Higher Education Funding

1. Higher Education Funding Haroon Chowdry Institute for Fiscal Studies 8 December 2008

2. Outline of lecture • Reasons for state intervention in HE • Overview of HE funding and reforms • Financial impact of reforms on students and graduates • Progressivity of HE reforms and potential alternatives • Potential implications for access to HE • Future plans

3. Reasons for state intervention in HE

4. Why might the market alone lead to inefficient outcomes? • Credit market failure • Risk and uncertainty • Externalities • Information problems

5. 1. Credit market failure • HE requires cash for fees and living expenses • With perfect credit markets, borrow now and repay for future income • But credit markets are not perfect • Lack of collateral to secure debt against • Asymmetric information: borrower has more information than lender • Lender exposed to adverse selection / moral hazard • Higher interest rates or credit rationing • Inefficiently small amount of borrowing and investment

6. 2. Risk and uncertainty • Student may be reluctant to borrow • Debt aversion • Perceived risk of failing the degree • Uncertain returns to a degree: positive on average but high variance

7. 3. Externalities • Education may create benefits to society over and above those that accrue to the individual • Total return to education = private return + social return • Average private return to HE vs. non-HE is roughly 25–27% for women, 18–21% for men • Social returns difficult to quantify • Do individuals incorporate socialreturn to education in weighing up costs and benefits?

8. 4. Information problems • To make rational decisions, individuals must be perfectly informed about • Nature of product (e.g. university quality, HE experience) • Prices (e.g. fees, living costs, foregone earnings) • Future (e.g. earnings, debt repayments) • Imperfect information may lead to under-consumption • Particularly among lower socio-economic groups

9. Efficiency • These arguments can justify state intervention and subsidies on efficiency grounds • But do not justify full subsidy given large private returns to HE

10. Overview of HE funding

11. Trends in participation and funding levels

12. Recent history • No tuition fees prior to 1998 • Living costs financed by grants and parental contribution, mortgage-type loans after 1990 • 1997 Dearing Report • Up-front tuition fee of £1,000, exemptions for poorer students • Income-contingent loans replaced grants • 2004 Higher Education Act • Deferred fees (currently £3,145), no exemptions • Grants and bursaries for poorer students • Debt write-off after 25 years

13. Shift in balance of funding

14. Implications for students • Government wants more people to go to HE, not fewer • Target of 50% participation rate by 2010 • Surely increasing fees prices students out of HE? • Not as contradictory as it seems • New grants and bursaries designed to help credit constraints for poorest • Risk insured by income contingency and debt write-off • On basis of cost-benefit analysis, poorest would be more likely to go

15. Non-London student finances under old system with up-front fees of £1,100 p.a.

16. Non-London student finances under new system with deferred fees of £3,000 p.a.

17. Implications for graduates (1) • Graduates will enter labour market with debts to government in the region of £20,000 • Nearly twice as much as under old system • Effects of reforms on graduates vary according to lifetime earnings and employment patterns • Income-contingency of repayments and debt write-off after 25 years • Requires a full distributional analysis of graduate lifetime income

18. Implications for graduates (2) General observations: • All graduates benefit from interest subsidy and raising of repayment threshold • Graduates with lower lifetime earnings receive higher subsidy • Interest subsidy is more valuable the longer it takes to repay the loan • Low-earning graduates more likely to benefit from debt write-off

19. How much do different graduates pay back? Amount borrowed: £18,290 (2006/07 prices)

20. How do repayments compare with the previous system?

21. Implications for graduates (3) • Must also take into account private debt • Attracts higher interest than government debt • Assume shortfall financed entirely by private debt • Lower shortfall for poor students means they pay back less overall than under old system • Most students from richer backgrounds would pay back more

22. Top-up fees vs. alternatives • Raising money on its own does not justify higher fees – there are other options • Examples proposed in run-up to 2005 election: scrap fees and raise funding for universities through • scrapping maintenance loan subsidies (Conservatives) • higher rate tax rise (Liberal Democrats) • Different policies shift balance of funding between public and individual contributions to HE in different ways

23. Top-up fees vs. alternatives • How do the costs incurred by paying for the additional university funding vary across income distribution? • What is distributional impact of different revenue-raising strategies? • Raising money through deferred fees is more ‘progressive’ than raising the equivalent amount through some alternatives such as • Direct taxation • Indirect taxation

24. Costs borne across the income distribution to raise same amount of money as top-up fees(ILLUSTRATIVE ONLY)

25. Potential implications for access to HE

26. Access to HE (1) • Major concern that top-up fees would discourage HE entry from poorer pupils • One aim of reforms was to widen access • Poorer students actually better off in cash terms • Well known that students from low-income backgrounds under-represented in university • Even more so in top universities • How likely are changes to student finance to encourage/discourage entry?

27. Poorer students are overall less likely to go university than richer students…

28. … But those with comparable A Level grades to richer students are not 25% of richest get top A levels 3% of poorest get top A levels 84% of poorest 45% of richest

29. Access to HE (2) • Most important determinant of HE attendance is having good A-Level grades • Conditional on this, relationship between income and HE participation is weak • Best way to widen access is to improve A-Level grades of disadvantaged pupils • Limited scope for tuition policy here • Resources/interventions would be better targeted earlier in life

30. Future plans • HE funding review expected in late 2009 • May explore further policy changes • Remove fee cap? • Resources • Competition • Remove interest subsidy? • Actually a ‘progressive’ measure

31. Conclusions (1) • Many economic reasons for state intervention in provision of HE • HE Act addresses borrowing constraints and risk • Student support package and repayment system are highly progressive • Low-earning graduates benefit most from loan subsidies and pay back less than: • High-earning graduates • Low-earning graduates under old system

32. Conclusions (2) • But may not be most effective way to get more disadvantaged students into HE • Barriers to entry for poor students occur earlier in life • Stay tuned for further developments!