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Write-offs: not as costly as Conservatives would have you believe

The Institute for Fiscal Studies has published a note on writing off tuition fee loan debt.

It focuses on the impact on Public Sector Net Debt and opens by making the same arguments I made back in July, though the IFS does not name Jo Johnson as the source of the erroneous claims about debt write-offs.

IFS instead estimate £20billion in today’s terms would be added to PSND by 2050 if all post-2012 tuition fee loans were abolished today: there is little to no immediate impact and debt increases only because repayments that were projected to arrive over the next three decades have been lost.

IFS also model a partial write-off designed to equalise the tuition fee loans taken out by pre-2012 and post-2012 borrowers. This they estimate would cost around £10bn.

Both estimates assume that the write-off is done now. The difficulty with this policy is that as loan outlay touches £15bn this year (and repayments remain low) the stock of outstanding loan balances grows rapidly. Were a political party to contest the next scheduled general election in 2022 with a full tuition fee loan write-off, IFS believe the long-run cost would climb to £60bn.

IFS downplay the immediate impact on the deficit of writing down outstanding loans, because this impact has no cash implications. It is largely a paper exercise which records the loss on loans; the cash impacts (loan outlay and repayments) have already happened, it’s just that they had no impact on the deficit at the time.

Even though there would be a one-off hit to the deficit today of £34billion, the real consequence is the lost future repayments, these push debt up by £20bn but only much, much later.

As has been explained here before, the way loans score as income and expenditure is bizarre (the deficit is a measure of how much expenditure exceeds income) with only interest accruing counting as income (even though that’s not repayments) and loan write-offs counting as expenditure.

The bottom line is that loan write-offs are a feasible policy option and the IFS appears to have gone out of its way to remind politicians of this.

You might read this summary as an endorsement of Neil Collins’ article in the FT about student loans and quantitative easing. But that piece is seriously confused, typifying a common failure to think through the connection between student loan interest and the much-quoted line that three-quarters of borrowers will not clear their loan accounts before balances are written off (30 years after repayments first fall due on “English” post-2012 loans).

One day, [graduates] suspect, [the loan scheme] will collapse and their debt will be written off. Even under the current rules, an analysis from the Institute for Fiscal Studies concluded that three-quarters of graduates will never pay off their loans. Meanwhile, the government is so unpopular with freshly enfranchised youth that Philip Hammond has signalled changes to the scheme and there’s another Budget coming up.

Writing off the entire £100bn would destroy the fantasy that the chancellor can ever balance the books. More likely is some variant on “extend and pretend” where the student’s liability continues to grow but the date when it’s actually due recedes into the distant future. It would amount to a sort of quantitative easing for students, rather as PPI mis-selling became QE for poorer borrowers, and the real thing helped the rich. Taking what looks like expensive money may not be so silly after all.

That three-quarters of borrowers do not clear their accounts indicates that you need to understand more than compound interest to understand income contingent repayment loans.

Firstly, you need to appreciate that the interest accruing may not be repaid. Student loans are not ‘expensive money’, unless you become a very high earner (in which case, you can repay early without penalty). The repayment threshold, policy write-off and built in death and disability insurance offer serious protection to future low earners.

Secondly, clearing balances is not the same as repaying the equivalent of what was borrowed in the first place. ‘Never pay off’ can easily conflate these two and mislead about what the cost to government is.

Thirdly, and most importantly, the loan scheme is not self-financing. It is supported by a large (projected) public subsidy (as well as the government balance sheet that allows so many loans to be issued before repayments rise to significant levels). What ‘balancing the books’ means in this context is that the current level of projected subsidy continues to be tolerated.  We already have the precedent for the ‘active management’ of variance from those projections (the freeze on repayment thresholds).

Fourthly, don’t be misled by the quantiative easing analogy: the government funds student loans by borrowing (issuing gilts) to cover the annual shortfall between loan outlay and repayments. It isn’t printing money or creating loan accounts out of thin air (like a private bank might do).

If Collins had made his point about ‘pretend and extend’ in the context of predicted growth in graduate earnings, he might have had been on firmer ground, but not in relation to interest accruing. It’s well understood that interest will accrue without being repaid. In fact, it’s a feature not a flaw. Write-offs are planned, the issue is whether they could and should be brought forward.

(You might though wonder why such interest is counted as annual income in the national accounts, but that’s another matter and reinforces the point above about why the IFS downplays the deficit impact of loan write-offs).

 

 

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Fiscal illusions & student loan interest

I have tended to neglect the impact of student loans on measures of the “deficit”, whether Public Sector Net Borrowing, the Current Balance or whatever. In this context, the deficit measures the amount by which public sector spending (explained here by the Office for National Statistics) exceeds income (taxes and the like).

My neglect was premised on the basic point that student loan outlay (new lending) and annual repayments (from borrowers) are classed as ‘financial transactions’ and are therefore not scored as expenditure or income in this way. They are outside “the deficit”. They do though require cash to cover the annual shortfall between outlay and repayments and this makes its way through to Public Sector Net Debt. I have then tended to focus on the cash impacts and how they bear upon PSND. (Note that this nuance in accounting leads people to mistake student loans as being somehow off-balance-sheet. They are on the national balance sheet they just don’t score as you would expect in the normal headline fiscal statistics).

These accounting quirks are one of the main attractions of student loans to politicians. You can reduce the “deficit” dramatically by switching from expenditure (e.g. on tuition or maintenance grants) to loans. The whole cash outlay disappears from expenditure regardless of the amount you expect to get back from loans. It looks like you are doing more with less.

However, elements of student loans do score against income and expenditure: interest receivable scores as income each year and the face value of outstanding loan balances scores as expenditure when such write-offs occur (and loan accounts are therefore closed). For a single set of loans, the net effect of this set of transactions is to record the cash loss or surplus generated.

This might be a bit surprising but it is based on the following accounting identity:

(1) Loan Outlay + Interest Accrued = Outstanding Balance + Repayments

A little algebraic manipulation tells us that when repayments are less than outlay:

(2) Loan Outlay – Repayments = Outstanding Balance – Interest Accrued

Since Loan Outlay – Repayments is defines our loss, we can also capture it with the right-hand side of our equation (2) above.

That is, loan outlay and repayments are never recorded directly in the deficit. Loss is captured by recording Interest Accruing each year as a benefit and then charging the outstanding balance as expenditure at the end.

There are three consequences to this:

  • Interest Accruing is recorded – but this is Interest Receivable not any measure of interest repayments. It is also non-cash.
  • Timings matter. The deficit benefits from the Interest Accruing for the whole lifetime of the loans (a maximum of 30-35 years for new loans) until at the end the deficit takes the negative hit and undoes those years of benefit!
  • Write-offs are also non-cash – they are simply recording the effects of the financial transactions once they are finalised. Loans went out the door and repayments came back in previous periods. (Write-offs count as capital expenditure and do not score in the Current Balance).

You might then conclude (like I did) that it’s better not to look at deficit measures when thinking about loans and instead concentrate on the impact on cash and debt and on the departmental accounts (which are run on an accruals basis, not on cash in, cash out). Indeed the Office for Budgetary Responsibility identified this student loan interest as a ‘fiscal illlusion’ in its most recent report.

I think that neglect is a mistake. We need to consider all of these fiscal and budgetary aspects and impacts. If only, because post-2012 loans run with real rates of interest (for graduates and university leavers, 3.1% to 6.1% from September; current students will see 6.1%). These real rates exceed the cost of servicing any borrowing used to create student loans in the first place.

Here are the OBR’s projections for Interest Receivable over the next five years:

2017/18

2018/19

2019/20

2020/21

2021/22

Interest Receivable
billions)

3.0

4.5

 

5.5

 

6.2

 

7.1

That’s a substantial impact on PSNB (and the Current Balance) when you consider that the current government is aiming to eliminate the deficit.

Here is the OBR’s March 2017 projection for PSNB:

deficit projection

With that to mind, it is perhaps no surprise that the Conservatives have chosen not to review current interest rates on student loans. (Though I think there are other budgetary considerations at play).

Governments have their main fiscal statistic “flattered” for decades after the introduction of higher loans with real interest rates. We won’t see the first substantial policy write-offs until the 2040s. (Loans are also written off annually in the event of death or disability but these unfortunate events affect only a very small number of loan accounts). Unfortunately, at that point it’s not as if the illusion will be pricked – you will have one year of loan write-offs set against the interest accruing against three decades and more of loan accounts!

A more general lesson follows: it’s a mistake to talk about “the deficit” and “the debt” without some awareness the composition and interrelation of those headline statistics (let alone what they mean for the state of the economy more generally). Student loans  represent a very particular case of what Simon Wren-Lewis calls “mediamacro”, as that is characterised by a focus on reducing the deficit.

Now that student loans are so sizeable it may make sense to develop new ways of capturing the fiscal position. So long as loans are loss-making and so long-lived, it makes little sense to include interest receivable (but likely never to be received) as income.

 

Target impairments – a correction (of sorts)

What is the Treasury target impairment on student loans?

Back in 2013/14, the government changed its accounting and budgeting procedures for student loans to handle exceptional volatility that threatened to undermine the higher education budget. Part of this change involved introducing a target impairment each year. This was initially set at 36% and, in the event of its being exceeded, a new budgeting facility could be accessed to smooth the budgetary pressure resulting from changes in projected loan repayments (either owing to new modelling data or variance in key macroeconomic conditions).

At the 2013 Spending Review, Business Innovation & Skills (BIS) – then responsible for loans – was allocated £2.9bn to cover loan impairments in 2014/15 and £4.4bn for 2015/16. With loan outlay expected to reach £11.7bn in the latter, the first financial year to have three full cohorts on the new fee-loan regime, it appeared that the relevant budgetary allocations were in line with the target impairment.

Then, at the 2015 Autumn Statement, George Osborne announced a series of changes to student support along with a decision to reduce the discount rate used to value future loan repayments.

Until 2015, the discount rate for student loans was RPI plus 2.2%. This was reduced to RPI plus 0.7%. Lowering the discount rate increases the value of future cash repayments (a future £1 is now worth more than it was before). As such, the cost of issuing loans was reduced.

Since discount rate changes are treated as “classification changes”, they cannot create new spending “headroom” for the relevant department. That is, the activity being undertaken by BIS had not changed, but how those same loans were scored had. BIS’s budgets were recalculated accordingly. Although this was a slow process: I chased BIS for 8 months to get an answer as to what the new allocations would be. Eventually, the publication of the 2015/16 annual accounts revealed the expenditure allocations for depreciation (under which student loan impairments were included).

These were reduced even though estimated loan outlay was (and is) increasing from around £12billion in 2015/16 to over £16bn by 2019/20.

Depreciation Allocations: £3.4bn (2016/17), £3.8bn (2017/18), £4.2bn (2018/19) and £4.5bn (2019/20).

At the time I was told by the department that the estimated long-run figures for loan impairment would be “about 30%” and the BIS accounts published in July 2016 contained the following passage on page 88:

“The current Resource Accounting and Budgeting charge (23%) is well below the HMT target rate of 28 per cent, largely as a result of the reduction in the HMT discount rate during the year, which was the first reduction in ten years.” (p. 88)

That would indicate that the target impairment was 28 per cent in 2015/16 down from 36 per cent in the previous year. And that was entirely consistent with the budgetary allocations and what you would expect to happen following a classification change: the target impairment was lowered and the relevant allocations were too.

However, the Department for Education, responsible for student loans since last summer, have confirmed that the target impairment is 36% and have just alerted me to a correction slip that was issued some months after the 2015/16 BIS accounts were published.

Read more…

Post-16 mathematics: Fine Art Maths Centre

This post represents Fine Art Maths Centre’s response to the recent Smith Review into post-16 mathematics.

I co-founded FAMC with Rich Cochrane at Central Saint Martins in 2014. Details of our activities can be found in the preamble to our Smith Review submission. We believe initiatives to increase post-16 mathematics participation are hampered by a conservative view of mathematics and the dominance of the quantitative skills lobby in England.

What follows  is taken from the FAMC blog:

Read more…

Student loan sale – “amber rating”

The Department for Education published information on its Major Project Portfolio last month.

Five of its projects are rated from Amber to Red, where Red indicates that the project is ‘at risk’.  Amber/green means a project is still “probable”, while “amber-red” is “in doubt”.

No projects are “at risk”, but two – Apprenticeships Reform programme and 30Hrs Free Childcase – are “in doubt”.

The Sale of Income Contingent Student loans, one of this blog’s concerns, is classed as “Amber” – between “probable” and “in doubt”.

The narrative provided with the judgement explains that the sale is meant to reduce Public Sector Net Debt, but has to ‘realise value to the taxpayer’. See here for why the latter is a problem: value here means ‘would tolerate a loss’.

The amber rating is glossed as follows:

All stakeholders and governance bodies are aware of the challenging timetable, lack of contingency and urgency needed in decision making, and continue to be regularly updated. On 6 February 2017, Government announced the start of the sale process, which is expected to take several months.

It further notes that the sale was delayed by the general election and that “Ministers will consider revised timings over the summer”. This suggests that the plan is to push on with the sale, but that achieving value for money is uncertain. Ministers will report to parliament on a sale within three months of it being finalised, while the Office for National Statistics will determine at that point whether the sale has achieved its main objectives.

Since March 2010 (the last days of the Labour), government has spent £15million on attempts to sell the loans. The budget for 2016/17 has been approved at another £5.5m.

 

 

About this blog in 2017

We’ll hopefully get round to more on institutional debt on here in the next 6 months.

I’m also available for talks and analysis (of institutional strategy and finances).

Critical Education

I’m a freelance writer (who does a bit of teaching), not an academic. I run this blog on a voluntary basis with no commercial or outside support.

I aim to provide an alternative take on English HE with a focus on finances. 2017 will mainly focus on the Higher Education Research Bill and the continuing series on university borrowing and debt.

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National Debt & Existing Student Loans

The third effect would be to hammer tax payers. That’s because abolishing fees and reintroducing grants would cost taxpayers £12billion a year, which means the equivalent of an extra 2p on the basic rate of income tax. And dealing with historic and outstanding student debt would cause an increase in our national debt of roughly £100billion, or some £3,500 debt per household.

That’s Jo Johnson writing for the Huffington Post last week. Let’s ignore the deliberate mispresentation of Labour’s revenue-raising measures (though not a buffoon, our Minister shares his brother’s “opportunism”) and concentrate on the claim about debt.

That claim certainly shouldn’t be read in the way Johnson wants you to read it.

  1. At end of March 2017, outstanding loan balances on the DfE’s books stood at £89billion. These are the “English” loans for which UK government is responsible. The more familiar £100bn figure relates to the whole of the UK (HE and student loans debts are devolved matters – the other £11bn or so is the responsibility of the administrations in Cardiff, Edinburgh and Belfast).
  2. DfE accounts state that the outstanding loans are worth £61.5bn: that’s the estimated value of the future cashflows associated with the existing loans (the ‘fair’ or ‘carrying’ value).
  3. Let’s say we write them all off. What have we lost? Those future cashflows.
  4. The immediate impact on Public Sector Net Debt is … zero. PSND excludes student loans as illiquid assets. They are on the national accounts but don’t count in the headline statistic. If we abolish them, we don’t have them anymore and they still don’t count in PSND.
  5. But what about Public Sector Net Borrowing (PSNB)? When you write-off student loans the government’s loss scores as capital expenditure and increases the main measure of the deficit, no?
  6. That’s right, but PSNB does not drive debt. The Public Sector Net Cash Requirement does. And when PNSB is translated into PNSCR certain elements are removed, including student loan write-offs.
  7. Why? Student loan write-offs have no immediate cashflow consequences. (If you have some familiarity with accounting think about translating profit and loss or income and expenditure into cashflow: things like depreciation are removed.) Student loans are only recognised in borrowing measures when the loss on them is known. The cashflows have already occurred: money was loaned, and money was repaid. It’s just that the loans are now being recognised as loss-making or surplus-making. (Student issuance and repayments do not affect PSNB only write-offs and  annual interest do).
  8. So if we write off outstanding loans, there is a hit to capital expenditure and PSNB, but no immediate effect on debt.
  9. In future years, cashflows and debt are affected. As the original repayments fail to be paid, projections will have to be updated and resulting shortfalls addressed. Repayments in 2016/17 amounted to £2.4billion and were expected to be over £10bn for the course of this parliament.
    For post-2012 loans, repayments are projected to last for 30 years and so the impact on national cash and debt of an abolition will drip through over those decades.
  10. The impact on PSND, though, will not be the face value, but the fair value. In abolishing loans we would be giving up those repayments that the government records as being worth £61.5bn in net present value terms.

 

PS Don’t just take my word for it. Here’s the OBR writing last year on student loans:

Chart 3.7 shows our implied projections for future write-offs. These will affect net borrowing as they are crystallised, but will only affect net debt indirectly, due to the absence of repayments thereafter.

Paragraph 3.10 of its Fiscal Sustainability Analytical Paper: Student loans update (July 2016).