False Accounting? Why Higher Education Reforms Don’t Add Up

Download the report

Author:

Dr Andrew McGettigan

Date:

17 May 2012

The Coalition government’s reforms to higher education funding in England have been enormously controversial ever since they were first announced. But why did the government decide to go down this path at all?

In this groundbreaking research paper, written on behalf of IF by higher education expert Dr Andrew McGettigan, he argues that the main reason why the government was so keen to enact wholesale changes to the English higher education system was because it would enable them to claim they were reducing the deficit. Directly funding higher education through block grants from the Treasury would have led to a bigger financial deficit; however, replacing direct funding with larger loans taken out by students enables the government to claim that it is lowering the deficit because of an accounting convention which treats loans as an asset rather than a liability.

This report shows that it will be future generations who feel the effect of this accounting trick in the long term, because a very high proportion of this student debt is unlikely ever to be paid back. In the meanwhile, today’s students are being burdened with more and more borrowing – which will lead to higher repayments during their working lives – in order to support a political narrative about reducing the deficit which, Dr McGettigan argues, is unlikely to produce any actual savings in the long run. This report should be read by anyone with an interest in higher education financing, as it offers a masterful exposé of the false accounting that has now been placed at the heart of the system.

10 thoughts on “False Accounting? Why Higher Education Reforms Don’t Add Up

  1. John Thompson

    I think this is a very important report. I do hope it gets the attention it deserves.

    I say this as someone who is not totally convinced about generational inequalities – or at least not in financial terms. (For example, I am glad I could cycle to school aged 8, and sorry very few 8 year olds can in 2012.) This is not because I had 50% tax plus NI in my first proper job – and saw 24.9% inflation – or that my savings built up over a lifetime of thrift are now being eroded by Government engineered negative real interest rates. It is because any inequalities between generations are trivial compared to the inequalities within generations – and these are definitely growing. And the changes to HE will further increase the inequalities within the future generations. This is why I think this report is so
    important.

  2. Julian Gravatt

    Fascinating, thought-provoking report which focuses attention on some important questions.

    A couple of extra questions:

    1. The 0.2% CPI inflation effect is significant but is it right to look only at the effect on pensions/benefits? The Bank of England might take action which squeezes inflation elsewhere and, if this does not work, won’t the Treasury get some benefit from fiscal drag as inflation-linked pay settlements mean more people pay higher rates of tax?

    2. If teaching grants were restored with the aim of reducing tuition fees (and thus eliminating this inflation effect), wouldn’t that require an even more rigorous set of controls on the fees charged by Universities and the numbers of students they can recruit. We have a flawed market in 2012 but at least there’s the longer-term prospect that a fee and loan driven system will allow for expansion.

    3. It’s a long and fascinating paper but you don’t give maintenance loans and grants the attention they deserve given that the total expenditure will be £5.5 billion in 2015. Do we spend too much in England supporting a residential, full-time mode of higher education? I know there are multiple benefits from this money but given the other issues you raise, I think the question needs to be asked.

    4. Your evidence on the lack of legal protection given to borrowers deserves a bit more attention. It suggests that the message that “some borrowers will never need to pay back loans” is wrong because we just don’t know.

    5. The evidence on repayments is a pessimistic view of future graduate earning growth but perhaps this is just being realistic. I guess a question here is that if future graduates aren’t going to be wealthy enough to pay back loans at a sufficiently high rate then they’re not going to be well off enough to pay back enough tax either. Also the evidence in your report suggests that the post-2015 government is probably going to be looking again at the repayment terms in some way (lower income thresholds or higher interest rates)

    6. The “10% extra income for Universities by 2015″ which you attribute to David Willetts was calculated by HEFCE who have also presented figures showing that the combined income (fees plus grants) for courses at 2012-13 average net fee levels (£8,000+) provide an income increase for all bands of courses but particularly Band D arts and humanities subjects. Universities will only benefit from these higher fees if they recruit students in the same numbers in 2012-13 but you could say that the the biggest transfers from the 2012 HE reforms are not from next year’s students to future pensioners but from next year’s students to current HE staff (academics and managers).

  3. aBalancedView

    Odd that you seem to have been a bit selective with the choice of independent cost estimates presented –

    The IFS have completed a lot of work on the long-term resource cost of loans but their modelling doesn’t even get a mention here.

  4. Andrew McGettigan

    Thank you for the comments.

    Julian, to reply briefly:

    1. I am not really in a position to comment on further implications of the ‘CPI effect’, but costs associated with index-linked gilts would be another factor to consider.

    2. Labour is currently pledging to reduce the maximum tuition fee to £6 000 per year. Is this what you mean by a more rigorous control on fees?

    I don’t see any prospect for overall expansion in the sector in the short to medium term unless there is a fundamental reversal of policy. I believe the restrictions on recruitment combined with the entry of new providers are designed to produce a big shake-up in provision.

    The Russell Group should benefit. But the rest? Willetts has written: “I expect that, in the future, as the data accrue, the policy debate will be about the RAB charge for individual institutions. One reason why we were not able to accept Browne’s ingenious idea of a levy on higher fees is that it was indiscriminate and did not reflect the actual Exchequer risk from lending to students at specific universities.”

    Perhaps once this kind of metric is reliable then we may see limited expansion for institutions whose graduates have good repayment profiles. (And perhaps sanctions against those institutions in the opposite situation).

    3. We originally planned to cover maintenance loans but decided it needed fuller and separate treatment. I think we need to consider how we can promote alternatives to what used to be called the “boarding school model”.

    Perhaps debt-averse individuals will increasingly opt to stay at home and study part-time. (However, many HEI’s have invested heavily in student accommodation.) But for full-time study in London, maintenance loans do not seem adequate given accommodation costs.

    4. The current government cannot determine what future governments will do but protection for borrowers has been eroded: with much higher debts now, I don’t believe that’s acceptable. Contractual terms could be improved relatively easily, I haven’t seen a reasonable objection to writing the terms on which the scheme was sold to parliament into the new agreements.

    5. There seem to be two points here. First, aren’t low-earning individuals with large, unpaid debts in a different situation to those in low earning individuals without debts? Revenues may be low in both situations, but we do not have the outstanding balances against individuals in the second case.
    Second, the scheme would appear to be more viable if administrators had the ability to review the repayment threshold. The last minute concession to index-link the threshold to average earnings removes a means to managing repayments.

    I feel we need a clearer understanding of the implications of the government’s policy: that it has not necessarily placed the funding of universities on a more sustainable footing and that the reduction to BIS’s contribution to the deficit is not the full picture.

    The policy is only part of a broader reconfiguration of the sector: generalized loans and no grants to Band C and D subjects fashion a level playing field for private providers.

    6. The sector will receive additional revenues but it’s less clear that every institution will see additional income. It is also not clear how those revenues will be spent. I think it will vary from institution to institution and I doubt that much of that revenue will automatically translate into additional staff salaries or protect posts and working conditions. Those in recruitment and marketing posts will probably be best off.

  5. Matt Grist

    Andrew, perhaps you can help me. I find this statement confusing:

    The loan book is ‘off-balance-sheet’ but the borrowing used to create it is not.

    Aren’t they both off balance sheet? Borrowing is not counted as expenditure so not on balance sheet either? Or am I misunderstanding?

    Thanks, Matt

  6. Andrew McGettigan

    Dear Matt, thanks for the comment.

    The balance sheet measures assets and liabilities, not income and expenditure.

    It may not be a very helpful formulation, and is a bit loose, but it was meant to convey one of the issues around the loan book – that it is an ‘illiquid financial asset’ and therefore not included in the calculations of Public Sector Net Debt.

    The borrowing used to create it is a liability and is included in the calculation of PSND.

    The borrowing is recorded as expenditure only as an impairment, the expected ‘loss’ on the loans issued.

  7. Andrew McGettigan

    Just to provide additional clarity.

    Say you borrowed £10billion (a liability) to create an asset worth £8billion, the net impact would be -£2billion to PSND.

    But here the illiquid asset does not figure in the calculations, only the borrowing does, so the impact is -£10billion.

    This may be one perspective from which to contemplate a sale of loans – it would improve the headline statistic which is central to political narratives.

  8. Matt Grist

    Thanks.

    So the illiquid asset status actually makes things look worse for the government doesn’t it?

    I am still a bit confused. There seems to be double counting going on. The borrowing to create the debt is counted towards PSND; and the ‘impairment’ is also counted towards PNSD. So if you borrow £10 billion with £2 billion impairment, that is accounted as £12 billion of debt. Is this right? If so it makes things look far worse than they are.

    Another issue. You recommend returning to block grants. Apart from the indiscriminate nature of such grants leading to dead-weight funding (i.e. we are funding rich kids’ degrees through teaching grants), money will also be borrowed for these grants that will add to PNSD. It would have been nice to have this recommendation costed, with similar analysis of how it adds to national debt over time.

    Finally, as far as I understand it the CPI effect is greatly contested – William Cullerne Brown presented it as a fact, but is far from that. You do at least proceed with some caution, but there are all sorts of economic effects that might flow from increased prices – e.g. UK’s debt gets slightly smaller through higher inflation, as do personal debts. It is very difficult to understand all these effects – and as one of the posts above says, the BOE might have already taken anti-inflationary action elsewhere without us knowing about it.

    Having said all this I totally agree that the financial sustainability of the current loans system is of crucial importance so thank you for raising it!

  9. Andrew McGettigan

    Dear Matt

    Thanks again!

    1. The ‘impairment’ is recorded in BIS’s departmental budget as expenditure – it therefore contributes to the deficit but is netted against the saving from the cut to grants.

    In a simplified system with the figures we’ve used above: £3bn saved by cutting grants but the £2bn impairment for the loss on loans give £1bn of savings.

    This would mean £9bn of borrowing – £10bn for loans minus the £1bn of departmental saving.

    Borrowing reduces as annual graduate repayments incease and reduce the shortfall against annual outlay (and hence the borrowing needed to finance it). This takes at least twenty years to happen on OBR and BIS estimates.

    2. The OBR figures on debt are the net impact of the new policy. It is therefore estimating the additional borrowing required as compared to the old regime (ie with block grant).

    So the old regime is effectively costed there.

    3. OBR has also offered a 0.2 percentage point increase in CPI as a result of higher tuition fees.

    I have had private emails casting doubt on it, but if you can point me in the direction of something published since the OBR November 2011 publication, I would appreciate it.

    In general, the manner in which the Coalition has presented this scheme as reducing the deficit is a huge simplification of the impact on public sector finances. It is technically correct, but the political narrative about deficit reduction is that it reduces the need for borrowing to cover the shortfall between income and expenditure. Deficit reduction would ‘normally’ imply a slow down in the increase of public sector net debt – that does not happen with loans, instead borrowing is increased for perhaps twenty years.

  10. Andrew McGettigan

    Sorry, I forgot to add to point 1 that you’ve set aside £2bn impairment in the budget covered by expenditure. So £2bn of the £9bn additional borrowing has been set aside to cover the expected shortfall.

    This £2bn combines with £8bn expected repayments. The net value of the loan book is the original borrowing to create it, minus the impairment – so no double-counting.

    It’s just that this takes time in the real world and depends on repayment levels meeting expectations.

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