Student Loans Contents

2Public finances and the design of the system

Funding the student loan system

An overview

5.The majority of people in receipt of student loans—for tuition fees, maintenance, or both—will not fully repay them.3 This is largely a product of two specific design features. First, repayments are contingent on income, meaning graduates only make repayments when their earnings surpass a given threshold, with these repayments set at a fixed percentage of income above that threshold. Second, the loans are written off after a defined number of years (currently 30 years for those starting their university education in England and Wales from 2012 onwards).4 Student loans are therefore unlike typical bank loans, and student loan debt is unlike other forms of debt.

6.Following the Government’s decision to increase the repayment threshold to £25,000 for all those who started university after 2012, the Institute for Fiscal Studies (IFS) forecasted that 83 per cent of graduates will not fully repay their loans. The Department for Education (DfE) puts this figure between 60 per cent and 65 per cent.5 Every pound of student loan debt that is not repaid represents a cost to the taxpayer; it is money paid out by the Government that has not been recouped. This taxpayer contribution can be thought of as an investment in the country’s skills base and productive capacity.

7.The Government has always intended a significant proportion of student loan debt to be written off. In oral evidence to the Committee, Jo Johnson, the then Minister of State for Universities, Science, Research and Innovation, said:

The fact that debt is written off is a conscious, deliberate policy decision by the Government. It is not a symptom of a broken student finance system; it is a deliberate investment in the skills base of the country, which delivers benefits for individual students and for society at large.6

Lord Willetts—Minister of State for Science and Universities when the current student loan system was introduced—echoed this point in his evidence to the Committee:

The 83 per cent of students, on one estimate, that may not repay in full—that is a deliberate policy decision, and it is very important that it is a policy decision that is taken democratically and that you can make alterations either way.7

8.It is only by including the value of the student loans written off that one can estimate the true size of the Government’s higher education spending. It follows that the overall size of this spend depends heavily on student loan repayments, which in turn depend on graduate earnings. Estimates of the cost to the taxpayer of funding higher education are therefore subject to a degree of uncertainty, as projections for graduate earnings can fluctuate in line with the economic outlook. The aggregate outstanding student loan balance was £89 billion at March 2017,8 with the Department for Education estimating that between 40 per cent and 45 per cent of the value of student loans will not be repaid.9

The fiscal illusions of student loan accounting

9.Student loans are accounted for in two separate ways for the purposes of the National Accounts and the DfE Annual report and accounts.

10.The purpose of the DfE Accounts is to reflect a true and fair account of the Department’s financial activities over the course of a financial year; they are prepared under the Government Financial Reporting Manual (FReM) issued by HM Treasury, pursuant to the Government Resources and Accounts Act 2000. The accounting policies contained in the FReM apply the International Financial Reporting Standards (IFRSs) as adapted or interpreted for the public sector context. For the past seven years the Government has produced “Whole of Government Accounts”, which present a summation of all of the individual departmental accounts.

11.The purpose of the National Accounts is to provide a single coherent and exhaustive description of the economic activity of the UK as a whole; they are compiled by the Office for National Statistics (ONS). The framework underpinning the National Accounts ultimately flows from the UN’s System of National Accounts, and the European System of Accounts (ESA2010).

12.The National Accounts are the basis from which Public Sector Net Borrowing (the ‘deficit’), Public Sector Net Debt (the ‘debt’) and Public Sector Net Cash Requirement are derived, and are completely independent of the figures in the departmental accounts. Therefore, the treatment of student loans in the National Accounts directly impacts on the deficit and national debt in a way that their treatment in the DfE Accounts does not.

Student loans in the Department for Education Accounts

13.The treatment of student loans in the DfE Accounts is consistent with the established method of accruals accounting for loans. When a loan is issued to a student, an asset (i.e. the loan owed by the student to the Government) is created in the books of the DfE. When repayments are made, the loan balance (and size of the asset) is reduced. When interest accrues on the loan, the outstanding balance of the loan and size of the asset increases, and interest income is recognised.

14.A significant design feature of the student loan system is that a large proportion of the loans will be written off after 30 years. For accounts prepared on the accruals basis, where an asset is known to be permanently impaired,10 the cost of impairment—also known as the cost of the write-off—must be recognised in full at the first opportunity. A student loan is written down in value if it is known that the recoverable amount of the loan is less than the value at which the loan is held in the accounts.

15.At the end of every financial year, the DfE must consider whether the outstanding balance of the student loan assets is impaired. This consideration principally covers the new loans that have been issued in-year, but also covers the student loan balance brought forward from prior years that has already been subject to impairment tests in previous years. In 2016–17, the DfE issued £13.6 billion of new student loans.11 Using its Stochastic Earnings Path (StEP) model,12 which is based on future income growth, employment rates and interest rates, the DfE calculated that £3.9 billion of the loans (29 per cent) needed to be written off immediately. Of the student loan balance brought forward from previous years, an additional £1.8 billion13 was written off.

16.The impairment on the initial outlay of loans is known as the Resource Accounting and Budgeting (RAB) charge.14 This number defines what proportion of student debt the Government expects to write off. It will change from year to year, depending on the state of the economic forecasts that underpin the StEP model. The Government does not consistently publish the RAB charge,15 although it can be calculated from the cost of new loans and the size of the write-offs, as above.

17.When the then Minister Jo Johnson confirmed the changes to the student loan repayment threshold in a written statement on 9 October 2017, he did not state what impact this would have on the RAB charge.16 In evidence to the Committee, he stated that the new RAB charge would be “between 40 per cent and 45 per cent.”17 Had this RAB charge been applied to the student loans issued in 2016–17, the level of write-off in the DfE Accounts would be between £6.2 billion and £7 billion of the £13.6 billion of loans issued, rather than the £3.9 billion at present.

18.A 36 per cent RAB charge target was included within the 2015–16 BIS Annual Report. The fact that the current RAB charge is estimated to be at least 40 per cent could suggest that the previous target of 36 per cent of student loans to be written off has been abandoned. In evidence provided to the House of Lords Economic Affairs Committee, James Bowler—Director General, Public Spending at HM Treasury—said:

The target has always been 36 per cent; we have not changed it since its inception. […] We and DfE will look at whether the target will remain the same now that the threshold has gone up. There is a potential case for changing the target rate, given the decision to put more subsidy in the system. We have a decision to make as to whether we reflect that in the target rate, rather than change the policy immediately to counteract it.18

19.Given that the level of repayment is dependent on wage growth, inflation and employment levels, the DfE has no ability to influence the RAB charge once the terms of the loans are set. Therefore, assuming university funding is to remain constant, if the Department is not meeting its RAB charge target, the only policy responses currently available are to alter the interest rate, repayment threshold, repayment rate or loan write-off period. As such, the RAB charge acts as a control on student loan write-offs for the Department, by forcing the Department to set the parameters of the loan repayment framework in a way that brings the RAB charge in line with the target.

20.The Government announced the sale of the first tranche of income contingent loans on 6 December 2017.19 The sale achieved proceeds of £1.7 billion, and sold student loans with a face value of £3.5 billion.20 When student loans are sold off, the final sales price of the loans would be compared to the value at which they were held in the accounts, and the difference between the two would be posted as either a profit or a loss in the income statement of the DfE. The profit or loss would not be expected to be very large because the sales price would be expected to be the loans’ fair value, minus a risk premium to compensate the purchaser for taking on the risk that the loans do not pay back as currently expected. As the loans are already held at fair value in the accounts (because they have been subject to impairment tests every year), the loss on the loans should not be dissimilar to the risk premium achieved by the purchaser.

Student loans in the National Accounts

21.The National Accounts treat the issuing of student loans as a “financial transaction”. A loan will be issued, due to be paid back in future, and unless the borrower fails to pay back there will be no impact on the deficit. In evidence to the House of Lords Economic Affairs Committee, James Bowler noted that the Government does not have a choice in determining how student loans should be treated in the National Accounts; noting that “ESA [20]10 is an international standard […] there are some snakes and ladders in the system. […] You must follow them and you cannot pick and choose when you do and when you do not.”21

22.The National Accounts value the loans throughout their life at face value and do not assess them for impairment. Therefore, despite £3.9 billion (29 per cent) of the new student loans issued in 2016–17 being written off in the DfE Accounts, there is no impact of this write off in the National Accounts and therefore no impact on the deficit

23.A key concept of accounting is that transactions should be treated in a way that reflects how they appear in actual substance rather than in legal form, in order to present a true and fair account of an organisation’s performance. Dr Andrew McGettigan, an expert on higher education policy, questioned whether it is reasonable to apply the financial transaction National Accounts accounting rules to student loans given the extent to which they differ from typical loans. He told the Committee:

The treatment of loans is set by these international standards, but, once you have made these loans so un-loan-like, there is a question about whether those standards are appropriate. The deficit measure is not capturing what is going on in loans here, and loans are flattering the deficit.22

24.For the purposes of the deficit, the National Accounts assume that the Government is receiving the interest on the student loans each year in full until the loans are paid off. The National Accounts ignore the Government policy that a large proportion of the loans, and the associated interest, will be written off after 30 years and therefore will not be received in full. The National Accounts therefore overstate how much interest the Government is earning each year, and the overall size of student loans that will be recovered. Sir Amyas Morse—Comptroller and Auditor General—told the Committee: “The fact that, effectively, the write-down in the value of the loan book does not have an impact on the National Accounts until the loan is actually written off means that it is all too easy to manage the impact.”23

25.Were the Government to hold the loans for the full 30 years and then write off the outstanding balance, the losses would be recognised in the National Accounts—and in the deficit—in full in that year. However, when the loans are sold off, they are revalued down to the price achieved and transferred into the private sector. Sir Amyas Morse confirmed to the Committee “If the loan book were sold, they would not be obliged to book a capital loss in the National Accounts.”24 The process of selling off student loans before they are written off circumvents the losses ever being recognised in the deficit.25

26.Sir Amyas Morse said of the accounting presentation of student loans:

It is important that it not be a position where the department comes out taking a loss and, actually, in the hands of the Treasury, it is not a loss. I would like to be reassured that that could not have any negative results. We are concerned by that, yes.26

27.Due to the National Accounts accounting rules, there is no impact on the deficit when student loans are issued. As such, shifting the vast majority of all higher education spending into loans that are written off in 30 years has shifted nearly all higher education spending out of the deficit. Policy decisions taken today will have no impact on the public finances for the next 30 years. Based on the current RAB charge, £6–7 billion of annual write-offs are missing from the deficit. This figure is approximately equivalent to excluding the entire NHS capital budget from the deficit.

28.The National Accounts accounting rules stipulate that if student loans are sold off at a loss before they are written off after 30 years, there is no impact on the deficit whatsoever. The policy of selling off student loans prior to their write-off allows the Government to spend billions of pounds of public money without any negative impact on its deficit target at all, creating a huge incentive for the Government to finance higher education through loans that can be sold off.

29.The Government concluded its first sale of income contingent student loans in December 2017, when it sold £3.5 billion of loans, writing off £1.8 billion (51 per cent) of those loans in the process. The Government plans to sell off £12 billion of loans over the next five years. If the rate of losses on these sales is maintained, billions of pounds of student loan losses will be crystallised without having any impact on the deficit. Its inclusion would increase the deficit as forecast by the Office for Budget Responsibility (OBR) by 13 per cent, from £45.5 billion to £51 billion.

30.Political control over increasing Government expenditure is exerted through analysis of Public Sector Net Borrowing (the deficit) which the Government sets as its fiscal target. The OBR assesses whether the Government will meet this target and subsequently the majority of political debate on public spending is focused on it. As the writing off of student loans will have no impact on the deficit for the next 30 years, the large and increasing level of money spent on higher education makes no difference to whether the Government is meeting its target, and therefore escapes scrutiny. There is no effective control over the increasing fiscal cost of the student loan regime. Better oversight could be achieved through linking the Government’s fiscal borrowing target to the Public Sector Net Cash Requirement, (how much money the Government actually needs to borrow).

31.The Government is not responsible for the international accounting rules that allow the fiscal illusions within student loans to exist. However, the National Accounts accounting rules regarding financial transactions were not intended to be used for loans that, as the Government readily promotes, are designed to not be paid back in full. Loans that are intended to be written off are, in substance, a partially repayable grant rather than a loan. The ONS should re-examine its classification of student loans as financial assets—which they are in legal form—and consider whether a portion of the loan should, in substance, be classed as a grant.

32.The Resource Accounting and Budgeting (RAB) charge is one of the most important numbers in the student loan debate. It presents, as a single figure, how much student debt the Government expects it will have to write off. Despite this, the 2016–17 Department for Education Annual report and accounts did not specify the RAB charge. The Committee recommends that it should be published prominently in the Department for Education’s Annual report and accounts, and should be publicly updated alongside any changes to the student loan repayment framework.

Is the sale of the student loan book value for money?

33.The Government announced the sale of the first tranche of income contingent loans on 6 December 2017.27 The sale achieved proceeds of £1.7 billion, and sold student loans with a face value of £3.5 billion.28 This represents a 51 per cent reduction in the face value of the loans upon sale to the market.

34.The performance of student loans as an asset class is subject to the risk that the overall level of employment falls and wages do not grow. It is very difficult for private companies to hedge against such risks. Therefore, when taking on an asset class that is exposed to these risks, private investors require a risk margin in the price they pay for the assets. The presence of a risk margin is a cost to the Government because the receipts from a student loan sale are lower than the expected future cash flows of those loans. If the expected future cash flows were lower than the price investors had to pay, investors would not purchase the loans, as the loans would be loss making.

35.When the Government places a value on the future cash flows of student loans for the purposes of a sale, it applies a discount known as “the Social Time Preference Rate (STPR)”. This rate is defined as “the value society attaches to present, as opposed to future, consumption”.29 Matt Toombs—Director, Student Finance and Analysis at the Department for Education—explained to the Committee why this rate was used:

The assessment of value for money involved looking at the alternative uses the Government could make of the money that was held within those assets if it was invested elsewhere. That is why they looked at the Green Book value-for-money framework in assessing whether they could achieve value in selling the loans.30

36.The DfE Accounts state that the discount rate used to calculate the present value of student loans for the purposes of a sale is different to the rate used to value the loans in the Department’s accounts themselves:

The decision about value for money ahead of the sale would take account of a valuation of the loan book made on a different basis to that used to value the loans in the financial accounts. Under accounting policies, the amortised cost discount rate (currently 0.7 per cent) applies in the financial accounts. Any decision to retain or sell an asset on the Government’s balance sheet involves an assessment of the retention value of the asset based on HMT’s Green Book principles where a discount rate must factor in a social time preference rate (currently 3.5 per cent).31

37.The use of a higher discount rate when valuing the student loans for sale as compared to the rate used for valuing the loans in the accounts will place a lower value on the loans than the value at which they are held in the accounts. As noted earlier, Matt Toombs told the Committee that the use of the higher STPR is designed to capture society’s preference for the alternative uses that the Government could put the sales proceeds towards, such as alternative policy spending.32 However, the Government proceeds from the student loans sales will be used to pay down the national debt, rather than be reinvested in alternative policies. The then Universities Minister Jo Johnson told the Committee the first loan book sales were “a part of a much bigger programme of student loan sales that should raise £12 billion for the Treasury over the relevant financial period” and described it as an “important contribution towards how we are going to sort out our public finances.”33 The Chancellor of the Exchequer told the House of Lords Economic Affairs Committee:

It is the Government’s intention, where they find that they hold assets on the public balance sheet for which there is no policy or strategic reason, to realise those assets and thus reduce public sector debt.34

38.When the Government sells an asset such as student loans, it is exchanging one illiquid asset, the loans, for a more liquid asset, cash. Public Sector Net Debt (PSND) does not net-off debt with illiquid assets that the Government owns, but does so with cash, because cash can be used to pay off the deficit, and therefore is netted off to reduce the national debt. The Government can therefore reduce Public Sector Net Debt by selling illiquid assets for cash, but its actual fiscal position has not improved. The Office for Budget Responsibility and the International Monetary Fund (IMF) have described Government asset sales that reduce the net debt as a fiscal illusion:

One risk posed by focusing on any particular fiscal aggregate is the temptation to set policy so that it has an effect on the chosen metric even if that is not a good guide to the effect on the underlying health of the public finances. The IMF describes such disparities as ‘fiscal illusions’. PSND is susceptible to such illusions because it includes only a limited range of liabilities and an even smaller range of assets. This makes financial asset sales superficially attractive as they reduce a liability that ‘scores’ by reducing an asset that does not.35

39.The Government is better able to manage an exposure to macroeconomic risks—such as low overall wage growth and low rates of employment—than the private sector. As a result, private sector investors require a large risk margin when taking on student loan assets from Government. The risk margin on the first student loans sale was, in aggregate, 51 per cent of the sale price.

40.Exchanging student loans for cash does not improve the Government’s financial position, it merely exchanges one asset for another. Despite this, the sale does reduce Public Sector Net Debt. Such a fiscal illusion does little to improve the Government’s financial position and may in fact cost the taxpayer money.

41.Such a high risk margin—and the fact that selling off the loans does not improve the Government’s fiscal position—suggests the Government may be better off keeping student loans on its own balance sheet, rather than shifting the risks to the private sector and paying a large premium for doing so.

42.Whether the sale of student loans passes the Treasury’s value for money test is heavily dependent on the discount rate used to calculate the future value of student loan repayments. As with all discount rates, there is a large margin for error. The Government has chosen a different discount rate for the purposes of the sale—a rate which places a lower value on the future repayments of the loans—than that which is used in the Department for Education Accounts. As part of its major review, the Government should consider using the same discount rate as that used in the Department for Education Accounts, as audited by the National Audit Office.

The funding split between the graduate and the taxpayer

43.The student loan system gives rise to a higher education funding model comprised of a contribution by the taxpayer and a contribution by the graduate. The larger the proportion of student loan debt that is written off, the larger the taxpayer contribution, and vice versa. Commenting on the funding split between the graduate and the taxpayer in a speech in July 2017, Jo Johnson said:

Students pay on average roughly 65 per cent of the cost of the system through fees, while the taxpayer bears around 35 per cent of the cost, through teaching grants and loan subsidies, and a much higher share if we were to consider also the Government’s £6 billion investment in research. This is a fair split of the cost of higher education.36

44.These comments were made before the Government announced its decision to increase the repayment threshold to £25,000 and to freeze the maximum tuition fee cap at £9,250. These changes were described by the IFS as a “significant giveaway to graduates”, and they have had a material effect on the funding split between the graduate and the taxpayer. Estimates of the new split vary slightly. In its written submission to the Committee, Universities UK stated that students now bear 53 per cent of the cost and taxpayers 47 per cent,37 whereas Jo Johnson told the Committee that the Department for Education now estimates that students bear 55 per cent of the cost and taxpayers 45 per cent.38

45.Given the taxpayer is now paying a share that is 10 to 12 percentage points larger than originally envisaged, the Committee asked the former Minister whether he still considered the split to be fair:

Broadly speaking, it is roughly right that each group’s share corresponds to the benefits that they receive from higher education in the form of the present value to the student of the higher lifetime earnings that they can expect and, for the public, the other benefits: the societal benefits that accrue from having an educated workforce and an educated population. If the splits correspond broadly to those benefits, it is a reasonable balance.39

Sustainability and changes to the model

46.The Office for Budget Responsibility has forecast that by 2021–22 total outstanding student debt will be seven per cent of GDP, or £160 billion.40 In 2005–06, total outstanding student loan debt was £20 billion—less than one per cent of GDP.41 The Committee asked the then Universities Minister Jo Johnson about the sustainability of the loan system, both from an economic and political perspective:

It is a strong model that has been put into place over a number of years and has undergone various changes. It is sustainable and it is achieving its core policy objectives […] The repayment threshold [change] had the advantage of benefiting students immediately in terms of the amounts that they would be required to pay […] It results in an immediate benefit to students of about £360 a year. That is cash in their hands that they would not otherwise have when they are in the repayment period, and it had that attraction.42

47.The Committee sought evidence on how the Government can pull various levers to modify the student loan system, including by retrospectively changing student loan terms. When asked about this, Lord Willetts said:

It is inherent in the system—because this is a democratically framed public policy—that you can adjust the repayment terms. It was made absolutely clear to students that the terms could be adjusted […] My view is that there should be a fiveyear review, in which these parameters of the system […] are openly discussed.43

The National Union of Students commented on the information available to those taking out student loans, saying “It is not clear that the terms and conditions of the loan […] can be changed at the whim of government”.44 Its view was shared by MoneySavingExpert, who said “the Government does not communicate clearly enough with students and parents around the fact that the terms of their loan can change retrospectively”.45

48.When asked whether changes to the 30-year write-off period would be considered as part of the Government’s major review—announced by the Prime Minister at the 2017 Conservative Party Conference—Jo Johnson said:

The review wants to examine the system to ensure it remains fair and effective, and the key elements of it—the interest rate, the threshold and the duration of the loan—are the kinds of levers that will always be under examination as we ensure that the balance of costs between students and taxpayers remains fair.46

However, the former Minister also told the Committee that he did “not expect radical change to the core architecture” as a result of the Government’s review.47 The Committee awaits the details of any actual review.

49.It is undisputed that writing off a significant proportion of student loan debt is a deliberate design feature of the student loan system, making a student loan unlike any other form of loan or debt. In the absence of an effective explanation of the student loan framework—including the terms and conditions students are accepting—it is inevitable that the public will see write-offs as emblematic of a failing system. The criticism of retrospective changes which increase the burden on graduates as “unfair”, levelled by MoneySavingExpert and the National Union of Students, is justified. The Government should cease this practice.

50.The then Universities Minister Jo Johnson stated that the higher education funding system “is delivering [its] core policy objectives”,48 one of which is to “fairly share costs between the general taxpayer and the individual student”.49 The fairness of the funding split is subjective; the Government should instead aim to achieve a split that is economically optimal. It is not clear how large a range of funding splits the Government would consider optimal, given that the split has swung by 10–12 percentage points since the new repayment threshold has been introduced. The Government should define what it considers to be an optimal split to give greater certainty for future public spending.

51.The Committee welcomes the Government’s planned major review of student financing and university funding. It is, however, regrettable that Jo Johnson effectively ruled out “radical change to the core architecture [of the student loan system]” in his oral evidence. The Committee hopes that Sam Gyimah, the new Minister for Higher Education, will approach the review with an open mind. The review must be objective, widely framed, and empowered to bring about any changes deemed necessary, be they radical or otherwise.

52.In his evidence to the Committee, Lord Willetts argued for a five-year review in which the parameters of the student loan system are openly considered.50 There is merit in this proposal—which the Committee assumes would mean changes are made only after such reviews—not least for greater transparency. As part of its major review, the Government should analyse the benefits and drawbacks associated with introducing a pre-defined periodic review of student loan terms, and should ensure it takes account of the thoughts of students when considering the merit of this proposal.

The interest rate

53.The interest rates applied to student loans represent one of the most widely discussed facets of the entire system. The relevant interest rates for post-2012 student loans are set out in Table One below.

Table 1: Interest rates for post-2012 student loans

Circumstances

Interest Rate

Whilst studying and until the April after leaving the course

RPI plus 3 per cent (equal to 6.1 per cent at the time of writing)

From 6 April after leaving the course until the loan is repaid in full

Variable rate dependent upon income. RPI (3.1 per cent at the time of writing) where income is £21,000 or less, rising on a sliding scale up to RPI plus 3 per cent where income is £41,000 or more

If the student does not respond to the Student Loans Company’s requests for information or evidence

RPI plus 3 per cent, regardless of income, until the Student Loans Company has all the information it requires.

Source: Student Loans Company

The purpose of the interest rate

54.Whether interest rates at current levels can be justified is an area of debate. Former Universities Minister Jo Johnson explained the rationale behind the Government’s policy in his oral evidence:

It is trying to address two issues. The first is students who do not need the finance taking cheap debt and putting that money to speculative purposes. The second issue, but more important in terms of why it is there, is to have a progressive dimension to the system […] to enable the highest-earning graduates to make a bigger contribution towards the overall public cost of supporting higher education. They subsidise some of the costs that the Government incur in enabling people to go into higher education who do not then go on to repay their loans in full.51

55.In evidence to the House of Lords Economic Affairs Committee, James Bowler—Director General, Public Spending at HM Treasury—provided an explanation of how the interest rate services as a redistributive tool:

… the IFS says that if you are in the top decile you will pay back £93,000 with the interest rates now, but if you did not have RPI plus 3 per cent but CPI plus 0 per cent you would pay back £53,000, so that is progressive. If you are in the system, the more you earn, the more you pay; but if you do not even get above the threshold, you do not pay anything. By the standards of progressivity in government, that is pretty progressive.52

56.The student loan system has complex redistributive effects. In general, graduates who are able to pay off their loan early pay less interest overall, and hence face a lower overall cost than those who pay off their student loan later. The most ‘expensive’ loans are paid by those with a high starting salary and slower career progression, such that they face a higher interest rate from the start, and pay off the loan capital just before the point of write-off.

Chart One: Cumulative cost of student loans with the existing interest rate structure53

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Chart Two: Cumulative cost of student loans with a 2 per cent interest rate

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57.Chart One illustrates the cost of student loans, using indicative examples of graduates in different professions making steady progress through their careers. For comparison, the chart also shows the cost faced by a graduate whose earnings track the average across the economy. Overall, the civil servant, the teacher and the accountant pay broadly similar amounts for their loan, but a graduate joining a “magic circle” law firm pays less, owing to rapid pay growth in the early stages of their career. The graduate whose earnings simply track the average pays much less. The system is therefore capable of redistributing both upward, to the high-flying lawyer, and downward, to the graduate who does not benefit from a substantial pay premium. Chart Two shows that, if instead graduates are charged a “flat” interest rate of 2 per cent, the disparity between the lawyer on the one hand, and the accountant, civil servant and teacher on the other, is reduced.

58.Lord Browne—whose 2010 report heavily influenced the design of the existing student loan system—did not envisage interest rates at current levels.54 In evidence to the Committee, Lord Browne stated that “we said that … the interest rate would be at the Government’s cost of borrowing”.55 The Committee also took evidence from Dr Andrew McGettigan who, when asked about the interest rate as a mechanism to introduce a degree of progressivity into the student finance system, argued that this was not the Government’s original intention.56

Perceptions of the interest rate

59.The public’s understanding of the interest rate was a recurring theme in the Committee’s evidence sessions for this inquiry. Former Universities Minister Jo Johnson said of the interest rate:

It is a poorly understood feature of the system. […] Very few people understand the progressive nature of the interest rate—the fact that it is the most graduate tax-like element in the system, in a way, in the sense that it is progressive and it is redistributing resources from the highest earning graduates […] to those who are earning less.57

Lord Browne and Dr Andrew McGettigan echoed Jo Johnson’s view that the interest rate is not well understood as a redistributive tool.58

60.Professor John Denham—who served as Secretary of State for Innovation, Universities and Skills between June 2007 and June 2009—told the Committee that “to an ordinary member of the public who knows that money can be borrowed far more cheaply than that, it just looks like a completely unfair charge”.59

The use of RPI

61.The student loan interest rate is based on the rate of inflation as measured by RPI, with an additional surcharge depending on an individual’s earnings. In March 2013, RPI was de-designated as a national statistic, and it has been roundly criticised as a flawed measure of inflation, including by this Committee.60,61,62 In a 2016 letter, the National Statistician, John Pullinger, strongly discouraged the use of RPI as an inflation measure.63 More recently, the Chair of the UK Statistics Authority, Sir David Norgrove, expressed “regret that the RPI is still used more widely than for index-linked gilts, including for student loan repayments”.64 In its written evidence to the Committee, the Royal Statistical Society said:

Instead of one or the other of the RPI or the CPI being used consistently by the government for indexation, these indices seem to be used very selectively indeed. It is grossly unfair that, presently, Government formulae which affect people’s incomes (in the form of pension and benefit increases) often use the CPI, which normally provides a lower estimate of inflation, while several of their outgoings including student loan repayments […] are still related to increases in the RPI, which normally gives a higher estimate.65

62.When asked why RPI was chosen, Lord Willetts told the Committee:

I cannot remember the arguments about which inflation measure to use. I would say that, back in 2010–11, RPI had not fallen so low in the esteem of the economics profession as it now has […] the main argument […] was the aim of making the system progressive.66

When the Committee asked the same question of Jo Johnson, he said:

RPI continues to be used for various purposes […] It continues to have relevance as a measure in the context for which we are using it here, in the sense that it includes things that are relevant to students that CPI does not, including, for example, mortgage interest payments and council tax.67

63.It is correct that RPI does include mortgage interest payments and council tax payments, whereas CPI does not. However, households in which everyone is a full-time student do not have to pay council tax,68 and it is uncommon for students to hold a mortgage. CPI also takes account of university accommodation costs, whereas RPI does not.69 The NUS also supported the use of CPI over RPI.70

64.The Committee sees no justification for using RPI to calculate student loan interest rates. RPI is no longer a National Statistic and has been widely discredited. In its Autumn Budget the Government acknowledged that the use of RPI was unfair for business rates, and the Committee is unconvinced by the case put forward for its use by the then Minister, in line with the Committee’s report on the Autumn Budget. The Government should abandon the use of RPI in favour of CPI to calculate student loan interest rates.

65.The Committee recognises the importance of preventing student loans being taken out to be invested, and it is right that the interest rate should seek to prevent this. However, given that tuition fee loans—which make up significantly more than half of an average student’s stock of debt on graduation—are paid by the Student Loans Company directly to the university, there is little justification for applying high interest rates to the tuition fee element of student loans while students are studying. Applying an interest rate above the level of inflation to tuition fee loans whilst the student is still at university is perceived to be a punitive measure and should be reconsidered.

66.The Government has justified the existing level and structure of interest rates on student loans on the grounds that it is progressive. In reality, the student loan system has complex redistributive effects that are not strictly progressive. High-flying lawyers will generally pay less than teachers; but both will pay more than a graduate who does not receive a pay premium from their time in higher education. As part of its major review, the Government should re-examine the repayment system to address this anomaly so that the highest earning graduates are those that make the highest contribution .

67.The Committee is therefore unconvinced that the interest rates currently charged on student loans can be justified on redistributive grounds. Nor has any other persuasive explanation been provided for why student loan interest rates should exceed those prevailing in the market, the Government’s own cost of borrowing, and the rate of inflation.

68.It is incumbent on the Government to ensure that the student loan system is well explained so that prospective students and their families are able to make well informed decisions. The Government must take steps to ensure that the student loan system—and particularly the interest rate—is well explained to those that it affects.


4 Student Loans Company website, accessed 4 January 2018

5 Q239

6 Q196

7 Q98

8 Department for Education, Consolidated Annual report and accounts 2016–17, July 2017, p 155

9 Q193

10 An asset (in this instance the student loan issued by the DfE) is impaired when its fair value (the higher of the value at which the asset could be sold, or the value of the future cash flows derived from the asset) is estimated to be permanently lower than the value at which it’s held in the accounts.

11 Department for Education, Consolidated Annual report and accounts 2016–17, July 2017, p 155

12 Department for Business, Innovation and Skills, Guide to the simplified student loan repayment model, June 2015

13 Department for Education, Consolidated Annual report and accounts 2016–17, July 2017, p 155

15 The Department for Education, Consolidated Annual report and accounts 2016–17, July 2017, did not refer to the RAB charge.

The Department for Business, Innovation and Skills (BIS) Annual report and accounts 2015–16, July 2016, disclosed a RAB charge of 23 per cent, but erroneously included a target RAB charge of 28 per cent when it should have been 36 per cent, which Correction slip: Department for Business, Innovation and Skills Annual report and accounts 2015–16 subsequently corrected.

Prior to 2015–16, Department for Business, Innovation & Skills: The RAB charge, referred to PQ HL5098 [On Mature Students: Loans] 18 January 2016, stating a charge of “between 20 per cent and 25 per cent.”

17 Q193

18 House of Lords Select Committee on Economic Affairs, The Economics of Higher, Further and Technical Education, Evidence Session No. 5, Tuesday 7 November2017

20 Q217

21 House of Lords Select Committee on Economic Affairs, The Economics of Higher, Further and Technical Education, Evidence Session No. 5, Tuesday 7 November 2017

22 Q21

25 Office for National Statistics (STL 0048)

28 Q217

30 Q217

32 Q217

33 Q220

34 House of Lords Select Committee on Economic Affairs, Chancellor of the Exchequer annual evidence session, Tuesday 12 September 2017

36 Speech by Jo Johnson to the Higher Education sector at Reform, “Delivering value for money for students and taxpayers”, 20 July 2017

37 Universities UK (STL 0026)

38 Q190

39 Q190

40 Office for Budget Responsibility, Fiscal sustainability analytical paper: Student loans update, July 2016, p 10

41 Office for Budget Responsibility, Fiscal risks report, July 2015, p 225

42 Q189, Q194

43 Q110, Q111

44 National Union of Students (STL 0029) para 27

45 MoneySavingExpert (STL 0046)

46 Q275

47 Q292

48 Q292

49 Speech by Jo Johnson to the Higher Education sector at Reform, “Delivering value for money for students and taxpayers”, 20 July 2017

50 Q111

51 Q199

52 House of Lords Select Committee on Economic Affairs, The Economics of Higher, Further and Technical Education, Evidence Session No. 5, Tuesday 7 November2017

53 A full explanation of earnings profiles and underlying assumptions can be found in Appendix 1

55 Q98

56 Q83

57 Q200

58 Q6, Q123

59 Q131

61 “Good luck to our latest measure of inflation, it’s the best of a bad bunch”, Paul Johnson, The Times, 21 March 2017

62 Treasury Committee, Autumn Budget 2017, HC 600, 22 January 2018

65 Royal Statistical Society (STL 0047) para 2

66 Q127

67 Q203

68 Council Tax: Discounts for full-time students, Gov.uk, Accessed 4 January 2018

70 National Union of Students (STL 0029) para 15




15 February 2018