Supplementary memorandum from Dr Nicholas
1. In 2002-03, the Student Loans Company
will lend £2,500 million. The cost of the interest subsidy
(some 35 per cent of total lending) is around £800 million.
2. If interest rates are held to the rate
of inflation, the resulting subsidy does not benefit a single
student, but only successful professionals in mid career. The
argument is worth spelling out:
Interest subsidies do not help students
(graduates make repayments, not students).
They do not help low-earning graduates,
since unpaid debt is eventually forgiven.
They do not help high-earning graduates
early in their careerswith income-contingent loans, monthly
repayments depend only on earnings; thus interest rates have no
effect on the size of monthly repayments, but only on the duration
of the loan.
The only people they help are higher-earning
graduates in mid career, whose loan repayments are switched off
earlier because of the interest subsidies than would be the case
3. Thus the question is whether we want
to spend £800 million on helping wealthy people become wealthier,
or whether we would rather use it to promote access through targeted
student support, and improved quality through more resources to
4. Note that this line of argument goes
a long way to solving the political problems of raising the interest
rate on student loans to the government's cost of borrowing (not
"commercial rates") discussed in the parallel note by
THE NUS POSITION
5. The objective of the NUS is "targeting
money effectively". There is complete agreement about that
6. However, the NUS puts forward the following
argument (paragraphs 188 and 213 of their oral evidence) against
abolishing interest subsidies. With income-contingent repayments,
higher earners repay more quickly and lower earners more slowly.
Thus lower earners pay more interest in total than higher earners.
Thus raising the interest rate on student loans harms lower earners.
There are three answers.
7. Answer 1. As a proposition in
logic the statement is true. But the basis of the argument is
that in order to protect the poor you subsidise the commodity
for everyone. This is the postwar argument for food subsidies:
food subsidies did, indeed, help the poor, but they helped the
rich much more. The same resources could do much more to help
the poor if spent in a way that did not leak out to the rich.
8. Answer 2. The whole point of income-contingent
repayments is that they tailor monthly repayments to ability to
pay by automatically extending loan duration for lower earners.
Someone who buys a house for £100,000 will pay more interest
if she opts for a 25 year mortgage with lower monthly repayments
than a 15 year mortgage with higher monthly repayments. Income-contingent
repayments do the same thing automatically.
9. It is, of course, entirely possible to
solve the NUS's "problem" by having mortgage repayments
(eg equal annual repayments for (say) 10 years, regardless of
income); thus loan duration, and hence interest payments, are
the same for all students with a given size of loan. That cure,
however, is vastly worse than the disease.
10. Answer 3. There is a range of
mechanisms (my main written evidence, paragraphs 58-62) for helping
low earners which are much more effective than blanket interest
Income-contingent repayments automatically
project low earners (the argument above).
Grants for students from poor backgrounds
mean that such students have no loan, or a smaller loan.
Targeted interest subsidies based
on current income. The attack on blanket interest subsidies is
not an attack on targeted interest subsidies. It would, as examples,
be possible to pay an interest subsidy to people who are unemployed
or looking after young children. Such targeted interest subsidies
are both possible (as currently in New Zealand) and desirable.
Conditional subsidies. It would also
be possible to pay interest subsidies to people with low current
earnings, but to claw them back if they subsequently become high
earners. Design work for the Hungarian Government established
that such an arrangement presents no administrative problems.
11. Any or all of the mechanisms in the
previous paragraph help low earners much more effectively than
blanket interest subsidies.
12. Make the cost of interest subsidies
transparent. Expenditure on interest subsidies is currently buried
in the overall cost of government borrowing, and hence does not
appear in the education budget. The most minimal reform is to
make spending on interest subsidies an explicit line item in the
education budget. A major advantage is to make the high cost of
interest subsidies visible. In addition, figures on expenditure
on student support, by correctly including the cost of interest
subsidies, would be more accurate and more readily comparable
with earlier years.
13. Abolish the blanket interest subsidy
for all the reasons given above.
14. Ensure that the education budget benefits
from its abolition. This is the issue discussed in main evidence,
paragraphs 38-41. The core of the issue is that the figure of
£800 million referred to above is the present value of the
savings from moving to the government's cost of borrowing, but
the savings in cash-flow terms are small in the early years. To
ensure that the withdrawal of blanket interest subsidies leads
to an immediate increase in spending on access and quality, a
deal will be needed between the Treasury and DfES to accelerate
the cash flow. As noted in paragraph 39, one way to finance that
deal would be to sell a further tranche of student debt, yielding
up to £2 billion.
15. Some analytical equivalences. The following
are logically equivalent:
An income-contingent loan.
A grant plus an income-related graduate
A grant paid for out of taxation,
except that the tax (a) is paid only by people who have been to
university, and (b) does not go on for ever.
Though analytically identical, the three representations
clearly have major differences in terms of perceptions. The companion
document by Iain Crawford suggests a way of addressing the perception
16. The balance between loans and grants
should be variable, not an either-or proposition:
Middle class students would be entitled
to an income-contingent loan sufficient to cover all living costs
and tuition fees, thus making higher education free at the point
of use (the Cubie advance).
A student from a poor background
would receive a grant. Depending on the size of the grant, he
or she might also need to take out a loanbut a smaller
A student from a particularly vulnerable
background might receive a full grant, and would therefore not
need to take out a loan at all.
17. Tuition fees.
All the previous discussion about
loans can be decoupled from the fees issue.
There is a strong case for a move
towards flexible fees (which can be higher or lower than the present
However, deregulation of fees should
be phased, not "big bang".
Dr Nicholas Barr
28 Department of Economics, London School of Economics
and Political Science, Houghton Street, London WC2A 2AE, UK. Back