The Future of Higher Education

Written submission from London Economics

Executive Summary

London Economics have undertaken extensive modelling of the current and proposed tuition fee and student support regime facing first time undergraduates in entering English higher education institutions. The quantitative analyses assess the impact of the proposed changes in funding on students/graduates, higher education institutions and the Exchequer. Our analysis of the outcomes following the Browne Report and the content of the Government's proposed White Paper suggests that compared to 2010/11, under a £7,500 average tuition fee:

Students

· Students/graduates will be £1. 489 billion per annum worse off

· The average student will pay approximately £4,500 more for their degree course

· Approximately 8 4 % of male and 67% of female graduates will pay more than is currently the case

· Individuals from middle-income households going on to achieve average or above average earnings will see the greatest increase in costs (more than £15,000)

· On average, graduates will take 10 years more to repay their loans than is currently the case (14-15 years)

· 70-80% of women will never repay their student loan (currently 20-30%)

· 30-40% of men will never repay their student loan (currently less than 10%)

H igher E ducation I nstitution s

· HEIs will be approximately £156 million [1] per annum better off – though probably much less

Exchequer

· In the short term, the Exchequer is estimated to be approximately £1.332 billion per cohort better off

· The greatest cost to the Exchequer will now be the cost associated with student loans (£3.591 billion p.a.)

· If tuition fees are £7,500 p.a. or more, Exchequer recovery of these loans is predicted to be less than 35%

· The net Exchequer benefit from funding a degree level qualification stands at approximately £82,000

· Although relatively unresponsive, the demand for HE will fall following tuition fee increases

· The number of students entering higher education may fall by approximately 45,000 per annum

· The loss in enhanced taxation to the Exchequer of these graduates is c. £ 3.72 b illion per annum

· The Exchequer rate of return (11-12%) on investment in HE exceeds the long term cost of borrowing implying that " p ublic investments in education, particularly at the tertiary level, are rational even in the face of running a deficit in public finances " (OECD, 2010)

Wider impacts

· Raising undergraduate fees is likely to have a negative effect on educational exports

· Raising undergraduate fees is likely to have a negative effect on postgraduate qualification attainment

· The system of student support has become more complex rather than less complex

· More straightforward and efficient approaches were not given appropriate consideration

The fundamental changes in Hefce funding, tuition fees and student support appears to be driven by the treatment of the various items within BIS Departmental accounts rather than a consistent or long term approach to the rebalancing the public and private funding of higher education.

Aggregate impact of proposed changes to tuition fees and student support

1. Based on information from the Labour Force Survey, Hefce, and HESA, and assuming a £7,500 annual tuition fee [1] , London Economics’ analysis estimates that first time undergraduates entering English higher education institutions will be approximately £1. 489 billion per cohort worse off than is currently the case. The additional subsidies that may potentially be available from the increased volume of loans and marginally increased grants will be dwarfed by the increase in tuition fee costs.

2. Under a £7,500 tuition fee, higher education institutions may be at most £156 million per annum better off. However, this estimate does not incorporate scholarships provided to students (National Scholarship Fund), some of the other sources of Exchequer funding that are subject to cuts (such as part time premiums and capital allowances) and assumes that there are no institution-level caps on student numbers. These items could significantly reduce this estimate. A £7,500 fee will raise approximately £3.41 billion in loan income from full-time and part-time students and offset the £3.26 billion loss of Hefce teaching funding.

Source: London Economics. Maximum government fee: £7,500; Real rate of interest: Increasing linearly from 0% at £21,000 to 3.0% at £42,000 (2016 prices discounted to 2013/14); Repayment threshold: £21,000 escalating (2016 prices discounted to 2013/14); Interest rate rebate: Yes; Period of repayment: 30 years; Rate of repayment over threshold: 9%; Total Maintenance Loan: £3,875 per annum increasing to £5,500 at £42,600 (Household Income (HHI)) subsequently decreasing to £3,565 per annum at £62,000 (HHI); Total government backed fee Loan: £7,500 per annum. We have modelled the Offa WP levy as being a subsidy to students which is 22½% of any tuition fee income in excess of £6,000. We have not incorporated any information in relation to the other sources of Exchequer funding that may be removed from universities (such as the part time premium or capital allowances) We have assumed that the elasticity of demand is -0.087.

3. The Exchequer will be approximately £1.332 billion per cohort better off overall if the government’s changes are finally implemented. The increased subsidies on full time student fee and maintenance loans will cost approximately £1.79 billion per annum more than is currently the case, while part time loan subsidies are estimated to be approximately £192 million per annum; however, the primary cost saving achieved by the Exchequer results from the £3.26 billion per annum reduction of Hefce teaching funding. The Exchequer will also be better off as a result of the reduction in the number of students that are likely to enter higher education following the increase in tuition fees.

The biggest cost to the Exchequer will now be the increasing RAB Charge

4. The size of the Exchequer maintenance and fee loan subsidy is measured by the Resource Accounting and Budgeting charge (RAB), which estimates the proportion of the nominal loan value that would not be expected to be repaid (in present value terms). Under the current student support regime, non-repayment occurs as a result of the zero real rate of interest subsidy and debt forgiveness after 25 years or in the case of permanent disability or death. Based on graduate earnings profiles (from the LFS) and the administrative information relating to repayment criteria, estimates of the RAB Charge stand at approximately 26.1%. However, despite the extension of the period of repayment and the introduction of a positive real interest rate, the increase in the threshold for repayment and the introduction of an interest rate ‘rebate’ will result in a significantly increased RAB charge (37.0%).

5. The total volume of government loans that will be provided under a £7,500 tuition fee are estimated to be approximately £3.33 billion per annum higher than in 2010/11. The steep increase in the RAB charge as the volume of loans issued increases is of particular concern. For every £500 increase in average fee above this £7,500 fee level, the RAB charge is estimated to increase by 0.8 percentage points (between 66% and 73% at the margin), which will result in a worsening of the Exchequer position by more than £180 million per cohort. If a £9,000 tuition fee is charged, the Exchequer will only ever expect to recover 27% of the final £500 in tuition fee loans (see Table 1).

Source: London Economics Maximum government fee: £7,500; Real rate of interest: Increasing linearly from 0% at £21,000 to 3.0% at £42,000 (2016 prices discounted to 2013/14); Repayment threshold: £21,000 escalating (2016 prices discounted to 2013/14); Interest rate rebate: Yes; Period of repayment: 30 years; Rate of repayment over threshold: 9%; Total Maintenance Loan: £3,875 per annum increasing to £5,500 at £42,600 (HHI) subsequently decreasing to £3,565 per annum at £62,000 (HHI); Total government backed fee Loan: £7,500 per annum. We have assumed that the elasticity of demand is -0.087. All values expressed in constant 2010/11 prices.

6. Although simplifying the student support system was one of the core objectives of the Browne Review, reducing Hefce teaching funding and increasing tuition fees and associated loans (alongside the very many other changes to the system of student support) has made the system even more complex than it is now. There were other options available that could have achieved the many aims set out in the Browne Review; however, the accounting treatment of student loans appears to have been one of the primary drivers for the course of action eventually decided upon.

There are other ways of making students pay more - why adopt this approach?

7. One of the primary reasons for settling on the approach to student finance reform finally adopted was to reduce departmental spending (i.e. planned Departmental Expenditure Limit (known as Resource DEL)). This is achieved because Hefce grants are counted directly within the Resource DEL, while only the estimated RAB charge associated with student loans is counted within the Resource DEL [2] . Substituting tuition fee loans for Hefce teaching funding reduces departmental expenditure by approximately 74%. For example, assuming that the RAB charge is 26.1% and £1.0 billion of new fee loans are issued to replace a £1.0 billion reduction in Hefce teaching grant, the Department’s Resource DEL falls by £739 million per annum compared to the current DEL. In accountancy terms, there has been a reduction in departmental spending; however, in economic terms, this has simply been replaced by borrowing, which has a significantly higher economic cost (RAB charge) to the Exchequer than is currently the case given the changes to student repayment mechanisms [3] .

Distributional Impacts

8. In aggregate, students will pay more for their higher education than is currently the case. Once all tuition fees and student support has been incorporated, we have estimated that the average student will be approximately £4,500 worse o ff over the course of a three year degree. However, averages can sometimes be misleading. It is also important to consider the costs based on household income and graduate earnings.

9. The cost of attending higher education for students depends on a number of factors. Firstly, household income determines the level of grant potentially received, as well as the volume of maintenance loan available (which increases for middle income households as the grant is withdrawn [1] and then falls back as household income further increases). However, the cost of attending higher education will also depend on the level of subsidy associated with fee and maintenance loans, which is only determined post-graduation. The subsidy results from any non-payment due to income contingent repayments, eventual write off after 30 years and interest rate rebate for those just above the repayment threshold (£21,000 in 2015/16 prices).

10. To assess the distributional impact, London Economics has estimated the total difference in cost between the 2010/11 current and 2012/13 system of fees and student support for individuals with household incomes ranging between zero and £100,000 per annum combined with different earnings across the income distribution after graduation.

11. The analysis suggests that approximately 1 6 % of men will pay less than for their degree than is currently the case as a result of the increased repayment threshold in operation; however, approximately 8 4 % of male graduates will pay more than is currently the case, with those individuals from middle income households going on to achieve average or above average earnings paying between £16,000 and £18,000 more for their three year degree than is currently the case. Approximately 3 3 % of female graduates will pay less under the current proposals, with the greatest benefits being captured by those women in the 3rd income decile whose earnings currently lie just above the threshold for repayment. Approximately 67% of women will pay more for their three year degree than is currently the case. 30% of female graduates are expected to pay between £10,000 and £15,000 more than is currently the case; while 13% of females are expected to pay between £15,000 and £20,000 more for their degree compared to the present time.

How long will graduates repay and how much will be outstanding after 30 years ?

12. Graduates will repay their loans for a significantly longer period than under the current system. Even after 30 years, between 70% and 80% of women will never fully repay their student loan, while between 30% and 40% of men will never repay. Across non-repayers, the average outstanding loan for women after 30 years is estimated to be approximately £26,500 (almost £17,000 for men). Graduates will repay their student loans for approximately 10 years longer than is currently the case. High earners repay for an additional 6 years while middle income earners will repay for 12 years longer than currently the case.

Source: London Economics

Wider Economic Impacts

13. So far, very little has been mentioned about the impact of fee increases (albeit part mitigated by subsidised fee loans) on the wider economy. All other things being equal, t uition fee increases will result in a reduction in the quantity of higher education demanded. This is a fundamental law of economics, and the extent to which demand will fall is the most important issue here.

Price elasticity of demand

14. The impact of tuition fees on participation in higher education in the UK was recently assessed by the IFS (Dearden, Fitzsimons and Wyness (2010) [1] ). Using cross sectional information from the LFS between 1992 and 2008, the authors assess the impact of various HE student reforms that have taken place including the introduction of upfront fees in 1998/99; deferred fees and loans in 2006/07; the reduction and abolition of student grants in 1999 and the re-introduction of student grants in 2004 (and extension in 2006). The IFS find that an increase in tuition fees by £1,000 per annum – holding all other factors constant – would be expected to lead to a 4.4 percentage point decline in participation. The authors also find that a £1,000 per annum increase in loans increases participation by 3 . 2 percentage points. The authors state that the ‘results indicate that a £1,000 increase in loans or grants is not sufficient to counteract the impact of a £1,000 increase in fees – the coefficient on fees being significantly higher than both loans and grants’. All results were statistically significant. Thus, increasing fees without increasing loans by the same value (or more) will result in a negative impact on participation.

15. Based on this analysis, for every £1,000 increase in tuition fees and matching fee loans, it is estimated that there would be a 1.2 percentage point reduction in participation [2] . Consequently, increasing tuition fee levels by 128% from £3,290 per annum to £7,500 per annum with a corresponding increase in tuition fee loans, might be expected to reduce participation by 11.2% in percentage terms (or 5 percentage points from 45% of the cohort entering higher education to 40% (SLC SFR 07/2010 [3] )). This equates to an elasticity of demand of -0.087 and corresponds to approximately 32,000 full time students and 13,000 part time students no longer attending higher education.

What is a degree worth to the economy?

16. Based on research commissioned by the Royal Society of Chemistry [4] , the net Exchequer benefit [5] associated with undergraduate degree level provision stands at approximately £81,875 overall in 2010 constant prices (see Table 3).

Note: All monetary values expressed in 2010 constant prices. IRR - The internal rate of return is defined as the discount rate (or rate of interest) such that the present value of a future stream of benefits equals the present value of a future stream of costs

Source: London Economics’ analysis based on Royal Society of Chemistry and Institute of Physics (2005)

17. These estimates are generally in line with other research in the field. Assuming that the impact of tuition fee increases is as suggested by the IFS (the elasticity of demand is -0.087), the total economic loss to the economy from the reduction in the number of graduates is estimated to be £3.72 billion per annum in present value terms.

18. Incorporating these wider economic impacts into the analysis implies that rather than the 2012/13 tuition fee and student support changes making the Exchequer better off, once the wider future taxation effects are considered, the Exchequer will be approximately £2.39 billion per annum worse off.

Should the Exchequer fund undergraduate degrees?

19. The Exchequer rate of return is defined as the discount rate at which the present value of the Exchequer benefits exactly equals the present value of the Exchequer costs associated with qualification provision. The rate of return provides an indication of whether the Exchequer investment is worthwhile relative to the next best option (generally considered to be the cost associated with long term borrowing). If the rate of return exceeds the cost of borrowing (30 year UK Gilt currently trading between 4.25% and 4.75%), then the investment might be considered to be worthwhile. The Exchequer rate of return resulting from the funding of undergraduate degrees stands at between 11.0% and 12.1% overall [6] .

20. Given the fact that the net Exchequer benefit associated with undergraduate degree level provision stands at approximately £82,000 and the rate of return on the investment is more than twice the long term borrowing cost, there are strong economic arguments in favour of the continued funding of undergraduate degrees. According to the OECD (2010) [7] "P ublic investments in education, particularly at the tertiary level, are rational even in the face of running a deficit in public finances. Issuing government bonds to finance these investments will yield significant returns and improve public finances in the longer term".

Educational exports

21. Based on research work commissioned by the British Council (Lenton, 2007) [8] , the estimated value of UK education exports was estimated to be approximately £14.086 billion in 2003/04 (expressed in 2008/09 prices excluding consultancy) [9] . Higher education accounts approximately £6.484 billion of this amount (in 2008/09 prices), which is approximately 46% of the total value of educational exports (see Table 4).

Source: Lenton (2007). Values for 2003/04 expressed in 2008/09 prices

22. According to Lenton, the higher education contribution, tuition fees only make up 36% with other direct expenditure from overseas students making up approximately 45% of export income. Any increase in tuition fees, even assuming that a large proportion of students from the European Union continue to attend and will pay significantly higher fees than is currently the case, may actually result in a reduction in educational exports from the United Kingdom. In addition, it may be unreasonable to assume that the demand for UK higher education from overseas is as unresponsive to changes in price as estimated by the IFS. Given the larger number of potential substitutes available to students from the European Union, it is probable that demand for higher education is more responsive to price changes than for UK domiciled students. As such there is a strong likelihood that the value of educational exports will decrease following an increase in tuition fees.

Spillover effects

23. The impact of increasing tuition fees at undergraduate level is likely to have a negative effect on completion rates at undergraduate level and entry into postgraduate degrees. Generally, there are strong Exchequer benefits associated with postgraduate qualifications – especially at Master’s level – where there is relatively low Exchequer support, but relatively strong enhanced earnings and employment outcomes (and subsequent tax receipts). This will reduce any short term Exchequer benefits that might be expected from the changes in undergraduate tuition fees and student support.

24. Finally, we have taken no account of the potential spillover effects that may result from a more highly qualified workforce (i.e. workers in possession of lower levels of qualification gaining from exposure to more highly productive workers and achieving higher earnings than would otherwise be the case). In addition, there are other significant effects that have not been considered that may have an impact on Exchequer spending – such as the effect of qualification attainment on the likelihood of committing crime, achieving better health outcomes or intergenerational effects. These should not be underestimated.

Conclusions

25. London Economics’ analysis of the outcomes following the Browne Report and the content of the Government's proposed White Paper suggests that first time undergraduates attending English HEIs will be significantly worse off, while higher education institutions may be marginally better off. Despite the £2 billion increase in the annual cost of student loans, the Exchequer will be better off in the short term; however, the lost taxation receipts resulting from fewer graduates and the impact on educational exports will have a long term negative impact on the Exchequer. The piecemeal changes to the system of student support have also made it more complex than was previously the case.

26. There are varying impacts on students depending on household income and graduate earnings. Approximately 84% of male graduates and 67% of female graduates will pay more for their degree than under the existing system; they will repay their loans for approximately 10 years longer; and will owe substantially more upon reaching the end of the 30 year repayment period. These effects will be concentrated amongst graduates from middle income households that go on to achieve higher than average earnings.

27. The changes in Hefce funding, tuition fees and student support appears to be driven by the treatment of the various items within BIS Departmental accounts rather than a consistent or long term approach to the rebalancing the public and private funding of higher education.

9 March 2010