Is the new student loan system really fairer?

The government says its new student loan scheme will be cheaper for the taxpayer while the richest grads pay less. How? Gavan Conlon and Andrew McGettigan find the discounts

Gavan Conlon is a Partner at London Economics.


Andrew McGettigan is a journalist, researcher and commentator on higher education.

When we first started reading the press releases ahead of the publication of the government’s response to Augar, we weren’t particularly surprised by the substance of the proposals – they had been rumoured for some time.

The reduction in the repayment threshold and removal of real interest rates had been modelled (by London Economics for HEPI) and their impact demonstrated. The extension of the repayment period had also been modelled (by London Economics for the University of Sheffield and LSE students unions).

Given the near impossibility of reducing the headline tuition fee (which we have also modelled), we knew something along the lines of what was finally proposed was going to materialise. The question was to what extent.

Same old same old

In all the analysis we have undertaken over the last decade, we have generally adopted the same approach. We consider the cohort of English-domiciled (all) undergraduate students commencing their studies (both part time and full time). We look at the student support arrangements facing those students, and add in the wider economic forecasts from the Bank of England and OBR. Same. Every. Time.

So we were surprised (on many fronts) when we saw the statement:

Taxpayers – most of whom have not been to university themselves – are funding 44p of every pound of student loans issued to full-time undergraduates. In future, taxpayers will fund less than 20 pence in the pound of the new loans issued each year.

This is presented fully in the government’s impact assessment (Table 12, p.31).

When you’re looking at student loan accounting, the Resource Accounting and Budgeting (RAB) charge is important – it’s the estimated cost to government of borrowing to support the student finance system. It is based on future loan write-offs and interest subsidies in net present value terms.

How had they got it down to less than 20p in the pound?

For eagle eyed observers, the figures appeared incorrect, as the RAB charge was actually modelled to have declined from approximately 52 percent (a weighted average over Plan 2 FT and PT students) (Table B1, p.93). London Economics’ current models estimate a RAB charge of 52.5 percent.

Last June ‘s publication of student loan forecasts show what were thought to be the current figures, which meant that for every £1 loaned by government, it was expecting to receive the equivalent of under 50p in repayments. The current loan scheme was actually looking more expensive than this because of other changes – with a new RAB expected to clock in at just under 60 percent.

So imagine our surprise when we looked at the Department for Education’s press release that was somehow claiming that the RAB charge was estimated to decline by 33 percentage points as a result of its policy announcements.

Having modelled almost every potential amendment to student support, and starting from a near identical spot, this reduction in the RAB charge appeared to be near impossible.

Eliminating tuition fees (and the associated loans) cuts the RAB charge by approximately 13 percentage points. Eliminating fees and increasing the real interest rate to a maximum of 5 percent would cut the RAB charge by 21 percentage points. Doing all of this, and extending the repayment period by 10 years, and freezing the threshold at £25,000 for a couple of years gets us to the magical 33 percentage point reduction.

The problem is that tuition fees haven’t been abolished, and the interest rate for new cohorts was reduced so that it tracks inflation measured by RPI. The government is going to extend the repayment term by ten years. The highest earning graduates will pay less via lower interest rates, and lower earning graduates pay more via a longer term and a lower repayment threshold. But even still, we couldn’t understand how they’d got the RAB down so low.

Here’s where the magic happens.

Student discounts

In annexes to the impact assessment, it is revealed that the government has reduced the “discount rate” for valuing future loan payments. In effect, it has said that the same pound paid in the future is worth more in today’s terms.

Specifically, the real discount rate for student loans has changed from plus 0.7% to minus 1.1% (and for nominal discount rate, apply inflation). That doesn’t seem like much, but it makes the world of difference. The discount rate essentially reflects the fact that loan repayments received by the government in the future are worth less than the value of the loans issued by the government today. The lower the discount rate, the greater the value of future repayments – and so the lower the RAB charge in consequence.

Here’s an example. If the government issues £1,000 of loans today, and receives a payment of £1,000 in ten years’ time, under the old discount rate assumption, this was worth a little less than £700. Under the new assumption, it’s worth over £800. When repayments clock in at billions of pounds per year in cash terms, that change in the valuation technique adds up. So existing loans are now worth more – much, much more – and the government’s deficit will improve when those are formally revalued.

So what about the new scheme? Well, the discount rate really comes into its own when you extend repayments out to 40 years after leaving study. Discount rates are like compound interest in reverse, because a small change multiplies over and over.

Let’s consider a one-off £1,000 cash payment made in Year 35 of repayment (sometime around 2060 – we know, we know) and assuming average inflation of 3 percent (we know, we know).

Using the old discount rate (inflation plus 0.7%) that payment would be worth around £250 in today’s terms. But with the new rate it is worth nearly double that. The same payment of £1,000 is worth over £500 today on the new discount rate.

Merry Christmas

The amendments to these rates were announced in December, and the suite of changes can be seen here. Maybe this accounts for the delayed government response to Augar.

Is there any issue about changing the discount rate? Well not really. It’s been done before on occasion. A couple of years after the introduction of £9,000 fees, the RAB charge shot up to an eye-watering 65 percent as a result of a change. The discount rate was changed to 0.7% (not unreasonably), and the implications (a reduction of the RAB charge to approximately 44%) were pointed out by Andrew McGettigan on the site at the time.

Its not brilliant, but if the rules have changed, then that’s fine. We play by the rules. The rules change elsewhere with equally significant implications. For instance, the National Accounting rules changed in respect of the treatment of student loans – and in particular how they were scored against the deficit. This delayed and severely limited what the Augar Review could propose in the first instance. Despite this, Augar played by the rules he’d been given.

So what’s the problem? Well, it turns out that most of the claimed savings to the taxpayer are not the result of the policies themselves – but a result of this hidden change.

As if by magic

The proposals are trumpeted as if they generate huge cost savings and put the loan scheme on a sustainable footing. That’s not really the case.

Using London Economics’ modelling, under the old discount rate, the current student support arrangements cost the Exchequer £10.63 billion in economic terms. Under the new discount rate, it’s £7.23 billion. The proposals themselves save the Exchequer approximately £539 million (old discount rate), but essentially, when we model the apparent cost savings from the proposals and the change in the discount rate, we get about £4.0 billion of savings combined. That’s really not playing by the rules, especially when an obscure and obscured technical change accounts for approximately 85 percent of the apparent saving.

A lot of people have commented about the potential impact of the proposed changes to student support arrangements. If you want to see our analysis of the impact of the proposals themselves (using the old discount rate) on a like for like basis, they are here. In a nutshell, the graduates who will benefit the most are the highest earning – predominantly male – graduates. The messaging has been that lower earning graduates need to pay more to make the system sustainable. In fact it’s the discount rate change that does most of that – with the extra contributions from lower earning graduates helping to fund the reduced contributions from the richest.

When you strip out all the noise, that’s it. It’s hard to see this when there is a lot of smoke and mirrors. What makes all this worse is the government knows that its discount rate change means that the extra payments made by lower earning graduates in years 30 to 40 are doing most of the heavy lifting.

Update: this article was amended on 28 February to clarify the cost of student support arrangements. 

3 responses to “Is the new student loan system really fairer?

  1. Really good explanation thanks. Came to the same conclusion that the savings outlined in tables 11 and 12 of the equality analysis are simply not credible without the accounting trickery of the cut to the discount rate. Including the old discount rate in the current system calculations is particularly ‘creative’ of the DfE. Possibly aimed at getting the Treasury off their backs more than anything. Won’t stop ministers lauding the savings in public though.

  2. Not sure of the justification for using a discount rate which is below the level of inflation – as I understand it, RPI will become a rebadged CPIH from 2030 so the new discount rate will effectively be CPIH minus 1.1%. Presumably it is linked to current government borrowing costs and so could change significantly in the future?

    It has a lot of odd implications e.g. a real-terms payment of £10,000 in 40 years’ time will be “worth” over 50% more than a payment of £10,000 today.

    One useful bit of analysis that the IFS could do is to repeat their analysis of the NPV of a degree – which underpins so much of the narrative on “low value courses” – if you apply a discount rate of CPIH minus 1.1% rather than RPI + 3.5%. I suspect the problem would get quite a lot smaller…

  3. The RAB grew from a forecast 28% to 45% over the Coalition Parliament 2010-2015.

    “The discount rate was changed to 0.7% (not unreasonably), and the implications (a reduction of the RAB charge to approximately 44%) were pointed out by Andrew McGettigan on the site at the time.”

    If you add in the intended repayment threshold freeze of 2016-2021 at £21,000, the forecast RAB was actually lowered to 20 to 25% (the change from maintenance grants to loans and indexing fee caps to inflation subsequently raised it to around 29%).

    https://www.timeshighereducation.com/news/student-loan-write-estimate-lowered-20-25

    Then of course the mad 2017 decision to jump the threshold to £25,000 indexed to earnings raised the RAB charge back to the 45% (and then 53%) level.

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