Another deep unfairness in devolved student loans policy

Earlier this week we published a piece from me and NUS Scotland’s President Justine Pédussel on devolved financing of HE.

Basically, Wales, Scotland and Northern Ireland are allowed to design their own student-finance systems. But the Treasury has built a series of ceilings around that “freedom”.

And one that we didn’t mention uses an interest-rate calculation that doesn’t normally apply to other devolved public services.

The three tests

When a devolved government changes student finance, it faces three tests.

The first asks how much it lends. Take a group of Welsh, Scottish or Northern Irish students and compare them with the same students under England’s rules. If the devolved system lends more, the Treasury can require the devolved government to meet the difference.

The second asks how much of that lending is expected to become public spending. Student loans are split into two parts – the amount graduates are expected to repay, and the amount that is expected never to return. The Office for National Statistics calls the second part a “capital transfer”. Again, the Treasury compares the devolved cohort with what England would have spent on the same students.

Together, those two tests form the Treasury’s “comparability assessment”. We’ve set out elsewhere why a cohort-based assessment that only funds debt is unfair.

But there is also a third test – RAB cover. RAB stands for “resource accounting and budgeting”. Each devolved government is given cover for an expected amount of loss on its new student loans, broadly related to its population share. If its calculated RAB charge exceeds that cover, it can be required to find the difference from its own budget.

That means there are two different scoreboards. A system can pass the comparability assessment but still exceed its RAB cover.

The discount-rate trick

RAB isn’t just a forecast of how many pounds graduates will repay. Repayments may arrive over the next 30 or 40 years. The Treasury therefore converts those future payments into what it thinks they are worth today. It does that using a “discount rate”.

Imagine the government lends someone £10,000 and expects to receive £7,000 back, spread over several decades.

That future £7,000 is not treated as being worth £7,000 today. Using its discount rate, the Treasury might value it at only £5,000. The remaining £5,000 then appears to be the cost of the loan.

If the discount rate rises, those future repayments look less valuable. The loan asset becomes smaller and the RAB charge becomes larger – even if students have borrowed exactly the same amount, the repayment rules have not changed and graduates are expected to make exactly the same cash payments.

The discount rate is not literally the interest rate on today’s government bonds. But it is a Treasury financial calculation about the value and financing of money over time. It brings considerations related to the government’s cost of capital into the student-loan budget.

The ONS calculation works differently. It also values future repayments, but uses the effective interest rate faced by borrowers rather than the Treasury’s financial-instrument discount rate. That is why the ONS and RAB can produce very different answers about the “cost” of exactly the same loans.

Why that is unfair

There is a sensible reason for RAB to exist. It prevents ministers from pretending that loans which will never be repaid are completely free. The problem comes when RAB is used to decide whether a devolved nation is receiving more than its fair share.

When the UK Government’s borrowing costs rise, Wales is not sent a separate bill for the extra cost of financing Welsh hospitals. Scotland is not charged a special interest-rate supplement on its schools. Northern Ireland does not lose money from its transport budget because gilts have become more expensive.

Higher borrowing costs may squeeze the UK Government’s overall budget. If Westminster then changes spending on English public services, that can produce Barnett consequences. But the financing cost is not normally applied directly to one devolved service.

Student loans are the exception. A change in the Treasury’s discount rate can increase a nation’s RAB charge and push it above its cover. The devolved government can then be required to use money that could have supported universities, students or other public services – even though it has not made its student-finance system any more generous.

It also produces an extraordinary possible result. On the ONS measure – the one appearing as public expenditure in the national accounts – Wales can be spending less than its fair population share. But on the Treasury’s RAB measure, it can simultaneously be accused of spending too much. And has been – which is why Wales was unable to meet its Diamond review commitment of raising maximum maintenance in line with the minimum wage.

Put simply, one scoreboard says Wales is below its allowance while another says it is over. The Treasury then uses the less favourable scoreboard to demand money back.

We need sensible spending controls. Governments should not have unlimited access to student lending. But if there is a limit, it should be based on the same public-expenditure principles used elsewhere in devolution.

If Barnett is supposed to divide changes in public spending, the fair test is how much is lent and how much the ONS records as public spending. A separate RAB ceiling allows the Treasury’s changing valuation of future money to decide how much can be spent on today’s students and universities.

I know it sounds like an obscure accounting problem. But it’s really another hidden interest-rate penalty on devolved higher education. Westminster always wins. And in this case, Wales loses.