Student debt: The radical plan that the Government refuses to consider

The Government is looking at how to fund students through their degrees so they don't pile up heavy debt. One radical solution is winning MPs' support. But Margaret Hodge, the minister for higher education, is opposed. Why, wonders Lucy Hodges

MPs were bewildered last week after a session with Margaret Hodge, the higher education minister. They had never anticipated extracting much information from her for their inquiry into student funding. But what really surprised them was that she expended so much energy rubbishing an idea that they have become attracted to. That is the proposal to abolish the interest subsidy on student loans in order to raise £700-£800m for higher education and hard-pressed students.

What bothered them most was their sense that she had been badly briefed. "She went over the top," said one MP.

The education select committee is looking at how students should be funded through their degrees, an issue that the Government is also examining. Tony Blair announced the inquiry at the Labour Party Conference last year because, he said, voters were angry about student debt. The investigation has taken longer than expected and there have been several changes of tack. First a graduate tax was on the cards, then it was off. The Treasury is said to have disagreed with the Department for Education and Skills, and now the inquiry is enveloped in secrecy.

Characteristically, Mrs Hodge, who was known to be in favour of a graduate tax, refused to say anything about the deliberations last week. Nothing is ruled in and nothing is ruled out, she repeats constantly.

So, the MPs were surprised that she seemed so keen to close off an option that is supported by a number of the most respected thinkers in this area, notably Nicholas Barr, reader at the London School of Economics, and Wendy Piatt, of the left-leaning think tank, the Institute of Public Policy Research.

There was particular concern at the figures she was using. Dr Barr argues that graduates should pay an interest rate equal to the Government's cost of borrowing, the base rate, which stands at 4 per cent. At present students pay only 2.3 per cent, the rate of inflation.

But in her evidence, Mrs Hodge presented some different figures. The Government's cost of borrowing was 6 per cent, she said. That was "the discount rate that the Treasury currently uses". The minister then added 2.3 per cent, the rate of inflation, to that. Hey presto, the interest rate that graduates would have to pay under Dr Barr's proposal would be 8.3 per cent. "I think the minister interpreted the Barr suggestions wrongly," says Barry Sheerman, Labour's select committee chairman. "My understanding is that the Barr system would work in quite a different way. The Government could choose how much above the borrowing rate to set the repayment rate for student loans."

The argument may seem difficult and arcane but it is important. Picking on an interest rate of 8.3 per cent enabled Mrs Hodge to construct a frightening scenario. Take a low-income graduate woman, who borrows £10,000, she said. At the moment, on the heavily subsidised interest rate, she would pay back a total of £12,700 over her lifetime. But under the Barr proposal that figure would rise to £28,300. If she took a career break for five years, she would end up paying back a total of £59,000. Mrs Hodge must have been assuming that the woman's debt would continue to mount up while she was off on her break and that compound interest would push it up to the scary figure of £59,000.

Dr Barr says that the statistics the minister used are wrong. First, he is talking about graduates being charged an interest rate equal to the Government's cost of borrowing. That is a factual matter, he emphasises. "It is significantly less than 6 per cent at the moment and includes inflation." That is why it is wrong to add 2.3 per cent to it. Second, he believes, as does Wendy Piatt, that special arrangements should be made for people in need. His paper for the select committee specifically favours targeting subsidies so that someone who is unemployed or caring for young children or others does not experience their debt spiralling out of control.

"That is all in my evidence," says Dr Barr. "If the Department is choosing to ignore that, it is just being naughty."

Some of those who witnessed the hearing or have read the oral evidence on Parliament's website are convinced that the Department is deliberately setting out to trash Dr Barr's idea. Dr Barr himself thinks that the Department is scaremongering with its figure of 8.3 per cent. "Someone somewhere is confusing interest rates in practice with test discount rates," he says. "The two are different economic variables."

One reason could be that the Department does not benefit directly from changing the interest subsidy on student loans. The money goes to the Treasury. So, if higher education were to benefit from charging graduates more, as Dr Barr suggests, there would have to be negotiations between the DfES and the Treasury so that education benefited. And that makes the education mandarins nervous because the Treasury is so dominant at the moment. "So much for joined-up government," says one seasoned observer.

Another reason Mrs Hodge may have been so anti the proposal is that she sees Dr Barr as right wing. An adviser to the World Bank, Dr Barr is an academic economist who regards himself as progressive in his aims, though pragmatic about method. In other words, he is thoroughly New Labour, probably more so than Margaret Hodge. And he is against blanket subsidies, such as the subsidy on the student loans interest rate, because it gives money unnecessarily to those who can afford to pay.

Interest subsidies on student loans don't help students, he points out. "The only people they help are higher-earning graduates in mid-career, whose loan repayments are switched off earlier because of the subsidy. Thus the question is whether we want to spend £800m on helping wealthy people become wealthier, or whether we would rather use it to promote access through targeted student support, and improved quality through more resources to education institutions."

The Dfes was standing by the figures Mrs Hodge gave to the committee last week. Meanwhile, observers were left asking whether their use was a deliberate attempt to obfuscate or whether the minister genuinely thought they were what Dr Barr had in mind and that her advisers had simply not read his paper properly.

Pros and cons of raising the interest rate:

Pros

1. You generate £700m, which can be ploughed into underfunded universities and into helping the disadvantaged students with grants/scholarships.

2. You thereby tackle the access problem. Grants should help to meet the Government's 50 per cent target of young people going to university.

3. A student from a particularly vulnerable background might get a full grant and so would not need any loan.

4. You could give all students an income-contingent loan to cover all living costs and tuition fees, making higher education free at the point of use. Currently, loans are supposed to be used only for living costs.

5. You end a blanket subsidy which benefits higher earning graduates in mid-career.

Cons

1. Many graduates would pay more than they do now.

2. Income-based repayments mean lower earners repay more slowly. Thus lower earners pay more interest in total than higher earners.

3. You would annoy the National Union of Students,which argues that raising the interest rate on student loans harms lower earners.

4. You would also annoy the Muslim Council of Britain, which is against the principle of usury.

To top up or not? That is the question

At the same select committee, Mrs Hodge created headlines by refusing to rule out top-up or differential fees. Favoured by the Russell group of leading universities, they were ruled out by David Blunkett, the former Education Secretary, before the last election. They were also ruled out in Labour's election manifesto. But that only applies to the lifetime of this Parliament. They are, however, known to be favoured by the Downing Street Policy Unit. The idea is that universities would be given much more freedom to set their own fees. At present there is a flat-rate tuition fee for all universities regardless of the subject being studied or the quality of the institution. The top universities, which complain about being unable to compete internationally because of a shortage of funds, know they would be able to charge more and not lose applicants. It is not clear whether Mrs Hodge was giving a signal or whether she was simply repeating her mantra that nothing is ruled out of the funding review. Those opposed to top-up fees are concerned that they would deter disadvantaged students from applying to university. Dr Nicholas Barr of the LSE favours doubling the flat fee to £2,000. Universities should be free to charge less if they wish, he says. And the ceiling should be raised over time. That is differential fees through the back door.

l.hodges@independent.co.uk