Government reform of Higher EducationWritten evidence submitted by Dr Mike Clugston
Analysis of the Government’s Proposed Changes to Student Loans
Part 1 First year after graduation
My intention is to demonstrate that it is impossible for any graduate earning less than £41,000 in their first year of employment to stop their student debt from escalating. This conclusion comes from a “simple interest” calculation.
The magnitude of the debt escalation depends on three variables: RPI, tuition fee, and maintenance loan taken. The above conclusion holds true with all of these variables set at very optimistic values (2.0% RPI, £7,800 for tuition, and £3,575 for maintenance). With these choices, the debt in the April after graduation is £38213, the interest rate on the debt is 5.0%, and hence the interest charged on the debt is £1911. A graduate earning £41,000 repays only £1,800.
The table presented below specifies the debt at the end of a three-year course (assuming no rise in the tuition fee or maintenance loan) together with the minimum salary needed for the graduate to experience no escalation in their debt. Three figures for each of the three variables have been chosen.
First, my chosen RPI range is between 2.0% (the Government’s stated target figure), 3.5% (the mean value over a 24-year period using ONS data), and 5.2% (the value in May 2011).
Second, my chosen tuition fee range is between £7,800 (the lowest value for any of the 83 universities collated by the Guardian: reference provided), £8,700 (the mean value in the Guardian’s list), and £9,000 (which is the maximum and modal value in the Guardian’s list). I note that the Guardian has not quoted a figure for 36 universities but it seems unlikely that any of these will offer a tuition fee much lower than £7,800. Even if some did, although the mean would obviously decrease, the modal value would remain the same, as 60 out of 119 universities charge £9,000.
Third, my chosen maintenance loan range is between £3,575 (the amount available to anyone whatever the household income) and £5,500 (the maximum amount, which is only available when the household income is around £42,000). As the maintenance loan varies so drastically with household income, a representative middle value of £4,500 is my third choice. (I note that £3,575 is close to the typical charge for accommodation, so a student cannot reasonably exist on this loan.)
The conclusion (that debt escalates for all graduates earning under £41,000) contrasts very strongly with the situation just eight years ago, when my daughter left university owing about £10,000. The interest rate applied this year is just 1.5%, so if she pays only £150 her debt will reduce. This she can do, despite earning under £21,000.
Analysis of the Government’s Proposed Changes to Student Loans
Part 2 Can student debt be repaid in 30 years?
In sharp contrast to the situation in the first year after graduation addressed in part 1 of my evidence, the answer to this question requires many assumptions to be made.
It is first necessary to choose the three variables required for part 1: RPI, tuition fee, and maintenance loan. In addition, the graduate’s starting salary needs to be chosen and salary escalation modelled over 30 years. Furthermore, an average earnings escalator has to be applied to the thresholds. Finally, to get a fairer picture, NPV values should be considered and hence the discount rate used to find the NPV values needs to be specified.
I recognise that my “individual” approach, based on a starting salary and salary escalation, differs from the ‘cohort’ approach favoured by BIS, with its Monte Carlo simulation. However, the BIS approach has been criticised as being “highly optimistic” in particular over the salary acceleration over the last ten years of the repayment period (as detailed in the HEPI annexes: their Figure A1 shows the fundamental disagreement in the direction of change over this period with the ONS analysis of graduate earnings). I shall therefore continue to examine the question from the “individual” perspective.
My spreadsheet (to be supplied) allows alteration of the RPI from 2.0% to 8.0%, the tuition fee from £7,800 to £9,000, and the maintenance loan from £3,575 to £5,500.
The starting salary can be selected in the range from £21,000 to £41,000, as this is the range where the interest rate changes in the Government’s proposed scheme. Also at least 90% of starting salaries lie within this range.
To model salary escalation, the spreadsheet allows selection of three separate escalators, covering the first five years, the second five years, and the remainder of the 30-year period. Each escalator is expressed as a margin over RPI.
The average earnings escalator can be adjusted, but it is initially set at RPI. It has been assumed that both the lower and upper thresholds will increase (although I am not aware of the latter having been explicitly stated). Uplifting the thresholds more makes the debt more difficult to repay so this escalator has been deliberately set low.
The determination of the NPV value uses a discount rate specified relative to RPI. At the moment, this is done using a single value for the whole 30-year period.
The average graduate cannot repay using reasonable variables: the 85 percentile may do so
In his first letter sent to my MP (Sir John Stanley), David Willetts suggested that around 55% of graduates would pay back their loan. This statement will be examined and challenged in this section.
Consider RPI set at the BIS recommended value of 2.75%, the mean value for tuition fee of £8,700, and a mid-range choice of £4,500 for maintenance plus the NPV discount rate set to RPI + 2.2%, used in the second letter sent by David Willetts. The debt at the end of a 3-year course is £45,108. Continuing the trend of using average values, consider a salary escalator of RPI + 2.0% throughout the 30 years, the figure suggested in the website reference given in the first Willetts letter.
A graduate with a starting salary of £25,000 (the average starting salary in 2010 according to the Association of Graduate Recruiters (AGR) Winter 2010 survey) sees their debt rise inexorably for 30 years. The graduate still owes almost £80,000, which will then be written off. In NPV terms, the graduate has paid back £23,259. At an RPI of either 2.0% or 5.2%, the NPV repayment is within 1% of this figure, although the final debt naturally varies wildly.
A graduate starting on £25,000 (the average starting salary) with salary increasing at RPI + 2% cannot repay the loan.
Choosing a starting salary of £35,000 would approximate to the 85 percentile graduate (using AGR winter 2010 Fig. 1.18). This graduate may be able to repay the loan: at an RPI of 2.0%, the loan is almost repaid; at an RPI of 2.75%, there is still some to pay off, and at an RPI of 5.2%, the final debt is more than it was at the start. In each case, the NPV repayments are close to £49,500, so the debt is repaid in NPV terms. It is striking that the NPV repayment remains within 0.5%, despite the huge variation in final debt and shape of the repayment curve.
In my letter to Sir John Stanley, I said the following: “The current loan book is worth £29 billion on tuition fees of £3,250 (Ref. 1): new loans were worth just over £5 billion, of which £2.1 billion was for tuition fees (Student Loan Company figures for 2009–10). With fees increasing to between £6,000 to £9,000, it is reasonable to assume that the total figure will rise to about £8 billion. If the Government is wrong and 40% more will default, the additional cost to the taxpayer will be over £3 billion per year … I would contend that repayment is unrealistic for almost all graduates and hence my conclusion that about 15% will be able to pay back the whole loan is justified.” The Commons briefing paper SN/SG/5753 suggests (on page 13) that at a fee level of £9,000 the new loans figure will be just above £10 billion each year and hence the additional hole in the Government’s finances will be around £4 billion per year.
From the point of view of the student, another worry is my main concern. Again, quoting from my letter to Sir John Stanley: “Furthermore, I believe it is morally reprehensible for students to be encouraged to live a life of unaffordable debt, as it was that attitude which was one of the main triggers of the latest recession.”
The other very significant variable is the shape of the salary escalator
For the graduate starting at £25,000 with RPI set to 2.75%, it is possible to repay the debt if the salary escalators are altered very significantly: margins of 7.5% over the first five years, 5% over the second five years, followed by 2% causes repayment. The debt continues to rise for 13 years. The total repaid in NPV terms is £48,662. I would seriously doubt whether such a rapid rise in salary is remotely reasonable for most graduates: it seems highly optimistic.
27 June 2011