Funding Higher Education

Emla Fitzsimons

Institute for Fiscal StudiesFebruary 2004

1. Economic principles underlying government intervention in the funding of higher education

2. Main provisions of the Higher Education (HE) Bill endorsed by a majority of MPs on January 27th

3. What are the implications of these provisions

• For the student• For the graduate• For the universities• For the taxpayer

4. Conclusions

OUTLINE

CONTROVERSIAL…OR NOT?

• ‘Higher education is a basic right and should therefore be free’

• ‘It is immoral to charge for higher education’• ‘Graduates pay for their degree anyway through

higher tax payments’ • ‘Students should make a contribution via a graduate

tax’• ‘Fees harm access’• ‘Loans harm access’

ECONOMIC PRINCIPLES UNDERLYING INTERVENTION IN HIGHER EDUCATION

1. EFFICIENCY

I. Liquidity Constraints

II. Information Problems

III. Uncertainty and Risk Aversion

IV. Externalities

2. EQUITY

HE requires cash upfront (for fees and living expenses) => With perfect capital markets, borrow and repay out of graduate income

But due to information asymmetry, risk and uncertainty in capital markets…

student inability to borrow (lenders reluctance to lend) due to• Lack of collateral (human capital?) - asymmetric information –

borrower has more information than lender => expose lender to adverse selection => risk premium inefficiently high => inefficiently small amount of borrowing

student reluctance to borrow due to• Imperfect information re nature of HE • High (perceived) risk of failing the degree• Uncertainty: average private return to a degree is positive but high

variance; no option to sell qualification to make repayments

EFFICIENCY ARGUMENTS I. Liquidity Constraints

EFFICIENCY ARGUMENTS contd.II. Information Problems

• In order to make rational decisions, individuals must be perfectly informed about

• Nature of product – quality of education [Good Universities Guide?]

• Prices – tuition fees, living expenses, opportunity cost of labour etc. [provide facts and information via internet, leaflets etc.]

• Future

• Likely that imperfect information leads to under-consumption, especially by lowest socio-economic group

• Stronger argument for centrally planned package at primary and secondary levels – capacity of younger children to make choices is limited, the case for uniformity of educational experience stronger

EFFICIENCY ARGUMENTS contd.III. Uncertainty and Risk Aversion

• Comparing expected and not actual incomes

- More certain income streams might be preferable to less certain income streams, even if E[Present Value] of latter is higher (closely related to risk aversion)

• Market for insurance fails due to• Adverse selection• Moral hazard

EFFICIENCY ARGUMENTS contd. IV. Externalities

Education may create benefits to society over and above those that accrue to the individual alone

i.e. return to education = private return + social return Strength of effects difficult to measure

Average private return to HE v non-HE is ~27%

Do individuals incorporate social return to educationin weighing up PV of benefits and costs? Affectsindividuals on the margin

EQUITY ARGUMENTS

• Do market failures to do with efficiency (information, liquidity constraints etc.) disproportionately affect individuals from less well-off backgrounds?

• If so, case for intervention also rests strongly on equity grounds

Horizontal Equity• Everyone who would benefit from HE (PV terms) should have

right of access• Equality of information to assist rational choice• Equality of power to enforce that choice: access to HE

should not be constrained by family income

TYPES OF INTERVENTION IN THE UK: TIME-LINE

• Pre-1998• No tuition fees• Means-tested grant (decreased a lot in real terms)• Parental contributions• Loans with fixed monthly mortgage-type repayments (from 1990); zero real interest

rate => from 1990 living costs covered by grant and loan

Problems led to establishment of DEARING COMMITTEE

• 1998 to present• Upfront means-tested fees of £1,125 (25% of average teaching costs)• No maintenance grants • Means-tested income loan entitlements; income-contingent repayments• Parental contributions

Possible criticisms of systems?

TIME-LINE contd.

• 2006 onwards (White Paper 2003, HE Bill 2004)• Variable fees: £0 - £3,000• System of deferred charges: HE free at the point of use – is

it? Extend income-contingent loans to cover all fees • Restoration of grants for poor students

Problems with existing system

1. Universities under-funded

2. Students poor – excessive use of credit cards (?)

3. Parental contributions

1 and 2 => students need more money up front

4. Improve access

THE HIGHER EDUCATION (HE) BILL 2004

• Fees

• UPFRONT

• No upfront fee

• DEFERRED

• Initial cap £3,000 p.a.• Fee exemptions replaced by grants

THE HE BILL 2004 contd.• Loans

• FOR FEES• Debt forgiveness after 25 years• Increased GCS loans for those who would have been eligible

for fee exemptions, i.e. if family income < £33,630 p.a.

• FOR MAINTENANCE• Decreased generosity for those who would have been eligible

for fee exemptions (cost neutrality)

Repayment of Loans• 9% of income above threshold of £13,925 p.a.• Zero real interest rate

THE HE BILL 2004 contd.

• Grants• Single combined Higher Education Grant. Means-

tested maximum of £2,700 p.a. comprised of (a) £1,200 if family income < £22,580 p.a. Tapered

to zero at family income of £33,630(b) £1,500 if family income < £15,970 p.a. Tapered

to zero at family income of £22,260 p.a.

• Bursaries

• Minimum of £300 p.a. if family income <£15,970 p.a. (‘poorest’ students) and university charges the maximum top-up fee of £3,000 p.a.

IMPLICATIONS FOR STUDENTS, BY PARENTAL INCOME

- Amount of debt students will incur

- Amount of support available through grants

- Will all of this be enough to live on?

Amount of debt students will incur(assuming students borrow max amount available to them)

Table 1

3 year course, non-London, non-home

Parental income Low

<£15,970

Middle

£25,500

Upper Middle

£35,000

High

>£44,000

Max Fee Loans 9,000 9,000 9,000 9,000

Max Maintenance Loans

10,335 10,335 12,440 9,665

Total Debt 19,335 19,335 21,440 18,665

Amount of support available through grants; shortfall

Table 1 contd.

Parental income Low

<£15,970

Middle

£25,500

Upper Middle

£35,000

High

>£44,000

HE Grants

and Bursaries 9,000 2,649 0 0

NUS Annual Shortfall 335 817 2,745 3,670

Figure 1 Non-London student finances under the Higher Education

Bill with fees of £3,000 p.a.

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

0 5,000 10,000 15,000 19,500 23,500 28,500 33,500 38,000 43,000 48,000

Parental income, £ p.a.

Sou

rces

of s

tude

nt fu

nds,

£ p

.a.

Fee Loan Maintenance Loan BursaryHE Grant NUS Shortfall

Figure 2Non-London student finances under the Current

System with upfront fees of £1,100 p.a.

0

1000

2000

3000

4000

5000

6000

7000

0 5000 10000 15000 20000 25000 30000 35000 40000

Fee Exemption Maintenance Loan SHORTFALL

Problems with proposed system

1. Loan and grant thresholds (parameters of the system) need to be clearly defined and refined

2. Debt entitlement not monotonic in income

3. Complexity of system, difficult to understand, not transparent – poorly marketed?

4. Shortfall – not enough money for students at university

5. Fee cap?

IMPLICATIONS FOR GRADUATE, BY PARENTAL INCOME AND GRADUATE

EARNINGS PROFILES

• Will depend on lifetime labour market earnings and employment patterns

• Some examples1. Median male and female graduates2. Female doctor3. Female with low-starting salary + career

break4. Male high-flyer

Long-term impact for median male graduate earner

MALE, 3 year course;

Starting salary £12,100

Family earns

<£26,000

Family earns

£35,000

Family earns

>£44,000

Debt £19,335 £21,440 £18,665

Taxpayer subsidy on debt £5,301 £6,103 £5,050

Yrs to pay debt 19 20 19

Lifetime gross earnings £1,201,004 £1,201,004 £1,201,004

Working-lifetime income tax and NI

£329,996 £329,996 £329,996

% increase in tax payments 5.9% 6.5% 5.7%

Long-term impact for female doctor graduate

FEMALE, 5 year medical degree;

Starting salary £21,000

Family earns

<£26,000

Family earns

£35,000

Family earns

>£44,000

Debt £32,445 £35,956 £31,271

Taxpayer subsidy on debt £7,568 £8,852 £7,149

Yrs to pay debt 18 19 17

Lifetime gross earnings £1,593,855 £1,593,855 £1,593,855

Working-lifetime income tax and NI

£487,250 £487,250 £487,250

% increase in tax payments 6.7% 7.4% 6.4%

Long-term impact for low-earning female with career break

FEMALE, 3 year course+career break;

Starting salary £6,800

Family earns

<£26,000

Family earns £35,000

Family earns >£44,000

Debt £19,335 £21,440 £18,665

Taxpayer subsidy on debt

£12,184 £14,289 £11,514

Yrs to pay debt 25 25 25

Amount of debt not paid £7,349 £9,453 £6,678

Lifetime gross earnings £806,715 £806,715 £806,715

Working-lifetime income tax and NI

£207,012 £207,012 £207,012

% increase in tax payments

5.8% 5.8 % 5.8%

Long-term impact for male high-flyer

MALE, 3 year course + high flyer;

Starting salary £20,000

Family earns

<£26,000

Family earns

£35,000

Family earns

>£44,000

Debt £19,335 £21,440 £18,665

Taxpayer subsidy on debt £2,781 £3,242 £2,635

Yrs to pay debt 10 10 9

Lifetime gross earnings £3,317,835 £3,317,835 £3,317,835

Working-lifetime income tax and NI

£1,178,032 £1,178,032 £1,178,032

% increase in tax payments 1.6% 1.8% 1.6%

IMPLICATIONS FOR UNIVERSITY FUNDING

1. How much extra will be generated?

Projections of approximate income from fees under

the central fee scenario in which- 75% of universities charge £3,000- 25% of universities charge £1,200

• Additional income from top-up fees

£990m-£1,010m• Total fee income implied (incl. basic fee)

£1,890m–£1,910m

IMPLICATIONS FOR UNIVERSITY FUNDING contd.

Universities will be able to keep all of the additional fee revenue coming in from top-up fees but…

2. What difference will bursaries make?

• If fees > £2,700 p.a. required to pay minimum bursary of £300 p.a. for students from ‘poorest’ backgrounds

• Total bursary expenditure ~ £50m => £950m for increasing teaching resources

IMPLICATIONS FOR UNIVERSITY FUNDING contd.

3. What will happen to the amount of funding per head?

• ~ £1,250 per student; Increase of 22%

4. Will the new level of funding reverse the decline in funding per student?

Will return the unit-funding levels to around those

observed in 1992-93 but will leave the levels well

below the unit funding of the late 1980’s.

IMPLICATIONS FOR TAXPAYER

Cost of fee deferral• Highest cost new loans to cover £1,800 variable fee £445m• Highest cost new loans to cover £1,200 basic fee £190m• Cost of loan write-off after 25 years £ 30m

Total cost of fee deferral £665m

Cost of student support• Increasing loan to meet median basic living costs £65m• Cost of new maintenance grant introduced 2004-05

and additional £500 grant from 2006-07 £485m Total cost of student support £485m

OVERALL TOTAL £1,150m

Source: DfES (2004)

CONCLUSIONS• Some quirks have worked their way into the proposed

system as piecemeal changes have been made – need to be ‘ironed out’

• Generosity of loan system means that even those who can afford not to do so, would be well-advised to take out the maximum loan and to invest any spare cash that they would have used for fees in interest-bearing account

• Average level of funding per student could be increased by ~22%

• Surprising feature of reforms – which are being sold on the principle that graduate should bear more of the cost of their HE – is the amount that the new fee and support proposals will cost the taxpayer.

REFERENCES• Blundell, R., L. Dearden and B. Sianesi (2003), “Evaluating the Impact of Education on

Earnings in the UK: Models, Methods and Results from the NCDS”, IFS Working Paper 03/20.

• Dearden, L., E. Fitzsimons and A. Goodman (2004), “An Analysis of the Higher Education Reforms”, IFS Briefing Note No.45.

• Goodman, A. and G. Kaplan (2003) “’Study now, pay later’ or ‘HE for free’? An Assessment of Alternative Proposals for Higher Education Finance”, IFS Commentary No.94.

• Barr, N. (2003), “Financing Higher Education: Comparing the Options”, LSE• Barr, N. (1998), “The Economics of the Welfare State”, Chapters 13, Oxford University

Press, July.• Barr, N. (2001), “The Welfare State as Piggy Bank”, Chapters 10-14, Oxford University

Press, June.• Department for Education and Skills (2004a), “The Higher Education Bill”, Bill 35,

London.• Department for Education and Skills (2004b), “The Future of Higher Education and the

Higher Education Bill 2004: Regulatory Impact Assessment”, London.• Department for Education and Skills (2004c), “Moving towards a Single Combined Grant

for Higher Education”, London.