How to spring the graduate debt trap and stimulate economic growth
This blog was kindly authored by Professor David Green CBE DL, Vice Chancellor and Chief Executive, University of Worcester.
Andy Burnham’s Government has a very long to-do list.
One vital area for reform is the crushing impact of graduate debt, arising from the disastrous ‘reform’ of tuition fees and student loans in 2012, which heaped most of the cost of earning a higher education on the graduate.
This system produced a situation where hundreds of thousands of working graduates in vital professions such as engineering, medicine, the allied health professions, information technology, teaching and more, who are earning enough to pay higher rate tax, find that they lose as much as 70 per cent of every additional pound in earnings to deductions. Most also find that despite repaying £3,000 plus a year, they are making little or no progress in reducing their outstanding student debt which averages over £50,000.
The Treasury Select Committee’s recent report Student Loans: Broken and Unfair was withering:
The government has described the student loans system as unfair and broken; universities and students have agreed. So do we.
The Treasury Select Committee’s report was accompanied by the publication of numerous stories of hard-working and successful graduates in their late 20s and early 30s whose lives are being significantly detrimentally affected by the large student loan repayments they are making.
A typical, highly telling example is Laura May Nardella, 31, who paid back £3,000 in 2025. The BBC reported:
Despite that, the Cambridge graduate, who now works in HR, said her overall debt had actually gone up rather than down.
That’s because, as a higher earner, her loan debt has accrued interest at a rate of 6.2%.
‘That is the most difficult thing when it comes to the Plan 2 loan – that it feels like you’re not chipping away,’ she said.
‘It’s quite psychologically difficult. And it’s not how it was sold to us at the time.’
Laura May and hundreds of thousands of hard-working, reasonably successful graduates who provide a crucial part of the UK’s productive, highly skilled, professional workforce are now suffering from very high effective marginal deduction rates from their pay.
In my evidence to the Treasury Select Committee, I drew attention to precisely this problem with detailed examples, including graduates in such fields as engineering, information technology, teaching, medicine and health care who face rates of deduction of up to 70%, make thousands of pounds in student loan repayments and yet find their debt still growing!
This disastrous situation has a highly negative impact on human behaviour, which turns into a considerable drag on economic growth. Treasury policy is to avoid such situations arising.
What is to be done?
This blog proposes a solution which will strengthen the public finances, help hundreds of thousands of graduates repay their loan in full and incentivise work.
The £300 billion UK student loan book functions as a large, partially impaired public asset. A significant proportion of loans will never be repaid in full.
The key group is neither the highest earners, who will repay anyway, nor the lowest earners, who are protected by income-contingent design. It is the broad middle: graduates earning roughly £45,000–£75,000. These individuals repay substantial amounts over many years, but will often fall short of full repayment, leaving balances that are ultimately written off.
This is the zone of fiscal inefficiency and deep unfairness. It is also the zone where better policy can make a truly significant difference for the good.
A reform agenda: broadening the repayment base
The proposals advanced in the Treasury evidence offer a new approach which aims to enable a much higher proportion of graduates to clear their outstanding student loan completely, relatively early in their working life.
This will mean that they no longer pay an additional 9 per cent on each extra pound of their earnings and that the negative psychological, behavioural and financial effect of a large deadweight debt can be put behind them.
The proposals, if introduced, will not increase public spending. Instead, they will strengthen the public finances by many billions each year.
This will be done by incentivising additional, voluntary channels for repayment, including:
- Introducing the opportunity for individuals to salary-sacrifice for additional voluntary student loan repayments. This would enable graduates to make additional voluntary repayments highly tax efficiently. Employers would also pay the National Insurance contribution they would normally save through salary sacrifice to HMRC for crediting to the student loan company – thus further accelerating graduate debt repayment.
- Introducing the opportunity for employers to include ‘student loan credits’ in their remuneration package. Credits would be paid through the tax system and then directly channelled by HMRC to the Student Loan Company. These credits would be exempt from income tax as well as employers’ and employees’ National Insurance and Pension contributions.
- Exempting third-party payments direct to the student loan company to repay student debt from inheritance tax. This will stimulate very significant intergenerational support for young graduates from parents, grandparents and family members.
These measures would significantly broaden the effective repayment base by unlocking existing but unused financial capacity. Potential abuse can be simply tackled by capping. The system could also be extended by allowing, for example, a higher earner in a couple to salary sacrifice to repay the debt of their lower-earning partner.
For the Treasury, the usual objections to salary sacrifice fall away as every pound not paid in tax or national insurance due to the sacrifice goes directly to the government via the Student Loan Company.
Why this matters
These proposals will increase the proportion of student loans that are fully repaid, particularly among the numerous middle earners earning £45k to £75k per year.
Where such reforms convert partial repayment into full repayment, the fiscal impact is substantial. It reduces long-term write-offs and strengthens the public balance sheet.
Crucially, these measures also bring forward repayments, helping a cash-strapped government now.
Fairness, work and responsibility
For the Burnham government, the political appeal of this approach is clear.
- It aligns with a strong fairness narrative. The current system is experienced by many graduates as arbitrary and punitive.
- It reinforces the value of work and progression. These reforms strengthen incentives for effort and advancement. Incentivising faster repayment restores a sense of agency and fairness.
- It avoids the pitfalls of more polarised approaches. It is neither a very costly write-off nor modest tinkering with a system that has clearly failed.
A strategic opportunity
The Burnham government can reshape the system, making it possible and worthwhile to repay this debt. This would reduce distortions in the labour market, improve productivity, and strengthen the nation’s fiscal position. Properly framed as both fair and fiscally responsible, it will be a politically compelling reform package.
Adopting these proposals means that the Burnham Government could say to graduates: ‘This government is helping you clear debt, keep more of your hard-earned salary, build savings, buy a home and improve your future.’
This will be a crucial part of securing good growth in every postcode.
Comments
Jonathan Alltimes says:
Arguably, the punitive student loan system is the reason why so many young people voted at the local elections against the Labour Party in their traditional strongholds and for the Green Party.
I expect there will be further electoral losses at the next local elections.
We do not know why tuition fees were set at the higher level in 2012. We have accepted students should pay for higher education and then the State slapped a charge on top for lending to the student and then it slapped a charge on top of the charge, that is, compound interest and then it added inflation. Students should not be paying interest on loans, as it is a charge for lending to the State. The State has passed on the interest to the student for the interest charged to the State for borrowing without any moderation in the rate. Interest is a cost for lending on the assumption that the lender charges the borrower for a return on investment which is at least equal to what could be made elsewhere and for risk of non-payment. The State is acting as a proxy for the student and the lender, so the student is paying for the behaviour and mistakes of the State. Why has the State absorbed none of the cost if it benefits from students? The State has pooled the risks of non-payment by students, but the distribution of risks is unfair, as the student who earns above the threshold pays for the one does not and the payment is progressive depending on income. Inflation should not be accounted for in the cost of loans, as it is outside the control of the student and so does not reflect the risk behaviour of the student. Other arguments can be developed.
Why have governments been reluctant to reform the system? Is it simply now the inertia associated with the size of the student loan book and its impact on the finances of the State?
“Currently just over £21 billion per year is loaned to around 1.5 million higher education students in England. The value of outstanding loans at the end of March 2026 reached £295 billion. The Government forecasts the value of outstanding loans to reach around £500 billion (2025‑26 prices) by the late-2040s.”
Source: https://commonslibrary.parliament.uk/research-briefings/sn01079/
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David Green says:
Many thanks for your thoughtful comment.
I publicly opposed the 2012 reforms when they were introduced because I believed they transferred much too much of the cost of higher education onto graduates and risked creating exactly the sorts of distortions we are now seeing. Had different choices been made in 2012, we would not be confronting this problem today.
The difficulty, however, is that we must deal with the world as it is now, as is described in your last paragraph.
We have a student loan book worth around £300 billion and still growing rapidly. The policy challenge is therefore not whether the 2012 system was wise in principle, but how to address the consequences of a system that is already deeply embedded in both the public finances and is harming the lives and prospects of many hundreds of thousands of graduates. Reading the Treasury Select Committee report it is quite clear that our politicians simply don’t know how to reform the system in any major way.
A truly key but largely ignored negative impact of this unfair system (whether Plan 2 or Plan 5) is the effect on middle-earning graduate professionals who form a large, growing part of the UK’s skilled workforce. In my evidence to the Treasury Select Committee, I drew attention to cases where graduates face extraordinarily high effective marginal deduction rates (EMDRs) once income tax, National Insurance, pension contributions and student loan repayments are combined. The rates are frequently over 60% – sometimes 70%+.
This is not a minor technical issue. The Treasury Green Book and the Mirrlees Review both emphasise the importance of minimising distortions to work incentives and progression. High EMDRs are important precisely because they negatively influence behaviour. They affect decisions about promotion, additional responsibilities, extra shifts and career advancement. High EMDRs harm economic growth.
Take the example of a Band 6 midwife, which is the main career grade. A typical midwife is likely to experience these very high deduction rates in her thirties, at precisely the stage of life when she may be hoping to buy a home, raise a family and build financial security. Will she really take that extra shift when she retains around one pound for every three earned? What about the psychological effect of repaying £3,000 in a single year and finding that her debt is still growing? Or reduces by just £100. Midwives almost never become genuinely high earners through their profession. Unlike a Magic Circle lawyer, investment banker or senior corporate executive, a midwife is not on a trajectory towards very high remuneration. She is, instead, exactly the sort of skilled public servant that successive governments have sought to recruit, educate and train, retain and encourage, but is now being thwarted by the loan she had to take out to finance her studies for a degree which is essential for entry to this vital and deeply valued profession.
The same issue arises for many teachers, engineers, IT professionals and health professionals. These individuals are not rich or even particularly affluent by any reasonable definition, yet they can face some of the highest effective deduction rates in the tax and transfer system.
This is both economically inefficient and fundamentally unfair.
The concern is becoming more rather than less significant because the direction of travel is now towards Plan 5 loans, with lower repayment thresholds and repayment periods extending to 40 years. The effects are therefore likely to be felt by an even larger number of graduates, and for substantially longer periods of their working lives.
My proposals are not a defence of the current system.
They are an attempt to mitigate the impact of a system which is deeply unfair and harmful to hundreds of thousands of predominantly young graduate professionals, whilst helping the UK’s economy and public finances.
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Marco Di Palma says:
The proposed solution is fundamentally flawed. UK student loans are income-contingent, so encouraging early repayment may save many borrowers little or nothing if part of their balance would otherwise be written off. Salary-sacrifice repayments would also reduce tax and National Insurance receipts, disproportionately benefit higher earners and wealthier families, and could encourage graduates to prioritise student debt over pensions, savings or house deposits. Rather than creating a tax-advantaged repayment scheme, a fairer solution would be to reform the repayment rate, thresholds and write-off period directly.
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David Green says:
Many thanks for your thoughtful comments.
Any reform should ultimately be judged against fairness, economic incentives and fiscal sustainability.
My concern focusses on the position of the very large group of middle-earning graduates who now face exceptionally high effective marginal deduction rates (EMDRs) whilst making substantial student loan repayments and often seeing little, if any, progress in reducing their outstanding balances.
The importance of these high EMDRs should not be underestimated. The Treasury Green Book and the Mirrlees Review both point policymakers towards reducing distortions that weaken incentives to work, progress and increase productivity. When graduates lose a very large proportion of every additional pound earned through the combined effects of taxation, National Insurance, pension contributions and student loan repayments, there is a real economic growth issue as well as a fairness issue.
The real-life examples in my Treasury Select Committee evidence are telling. For example, an experienced Band 6 midwife in her early thirties can be repaying around £3,000 per year while making little meaningful progress in reducing her debt. Importantly, she is not someone who will eventually become highly affluent. She has chosen an essential public service profession and will never enjoy the earnings trajectory available to a Magic Circle lawyer or investment banker. Yet she will face effective marginal deduction rates that materially weaken the reward for additional responsibility and working nights, weekends and public holidays.
Likewise, an IT professional earning a good but far from exceptional salary may be paying £3,000 plus annually towards a loan balance that barely moves. These are exactly the highly skilled workers the UK economy needs more of, not fewer.
The direction of travel now matters greatly. Plan 5 loans lower the repayment threshold and extend the repayment term from 30 years to 40 years. While interest rates are lower, the result is that these harmful effects are likely to persist for longer and affect an even broader range of middle-earning graduates.
The Government’s own forecasts indicate that only around one-third of Plan 2 borrowers will repay in full. The forecast rises to just over 50% for Plan 5 borrowers.
Of course, some Plan 2 and Plan 5 graduates repay in full quickly, these graduates are either high earners or receive substantial family support. The really big policy question is what is to be done about the much larger group who are making large payments for years, but never reach the happy day when they pay 9% less on each additional £ earned as their balance has been paid.
My proposals do not involve large-scale loan forgiveness or increased public spending. Instead, they would create additional voluntary and incentivised routes to repayment so that many more graduates can clear their debt and escape the additional 9% graduate deduction much earlier in life.
This will help hundreds of thousands of hard-working, middle earning graduates who are the backbone of the economy and public services. If adopted these proposals will also lead to more shifts being worked, more responsibility being taken, a more productive labour force and economic growth in many, many more postcodes.
This is an important consideration for a government that places fairness at the centre of its agenda. Hundreds of thousands of middle-earning graduates are carrying substantial debts for decades despite making significant repayments throughout their working lives. My contention is that helping these graduates clear their obligations more quickly is not only economically sensible and consistent with Green Book and Mirrlees principles, but also a fairer approach than any alternative currently being advanced.
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Tim Leunig says:
Marco Di Palma is completely correct. For many people early repayment would be a gift to the government. For the highest earners, however, this system would massively reduce the amount they have to pay and cost other tax payers a lot of money.
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David Green says:
Please see my reply to Marco di Palma. The proposals to incentivise early repayment do not amount to a “gift” to the government not would they “massively reduce the amount that the highest earners would have to pay and cost taxpayers a lot of money”. We already have the situation for Plan 2 loans, where the real rate of interest is typically 3%, that those with family money repay their loans as soon as possible, and those who enter magic circle firms and other very high high paying professions in their early mid 20s pay off as soon as they can to avoid the interest charges (currently 6.2%, capped at 6% from September). These proposal will greatly extend the opportunity to other hard-working graduate professionals to repay early and escape the extra 9% charge on each additional pound of income which is so blighting their prospects in their late 20s and 30s. The ‘income contingent’ system has failed hundred of thousands of graduates and the country as a whole.
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