Funding Higher Education Emla Fitzsimons Institute for Fiscal Studies February 2005

1. Funding Higher EducationEmla FitzsimonsInstitute for Fiscal StudiesFebruary 2005

2. OUTLINE • Economic principles underlying government intervention in the funding of higher education • The Higher Education (HE) Bill (endorsed by majority of MPs Jan 2004) • Main provisions • Implications of these provisions • For the student • For the graduate • For the universities • For the taxpayer • 3. A brief look at the Conservative proposals (announced • Sept 2004) • 4. Conclusions

3. 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’

4. ECONOMIC PRINCIPLES UNDERLYING INTERVENTION IN HIGHER EDUCATION • EFFICIENCY • I.Liquidity Constraints • II. Information Problems • III. Uncertainty and Risk Aversion • IV. Externalities • 2. EQUITY

5. EFFICIENCY ARGUMENTSI. Liquidity Constraints 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 inabilityto 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 reluctanceto 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

6. EFFICIENCY ARGUMENTScontd.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

7. EFFICIENCY ARGUMENTScontd.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

8. EFFICIENCY ARGUMENTScontd.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 education in weighing up PV of benefits and costs?

9. 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

10. 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 £1,200 (25% of average teaching costs) • No maintenance grants • Means-tested income loan entitlements; income-contingent repayments • Parental contributions Possible criticisms of systems?

11. 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

12. Problems with existing system • Universities under-funded • Students poor – excessive use of credit cards (?) • Parental contributions 1 and 2 => students need more money up front 4. Improve access

13. THE HIGHER EDUCATION (HE) BILL 2004 • Fees • UPFRONT • No upfront fee • DEFERRED • Initial cap £3,000 p.a. • Fee exemptions replaced by grants

14. 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

15. THE HE BILL 2004 contd. • Grants • Single combined Higher Education Grant. Means-tested maximum of £2,700 p.a. comprised of • £1,200 if family income < £22,580 p.a. Tapered to zero at family income of £33,630 • £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.

16. 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?

17. Amount of debt students will incur(assuming students borrow max amount available to them) Table 1 3 year course, non-London, non-home

18. Amount of support available through grants; shortfall Table 1 contd.

19. Figure 1 Non-London student finances under the Higher Education Bill with fees of £3,000 p.a.

20. Figure 2Non-London student finances under the Current System with upfront fees of £1,200 p.a.

21. Problems with proposed system • Loan and grant thresholds (parameters of the system) need to be clearly defined and refined • Debt entitlement not monotonic in income • Complexity of system, difficult to understand, not transparent – poorly marketed? • Shortfall – not enough money for students at university • Fee cap?

22. IMPLICATIONS FOR GRADUATE, BY PARENTAL INCOME AND GRADUATE EARNINGS PROFILES • Will depend on lifetime labour market earnings and employment patterns • Some examples • Median male and female graduates • Female doctor • Female with low-starting salary + career break • Male high-flyer

23. Long-term impact for median male graduate earner

24. Long-term impact for female doctor graduate

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

26. Long-term impact for male high-flyer

27. IMPLICATIONS FOR UNIVERSITY FUNDING • 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

28. 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

29. IMPLICATIONS FOR UNIVERSITY FUNDING contd. 3. What will happen to the amount of funding per head? • ~ £1,250 per student; Increase of 22% • 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.

30. 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)

31. SUMMARY OF HE BILL • 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.

32. A brief look at the Conservative Proposals • Fees • Scrap all tuition fees • Loans • FOR MAINTENANCE • Borrowing limits at £5,000 per year for all students, regardless of family income • Repayment of Loans • 9% of income above threshold of £13,925 p.a. • Market interest rate  removal of student support in the form of loan subsidies

33. Conservative Proposals contd. Grants • to remain at current (2004-05) level of £1,500 for the poorest students

34. Figure 3Student finances under the Conservative Proposals, assuming maximum debt

35. Conservative Proposals contd.-Key ways in which they differ from HE Bill • Abolition of tuition fees, including their variable element, essentially closes down the market for university courses • Shift to bank loans will effectively remove much support for maintenance and living expenses

36. Conservative Proposals contd.-Broad implications for universities and taxpayers Despite loss of fee income, universities to be at least as well off as under HE Bill proposals, at no extra cost to the taxpayer…how? Mainly by diverting a large proportion of the public spending that the Labour Government will have earmarked for student support (loan subsidies and higher grants) to universities

37. REFERENCES • Barr, N. (2004), “Higher Education Funding”, Oxford Review of Economic Policy, 20(2), 264-283. • 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. • 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. • Blundell, R., L. Dearden, A. Goodman and H. Reed (2000), “The Returns to Higher Education in Britain: Evidence from a British Cohort”, The Economic Journal, 110 (461), F82-99. • Dearden, L., E. Fitzsimons and A. Goodman (2004), “Conservatives’ plans for Higher Education funding: who gains and who loses?”, IFS Press Release, 8th September 2004. • Dearden, L., E. Fitzsimons and A. Goodman (2004), “An Analysis of the Higher Education Reforms”, IFS Briefing Note No.45.

38. REFERENCES contd. • 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. • 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.