The HE Debate: Where next for...a graduate tax?

10 Feb 2015

Baroness Margaret Sharp of Guildford

Making the case
The disclosure last May (2014) that some 45 per cent of the sums lent by the Student Loans Company (SLC) would never be recouped by the Government raised serious questions about the long term viability of the student fee regime introduced in 2012. This in turn prompted the all-party Higher Education Commission (of which I am a member) to initiate an inquiry into the sustainability of the 2012 student loan system. Its Report Too Good to Fail – the financial sustainability of Higher Education in England was published last November.

The Report concluded that there were a number of serious risks to the sustainability of the current system over the longer run. Indeed, it suggested that in many respects it represented “the worst of all worlds”. The Government were heavily subsidising Higher Education – some £12 billion a year in making upfront fee loans with barely a half being repaid – and yet was getting no credit for it. Students felt they were paying a substantial amount for their higher education but getting no obvious benefits. Universities for their part were perceived to be “rolling in money” now most of them were receiving  £9K per student, with few people realising that the Government had simultaneously cut nearly all their teaching and capital funding.

Perhaps more than anything else the Commission was shocked by the IFS calculations that 73 per cent of all student loan recipients would never pay off the full sum and in particular that middle earners (on current salaries of £40K to £45K) such as teachers, many health professionals and other public sector employees, who needed a degree to enter the profession, stood not a chance of paying off their debt. To add to this we learned that the new Financial Conduct Agency rules would make it increasingly difficult for those in this income bracket to obtain a mortgage because their disposable income, after paying to HMRC the 9 per cent ‘graduate contribution’ on top of income tax and national insurance, would be too low to justify the amounts they were seeking. We also found through Focus groups that students aged 18-21 had no real understanding of the longer run implications of their debts. ‘Sufficient unto the day’ was their attitude; whereas there has been a 40 per cent drop in applications from older mature and part-time students who already have household obligations.

The Commission’s main conclusion was that the system in its current form was unlikely to last. It was costing the Government too much; was not bringing any noticeable benefits to students while the fee cap, at £9K, was both politically difficult to raise and increasingly under attack from VCs. There was no obvious solution given the funding constraints, but we called for the whole system to be reviewed post-election and put forward six possible alternatives, ranging from tweaking the present system (the favourite here was to reduce the threshold for repayment to £15K), through variants on Labour’s seemingly preferred system of bringing down the fee cap to £6000, to the wholesale switch to a graduate tax.

The purpose of this essay is to make the case for a graduate tax as a system that is both sustainable and fair over the long run. It is also by far the most ‘revolutionary’ of the proposals put forward since it would mean radical changes from the current system and riding roughshod over present Treasury taboos.

How might a graduate tax work? A good starting point is the modelling done for million+ by London Economics and explained in their joint publication of May 2013 ‘Do the alternatives add up?’. These contain London Economics calculations of how two alternatives – Labour’s proposal for the £6000 fee cap and some form of graduate tax – might work financially compared to the 2012 £9K loan fee system (hereafter called the 2012 system). The idea of a graduate tax is that it is paid by all those graduating (approx. 350,000 students a year) as a supplement to income tax for a given period of time irrespective of whether or not they have repaid the original fee cost - so there is no loan, no need to keep tabs of how much has been paid and therefore no need for the SLC and its bureaucracy.

The question London Economics posed was whether such a tax could bring in, in present value terms, as much to the Exchequer as the 2012 system (e.g. discounting and comparing future payment flows – whether loan repayments of graduate tax payments - back to the present). They present two different models both of which brought in the same income over the longer term as the present system. One was a 30 year tax which would vary from 2 per cent for incomes between £10K and £25K; 2.5 percent between £25K and £42K, and 3.5 per cent over £42K. The other was a 40 year tax with lower rates - 1.5 per cent for the first band; 2.25 for the second and 3 per cent for the top band. Clearly you can feed different parameters into this model – it would be quite feasible to have a higher threshold for repayment (£15K or £20K for example); different rates of tax for different bands; a flat rate across all incomes; or different lengths of time for payment.

The most important lesson from this modelling is that a graduate tax of 2-3 per cent can bring in an equivalent income to the present 2012 repayment system which effectively levies a tax of 9 percent for 30 years on the majority of graduates with incomes over £21K. The reason for this is that those on high incomes go on paying for all 30 years, irrespective of whether they have paid off the cost and are, in effect, cross subsidising those on middle and lower incomes whom, as we saw earlier, would never pay off the debt. The case for such a cross subsidy is that those earning higher incomes can be said to be gaining a much higher premium for their degree than others. It would also be paid by those whose parents/ grandparents at present pay off their student debt and who often go on to earn relatively high salaries. In this respect the graduate tax would be redistribution from the better off in both income and wealth.

My own preferred variant for a graduate tax would be to have a starting threshold to £15K, to opt for a straight 3 per cent rate of tax across the whole income range and to suggest that it is paid for the whole of a graduate’s working life which may in future be considerably more than 40 years. To avoid discrimination against English graduates, I would levy it on all graduates, English, other UK or foreign, which would compensate in a rough and ready way for the EU graduates who would benefit from the no fee regime but escape paying the tax (as at present they escape loan repayments). Over time such a flat rate tax would probably bring in an income closer to £10 billion which would cover much of the present H E teaching budget. Inflation would look after itself since both threshold and yield would rise with inflation. I would ring fence this income into the coffers of an independent self-governing Higher Education Council whose task it would be to distribute the income between universities.

The big objection to any graduate tax model is that unless it was made retrospective, which is not really feasible, the yield for the first 10 years or so years would be well below self-sustaining levels. There would be some income from existing fee repayments under present loan schemes and those affected might be offered the choice of continuing on the repayment system or switching to a graduate tax. Initially any graduate tax scheme would require direct Exchequer borrowing instead of the indirect ‘off the books’ borrowing through the Student Loans Company. At a time when the prime objective is to cut the deficit this is the great attraction to Governments of whatever complexion. Surely however it is better to be open about how much the system is costing and to accept the extra borrowing required in the short run in return for a system which would be near self-financing over the longer term?  We are constantly being told that education is an investment:  is this not one worth making? It seems absurd our arcane public sector accounting systems should burden the current generation of students with the current unnecessarily expensive, unsustainable and unfair system.

Margaret Sharp is a member of the House of Lords and a former Liberal Democrat spokesperson on higher education. She writes here in a personal capacity. The opinions expressed in this essay are entirely her own and do not in any respect represent the views or policy of the Liberal Democrats or those of the Higher Education Commission.