What is the best way to pay for higher education? General taxation, student loans, or a graduation tax? The answer is, of course, that this is the wrong question. These options merely look at how to distribute the costs of higher education, rather than how to cut them. This week’s column looks at how to reduce the costs of higher education for all.
To fundamentally change the higher education finance equation, instead of getting graduates to repay the debts they build up from studying why don’t we get them to invest in the education of future students? You might think that the difference is just semantics, but it is profound.
Currently students pay interest of 3 per cent of their debts, which, according to a recent report by the Sutton Trust and IFS means that the average graduate will not only build up a debt of £44,000 but still be paying this off in their 40s and 50s.
One interesting thing about universities, particularly the long established ones, is that they often have very large investment funds. The colleges that collectively form Cambridge University manage a whopping £4 billion of investments. Their funds have been built up over 800 years and swollen by sizeable contributions from alumni and other donations from benefactors. Oxford University has its own limited company to handle its investments. When it comes to investing universities have a great deal of expertise to offer. It is at the core of what they do, precisely because it helps them secure the income necessary to support future generations of students get a high quality education.
Their portfolios include shares, property investments, bonds and other assets. In the long term it is quite easy to make your money grow. Across the whole of the last century equities grew by 5.8 per cent on average each year. The compound effect of this is very potent.
To take an example, assume a student leaves college with £22,000 of debt, about the amount they typically would have done under the old student fees regime. If they make regular payments of £80 per month into an investment fund, and we assume 5 per cent growth of that fund per year, in just over 15 years they would pay the debt off. In the next 15 years, without any additional payments, this sum would grow to £46,000. A very different scenario from now.
So, if an investment fund, or series of investment funds, were set up for graduates to contribute to, governed by universities, in partnership with government, potentially tracking the investments already made by various universities through their own funds, it is clear that the outcome is likely to be significantly better for all.
Instead of incurring more interest on their debt students would be investing in the education of the next generation. Moreover, once this system is in place there is an incentive for the state to encourage students to make earlier payments (because the earlier a payment is made the greater the compound effect) and this could be recognised by offering discounts for faster payments. This is in contrast to the current system which creates perverse incentives, including to work abroad rather than in the UK, and thus avoid or delay repayments.
You might be thinking at this stage that this is all very well but the public finances would deteriorate significantly in the early years, but the opposite is likely to be true.
Of course, students would not be paying into the government’s coffers directly, so revenues would be lower. But if the fund or funds were put on the government’s books, which would be normal practice, the value of the assets would be offset against the deficit, and it is very likely that quite quickly the deficit would be on a much better trajectory than with the existing model of finance. Once the fund reached an agreed target it could begin to disperse money to higher education establishments.
With this approach in place it would be perfectly possible to reduce student contributions to £3,000 a year or less and still improve the public finances. Then the debate about the distribution of the financial burden between taxpayers, institutions, and students, and repayment tapers for graduates, will become a lot more enjoyable.