What did the three wise men, Ron DEARING, John BROWNE & Philip AUGAR, say about student loan interest?

Nick Hillman OBE, HEPI’s Director, takes a look back at the Dearing, Browne and Augar reports to see what lessons – if any – they hold for those campaigning against student loans today.

It is (very) often said that the best way to resolve problems in the student loans system would be to set up a committee of the great and the good to opine.

The general assumption seems to be that the current system is so obviously broken that getting a few wise heads together would guarantee reforms to please all those angry at the current state of their Plan 2 debts. Perhaps.

But it is far from guaranteed. There have been three major reports covering student finance in the last 30 years: the Dearing report of 1997; the Browne report of 2010; and the Augar report of 2019.

Some people think we are overdue another, yet there is no big higher education issue that these previous reports ignored and we can still learn from them.

Reprinted below is what each of the three says about the most controversial issue affecting today’s Plan 2 student loans: whether they should have a real rate of interest applied. 

Perhaps the most notable thing is that that, while – on ‘balance’ – the Dearing report wanted no real rate of interest on student loans in common with many of today’s campaigners, the other two reports most definitely did.

Browne wanted a 2.2% real rate of interest on top of RPI, albeit mitigated by a ‘targeted interest rate subsidy’ to ensure low earners’ debts did not grow in real terms, while Augar also favoured a real interest rate (after study rather than during study and with repayments capped so that no one would pay back more than 1.2 times what they borrowed).

Perhaps these complicated mitigations (especially Browne’s) would satisfy today’s campaigners, though that is far from certain – after all, the most vociferous of the contemporary complainants are among the highest-earning graduates and none of them seems to have been pacified by the fact that the current system includes a mitigation of its own: one poorly understood but important feature of the current system is that, among graduates, the full 6.2% interest (3% plus RPI at 3.2%) is only applied to the loans of those on salaries that are significantly above the average. That is why the loudest contemporary complaints are coming from MPs, journalists at long-standing national outlets (like the New Statesman) and, above all, doctors.

The Dearing, Brown and Augar reports are worth revisiting for other reasons too. All three took a different view from today’s campaigners on how the loans system should treat the very richest graduates: those who can repay their loans most quickly of all, assuming they take on any student debt in the first place.

Dearing, Browne and Augar all knew the Treasury likes to loan out as little money as possible and to recover as much as it can as quickly as possible.

That explains why Dearing, Browne and Augar all felt it was a positive feature that students from richer families ending up in high-paid jobs would face lower loans and quicker repayments:

• Dearing wanted ‘to maximise the proportion of students who pay in advance rather than taking up a loan’ via a discount for early repayment;
• Browne favoured a real interest rate so that ‘Families with high household incomes will be more likely to pay upfront voluntarily’; and
• while the Augar report favoured no real rate of interest during study, it nonetheless still wanted loans to grow in line with inflation during study ‘to mitigate the risk of wealthy students taking on debt for investment purposes’.

In other words, rich people not using the loan system to the same degree as others has generally been regarded as a feature, not a bug. We don’t make rich people buy their cars on hire purchase or compel them to have a mortgage. Similarly, the Treasury neither forces richer students to borrow more than they need to from the generality of taxpayers nor forces richer graduates to pay their loans back more slowly than they want to.

The Treasury’s goal is to look after the nation’s purse and giving people more money than they need or delaying them from paying back what they owe would seem perverse to Treasury officials.

My experience inside a Government Department helped me understand this because, during the Coalition years, I saw close up how quick the Treasury was to kill the Liberal Democrats’ idea of penalising early student loan repayments. Whether people like it or not, the Treasury rules the roost.

Above all, the extracts below culled from the triumvirate of Dearing, Browne and Augar serve, if nothing else, as a reminder that some sort of major review of student finance, were one to happen, would not be guaranteed to deliver what today’s campaigners want.

[NB Let me give a special shoutout to the Education in the UK website, which includes the full text of the Dearing report – the other two reports (Browne and Augar) remain available on the Government’s website.]

The Dearing report (1997)

20.86 Given the need to release substantial resources in the short term, as described in Chapter 17, we believe that the Government should structure any new arrangements for contributions to tuition costs so as to maximise the proportion of students who pay in advance rather than taking up a loan. Means testing the access to the loan or introducing a real interest rate would increase this proportion without additional incentives being offered. If neither of these options is pursued, we believe that there is a strong case for the introduction of a discount along the lines of the Australian model. Further detailed work would be necessary to determine the appropriate level of discount and ensure that the arrangements provided value for money over the longer term, as well as releasing additional funds in the short term. …

20.92 The previous Government’s experience with the ‘twin-track’ scheme, which would have involved both the Student Loans Company and the banks lending to students, demonstrated how hard it is to involve the private sector in heavily regulated and subsidised lending schemes at a price which offers any advantage to the taxpayer. We spent some time investigating whether we could design a loans scheme which was more like a commercial scheme and, therefore, more likely to be attractive to private sector lenders. In doing so, we still held to the principle that there should be income contingent repayment arrangements. We found that moving to a rate of interest which is close to a commercial rate of interest (the current scheme has an interest rate equivalent only to the Retail Prices Index) created certain problems. The protection of income contingent arrangements for the low paid means that a significant minority of graduates would be making repayments which did not even cover the interest on their loan, let alone repay the debt. Their debts would, therefore, continue to grow through life becoming, in some cases, very large before write-off. Even though individuals would be protected from unreasonable debt-servicing burdens, we felt that the possibility of an ever-rising debt would be a deterrent to participation in higher education. Although the same difficulty can arise with any real rate of interest, it is severe with commercial interest rates. We were told that the Australians had considered real interest rates for their Higher Education Contributions scheme, but had rejected them for the same reasons.

20.93 We also considered whether a mutual scheme might help to make a contributions scheme more attractive as a commercial proposition. Under a mutual scheme, all those taking out loans would be liable to pay not only the sum borrowed, but the sum borrowed plus a premium of perhaps 20 per cent to cover the payment of the commitments of those who will never earn enough to pay their commitments. It would seek to deal with two of the main problems with loan schemes:

• the percentage of individuals who will never repay their loans, which represents a loss of income;
• the impossibility of individuals, or those making loans, identifying in advance who is unlikely to pay.

20.94 This approach also increases the amount paid by those graduates on higher incomes; and may thereby provide an incentive for individuals who are confident about their future earning potential to pay up front. While this might be desirable in terms of short term increases in funding, it risks undermining the basis of the loan scheme by negative selection. Only those with the poorest prospects would take out the loan, which would increase the size of the mutual premium required to cover non-repayment. This would encourage even more of those with better prospects to opt out, leading to a scheme which was unstable. To avoid this, it would be possible to require all students, whether they took out a loan or not, to make a 20 per cent contribution to the loan fund. That would, however, be simply equivalent to requiring a higher contribution from all.

20.95 Although we find the concept of the mutual scheme attractive, we have concluded that it is unlikely to provide a funding approach that is stable in the long term. In the light of these considerations, we have concluded that the twin-track approach has fundamental difficulties that cannot be readily overcome. …

21.18 The largest element of subsidy in the current student loans scheme is the interest rate subsidy (ie the difference between the Retail Prices Index-linked rate of interest charged to students, and the cost to the Government of borrowing the funds). Some of those who submitted evidence to us argued that this ‘hidden’ subsidy should be reduced, or even removed entirely, and the funds released used to provide more targeted support.

21.19 There are a number of arguments for this approach:

• it would produce a material increase in revenue from loan contributions over the medium to long term. However, this would be limited by the introduction of an income contingent contributions regime. This is because the contributions which individuals make under an income contingent scheme are determined by their income, rather than the interest rate: for those on low incomes, the effect of an increase in the interest rate is to substitute contributions to interest for the contribution to repayment of principal, so ultimately a larger proportion of principal is written off on cancellation;
• if the interest rate was set at a level which met the Government’s cost of borrowing, there would be no ongoing subsidy paid by the Government, other than the eventual cost of default or cancellation. It would, therefore, matter less if contributions were spread over a longer period than now;
• if access to the scheme is not means tested, and the interest rate is heavily subsidised, there is a real risk that students who do not need the facility will make use of it anyway and reinvest the money to secure a net financial gain. Real interest rates would reduce the subsidy and this risk (thus also reducing costs).

21.20 Real interest rates can, however, have the effect of increasing the burden for those on lower incomes. To avoid that, it would be possible to prevent the level of graduates’ outstanding obligations increasing in real terms, while their incomes were too low for them to make contributions, by charging a zero real interest rate during those periods. Those on low incomes would also be protected because, although the size of their outstanding loans might rise over their working lives, their monthly contributions would be capped, and the outstanding debt would ultimately be cancelled (see paragraphs 21.23 and 21.24).

21.21 Those on low incomes who paid in full, however, would pay more in total than those on high incomes who paid their total contribution quickly. With a zero real interest rate, by contrast, the highest subsidies go to those on the lowest incomes. The existence of a real rate might be a disincentive to participation by students worried about escalation of debt after graduation.

21.22 Clearly there is a balance of considerations. The differences in income to the Government, and in charges to graduates, from rates of interest of 2.5 and 5 per cent amount to some £100 million a year initially, rising to £200 – £300 million a year in 20 years’ time. Providing contributions are income contingent, and that rates of interest are limited to 2.5 per cent (ie the rate of inflation) during the years of studentship or during periods of sickness or unemployment, the burden for graduates in work need not be heavy. But that has to be balanced against the potential risk of discouraging participation in higher education. This risk led us to the view that any rate of interest should be linked to the rate of inflation.

The Browne report (2010)

The current system does have some attractive features but it does not produce progressive effects. No students pay any interest on their loans. This means that even the wealthiest students after graduation receive a subsidy from Government – typically £3,000 – whereas that subsidy could be targeted on students on lower incomes. Wealthy students and families who understand the way the subsidy works realise they are being paid by the Government to borrow money and some will do so regardless of whether they have a genuine need.

By contrast – because the current system is poorly understood – many other students and their families are worried by the fact that they run up debt by going into higher education. In these discussions of debt, student loan obligations are still grouped alongside credit card debts and commercial mortgage style loans, as if they are all the same.

Another as-yet hidden problem in the current system is that the threshold at which payments begin has not changed since the 2006 reforms. It has remained constant at £15,000, even though earnings have grown in the meantime. This means that students who were regarded as low earners before 2006 – and not required to make payments – are now earning above the threshold and so they are making payments. If the threshold remains as it is, soon even a student working full time on the minimum wage after graduation will have to make payments. That is unacceptable.

To deal with these issues, we will make the following changes to how the current system works to create the new SF (Student Finance) Paying system:

• Students with higher earnings will pay a real interest rate. The interest rate will be equal to the Government’s cost of borrowing (inflation plus 2.2%). 
• Students earning below the repayment threshold will pay no real interest rate. Their loan balance will increase only in line with inflation.
• Those earning marginally above the threshold whose payments do not cover the costs of the real interest will have the rest of the interest rebated to them by Government.
• The repayment threshold will be reviewed regularly and increased in line with average earnings. As the threshold has not been increased since 2005, there will be a one-off increase at the start of our new system from £15,000 to £21,000.
• Changing the threshold in line with earnings increases the costs of loans for Government. Some of that cost will be offset by increasing the maximum payment period from 25 to 30 years. After 30 years, any outstanding balance will be written off by Government.

The introduction of a real interest rate will remove the perverse incentives around loan take up and fee deferral. Families with high household incomes will be more likely to pay upfront voluntarily and graduates with very high earnings will be more likely to choose to make early payments to clear their obligation. Both of these behaviours will ease the cash borrowing requirement for Government, focus the Government support for students on those who need it and make the Student Finance Plan as a whole more sustainable.

It will mean that the student from a wealthy household who goes on to become a high earning graduate will no longer benefit from any public subsidy. Even if this student took up the full amount of maintenance loan for the costs of living and paid no fees upfront, the public purse will receive in time payments equal to the net present value of the costs paid by Government upfront.

At the other end of the earnings scale, the targeted interest rate subsidy means that the outstanding balance of low earners will not grow in real terms – and, if they never earn enough to pay back the costs of living and learning, then after 30 years these will be written off by Government.

We envisage that the lowest paid graduates – or those who take significant breaks from work to fulfil other responsibilities – will pay no more than they do in the current system; whereas students who go on to have successful careers after graduating will pay more.

Our proposals also create the potential for Government to review the restrictions on access to funding to students who are studying for a second degree. The ability to re-train will be increasingly important in a changing economy. As more students will pay back the costs of learning in full in our proposals, access to upfront support for the costs of learning could be expanded.

The Augar reprt (2019)

Currently students are charged an interest rate 3 percentage points above the level of inflation whilst studying – i.e. before the point when they can reasonably be expected to begin to make repayments. This particular feature has attracted widespread criticism, including in responses to our call for evidence. At current inflation rates, a new student doing a one-year Level 4 HE course in 2018, taking out maximum HE maintenance and fee loans, will take a loan of £17,950 and by the time they enter their repayment term this will have increased to £19,250 – a rise of £700 for inflation with an addition of £650 in-study interest. A new 3-year degree student in 2018 taking out maximum HE maintenance and fee loans will see £3,800 added to their debt during their study years because of the above-inflation interest element. Students on longer courses will accrue even greater in-study interest, owing to both their larger balance and the longer duration spent under the in-study interest regime. A student studying for 5 years could accrue £10,000 in real interest while they are studying (e.g. if a student enrolled on a 4-year Master’s course and retook one year). …

A key part of the government’s case for in-study interest is that it deters students from taking on student loans if they can self-finance their education. In the absence of any in-study interest students would have an incentive to take out a loan and instead of using it to pay their student fees, could invest it. The in-study interest also has the effect of increasing the overall contribution made by high earners because it is they who predominantly repay this interest – helping to make the system progressive – whereas most lower earners will not repay it because it will form part of the remaining debt written off at the end of their loan term.

However, this interest serves to increase all borrowers’ debt balances when most borrowers are in no position to make payments, adding to concerns about rising debt levels … . Furthermore, some lower earners – albeit a minority – will repay this interest. These repayment terms apply not only to students taking full degrees with large loan balances but also to many other borrowers, for example those taking Advanced Learner Loans (ALLs). ALLs, which are typically taken out by older adults with quite low initial achievement levels, can be far smaller and these borrowers may well repay in full – including in-study interest. We consider that there should continue to be a single set of repayment terms at Level 6 and below, across different routes, and that this should be as fair as possible for all borrowers. Furthermore, the extension to the repayment period we are proposing would increase the proportion of students having to eventually repay this interest.

We consider it unfair that students should incur an above-inflation increase in their debt while studying full-time at a time when they are unable to generate earnings to start to repay their loan. We do however believe it is fair to increase loan balances with inflation during study, to maintain the real value of the debt and to mitigate the risk of wealthy students taking on debt for investment purposes.

Recommendation 6.4 Remove real in-study interest, so that loan balances track inflation during study. This should apply for new students entering the system from 2021/22.

Some of our respondents argued that student loans should never attract real interest – not even for borrowers who have left education and begun earning. We do not accept this view: a level of real interest should continue to be charged on the grounds that it would be imprudent and wasteful for government to provide entirely costless finance. It is worth reiterating the point that the variable interest rate mechanism protects low earners from high real interest rates, while increasing the contribution from higher earners. The provision of loans at zero real interest throughout the whole loan period could encourage almost all students to take out loans (as opposed to paying fees with their own funds) and to continue to hold this ‘debt’ throughout the contribution period as it may eventually be written off. This would be at considerable additional cost to government at the expense of investment elsewhere in tertiary education.

Recommendation 6.5 Retain the post-study variable interest rate mechanism from inflation to inflation plus 3 per cent.

Some feedback in the call for evidence questioned the use of the Retail Price Index (RPI) rather than the Consumer Price index (CPI) as the appropriate measure of inflation in the student loan system. We have also considered recommendations from the House of Lords Economic Affairs Committee’s recent report Measuring Inflation, and the joint letter from this committee and the House of Commons Treasury Committee to the UK National Statistician regarding the need to reform the RPI measure. We recognise widespread concerns about the quality of the RPI measure, but note that HMT continues to use RPI in a range of cases, especially for inward payments (e.g. interest) as distinct from outward payments (e.g. pensions). This is a matter for the Treasury; different inflation measures are in use in different areas of public finance and we recognise a change would need to be considered in a wider context than the student loan system alone.

A student borrower’s debt and repayment profile is particularly sensitive to the trajectory of their lifetime earnings. In a system with real interest some borrowers will repay more than 100 per cent of their initial loan, and those that pay back more slowly – in the middle to upper end of the earnings distribution – can pay proportionally more than the very highest earners who are exposed to real interest for a shorter time. In the words of the Treasury Select Committee Report into student loans: ‘ … the civil servant, the teacher and the accountant pay broadly similar amounts for their loan, but a graduate joining a “magic circle” law firm pays less, owing to rapid pay growth in the early stages of their career.’

… The earner at the 95th percentile repays more quickly and spends less time accruing interest than the earner at the 90th percentile, resulting in the 90th percentile borrower repaying more in real terms over their lifetime, for the same starting balance. The system is therefore not producing progressive outcomes for this part of the earnings distribution.

We acknowledge that over the longer repayment period recommended by the panel the problem would be somewhat exacerbated. We considered a wide range of options for solving this difficult issue. If real interest is charged, some borrowers are bound to accrue more interest than others, so we have sought mechanisms to limit the extent to which the highest earners paid back into the system less than those in the deciles below.

Options we considered included the adjusting of interest charges and thresholds; the addition of a further higher threshold with higher interest charges; forgiving unpaid interest each year; and an additional fixed charge on the highest earners who had cleared their loan. Many of these resulted in higher costs to the taxpayer due to the inefficient targeting of borrowers, benefiting fast high earners in particular. Some options incentivised fast high earners to opt out of the loan system altogether or to accelerate the repayment of their loan; in such cases the highest earners of all would be contributing less in interest overall to the system than borrowers with lower earnings. Other options would have been scored as a tax under accounting rules and hence are beyond our terms of reference.

We concluded that the most efficient way of addressing this problem would be to introduce a cap on real terms total repayments. Any borrower that reached the cap would have the remainder of their loan written off at that point (all of which would be accrued interest). We propose that this cap be set at a multiple of 1.2 times the initial loan in real terms. This level of cap broadly limits borrowers to a similar maximum level of repayment to that which was being contributed by the highest earners (relative to the initial loan). Because the protection of the cap is only triggered if a borrower has already fully repaid the real value of the initial loan, it is well targeted at a specific group of borrowers. Because it scales with the initial loan amount it would protect borrowers with any size of loan in a proportional way. Given the number of permutations of initial balance and earnings in each year of a borrower’s working life, there could be some instances where borrowers with lower lifetime earnings would repay proportionally slightly more than someone with higher lifetime earnings, but we believe this mechanism is the best available for limiting the number and extent of such instances.

We would expect the Student Loans Company (SLC) to monitor the real value of the initial loan, alongside the other data it holds on repayments, and regularly notify the borrower of the proportion of the real loan repaid and when the cap had been reached. Although the cap is a component of the new system we recommend that the government implement the same cap for graduate borrowers who are still repaying their Plan 2 loans. While this would not affect most borrowers, it would increase the fairness of the system.

Recommendation 6.6 Introduce a new protection for borrowers to cap lifetime repayments at 1.2 times the initial loan amount in real terms. This cap should be introduced for all current Plan 2 borrowers, as well for all future borrowers.