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Does the Adam Smith Institute understand how student loans work?

Student loans will be interest free for many 2012 starters

Does the Adam Smith Institute understand how student loans work?

I was shocked and befuddled to read a confused argument in a blog by the Adam Smith Institute (ASI), supposedly the bastion of free market economics. It effectively suggested all students under the new 2012 system should be encouraged to repay their debts early. BALDERDASH!

That’s financial suicide for many. Like it or loathe it, the premise of the student loan repayment system is you contribute in accordance with earnings. Those who gain more from their education end up repaying more, and more quickly (though admittedly for very high earners the curve is perverted, see www.studentfinancecalc.com)

The Adam Smith article comments on the back of a Times Higher piece, which says:

quotes Tim Leunig of CentreForum and a lecturer at the London School of Economics as saying graduates should think twice about paying off their debts early because most will never repay the full amount within 30 years, after which time arrears are written off".

Well Tim is 100% right – and he knew I’d say that (and probably blog on it) which is probably why he tweeted this, so I’d see:

The Adam Smith Institute thinks I am "morally bankrupt" (!) Still, @MartinSLewis agrees with me: www.moneysavingexpert.com/students/student-loans-repay"

Why overpaying student loans can be dangerous

Even current graduates should think carefully before repaying student loans any quicker than needed. Because the interest rates are so low (1.5% for most), they could earn more by saving it (see Should I repay my student loan?).

Under the new system, while the interest is higher for some, many won’t repay in full within the 30 years before it wipes. So for them to overpay often doesn’t make sense, as paying more doesn’t usually reduce their future repayments (though overpaying does work for some in this situation depending on the interrelation of interest and when they overpay, but let’s leave that for another day).

Let me use a simple example

Student loans are repaid after graduation at a rate of 9% of everything you earn above £21,000 (this threshold will rise). So if you never earn above the threshold, you never repay a penny. Therefore overpaying here is clearly throwing money away.

Now an example of someone earning more

Even a graduate on a starting salary (£22,000) which rises at 3% above inflation for 30 years, who has taken the full £9,000 tuition fee and away from home (non-London) maintenance loan of £5,500 would have accrued a total borrowing of around £43,500.

According to www.studentfinancecalc.com, their repayment over the 30 years before the debt is written off (at today’s prices) would be £27,410 – far less than their original borrowing. So even then, most overpayments wouldn’t reduce the amount paid back. For more on how this works see Student Loans 2012 Mythbusting.

With that said, you can see why I was surprised about the Institute’s view. It goes on to attack Tim’s view saying:

What he really means is that failing to repay is a good kick in the ass to every hardworking taxpayer now stumping up the cash".

Ridiculous. As I’m sure Adam Smith himself would’ve understood, the loan repayment system is more of a hybrid between a loan and a tax. It’s proportionate to earnings, doesn’t go on your credit file and if you lose income you don’t need to repay, as it’s paid through the payroll.

In Australia they call it a ‘contribution system’, not a tax. So let’s be plain, this is a predefined contribution the graduate must make. Yet the ASI is arguing people should volunteer to pay more, even when it won’t save them anything.

The Adam Smith Institute’s point is about Government outlay

Of course, its argument is that if people paid more, it’d help the Government out, especially as under the new system fewer people will repay in full than before.

Yet again I think this is a weak point…

  • It’s about a fair share. When you go to university, hopefully you gain and the economy gains too. It’s a partnership. The current system assumes all bear some brunt of the cost (under the new system the student’s brunt is heavily increased). This is what a contribution system is all about – it’s about paying what politicians have decided (rightly or wrongly) is an adequate percentage.
  • The new system costs the Government less. The idea that because fewer people will fully repay, the Government must pay more is fallacious. Under the new system, almost the entire funding now needs repaying by the student. Under the old system, of big block grants, it was less than half. Not only that, but many graduates must now pay real interest rates too.

    So while a lower percentage of what’s ‘owed’ is repaid, a much bigger total amount is. (For a full explanation see my If few will fully repay student loans, how’s the system sustainable? blog)

I say the Government should TELL people not to overpay

In fact, I think the system is duty-bound to warn people when they overpay their student loan if they won’t gain from it. Even now, many get it wrong. Under the current system the average salary of people who overpay is just £18,400. While this is likely to be pushed up under the new system, it still means many who pay early will already be financially penalising themselves.

This is why in the MSE Submission against early redemption penalties, we jointly proposed this with the NUS:

Whether repayment penalties are introduced or not, it is important students understand the impact of their repayments – as for many it will be a futile gesture.
The Student Loans Company, on receipt of an application to repay early, should be mandated to produce a quote on the impact to the student. Based on their current salary it should be signed and returned before the money is credited to the account."

So with all that said, I don’t think my view could be further away from the ASI. Wonder what they’d make of my Don’t pay tuition fees upfront guide? It says even some who have got the cash to pay upfront should avoid it.


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