Student loan reform is a leap into the unknown – Institute For Fiscal Studies

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At the end of February, the government announced the most significant reform of the student loan system in England since at least 2012. The central elements of the reform are a lower income threshold for student loan repayments (reduced to £25,000 then frozen until 2026 –27); a change in the future increase in the revenue threshold from the average revenue growth rate to the RPI inflation rate; an extension of the repayment term from 30 to 40 years; and a reduction in the maximum interest rate on student loans to the RPI inflation rate (from a maximum RPI inflation rate plus 3%). The new system will apply in full from the 2023 college-entry cohort, but the 2012-2022 entry cohorts (“plan 2 borrowers”) will also see significant changes.

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Our first analysis showed that:

  • The announced reform package will transform the student loan system. Despite their name, pre-reform student loans functioned primarily as a tax on graduates: a large majority of graduates had to repay 9% of their earnings above the repayment threshold for 30 years, regardless of the balance of their student loan. Under the new system, this is no longer true: more than 70% of graduates can expect to repay in full and will not benefit from any taxpayer-funded loan forgiveness.
  • Graduates with lower average incomes will be most affected by the changes with a lifetime loss of around £30,000. These wage earners benefited from substantial taxpayer subsidies before the reform, but will have to repay a much larger share of their loans under the new system.
  • Higher earning graduates will pay around £20,000 less due to lower interest rates. These graduates would have largely repaid their loans in full, even under the pre-reform system. For them, the lower interest rate translates into lower repayments overall, while the lower repayment threshold simply causes them to repay their loans faster.
  • The long-term savings to taxpayers following the changes announced at the end of February amount to around £2.3billion. The short-term impact on the budget deficit will be much larger, at around £6.3bn for the 2023 cohort. This is due to an accounting quirk.
  • The system will also become significantly less generous for middle-income graduates from the 2012-2022 starting cohorts. These students are almost as affected by changes in repayment thresholds as students from the 2023 cohort, but do not benefit from lower interest rates. Compared to the pre-reform system, 2022 starters stand to lose around £20,000.

In this briefing note, we present a more detailed analysis of the effects of the reform on students and the taxpayer – both on the 2012-22 entry cohorts and on the entry cohorts from 2023 – updated from the latest economic forecasts from the Office for Budget Responsibility. Throughout, we will emphasize the great uncertainty about the consequences of the reform. It is unclear how the announced changes will affect the behavior of future students. And while we can roughly say who will gain and who will lose financially from the reform, it is difficult to say exactly by how much. This is mainly because the impact crucially depends on what current youth incomes will be decades from now, something we cannot hope to predict accurately.

Main findings

  1. The results of our initial analysis hold up as we update our projections using the latest economic forecast from the Office of Budget Responsibility and new data on graduate earnings. Thanks to the new interest rate forecasts from the OBR, we are now able to model how the interest rate cap on student loans works. However, all these updates have only very small effects on the estimated impact of the reforms.
  2. The reform makes the funding system for higher education in England even more aberrant internationally. Even before the reform, England relied less on public funds to fund higher education than comparable countries. It is unpredictable how the low public subsidy will affect the choices of future students.
  3. The change in indexation threshold from average earnings growth to RPI alone is likely to cost middle-income graduates in the 2022 and 2023 cohorts over £10,000 over their lifetime. For the taxpayer, this change alone is expected to save substantially more than £2 billion in undiscounted real terms. It is somewhat concerning that such a significant change was not mentioned at all in the press materials announcing the reforms.
  4. Overall, higher earning borrowers will be better off under the system from 2023, and lower income borrowers will be better off under the 2022 system. For students leaving school in 2022, this means that the incentives to take a gap year or not will depend crucially on their expected future earnings.
  5. In the medium term, the reforms will allow graduates of the 2023 entry cohort to repay around £750 a year more from 202728 (when they usually start paying back their loans) if they earn more than £33,900. Graduates from previous cohorts since 2012 earning more than £32,900 in 2026-27 (when the 2022 cohort will generally start paying back) will have to pay around £400 more than under the pre-reform system.
  6. The taxpayer will likely save more on loans from the 2022 cohort than on cohorts from 2023 as a result of policy changes announced this year. Indeed, cohorts from 2023 will benefit from a lower interest rate on student loans, which will be expensive for the taxpayer. In undiscounted terms, the reforms are likely to reduce the cost to taxpayers by three-quarters for the 2022 cohort and by half for the 2023 cohort.
  7. Despite this, the short-term reduction in public borrowing resulting from the reforms will be much larger for the cohorts from 2023 than for the 2012-22 cohorts. This is entirely due to the treatment of student loan interest rate changes in the national accounts. Paradoxically, lowering student loan interest rates lowers the initial cost of extending student loans, as it means that more of the loans will be repaid with interest.
  8. Government policy choices have made the cost of the student loan system less predictable for taxpayers. The change in the indexation of the repayment threshold ties the cost of borrowing more strongly to future earnings growth. Because of the longer repayment term, graduate earnings 40 years from now will count for student loans, and that earnings are even harder to predict today than earnings 30 years from now. Freezing the repayment threshold means that the future cost of loans will depend on the unpredictable path of inflation over the next few years.

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