The student loan system: unpredictable, incomprehensible and increasingly unfair

Debt Payment” by Images_of_Money is licensed under CC BY-SA 2.0.

After successive changes to the student loan regime in England it is difficult to remember that it started out as a reasonable idea.

Graduates benefit considerably from gaining a degree, despite the nonsense about ‘Mickey Mouse’ subjects that regularly surfaces in the right-wing press. It was not irrational to ask them to meet some of the costs.

Universities have benefited from increased funding through fee income that would never have been delivered through general taxation. The demands of the health service and social care were always going to command higher political priority.

Finally, student loan repayments were structured so that students only paid if their earnings were above average, and any outstanding debt was written off after 30 years. The prospect of debt has not reduced the participation of students from disadvantaged backgrounds in higher education.  

There were, of course, downsides to the system even before recent announcements. Bizarre accounting rules applied by the Treasury had the effect of hiding the true cost of student loans and concealing the fact that many loans would never be repaid. Paul Johnson, from the Institute for Fiscal Studies (IFS), describes it as a fiscal illusion which we wrote about last year – “Smoke, mirrors and student debt”. This fiction gave those who obsess about government deficits an incentive to move more expenditure from grants to loans and to charge excessive interest rates.

Furthermore, student debt has been not so much a debt as a tax. True debts need to be paid off. Student loan repayments, on the other hand, consist of a nine per cent increase in income tax once an earning threshold is exceeded for a limited period of years. Calling it debt, perversely, made the arrangement sound rather more burdensome than it was.

It seems, however, that there is no aspect of national life that the current government cannot make worse, and student finance is no exception. Changes announced in late February 2022 make the perceived debt burden much more of a real debt burden. They also mean that in future high-income earners will pay less and low-to-middle income earners will pay more. So much for levelling up!

There are two key changes that will apply to future cohorts of students. The largest impact will result from extending the period over which repayments are required from 30 years to 40 years. According to modelling by the IFS, around 70 per cent of new graduates can be expected to pay off their debt in full, receiving no taxpayer-funded write offs.

The other change is to the threshold at which repayments start. It is currently set at £27,295 per year. For new borrowers the rate will be cut to £25,000, and for existing students frozen for two years. Thereafter, instead of being uprated for inflation with reference to the index of average earnings, government will apply the Retail Price Index (RPI) which it expects to be around 1.8 per cent per year lower. Over time, therefore, graduates will pay a high and ever higher percentage of their earnings.

The combined effect of these changes means that high-earning graduates will be, on average, £20,000 per year better off. Those on modest earnings will pay around £30,000 more. Our students already pay far more for their higher education than those in almost every other country. Government is increasing that further for most graduates at the same time as they face a hike in National Insurance contributions and soaring inflation.

The topsy turvy world of student finance accounting makes even a positive sounding change mean not what it seems. At the moment, government charges interest on student loans at three percentage points above RPI. In future it will charge only at the RPI rate. This, of course, only benefits those students who pay back their loan in full, that is the wealthier. If you never pay off your debt it doesn’t matter what interest rate you have been charged.

Less easy to understand is that lowering interest rates to students reduces the cost to the taxpayer. The IFS explain it here but I wouldn’t bother trying to follow it. The key thing to note is that student finance is so complex that normal political debate on the topic is rendered impossible.

A final consequence of the changes is that the system will become even less predictable. The IFS highlights the impact of the current arrangements on interest rates which will see, for a short time, interest on loans soar to 12 per cent for some students before falling sharply again. This will have very different, and unjustifiable, impacts for different groups of students. In the longer run the difficulty of predicting inflation and wage rates 40 years ahead makes the impact on public finances harder to assess. IFS talks of “a leap into the unknown”. 

In the short term, freezing the repayment threshold at a time of rapidly rising inflation, means unpredictable, but substantial, increases in repayment costs for most existing graduates. Moreover, retrospective changes to the repayment threshold underline the fact that students cannot guarantee that the terms on which they took out a government loan will not be radically changed.

Although initially well intentioned, the student loan system has become a monster. Few people can understand how it works and the few that do understand know its impact is unpredictable.

What is certain, however, is that it casts the shadow of debt over increasing numbers of people and places an unfair burden upon the young. It is beyond reform and needs to be scrapped.