Written evidence submitted by Professor Andy Green and Professor Geoff Mason (STL0031)

Professor Andy Green and Professor Geoff Mason

ESRC Research Centre on Learning and Life Chances (LLAKES),

UCL Institute of Education

Executive Summary

This response focuses on the Committee’s question about whether a graduate tax would be preferable to the current model.

Our short answer to this question is: Yes, so long as the tax is applied to graduates of all generations, not just to recent and future graduates.

In the first part of this response, we elaborate on this point by drawing on new evidence presented in our recent research paper: ‘The Case for an All-Age Graduate Tax in England.’ The other questions posed by the Committee are addressed in the Appendix.

Our research suggests that an all-age graduate tax would offer a number of clear advantages over the current system of financing higher education.

1. It would reduce inter-generational inequity since, unlike in the existing system, all graduates would be contributing to the costs of higher education and not just recent and future graduates.
2. Because the tax would be paid by all graduates, the burden of annual payments for young graduates would be much lower than with the current system. This would be a significant advantage for younger graduates who already face historically high costs for rents and mortgages.
3. The costs to the taxpayer would be lower than under the current system in two ways. Firstly (at the tax rates we suggest) the Government would immediately receive more than twice as much in current revenue from the tax as from loan repayments. Secondly, the all-age graduate tax offers the likelihood of lower costs to taxpayers in the long term because the number liable for the tax would continue to increase, even if enrolment rates in higher education plateau.
4. Importantly, if the Government adopted an all-age graduate tax, it would be giving an important signal to younger people that it intends to reduce inter-generational inequalities. 

Key Findings

• We estimate that annual repayments would be significantly lower for almost all young graduates under a graduate tax than under the current system. For example: even if the new income threshold of £25,000 is assumed to apply to repayment of student loans, currently indebted graduates with a gross annual income of £35,000 will be expected to repay £75 per month compared with £40 under our preferred version of the proposed graduate tax.
• Drawing on Labour Force Survey data on the annual earnings of English-domiciled graduates in employment aged 20-64, we estimate that a graduate tax would have yielded approximately £3.6-3.7 bn in annual tax revenues in 2016, more than double the annual loan repayments made by English-domiciled graduates in that year.
• The annual revenue from an all-age graduate tax would represent approximately 30-31 percent of the total costs of tuition and maintenance of First degree students in English universities

Recommendations

1.     Government should restore maintenance grants and introduce a new ‘all-age graduate tax’ to replace the existing system of fees and loans.

2.     This tax should be applied to all graduates of ‘First degree’ (Bachelors) courses from English universities who had received subsidised tuition and who were employed in England with earnings over £21 000. The tax would therefore apply to past, current and future UK and EEA-born graduates from English universities, but not to international students who had paid ‘full-cost’ fees.

3.     The tax should be levied at 2 percent of taxable incomes in the basic rate tax band and 3 percent in the higher rate band.

4.     The tax should be collected either through employers, as with the current system for student loan repayments, or through the HMRC self-assessment tax return system.

Answers to Questions Posed by the Inquiry

1 Would a graduate tax be preferable to current model?

1.1 Providing that it were paid by graduates of all ages, a graduate tax would offer a number of clear advantages over the current system of financing higher education.

1.2 It would reduce inter-generational inequity since, unlike in the existing system, all graduates would be contributing to the costs of higher education and not just recent and future graduates. Because the tax would be paid by all graduates, the burden in annual payments for young people would be much lower than with the current system. This would be a significant advantage for younger graduates who currently face historically high costs for rents and mortgages. At the same time the costs to the taxpayer would be lower than under the current system in two ways. Firstly (at the tax rates we suggest below) the Government would immediately receive almost double as much in current revenue from the tax as from loan repayments. Secondly, the all age-graduate tax offers the likelihood of lower costs to taxpayers in the long term, because the number liable for the tax would continue to increase, even if enrolment rates in higher education were to plateau. Importantly, if government adopted an all-age graduate tax, it would be giving an important signal to the younger electorate that it intends to reduce inter-generational inequalities. 

2 How would an all-age graduate tax work?

2.1 In a recent research paper published by the ESRC Centre for Learning and Life Chances (LLAKES) at the UCL Institute of Education[1], we set out a detailed proposal for an all-age graduate tax for England which could - if tuition fees are abolished - contribute substantially to the costs of HE students’ tuition and maintenance in England.

2.2 We proposed that the tax should be levied on all graduates of ‘first degree’ (Bachelors) courses from English universities who had received subsidised tuition and who were employed in England with earnings over £21 000.[2] The tax would therefore apply to past, current and future UK and EEA-born graduates from English universities, but not to international students who had paid ‘full-cost’ fees. We estimate the costs to graduates and revenues to the Treasury from two models for the tax.

• Graduate Tax (GT) Option 1: 2.5 percent of taxable income for employed graduates in England aged 20-64 and earning over £21 000.

• GT Option 2: As above, but at 2.0 percent of taxable income in the basic rate tax band and 3.0 percent of taxable income in the higher rate tax band.

2.3 In both cases a steep taper would be applied so that graduates earning between £21 000 and £25000 would have very low graduate tax repayments

Table 1: Estimated Individual Tax Liabilities under All-age Graduate Taxes

(A) GT Option 1: tax levied at 2.5% of taxable income for graduates with gross annual incomes of £21,000 or more

(B) GT Option 2: tax levied at 2.0% of taxable income in the basic rate tax band; and 3.0% in the higher rate tax band; applies to graduates with gross annual incomes of £21,000 or more; tapered tax rates for gross incomes between £21,001-£24,999.

Notes to Table 1:

(a)  Gross annual income less £11,000 personal allowance applicable in the 2016-17 tax year

(b)  Basic rate tax band in 2016-17: taxable income ranging from £0-32,000

(c)  Higher rate tax band in 2016-17: taxable income ranging from £32,001-150,000

3 Reducing repayment burdens on young graduates

3.1 Both of these models would considerably reduce the annual payments required for almost all liable graduates.

3.2 Under the present student loan system, assuming a repayment threshold of £21,000, indebted graduates with a gross annual income of £35,000 will be expected to pay £105 per month, calculated as follows:

1)     £35,000 less £21,000 = £14,000

2)     9% of £14,000 = £1260

3)     £1260/12 = £105

3.3 If a higher repayment threshold of £25,000 is assumed, indebted graduates with a gross annual income of £35,000 will be expected to pay £75 per month, calculated as follows:

4)     £35,000 less £25,000 = £10,000

5)     9% of £10000 = £900

6)     £900/12 = £75

3.4 Regardless of which of these two repayment thresholds is assumed, for recent graduates the reduction in monthly outgoings under GT Option 1 for an all-age graduate tax would make a considerable difference to net incomes. Assuming the same gross annual income of £35,000, monthly outgoings would decline to £50 per month, calculated as follows:

1)     £35,000 less £11,000 (personal allowance in 2016-17) = £24,000

2)     2.5% of £24,000 = £600

3)     £600/12 = £50

3.5 Under GT Option 2, the estimated monthly outgoings for a graduate with the same gross annual income of £35,000 would decline further to £40.

4 Potential Revenue from all-age graduate tax

4.1 Drawing on Labour Force Survey data on the annual earnings of English-domiciled graduates in employment aged 20-64, we estimated that GT Options 1 and 2 would have yielded approximately £3.6-3.7 billion in annual tax revenues in 2016, more than double the annual loan repayments made by English-domiciled graduates in that year. This level of tax revenue represented about 30-31 percent of the estimated total annual cost of providing tuition and maintenance for students studying towards first degree qualifications in England in 2016.

Table 2: Estimated Tax Revenue from All-Age Graduate Taxes Levied on English-Educated Graduates Aged 20-64 in Employment in England, 2016

A: GT Option 1: 2.5% tax levied on all graduates with gross annual earnings of £25,000 or more per year; tapered tax rates for gross earnings between £21,001-£24,999.

B: GT Option 2: 2.0% tax levied on taxable income in the basic rate tax band and 3.0% of taxable income in the higher rate tax band for all graduates with gross annual earnings of £25,000 or more per year; tapered tax rates for gross earnings between £21,001-£24,999.

Notes:

Salary estimates derived from LFS 2016 as described in notes to Green and Mason (2017), Table 3.

Basic rate tax band in 2016-17: taxable income ranging from £0-32,000

Higher rate tax band in 2016-17: taxable income ranging from £32,001-150,000 

4.2 Thus an all-age graduate tax levied at the rates discussed in our examples could make a substantial and immediate contribution to the costs of First degree tuition and maintenance were student fees to be abolished. As at the present time, a further substantial proportion of higher education costs would continue to be paid out of general taxation, consistent with the fact that higher education generates many social benefits as well as private benefits.

5 How would the tax be collected?

5.1 A number of problems have been identified by the 1997 Dearing report and subsequent commentators in collecting a graduate tax, including those relating to the lack of a full register of English graduates, the alleged difficulty of defining First degrees and the difficulty collecting the tax from those who go to work abroad. We believe these are largely surmountable and where not, they exist in any case with the current loan system.

5.2 It is true that the tax could not easily be collected from graduates working abroad. However, there is a similar problem in this respect with loans, albeit that they are legally binding, because it can be hard to track down indebted graduates working abroad.

5.3 We do not believe that defining First degrees and identifying those who have them and are liable for a graduate tax present problems of a different order from those for tax collection in general. We already have clear definitions of what constitute a ‘First’ or Bachelors degree. HESA classify student enrolments according to certain criteria, which identify First degrees, and governments use the comparable definitions in the OECD ISCED classification in making international comparisons. Government funding for Further Education already differentiates between students on different levels of course. Although we only have incomplete historical data on those who have graduated from English universities (the Student Loans Company data on those who have taken out loans), identification of graduates liable for a graduate tax can rely on self declaration, as with other tax liabilities.

5.4 Student loan repayments are currently collected at source from employees’ gross earnings, and employers already take responsibility for calculating loan repayments that recent graduates are obliged to pay. The same system could be used for collecting the graduate tax were employees obliged to declare details of their degrees to their employers. Alternatively, the graduate tax could be collected through self-assessment returns to HMRC. All graduates could be required to file an annual tax return to HMRC providing details of the type of degree they held and where and when it was conferred. For those who would not normally be required to make a tax return, this could take the form of a  simple declaration of these degree details, without the requirement to complete all other sections of the tax return form, thus reducing the costs of additional processing by HMRC.

5.5 As with any new tax, concerns will arise about possible avoidance. However, the incentives for honest compliance with an all-age graduate tax by individual graduate employees - and the penalties for non-compliance - would be the same as for any other element of the tax system.

6 Dealing with the accumulated loan debt

6.1 The outstanding loan debt has been built up over a period of twenty years and will take many years to resolve. The loan debt held with the Students Loans Company for students and graduates in England currently stands at £89 bn.[3] With inflation and rising non-payment rates due to lower than expected graduate earnings, this figure for total loan debt is predicted to rise to £1 tn by the early 2040s.[4] None of the existing proposals on the financing of higher education, including ours, provide quick solutions to this problem. However, the proposal here has the advantage over the current loans system that it will at least not be adding further to the already large loan debt. New entrants to higher education would not be charged fees and would not be taking out tuition fee loans. Graduate tax would be formally substituted for debt obligations for existing graduates with loans. Those who have already paid off all or part of their tuition fees would be exempted from the all-age graduate tax in full or in part (depending on the level of fees involved).

6.2 For most of these graduates, the monthly graduate tax payments would be less onerous over a long period of time than their debt obligations. However, there would be some long-term benefits in terms of tax revenue because, in common with all other graduates, these indebted graduates would be liable to pay the all-age graduate tax throughout their working lives - in contrast to their outstanding loan repayments which are scheduled to be written off after 30 years.

7 How would universities be funded?

7.1 The replacement of the fees and loans system with an all-age graduate tax implies that the funding for undergraduate teaching in universities, except in  the case of international students, would come directly through government agencies. A large proportion of university income in England is still allocated through bureaucratic means involving HEFCE (Higher Education Funding Council for England) and the Research Councils. Under this proposal that proportion would substantially increase, close to levels that applied in the years before the introduction of student fees. As now, teaching grants to universities would need to reflect not only student enrolments but also the actual costs to universities of delivering different types of course, whether they be classroom-based or laboratory-based and so on. Governments would re-gain powers to regulate student numbers if they wished to do so.

7.2 There would be concerns in the university sector that universities would not receive the same enhanced level of resources that most have enjoyed since the 2012 fee increases.  Our response to this is that Government should maintain existing levels of resourcing to support our high quality higher education system and should give strong assurances to this effect. To ensure that additional revenue from an all-age graduate tax is used for HE purposes, we recommend that future governments be obliged to publish figures for the revenue generated from an all-age graduate tax and to demonstrate how this revenue has been used to augment the portion of higher education funding pledged from general taxation.

8 Conclusion

8.1 In summary, an all-age graduate tax would reduce the financial burdens on young graduates, enhance inter-generational equity and provide a more robust foundation for university funding into the future. It would provide a more credible and fiscally responsible way to deal with the considerable problems facing university financing than either tweaking the current inequitable loan system or returning to the old model of higher education funded entirely from general taxation.

Appendix: Responses to Additional Questions

9 What are the impacts of higher education funding on the public finances?
- What is impact of student default on the long-term sustainability of the public finances?

9.1 The loan debt held with the Students Loans Company for students and graduates in England currently stands at £89 bn.[5] With inflation and rising non-payment rates due to lower than expected graduate earnings, this figure for total loan debt is predicted to rise to £1 tn by the early 2040s.[6] The recently announced increase in the earnings threshold for repayment of graduate loans from £21 000 to £25 000, combined with the raising of the fees cap to £9 500 pa, is predicted to increase the proportion of students not paying their debt in full to 83 percent, thus requiring an increase in the long-run subsidy by government for students loans. With these changes there is an estimated increase in the net long-run government subsidy to student loans (the RAB charge) to 45 percent (for English-domiciled students taking full-time First degrees in English universities after 2017). These students are now predicted to repay £34 000 of the loans during their lifetimes, with the taxpayer subsiding the loans by £17 700 for each student.[7]

9.2 The ‘visible’ effects of these loan debts on public finances are positive. The interest paid on loans counts as income in the public accounts, whereas government contributions towards the costs of loans are not counted as spending. The unpaid debt will not appear in the accounts until the debts are written off. However, within the departmental accounts there is an ‘impairment charge’ as ring-fenced spending, which represents the annual contribution towards the expected long-run subsidy  which the government will have to make towards the loans. This represents public funds within the DFE which cannot be spent on other areas of education.

9.3 While the student fees and loans system serves to reduce the annual public sector deficit in the short-term, in the long-term, as loans are written off, it will have a large negative impact on the national debt. 

10 What is the economic rationale for post-2012 student loan interest rates?

10.1 Lord Willetts argues that the increase in the top interest rate to 6.1 percent was designed to ensure that high earning graduates re-paid more,[8] thus subsidising middle and lower earning graduates who would not pay the accrued interest since their loans would be written off before interest was due. However, highly paid graduates are able to pay off their loans early, before much interest has accrued, which means that there is no guarantee that this measure will work in a progressive fashion. Government finances will benefit in the short-term from the higher interest rates and the early repayment of loans, but there will not necessarily be any benefit to the majority of graduates with loans.

11 What is the rationale behind the repayment threshold?

11.1 The repayment threshold is very important to graduates with loans because it determines when they will start paying off their loans and the annual repayments they will have to make. The freezing of the threshold at £21 000 represented a real-terms reduction in the earnings level at which graduates would have to start repaying their loans and an increase in their annual payments. For instance, in 2017 those with a gross annual income of £35 000 would be expected to pay back £1260 pa (9% x (£35 000 – £21 000). The recently announced raising of the repayment threshold to £25 000 will reduce these payments by £360 pa to £900 pa.

11.2 The increase in the repayment threshold is clearly beneficial to recent graduates. However, at a time when graduate earnings are declining in real terms and when the costs for young people of buying or renting homes are at an historic high, for many these annual repayments are still onerous. At the same time, the cost to the taxpayer of raising the threshold will be high. For an English-domiciled undergraduates starting full-time higher education in 2017 the long-run government subsidy (the RAB charge) is predicted to increase to £7.9 bn per cohort (or by £2.63 m per year of study), according to the IFS.[9] Another estimate which includes both English- and EU-domiciled students studying full- or part-time in English universities predicts the change will mean an additional £2.85 bn cost to government at current prices, raising the overall annual cost of subsidies for these students at university to £8.491 bn.

12 Did altering the repayment threshold for post-2012 loans being taken out undermine the perceived fairness or confidence in the system?

12.1 It seems likely that the freezing of the repayment threshold at £21 000, which meant higher repayment costs to graduates, was perceived as unfair by many students and young graduates. One of the problems of the current system is its extreme complexity and relative opaqueness. It is very hard for young people aged 17, or indeed their parents, to work out exactly how much studying at university will cost in the long run. The fact that interest rates impact differently on graduates at different levels of earnings, with high earners repaying interest, and middle and low earners not paying, makes it extremely difficult to compare the costs of student loans with other form of ‘commercial’ borrowing where interest rates are fixed and interest is repayable in every case.  The fact that governments can alter the threshold for repayments adds to insecurity felt by those taking on student debt.

13 What impact has the 2012 student loan reforms had on the finances of the higher education sector?

13.1 The reforms to fees and loans since 2012 have been highly beneficial to many (if not all) universities. IFS estimates that they have increased university resources on average by 25 percent. However, this has come at a cost in terms of public perceptions of the fairness of the fees and loans system. At £9 250 pa, the fees charged to home students are amongst the highest in the world. Students are aware that this fee considerably exceeds the actual cost to universities of delivering undergraduate provision for most classroom-based subjects. They may welcome the fact that the additional resources available to their universities may enhance the quality of research and teaching in those institutions and thus increase the value of their degree. But many are also aware that their fees are cross-subsidising courses in other subjects, including STEM and laboratory-based subjects, whose degrees may have higher wage returns on average on the labour market than their own degrees. So it is fair to say that there is considerable public disquiet about the level of fees charged in English universities. 

13.2 The current system of loans and fees has a number of disadvantages. Firstly, it is overly complicated and opaque, which means that it is hard for the general public to assess what effect it is having on public finances and taxpayer costs, and hard for prospective students to judge the relative costs and benefits of taking out loans. This, combined with the frequent changes made to the system, diminishes public trust in this form of higher education finance. Secondly, as a hybrid system of government-subsidised, income-contingent loans, it is neither a graduate tax, nor a pure loan system. While the system does enhance the independence of universities, it has not generated a genuine market in higher education since price competition is incompatible with government-subsidised loans. Nor is it a proper graduate tax where costs to graduates would be transparent and government would remain responsible for student numbers and fee levels. Thirdly, the system is expensive both for recent and future graduates and for taxpayers. Fourthly, and perhaps most important, the system is grossly inequitable in inter-generational terms. Current students and young graduates are paying high costs for the privilege of a higher education that previous generations (including most graduates over age 37) had for free. This fact has been mostly ignored by policy-makers and commentators, but it is very much in the minds of young people.

December 2017

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