There are three ways to tackle the current student loan crisis: one is unwise, one is unaffordable and one is unpalatable. All are unfair.
HEPI Director Nick Hillman takes a look at the continuing row over whether student loans are turning out to be fair for graduates.
The weekend media were full (yet again) of the perceived unfairness of Plan 2 student loans. These are the loans taken out by undergraduate students who started their studies in England between 2012 and 2022. They cover both tuition fees and maintenance costs.
Graduates with Plan 2 loans face a high-ish variable interest rate (6.2% if they are on a salary comfortably over £50,000) and a 30-year payback period before the loans are written off. Plan 2 remains the norm in Wales, where Labour chose not to copy England’s shift to Plan 5 loans (which have no real rate of interest but a 40-year repayment term).
The first students who took out Plan 2 loans are now graduates in positions of influence, including in Parliament and in the media. They are using this influence to complain about how much money they are having to pay to the Government through income tax, National Insurance and student loan repayments combined – often 51% of salary.
Many people will feel sympathy for them, both for the large debts detailed on their student loan statements and for the wider ‘failure to launch’ challenges faced by younger people, given the ups and downs of the graduate labour market and high housing costs. But much of the rhetoric on Plan 2 is overblown.
Some – I stress not all – of the complaints are nothing more than successful graduates wanting someone else to cover their own debts. Intriguingly, given how progressive the loans are, the loudest complaints come from the left – for example, from Oli Dugmore of the New Statesman, Zarah Sultana MP, Nadia Whittome MP and Chris Curtis MP.
What is to be done? Policymakers tend to work by the rule of three, meaning a tricky policy challenge may only have three possible big solutions. The Pensions Commission, for example, responded to the pensions crisis of the early 2000 by claiming the only options were: later retirement; higher taxes; or more saving.
The same goes for Plan 2 student loans. There are just three options for tackling the perceived problems, and each is as unattractive as those three pension options. Yet we don’t know which one the complainants would prefer. In other words, those unhappy about Plan 2 loans need clearer answers on how they think the system should be fixed.
- One option is to hide the issue by no longer giving access to student loan balances. New graduates don’t worry they will pay hundreds of thousands of pounds in income tax over their careers, as no one ever rolls the total number up. Yet they do worry about comparable student loan payments. We’ve had stealth taxes; in this scenario, student debt would become stealth loans.
- Another option would be to reduce student debts. By tweaking the features of Plan 2 loans, such as the repayment thresholds or the interest rate, policymakers could reduce current monthly repayments and / or cut outstanding balances. But someone would have to pick up the tab, including – presumably – those who have not directly benefited from higher education.
- A third option, and the one that has been favoured by policymakers in the past, is to hit graduates harder, so the loans get paid down faster. While comparisons are not always easy, it is thought other countries with student loans have typically had lower repayment thresholds (see page 31). But if you currently dislike watching your total debt grow despite making repayments, you might really hate the larger payments necessary to reduce the total debt even more.
If policymakers are to fix the supposed problems faced by those with Plan 2 loans, they will have to choose one of these options or a mix of them (or something like them). To me, the first option seems unwise, the second seems unaffordable and the third seems unpalatable. All three seem unfair. It is time for the campaigners to say which they prefer.
To return to pensions, the Plan 2 protests resemble the failing WASPI campaign by those who say the equalisation of State Pension Ages was so badly communicated that billions in compensation should now be paid. Whether it is WASPI or Plan 2 student loans, people are trying to unwind policies that were specifically designed to aid the bulk of taxpayers.
Nick Hillman’s previous blog on the row about Plan 2 loans can be read here: Why the current campaign on student loan interest may be misguided, misunderstood and misdirected
Comments
Pete says:
A lot of the current commentary is focused on the high interest rates and the fact that they mean that most will not pay their loan off.
Michelle Donelan dealt with this issue for new students starting their degree from 2023 via abolishing real interest rates funded by lower earnings thresholds & a 10 year longer repayment period. This removed much of the progressivity built into the system by its architects, reducing public subsidy significantly for low graduate earnings to fund a big interest rate subsidy for high earners.
As you say, it is odd that left-wing commentators are implicitly saying that Donelan got it right given how regressive these changes were.
One correction: it is the marginal rate that is 51% – the average rate is far lower than this e.g. even someone earning £50K pays has an average tax rate including student loan repayments of 25% (with student loan repayments contributing 3.9 percentage points of this)
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Yon says:
Perhaps, if you were subject to the same indentured servitude we are going through, you’d be the first one in the streets with a placard. The effective tax rate you speak about is meaningless wheny you are talking about ambitions. First of, the reason we have marginal tax rates is to ensure that those who earn pay more at some earnings tresholds. Second, since you want to talk about effective rate, I am one of those who took a student loan in 2012 and then postgraduate loan in 2017. My effective tax rate currently sits at 38%, not the 25% you pulled out of thin air.
I am lucky enough to earn £6,000 per month before taxes. My deductions are £2,238, of which my deductions consitute 26% (13% if you take the postgraduate repayment out, 10% above the 3.2% you pulled out of your backside).
The sad thing about people like you is that you are somehow in that room when decisions about our future is being made. For God’s sake, its ok to say I don’t know.
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Brian Harrison says:
It’s 2 for me. I’ve seen time and time again the view among graduates with Plan 2 loans (me included) that “I’m happy to repay what I borrowed but the interest is unfair and doesn’t make that possible through my earnings.”
Student loans are very personal. You borrow X amount depending on a range of factors including how much study you do. Most people perfectly reasonably take the view that I borrowed that. I’m happy to repay that through my earnings, with it adjusted for inflation being fair enough. I’m not happy to pay “over the odds” (in the words of Nick Clegg) to fund the write offs of students who I believe should not have gone to university in the first place as they were funded to take a course of little public value and low earnings prospects. It’s simply a system that punishes ambition and hard work which was so anti-Conservative that future Conservative administrations overturned it with Plan 5. They ought to have overturned it for existing students as well.
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Ed says:
I’m not convinced that reducing interest rates on Plan 2 is unaffordable within the fiscal rules.
Originally, as the whole thing used to be classified as a loan (despite, by design, a proportion of loan outlay being forecast to go unpaid), ALL of the interest accruing reduced the deficit (public sector net borrowing, PSNB) as it counted as government revenue. Hence the huge incentive to levy RPI+3% rates on the loans from the start and give out as many loans as possible.
ONS corrected this perverse situation in 2018, meaning had the current accounting rules been in place from the start, Plan 2 would never have been designed as it was. Now interest forecast to be written off actually counts as government SPENDING which increases PSNB.
ONS had said that if a reduction in revenue streams (i.e. interest rates) is implemented alongside a policy change that increases the forecast of the amount of existing loans stock to be repaid, then those lower interest rates will actually be scored as reducing PSNB. So I would be lowering Plan 2 interest rates (by either raising interest thresholds or reducing the maximum rate from RPI+3%) alongside the freeze in the repayment threshold.
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Jonathan Alltimes says:
Welcome to the legacy of Osborne and Willetts.
The government has changed the accounting convention, so that the loans to students now counts as an asset with which to borrow against for infrastructure spending, which means non-payment of the loans counts as an advantage for public sector borrowing.
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Paul Woodgates says:
Is there an option here to allow Plan 2 borrowers to convert their loans to Plan 5? They would in effect be trading the removal of real interest rates for the lengthening of the loan term. For many (though not for all), they would end up paying more but if their concern is the perception of a debt that keeps growing in spite of repayments, they might opt for that. This is a situation when the perception of the debt seems to count for me than the reality.
Offering (but not mandating) a swap of Plan 2 terms for Plan 5 terms would give borrowers the choice. No doubt Martin Lewis and others would have fun trying to work out what combination of outstanding balance, expected earning potential and anxiety caused by debt would imply a borrower should opt for the change.
That would of course remove the progressivity inherent in Plan 2. But surely that ship has already sailed since Plan 5 came in. In any case, if we believe that higher education should be accessible for graduates who don’t one day earn a large salary (which I firmly do), I have never really understood why the burden of paying for that should fall disproportionately on richer graduates, rather than on richer people in general. The very sound argument against a graduate tax – that the beneficial societal effects of de-linking higher education from ability to pay (such as the benefit of having qualified nurses) accrue to everyone not just to graduates – applies similarly to attempts to make repayments progressive.
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Ed says:
This is a great idea, and one I put to the Augar Review call for evidence should they opt to design a ‘new system’ for future students (which they did even though their recommendations were really tweaks to the existing system).
Whether SLC’s flaky IT system would be a hurdle us a question.
https://wonkhe.com/wonk-corner/is-the-slc-really-on-the-verge-of-collapse
An option to switch from Plan 2 to Plan 5 with an immediate reduction in balance by applying an interest adjustment wiping out all historical real interest applied would be very tempting to many, be perceived as fairer, and possibly better for the taxpayer in the long run.
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Pete says:
I genuinely cannot see why the current government would want to spend billions of pounds on a de facto tax cut for the top 30% of graduate earners or how political parties more sympathetic to big tax cuts for the rich would fund it.
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Ed says:
The point is, given the accounting methodology now in place, it wouldn’t cost anything in the short-term (and done shrewdly could actually reduce PSNB), only reducing revenue (and therefore increasing PSNB) in the long-term.
https://x.com/IGMansfield/status/2014653279536324954
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Paul Wiltshire says:
Allowing people to switch to Plan 5 from Plan 2 is indeed a good idea. I included it in my recent report ‘Student Loans : How to turn despondency into hope’ https://universitywatch.org/wp-content/uploads/2026/01/Student-Loans-How-to-turn-despondency-into-hope.pdf
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Paul Wiltshire says:
I would add a fourth option. Reduce the amount going to University by about 50% by raising minimum academic entry standards. Use some of the money saved on Loan write-offs to fund more generous terms for the fewer graduates remaining – such as Zero interest rates , shorter terms , lower fees. And change the mentality into ‘Pay it back’ rather ‘Just give up and don’t care about the balance’. Encourage voluntary over-payments by making them tax deductible – for either the Graduate, their extended family, or their employers. Allow voluntary over-payments to be refundable (subject to modest %penalties and time limits to avoid abuse), so that people don’t see it as possibly money down the drain if the graduate doesn’t end up repaying in full
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Jonathan Alltimes says:
What the state did was add a layer of interest rate to the loan, then add a layer of a progressive factor, and then slap on RPI and now it is going to top it off with the cherry of freezing thresholds. It is changing 2the terms of the loans. Can you imagine if a private lender did such things? Is it moral to transfer the risk of debt from the government to a cohort of students, who then unknowingly act as guarantors for each others’ loans?
What should be the rules for paying for tuition fees and maintenance costs? It is a moral question. Using calculations to solve the issue and justify the government policy is the wrong way round and nothing but political expediency. Before we get to that question, we need to review the political justification for expanding higher education.
“All those who have the potential to benefit from higher education should have the opportunity to do so. This is a fundamental principle which lies at the heart of building a more socially just society, because education is the best and most reliable route out of poverty and disadvantage.” The Future of Education, White Paper, 2003.
Education could be, but what sort of education and does the private sector matter? The government is working its way round to understanding that higher education does not deliver without the prevailing situation in the economy.
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Luc-Pierre Riou says:
Nick was responding to my comments on BBC Radio 4 Moneybox on the weekend.
I raised the point that the very high interest rates (up to RPI + 3% on plan 2 loans) are damaging because they are impacting significant financial decisions for millions of graduates, such as purchasing a home or starting a family. Furthermore, we were not give adequate advice at the point of taking out the loans – for example we were not told that we would be charged high interest rates to subsidise NHS waiting times (as the chancellor recently outlined) or to pay insurance costs of writing off loans after 30 years.
There were two comments made by Nick in particular that I wanted to reply to:
1) Nick advised that we should not see the loan as a loan, but rather a tax. However, the wealthiest students had their tuition paid for by parents, and therefore escape being taxed via interest. This goes against all fundamental tax principles.
2) Nick claimed that you only pay RPI plus 3% interest if you earn “significantly over £50,000”. The threshold is £51,245. I do not think £1,245 is a significant amount.
The student loans system needs a radical overhaul. It was designed at a time with incredibly low interest rates. Society also needs to wake up to the problems facing the younger generation. It did not feel right that Nick described those on plan 5 loans as being “hit in other ways” by having longer term student loans. It made it sound like the higher education system has turned into a money generating business for universities and the government.
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Brian Harrison says:
The higher interest threshold should be significantly above £50,000 but has only risen 29% since it was introduced at £41,000 in 2016, despite the lower interest threshold being raised by 40% in the same time and despite an original intention to index both thresholds annually by the same rate.
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Luc-Pierre Riou says:
The treasury did a review into student loans in 2018 and found:
– There is no justification for using RPI instead of CPI.
– Charging high interest while a student is at university is punitive and has no justification.
– The interest rates being used can’t be justified on redistributive grounds – what Nick and Rachel Reeves claim.
6.2% interest rates are not “high-ish“. They are 3% higher than RPI, a rate of inflation that the treasury has flagged as unacceptable, higher than the governments’ borrowing costs through GILTS and far higher than you could hope to achieve saving in a cash isa.
These high interest rates are not applicable to salaries “comfortably over” £50,000. They are applicable to salaries over £51,245.
I have not met a single graduate who does not want to pay back their loan. However the level of interest is ensnaring an entire generation into paying a significant proportion of income into what is effectively a tax. And a tax that the very wealthy will never have to pay, if their parents paid for their education.
You can find the report below.
https://committees.parliament.uk/work/5000/student-loans-inquiry/news/98634/government-must-reconsider-high-interest-rates-on-student-loans/
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Luc-Pierre Riou says:
I cannot comprehend the statement “much of the rhetoric on plan 2 loans is overblown“. If I manage to achieve my career ambitions I will pay off my loan within the 30 years. Ergo, unless something awful happens, I am faced with the following decision:
1) Do I save in a cash ISA and get 3-4% return.
2) Do I invest in an ISA in an incredibly turbulent global economy, where my capital is at risk.
3) Do I use all my savings and money I continue to earn to pay off my student loan on which I am charged 6.2% interest.
The logical answer is option 3 – so I am stuck working to pay off a loan I had to take to go to university. While the generation before got to go to university for free.
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Luc-Pierre Riou says:
The treasury carried out a report in 2018 which stated:
1) There’s no justification for using RPI instead of CPI
2) Charging high interest rates while a student is at university is punitive and has no justification.
3) The interest rates being charged (Plan 2) cannot be justified on redistributive grounds.
Even the treasury thinks the interest rates on Plan 2 loans are unjustifiable.
Link below.
https://committees.parliament.uk/work/5000/student-loans-inquiry/news/98634/government-must-reconsider-high-interest-rates-on-student-loans/
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Pete says:
Firstly, that’s the Treasury Select Committee rather than the Treasury. A Treasury official is quoted in the report, as is his role, defending government policy as it stood when he gave evidence.
Secondly, their analysis which they used to conclude (3) seems faulty given that a) only 30% of Plan 2 borrowers were expected to repay their loans yet all of their case study examples to do illustrating that they are highly unrepresentative; b) it seemingly adds up nominal repayments rather than adjusting them for inflation. The government explained why they disagreed with the Committee here https://publications.parliament.uk/pa/cm201719/cmselect/cmtreasy/995/995.pdf
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Luc-Pierre Riou says:
I cannot understand how anyone can call the system progressive and fair when I am using all disposable income to pay off a student debt – because the interest rate is so high it doesn’t make sense for me to do anything else with my money (invest/save for a house). Meanwhile wealthy friends whose parents paid for their education do not have to.
I am going to end up paying tens of thousands of pounds more than i borrowed just for working hard and having a good job.
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Jonathan Alltimes says:
The ministers and their advisers of the former Coalition Government who approved Plan 2 have moved on with their lives and do not need to pay for the consequences of their choices or even continue to justify them:-
George Osborne
Danny Alexander
Vince Cable
David Willetts
And a whole host of very senior academic administrators.
I have no doubt it will be a political issue at the next general election, as the loan scheme should not have been be used as a (progressive) tax along with all the other conditions of loan, which been changed since. The student loan scheme does not support the alleviation of poverty, it enforces it and so opposes the original intent of the government policy for equality of opportunity.
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Martin Williams says:
Nick’s three options above don’t offer real alternatives. Option 1 is simply impossible; one can’t just refuse to tell someone the amount of their outstanding loan balance. Option 3 does nothing to ameliorate the position of irritated Plan 2 graduates, who are the reason this issue is in the news. That leaves Option 2, with its many possible variants, as the only realistic alternative to doing nothing (which is where we currently are).
Whether anything is done will obviously depend on how far the politicians believe that the electorate cares about Plan 2 graduates. But, as Nick has written elsewhere, this moment of truth was always going to come, and the Plan 2 graduates are simply the first in line. With or without real interest rates, a £9k fee plus maintenance loans means a lot of post 2012 students, whatever Plan they are on, will have have to borrow more than they will repay over their working lives, so will experience this “loan” as a graduate tax. Some won’t care too much about that, or will be pleased that they will have received more money than they will pay back. Others will feel that they had aspired to repay and that the system is frustrating this. Some of the comments above show that, whatever the theoretical advantages of a loan that is never expected to be paid back in full, this feels simply wrong to a fair number of people. Crucially, I doubt the general public have grasped and accepted the implications of the student loan system as it now exists. If that is true, the situation is inherently unstable, and this dog will keep on barking.
The 2012 changes came as a package. Their architects wanted to remove student number controls, thereby allowing an unlimited number of people to access higher education, and to allow more providers to access public funding, while reducing expenditure on government grants and increasing the cash flow into universities. All of these have been achieved, so the changes have, in their own terms, “worked”. But they required government to lend at levels that were always going to create tensions down the line. The Student Loan book has a face value of £260bn, but its “real” value for the accountants is obviously dependent on how much of it will ever be repaid. That’s partly down to the graduate labour market (hence government obsession with graduate salaries), but also about repayment thresholds, interest rates etc, which are set by government (Treasury). Treasury will always be tempted to squeeze a bit more out of this asset by nudging the dial towards more repayments – and this nudging will come at the expense of graduates with student loan debt.
The system is now set up to create perpetual tension between Treasury (ie government) and growing numbers of graduates, couched in arguments about what is “fair”. It isn’t a problem with loans per se; pre-2012, the loans were much smaller (£3,500 fee loan) and most of them could and would have been paid back over a working life. The problem comes with the scale of the loan system as it now is, which was an inescapable corollary of the whole HE funding system that was consciously created in 2012.
The current government did not create this system, but it is holding the parcel as the music stops playing. At present it is deciding to stick with the choices its predecessors made. Fair enough, but it will need to win the public argument about why the downsides of those choices are the least-bad options available. At present these are proving a nasty surprise for too many people. I think everyone would be well-served, including the public interest, if government commissioned an open, warts-and-all appraisal of all the results of the colossal and unprecedented changes that were made in 2012. If government is going to stick with this system (and there are no painless alternatives), everyone needs the best possible understanding of the likely consequences.
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Jonathan Alltimes says:
The annual outlay for student loans is 1.5% of the total UK government budget, so a relatively small proportion, but the accumulated debt is about 10% of the accumulated UK government debt, so a relatively large proportion. I just do not see graduates accepting an additional tax on their earnings (for life), which could changed. We need to try a different government education policy for alleviating poverty. There is a lot of policy drift. The number of graduates is not going to fix our economic growth by itself.
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Yon says:
Watching these dumbasses in the comments pontificating about our future is interesting. Most of you probably went to university for free. You are talking about real people here, remember that.
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Huy Duong says:
For Plan 2 graduates, repaying the student loan reduces the marginal take-home rate from 58% to 49%. This is a 15.5% reduction in the marginal take-home rate, but it’s easy to misunderstand that it would be only 9%.
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Huy Duong says:
It is true that someone has to help to pay for the student loans borrowed by students who later don’t earn enough to pay. However, why should that burden be on other students who went to university at about the same time as the first group? If on average it is beneficial for society or right that the first group went to university, why shouldn’t society as a whole helps to pay but just the second group does? After all, the second group benefits from the first group going to university no more than society as a whole does.
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