Graduate gilts

Iain Pears on the proposed changes to university funding in Britain:

Another thing to note is the extraordinary nature of the loans system being proposed, which is that students will be charged at 3 per cent plus inflation for a very long period of time once they hit a certain level of income. This is sheer profiteering disguised as fairness. Essentially, the government will be requiring individuals to issue 30-year index-linked bonds on their own balance sheets, rather than do it itself. A few sums shows what this might mean. For the government will raise the money to advance the loans on a flat rate basis. It will, in other words, borrow the money at about 2.5 per cent, and lend it out at 6.1 per cent, more if inflation increases. While it will enjoy the benefit of seeing its real debt eroded by inflation, the student will not be permitted the same escape route. If only half the total number of students take out a loan of £7000 every year, then that would amount to a transfer from the state’s balance sheet to those of individuals which stabilises over 30 years at about £110 billion. The government would pay a peak £2.75 billion a year in interest for this, and receive peak income of £6.75 billion back, as wage inflation will ensure within 12 years that most graduates earn over the £41,000 benchmark which triggers the maximum levy, and there seems to be no provision for this to be index-linked.

Even Barclaycard would applaud such audacity, not least because there are measures to guarantee this income stream by imposing financial penalties on anyone who wishes to pay off their debts early – a unique and almost feudal arrangement, where individuals are going to be forced to remain in debt, effectively to provide the government with cash flow, for most of their working lives. I know of no other case of a government requiring its citizens to be in permanent debt. The argument that this is just like a mortgage is specious, as mortgages are not index-linked, there are a wide variety of different time periods available, individuals have a choice of which ones to take, and they are secured on hard assets which have traditionally risen in value over time. None of these conditions apply to student loans.

Even if you think it right for students to carry all or most of the cost of their degrees, you surely have to do extra work to demonstrate why a student should pay a graduate tax on top, in the form of an interest rate set three points higher than inflation. And once graduated, why shouldn’t the student loan recipient be allowed to refinance his or her new debt?

18 thoughts on “Graduate gilts

  1. There’s also the fact that such a system of taxation is blatantly regressive: higher earners will actually pay less in the long run (in real terms, not just as a proportion of income) because they pay earlier. If you allow voluntary early repayment, it becomes even more regressive as rich parents can bail their offspring out and avoid all that compound interest.

  2. Maybe this is a bad idea. But is there a competitive loan market? If so, students can skip the government option. Moreover, maybe the govt will inherit the bad risks. Either way, this kind of writeup is helpful in letting borrowers know what they’re signing up for.

  3. Surely the reasoning (for not allowing refinancing) is that they are being given a fixed rate decided at a time when their future earnings prospects are very uncertain, so they are part of a large risk pool? If later, the higher/more reliable earners can opt-out (by paying it off with their bonus, or refinancing with a bank who won’t need anymore to guess about earning prospects) the government is left with an ever less-likely-to-pay pool of loans.
    I’d be astonished if 3% above inflation could come remotely close to what would be needed to break even in such a market, in the face of such adverse selection.

  4. @Charlie Whitaker: Regressiveness is seen as a good thing by the Tories; I’m just commending them on their chutzpah. Though in a way they could be victims of their own success, if they manage to narrow access so much that only natural Tory voters go to university…

    Maybe the next step will be to introduce something like this at secondary school level. Either your parents pay up front for a proper independent school education, or you are forever indebted to the state.

  5. I always enjoy trying to spot the unspoken and usually incorrect assumptions in Charlie’s posts.

    Nowhere in this piece is it argued, or even mentioned, whether students will actually get around to paying these loans back.

    If US experience is anything to go by, the default rate will be very high and the cost of making the loans whole will fall on the taxpayer, so 3% actually looks pretty low to me. Funny, isn’t it, that no matter how much special pleading these columns produce, they are never in favour of the taxpayer; always in favour of some special interest group.

  6. So, the gist of some of the comments here is that a student loan program ought to be self-funding, and therefore loan interest rates should be set high enough to cover the cost of defaults. But I’d put things this way: given that some former students will default, who should pick up the slack? The non-defaulting former students, or all taxpayers? I don’t see that the answer is obviously the first group: what did they do to deserve it? Bear in mind that a bank, unlike a government, doesn’t have tax-raising powers, so it must look to interest and other charges to cover its exposure.

    I say all this as a UK taxpayer myself, by the way. Jon, you must have done some sums there, mate. What do you consider a “very high” default rate, then?

  7. *IF* one considers that the program should be self-funding, and not a certain drain on taxpayers then (a) the need for some charge beyond inflation (to account for defaults), and (b) the role of restrictions on prepayment/refinancing as a price for making such a low rate possible, should both be crystal clear to as a matter of really basic and inevitable economics.

    Yet I read your original article as criticizing these aspects of the program as mysterious additional (and punitive) complications. No, they are logical and sound requirements that probably are beneficial to all concerned (again, IF one buys the self-funding requirement).

    You would be on clearer ground if you had started more clearly with the gist of your last followup, raising the basic philosophy of taxpayer picks up the tab vs having the winners of the graduation/jobs lottery doing so. That’s the interesting issue you raise. Picking on details of the scheme that follow from the self-funding requirement without more clearly saying that is that underlying principle you object to, not these consequent details (and frankly, making you seem ignorant, as if you cannot connect the dots that from the self-funding principle in an otherwise unobjectionable way) isn’t useful.

  8. bxg: that sort of way of going about things is just going to get your comments removed, I’m afraid. The stuff we put up here at AFOE is written in good faith. I don’t see any reason for you to take the tone that you do.

  9. Mr Whitaker,

    I have to squint to see the “tone” you might read as so offensive, but at end I perhaps might: several of my sentences have a rhetorical crudeness that can come across as personal attacks – written expecting the context would make the actual purpose clear, but can see how this could fail. I truly apologise for this carelessness.

    I’m more surprised by your felt need to tell me about the “good faith” of your articles. By my lights, I wonder what other comments or reaction you have had in this thread that take your good faith remotely as seriously. You’ve asked questions and I sincerely thought there could be discussion around answers. You made a follow-up comment which I thought was superiour in substance and approach (to what I am guessing are your real concerns) than the head entry and I wanted to tell you so. The comment that excites you was intended, at the end of the day, to be constructive on this score.

    I tried objectively to understand how I could have shown bad tone, and concede so. But I have tried and tried to see objectively how I could be interpreted as taking you other than seriously and constructively, and am at a complete loss on this point.

    I am very much looking forward to having all my comments from this thread deleted; thank you very much in advance.

    Regards.

  10. Over here in the UK, you have to understand that “fairness” is only judged from where your interests really lie. David Cameron (our PM) says to the country, from a Cabinet of millionaires, that “We’re all in this together”, whilst they give our pensioners less a week to live on than they spend on a “decent bottle of wine for dinner”. Such blatant self-interest informs their proposed student loan scam and graduate taxes.

  11. “But I’d put things this way: given that some former students will default, who should pick up the slack? The non-defaulting former students, or all taxpayers? I don’t see that the answer is obviously the first group: what did they do to deserve it?”

    But “all taxpayers” is, or at least will eventually become, a set made up of “non-defaulting former students” and “people who’ve never been to university”. So the question now becomes: given that some of the slack will inevitably be picked up by former students, why should the rest of the slack necessarily be picked up by people who have never gone anywhere near the student loan system? What the first group has done to deserve it is “borrow money to go to university”.

    The early-repayment fees are not entirely unexpected. What gets me is the inflation-linked interest rate, which is a bit of a shock.

  12. So the question now becomes: given that some of the slack will inevitably be picked up by former students, why should the rest of the slack necessarily be picked up by people who have never gone anywhere near the student loan system? What the first group has done to deserve it is “borrow money to go to university”.

    But this isn’t obviously fair, though, is it? The justification is that they will be borrowing money for their own education, on the principle that people should pay for what they consume. How is it that by going near a university they suddenly become liable for the tuition costs of other students, while the general population doesn’t?

    Now admittedly, we very often do ask people to pay for things they themselves don’t consume, through taxation. But this is then managed on an ability to pay basis, where higher earners contribute more (where one of the justifications is that it’ll hurt them proportionately less). We don’t manage taxation along the lines of ‘well, you once went to Plymouth for a navy day, therefore you should contribute a higher proportion of the defence budget’. Is it that having other students around you improves the quality of your own education, therefore you should help some of those other students out? This is the only thing I can imagine that comes close to a justification.

  13. I can see that there’s potential for a category error here, though. When you borrow money from the bank, you do in some sense become liable for the cost of defaulters (i.e. other borrowers). Although this is probably unfair, we don’t question it because we accept that a private bank has to keep itself afloat and it has no tax raising powers. The government isn’t like that, though, and students will be borrowing from the government, not a bank. (Unless the whole scheme gets privatised, of course, in which case we’re in new, and not particularly neighbourly territory.)

  14. The higher education of the young contains much social value, such as providing capitalists with productive employees and the military with promising young officers. It is not unreasonable to ask society at large participate in covering the cost of this social good, as it is society at large that captures much of the benefit. Making the successful students directly pay for their failed peers seems economically perverse.

  15. “There’s also the fact that such a system of taxation is blatantly regressive: higher earners will actually pay less in the long run”

    Socialist nonsense. Pay what you borrowed and end of the story. It’s a loan after all, no?

    UK should learn from US, cheap and easily avail student loans drove up the cost to as much as $250K for a 4 year degree

  16. But this isn’t obviously fair, though, is it? The justification is that they will be borrowing money for their own education, on the principle that people should pay for what they consume. How is it that by going near a university they suddenly become liable for the tuition costs of other students, while the general population doesn’t?

    How? In exactly the same way that you become liable for the general consumption of other people who use the same bank or credit card company as you, and fail to make their payments. Some part of the interest I am paying on a bank loan is going to make good the loss the bank took on Bob, whom I’ve never met, but who defaulted on his loan last year. I’ve always been a good customer, never missed a payment, and I certainly don’t benefit at all from whatever Bob bought with his loan money.

    You could see this as unfair; but a better way of looking at it is “this is the money I am paying the bank in exchange for them taking a risk on my ability to repay”. Whether I end up being able to repay or not is irrelevant, in this description. People need to be paid to take risks. It’s no more unfair than paying money for fire insurance you never use is unfair. If I want the bank to lend me money, they won’t do it unless I effectively buy “ajay insurance” for them.

    And if you say “well, governments are different and so they shouldn’t be paid for taking credit risk”, you’re really just saying that student loan rates should be subsidised from general government funds to be at lower rates than they would be if they were self-financing.
    Which is entirely a defensible position – but you need to be clear that that’s what you’re saying. And you also need to be clear why that specific degree of government subsidy is preferable to, say, offering completely interest-free loans, or simply partial or full grants.

    The inflation link is new and weird and more interesting to my mind.

  17. And if you say “well, governments are different and so they shouldn’t be paid for taking credit risk”, you’re really just saying that student loan rates should be subsidised from general government funds to be at lower rates than they would be if they were self-financing. Which is entirely a defensible position – but you need to be clear that that’s what you’re saying. And you also need to be clear why that specific degree of government subsidy is preferable to, say, offering completely interest-free loans, or simply partial or full grants.

    Sure. But isn’t it obvious that I’m not taking on the burden of proof here. On the contrary, I’m asserting that if you think that only former students should subsidise the defaults of former students, then you have the obligation to show why that should be.

    If you’re saying that you don’t think you have that obligation, then I’ll tend to think that you’ve slid into thinking that the government is like a bank. This is very much against my intuition, but perhaps we should leave it there.

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