Who'll pick up the tab tomorrow?

An expanded student loan scheme would be a burden to the taxpayer. By Peter Watson

We are all susceptible to financial schemes that appear to offer something for nothing. Most of us have learnt to be profoundly suspicious of them. Most financial scandals are a result of the time-honoured tendency to put off the evil day. Pyramid-selling is a prime example of this genre. It is fine for those in at the beginning. It is the latecomers who pick up the tab.

On the face of it, the student loan scheme that universities are advocating to the Dearing Committee has something for everyone: it will provide more funds for universities themselves; it will allow universities to pay their staff a significant increase in salaries which have fallen behind those of other occupations; it will contribute more to students' living expenses; it will persuade more students from less well-off families to attend university.

The scheme offers so much that one is tempted to wonder why it was not introduced long ago. Alternatively, one may ask whether behind the blandishments of the salesman there are disadvantages.

The scheme is quite simple. Students will be able to borrow to meet the costs of higher education, with no questions asked. They will be charged what is described as a real rate of interest on amounts borrowed, though presumably one that is less than market rate, or the scheme would discourage those from less well-off backgrounds.

Repayments will be collected through the national insurance scheme as a percentage of income above a certain level. This will work as an additional tax rate that graduates will pay until any loans advanced, plus interest, have been repaid. Graduates whose subsequent income is insufficient will therefore be relieved of the burden of repayment. As a result the scheme is described as income-contingent.

Where, then, are the hidden snags, and how are they hidden? The first is the cost of the interest subsidy. At first this appears to be only a small sum. At the level of utilisation estimated, about pounds 5bn in the first year, a 1 per cent interest subsidy will cost only pounds 50m each year. If the annual subsidy is totted up over the life of a group of graduates, however, the sum is closer to pounds 500m. The trick of the scheme is to transfer this cost to future generations. It may not have to be paid today but it will certainly have to be paid tomorrow.

The second problem is the cost of default. The exact costs of this are something that will emerge only over the lifetime of the students concerned. Suppose that one-fifth of the initial payments plus interest are never repaid and have to be written off. The effective cost of this would be pounds 1bn, measured today. Again, this is an issue the scheme neatly postpones, leaving it to be picked up by a subsequent generation.

The third problem involves the cost of operating the scheme, estimated at pounds 700m in the first year. The estimates fail to specify the costs that will be imposed on employers as they collect the money from their employees, amend computer software, and so on.

The fourth problem is the size of the borrowing. Again, this is hidden to start with. It is possible to see that it will be some time before repayments will reduce the size of the loan outstanding. For example, with a repayment rate of 5 per cent of gross income, and a threshold income of pounds 10,000, an individual would have to earn more than pounds 29,000 before repayments would cover the cost of the annual interest added to the loan accumulated at the date of graduation. When the loan scheme is fully mature, which could take 20 years or more, the total borrowings may well exceed pounds 100bn, or 20 per cent of the national debt. This will be a more than trivial problem for a future government.

The fifth problem is that the scheme appears to be open-ended. Postgraduates are included and, presumably, universities would be able to extend the length of their courses "to maintain quality". This would only exacerbate the problems outlined above.

The final problem is that the scheme relies on a general subsidy to all students. This is a luxury taxpayers can no longer afford. In most areas of government activity there is pressure to target help more precisely on those in genuine need. The funding of higher education already involves significant subsidies to the middle classes. What this scheme does is to offer them the opportunity to transfer their existing borrowings at market interest rates to a borrowing scheme supported by the general taxpayer. This is surely a retrograde step.

Everyone is conscious of the need to be careful about borrowing to fund expenditure. The universities have devised a crafty way of avoiding that advice in a manner that does not penalise them. It involves somebody else borrowing to meet their current expenditure. The way the borrowing is arranged carries a nasty sting in the tail. The person to be stung will be the taxpayer, in this case some time in the future.

If this scheme is not viable, how can universities resolve their financial problems? The only way forward is the honest one. If they are short of money, and the taxpayer will not pay more, students or their families must. But it is wrong to hide this unpalatable truth in a burdensome loan scheme. Those who can afford to pay fees will have to become used to doing so; help should be reserved for those who cannot.

The writer is executive pro-vice-chancellor of the University of Buckingham.