken to repay
	Current policy	3.5% RRI	6% RRI	Current policy	3.5% RRI	6% PPI
Low	15	28	59	20	24	30
Medium	13	19	27	14	16	18
High	11	14	17	11	12	13
1A total interest rate of 6%, assuming inflation at 2.5%. 2A total interest rate of 8.5%, assuming inflation at 2.5%.

  The graphs below illustrate that the data above.

  Commentary on charging a 6 per cent real rate of interest:

FIVE YEAR CAREER BREAKS

  During the five year career break, the debt for the low income graduate increases from £13,500 to around £20,500 (the annual interest charges on which are around £1,700). After that point, because the annual repayments are less than the interest, the debt continues to grow to around £27,000 after 20 years. The middle and high income graduates have paid off more of the loan in the early years before taking the career break so the increase in their debt during that period is far less pronounced, and the overall repayments are therefore much lower.

  The graphs below shows the level of debt in each year after the student graduates (after payments have been netted off) and illustrates the time taken to pay off the £10,000 loan.

---

---

Prepared 11 July 2002