FUNDING HIGHER EDUCATION

FUNDING HIGHER EDUCATION Emla Fitzsimons Institute for Fiscal StudiesMarch 2007

OUTLINE • Funding Higher Education (HE) • Higher Education Act, 2004 • Public-Private Contributions • Reasons for State Intervention – Efficiency • Impacts of reforms on • Students • Graduates

FUNDING HE University funding per student

HIGHER EDUCATION (HE) ACT 2004 Universities facing funding crisis  HE ACT 2004 Pre-reform (2003/04) and new (2006/07) systems compared Note, repayment of loans: - 9% of income above £13,925 p.a. (income-contingent) - zero real interest rate (subsidy) - debt write-off after 25 years (subsidy)

FUNDING HE Introduction of top-up fees in HE ACT a means of increasing university funding - Universities gain (£1.2 billion) - Allows up to 30% increase in spending per head - Leave scope for bigger fee increases later

FUNDING HE But raising money alone is not good argument for fees – there are other options Examples of this observed in run-up to election May 2005:  scrap fees and raise funding for universities through • scrapping maintenance loan subsidies (Conservatives) • higher rate tax rise (Lib Democrats)  Different policies shift balance of funding b/w public and private contributions for tuition in different ways

FUNDING HE CONTD. Compare for example Labour and Conservative proposals: Taxpayer cost rises (relative to 2003/04 system) under both, but the way in which this occurs is different: Lab: increased loan subsidies (benefitting low earning graduates the most) Tories: increased direct payments to universities (scrapping subsidies, which harms low earning graduates the most)

FUNDING HE CONTD. Graduate contribution rises under both • Lab: higher fees (~£800 million) • Cons: reduced loan subsidies (~£1.6 billion)

FUNDING HE: PUBLIC-PRIVATE CONTRIBUTIONS FOR TUITION Now compare “pre-reform” and new (Labour) systems Pre-reform system: Average total public and private contribution to tuition costs amounts to ~£6,000 p.a. Once fee exemptions are taken into a/c, only around £600, or ~10% is derived from the up-front fee  contributions skewed heavily towards the taxpayer 2006-07 system: Average total public and private contribution to tuition costs ~£7,600 p.a. if all universities charge full fee (increase of ~30% on average in real terms per head) Private fee contribution w/o subsidies ~38% of the total; But once fee loan subsidies taken into a/c, net private contribution ~22% substantial proportion of private fee revenue will still come from the public purse in the form of loan subsidies

FUNDING HE: PUBLIC-PRIVATE CONTRIBUTIONS FOR TUITION Balance b/w public and private costs of tuition

STATE INTERVENTION IN HIGHER EDUCATION Why might the market alone lead to inefficient outcomes? I. Liquidity Constraints II. Information Problems III. Uncertainty and Risk Aversion IV. Externalities

I. LIQUIDITY CONSTRAINTS HE requires cash upfront, for fees and living expenses  with perfect capital markets, borrow and repay out of graduate income But capital markets are not perfect, due to information asymmetry, risk and uncertainty… Student inabilityto borrow (lenders reluctance to lend) due to • Lack of collateral (human capital?) • Asymmetric information - borrower has more information than lender • expose lender to adverse selection • risk premium inefficiently high • inefficiently small amount of borrowing Student reluctanceto borrow due to • Imperfect information re nature of HE • High (perceived) risk of failing the degree • Uncertainty: average private return to a degree is positive but high variance; no option to sell qualification to make repayments

II. INFORMATION PROBLEMS • To make rational decisions, individuals must be perfectly informed about • Nature of product – quality of educ [Good Universities Guide?] • Prices – tuition fees, living expenses, opportunity cost of labour etc. [provide facts and information via internet, leaflets etc.] • Future • Likely that imperfect information leads to under-consumption, esp by lowest socio-economic group • Stronger argument for centrally planned package at primary and secondary levels – capacity of younger children to make choices is limited, the case for uniformity of educational experience stronger

III. UNCERTAINTY AND RISK AVERSION Comparing expected and not actual incomes - More certain income streams may be preferable to less certain income streams, even if E(Present Value) of latter is higher (closely related to risk aversion) Market for insurance fails due to • Adverse selection • Moral hazard

IV. EXTERNALITIES Education may create benefits to society over and above those that accrue to the individual alone i.e. return to education = private return + social return  Strength of effects difficult to measure Average private return to HE v non-HE is approx 25-27% for women, 18-21% for men Note also that financial returns to different degrees vary quite markedly Do individuals incorporate social return to education in weighing up PV of benefits and costs?

EFFICIENCY: RECAP I Moreover, market failures to do with efficiency may disproportionately affect individuals from less well-off backgrounds  All of these arguments can justify govt intervention on efficiency grounds But efficiency arguments for intervention do not justify full subsidy, esp. given large private returns to HE DO TOP-UP FEES IMPROVE EFFICIENCY? • max fee level seems justified given potentially large private returns to HE • feevariability could mean that costs and benefits for different degree courses, which vary quite widely, could be more closely aligned  might also allow some price competition within the university sector, thereby improving efficiency (but v little variability in practice below fee cap of £3,000)

EFFICIENCY: RECAP II Govt aim: wants more people to go to HE, not less • But won’t the increase in fees effectively improve efficiency by curtailing excess demand, if university degrees are currently priced below their optimal level? Govt aim not as contradictory as it seems: • New grants and bursaries designed to remove credit constraints for poorest; in addition poorest see net gain in loan subsidies; also risk is minimised due to income contingency of loans In fact, a pure cost benefit analysis would suggest that entry by poorest should increase • Note also that overall impact on demand is unclear when (if?) money is channelled back into improving quality of supply

‘PROGRESSIVITY’ OF TOP-UP FEES VIS-À-VIS OTHER ALTERNATIVES? As we saw, there are other ways apart from fees to boost university coffers, e.g. tax increases How does the profile of those who will pay for the additional university funding compare to other alternatives? Raising additional funding for universities through deferred fees is clearly more ‘progressive’ than raising the equivalent funding through general direct or indirect taxation, since most graduates end up well into the top half of the income distribution, whilst taxpayers are drawn from across the income scale See figure on next page

PATTERN OF PAYMENTS ACROSS THE INCOME SCALE TO RAISE £1.2BN FOR UNIVERSITIES (ILLUSTRATIVE ONLY) Shows an estimate of the proportion of the total income of each decile group that would be required to raise an additional £1.2 billion from direct taxation, indirect taxation, and from the GCS

IMPLICATIONS OF HE ACT FOR STUDENTS, BY PARENTAL INCOME • Amount of debt students will incur • Amount of support available through grants and bursaries • Will all of this be enough to live on?

AMOUNT OF DEBT STUDENTS WILL INCUR(a/s students borrow max amount available to them) Table 1 3 year course, non-London, non-home

AMOUNT OF SUPPORT AVAILABLE THROUGH GRANTS; SHORTFALL Table 1 contd.

Figure 1 Non-London student finances under the HE Act with fees of £3,000 p.a.

Figure 2Non-London student finances under the Old System with upfront fees of £1,200 p.a.

IMPLICATIONS OF HE ACT FOR GRADUATES • Graduates will start their careers with Government-backed debt in the region of £20,000 • These debt levels are around 1.5 times higher than under the former system for the poorest students, and around twice as high for the richest students • Effects of reforms will depend on lifetime labour market earnings and employment patterns, as debt repayments are income-contingent and debt write-off clause after 25 years

IMPLICATIONS FOR GRADUATES CONTD. So need an estimate of the paths of graduate incomes in order to assess effects of reforms on graduates But first, some general observations • All graduates will pay back less than the face value of the loan (i.e. receive a subsidy), due to 0 real interest rate • Value of the government subsidy to the graduate is decreasing in graduate lifetime income, because (1) the subsidy is more valuable the longer it takes to repay the loan, and low-earning graduates repay more slowly due to income-contingency (2) it is low-earning graduates who benefit from the debt write-off subsidy

IMPLICATIONS FOR GRADUATES CONTD. Now, some more specific observations (Dearden et al, 2006) Based on estimated lifetime income profiles of graduates – full distributional analysis • Value of the subsidy in the new system is more substantial for females than for males: amongst lowest earning females, 4/5 of the total value of debt is subsidised; equivalent figure for males is 2/5 • Comparing the old and the new systems • most grads will be required to make higher total govt debt repayments under new system, due to higher levels of govt debt upon graduation. However for the bottom 1/5 of female graduates, the more favourable loan repayment terms outweigh the increased debt & are likely to make lower repayments under the new system.

IMPLICATIONS FOR GRADUATES CONTD. Comparing the old and the new systems contd. (b) However, students would need to take out private debt under the old system to be as well off in university as under the new system. Taking into a/c the amt of private debt that would have been needed under the former system, we find that… • graduates who came from the poorest backgrounds would all pay back less under the new than under the former system • for graduates who came from richer backgrounds, it depends on where they end up in the graduate lifetime earnings distribution Majority of females pay back more under the former system, the exception being high earners Majority of males pay back more under the new system, the exception being low earners.

CONCLUSIONS Under 2003-04 system, average total public and private contribution to tuition costs of ~£6,000 per year skewed heavily towards the taxpayer, with ~10% derived from the up-front fee University coffers need replenishing! Many ways of doing this…  HE Act 2004 increases private contribution to HE: taking into a/c the loan subsidy element of the fees, the private contribution will be ~22% Do top-up fees improve efficiency in HE? There is scope for this but it really depends on the nature of fees Do they improve equity? Cannot just consider fees alone: other significant changes in system of student support put in place at the same time. Mostly for poorest students

CONCLUSIONS CONTD. Top-up fees progressive relative to raising money through direct or indirect taxation Implications of 2006-07 system for students: depends on family background. Upfront support greatest for poorest students, lowest for richest students Implications of 2006-07 system for graduates: depends largely on how they fare out in the labour market. Due to income-contingency and debt write-off, if they turn out to be low lifetime earners, they will benefit from substantial subsidy

FUNDING HIGHER EDUCATION