IFS - Student loans reform is a leap into the unknown

11 Apr 2022 02:03 PM

New analysis by the Institute for Fiscal Studies of the package of reforms to student loans announced this year shows how we are moving away from a system which redistributes heavily from high to low earning graduates.

Under the new system, most will just pay back what they borrowed – neither more nor less. This moves us away from something very much like a graduate tax to something for which the term ‘student loans system’ is much more appropriate. The reforms:

• Will affect the cohorts starting university in 2022 and 2023 quite differently. Those expecting high earnings – for example those attending high status institutions and studying subjects with high expected earnings like economics, medicine or law – could gain substantially by delaying entry until 2023. That way they would benefit from a lower interest rate on their student loans. Those with lower expected earnings might be better off entering university in 2022 rather than 2023.  They would benefit from a shorter repayment period (30 instead of 40 years) and a higher earnings threshold for repaying their loans.
• Will result in graduates from the 2023 entry cohort repaying around £750 a year more from 2027-28 (when they typically start repaying loans) if earning more than £34k. Graduates from earlier cohorts since 2012 earning more than £33k in 2026/27 (when the 2022 cohort will typically start repaying) will have to pay around £400 more than under the pre-reform system. 
• Greatly increase the uncertainty in the public finances. With a lower discount rate, an extended repayment period, and a change to the indexation of the loan repayment threshold that makes the system less responsive to economic conditions, uncertain earnings levels far into the future will greatly affect the long-term cost of the reforms.

In addition, our analysis shows how a quirk in accounting rules meant that a reduction in the interest rate charged on student loans managed to benefit both graduates and the public finances. Clearly, the reality is that a lower interest rate on student loans will cost the Exchequer money in the long run. But this accounting quirk has allowed the chancellor to record a £6 billion improvement in borrowing for the 2025/26 fiscal year as a result of student loans reform in his recent Spring Statement – roughly double what we estimate will be the true long-run cost saving of the reforms.

These new findings complement our initial analysis, which showed:

• Among graduates from the 2023 university entry cohort, those with lower-middling earnings will be hit the most by the changes with a lifetime loss of around £30,000. These borrowers enjoyed large taxpayer subsidies before the reform, but will have to pay back a much larger share of their loans under the new system.
• The highest-earning graduates from the 2023 entry cohort will repay around £20,000 less as a result of the lower interest rate. These graduates would largely have paid back their loans in full even under the pre-reform system. For them, the lower interest rate translates into lower repayments overall.
• The system will also become substantially less generous for middle-earning graduates from the 2012–22 starting cohorts. These students are substantially affected by changes in repayment thresholds, but do not benefit from lower interest rates. Compared with the pre-reform system, they stand to lose around £20,000.

Ben Waltmann, Senior Research Economist at the Institute for Fiscal Studies, said:

‘Student loans reform will reduce the cost of loans for the taxpayer and the highest earners, whereas borrowers with lower earnings will pay a lot more. How much more exactly is inevitably uncertain, but our best estimate is that lower-middling earners from the 2023 entry cohort onwards face the highest extra cost at around £30,000 over their lifetimes. The eventual impact of the reform is hugely uncertain, and will depend on economic developments and on government policy many decades into the future.  

‘Substantial uncertainty in the cost of student loans is to be expected. But the government has needlessly added uncertainty by freezing student loan repayment thresholds in nominal terms at a time when inflation is high and unpredictable. This may mean that the reform will raise more money – or less – than the government intended.’

Student loans reform is a leap into the unknown