The Social Market Foundation proposes a radical new student finance model

The Social Market Foundation summarises its latest piece of research:

In our latest publication, Funding Undergraduates, we outline a new funding model which takes the best of two existing proposals – tuition fees and a graduate tax – to build a system that creates a fair market for students and universities alike.

Under the current system, students are charged tuition fees upfront and are offered loans at zero real interest rates to cover their cost. Loan repayment is made at the rate of 9% of graduates’ income above an income threshold of £15,000 per year. Any outstanding debts are written off after 25 years. Since tuition fees were raised significantly under this system in 2006, universities have generated additional revenue. But participation among students from lower socio-economic groups has also increased.

However, this model is now unsustainable. The subsidy on the loans costs the taxpayer £1.38 billion, on top of the £5.31 billion it gives to universities for Teaching via the HEFCE Grant. The subsidy has capped the number of loans Government can give out, despite growing demand. The cap on tuition fees has also prevented the emergence of a market with variable fees, desperately needed if we are to reward universities and courses that deliver good returns for their students and the wider economy.

Increasing tuition fees under current arrangements would cost Government disproportionately more. This is because the total amount of loans distributed would increase, graduates would hold the subsidised debt for longer, and more debt would be written off at the 25 year point.

Other think tanks have proposed the following to get round this problem:

• Charging a real rate of interest on loans. This would substantially reduce costs to Government. But, as SMF analysis has shown it would mean middle-income graduates paying substantially more than upper-income graduates for the cost of their education. This is unfair and would be very likely to damage access.
• Extending the repayment period once graduates have repaid their loan. This would mean higher income graduates who take out loans would pay more than their peers. However, this would lead to ‘adverse selection’, with students from wealthy backgrounds opting out of the student finance system altogether. By paying upfront, they would pay substantially less than graduates who have gone through the student finance system - including graduates of the same course from less privileged backgrounds who have nevertheless been successful. The system would, in other words, effectively impose a tax on social mobility.

Another idea floated is variable interest rates on student loans, with those on higher incomes facing higher interest rates. This was first suggested in our Axing and Taxing paper. However, such an approach would still provide some incentive for students from wealthier backgrounds to opt out of the system or pay their loan off earlier, resulting in the problems outlined above. This is less than ideal.

Instead, SMF proposes a radical new student finance model.  We propose that:

• Students should no longer be charged tuition fees for which they need to take out loans;
• Universities borrow money from Government to cover the cost of tuition;
• Universities repay these loans through the earnings of their graduates – a graduate contribution - at a rate and over an income threshold set by Government;
• Each university will be free to set a Graduate Contribution Limit (GCL) – the maximum amount that a graduate could eventually repay for their degree. This would not be capped by government and would vary between universities;
• Each university’s GCL would be based on the reasonable salary expectations of their graduates, taking into account interest on their loans and building in an insurance premium such that lower-earning graduates who do not cover the cost of their degree are subsidised by higher-earning ones;
• Graduates pay the graduate contribution to their university via the Student Loans Company, once earning above the repayment threshold;
• Contributions would be suspended after 25 years, meaning many low and middle income graduates do not pay the full GCL.

Students would still be able to access maintenance loans at zero real interest rates, but this would be more tightly means-tested, producing further savings for the exchequer.

Authors of the report Ian Mulheirn and Ryan Shorthouse said:

“Universities should be able to charge graduates what they like. But they must take on the risk, rather than expecting Government to subsidise their graduates who do not meet the costs of their education.  Asking universities rather than students to borrow money to pay tuition costs ensures university remains affordable to all but also creates a market as those universities who deliver better returns for their students will be able to charge a higher GCL. So universities will effectively be paid by the results they achieve.

"SMF has devised a model which ensures access to university remains affordable for all, reduction in public expenditure on the HE sector, greater revenue for universities who deliver good returns for their graduates, a progressive system where higher-earning graduates pay more than lower-earning graduates and a market that rewards institutions that deliver benefits for graduates and employers”.