discount rates

I have penned a short opinion piece in response to yesterday’s THE Willetts-fest. That should appear in next week’s issue and is mainly concerned with something i’ve been warning about for a while – the future-policy contingency of students loans. At last, Willetts has admitted that changing terms for existing borrowers may be crucial to the sustainability of the curent iteration of the fee-loan regime.

I agree with Martin Lewis on fundamental opposition to varying terms for existing borrowers. You might also want to note Greg Clark’s response to my question on this point in April: ‘The strength of our system is that it is robustly sustainable – as the OECD has confirmed – without any changes in terms being needed.’

Here, I’ll just quickly deal with a technical point about discount rates (quick explainer here). The government chooses to discount expected future loan repayments by RPI plus 2.2%. Over the last few years, several commentators have argued that the Treasury is ‘overcharging’ BIS because the government’s cost of borrowing is much lower. Willetts takes up there cause in his concluding paragraphs:

 Finally, the government should shift to a more sensible discount rate for RAB charge calculations linked to the actual cost of borrowing as shown in index-linked gilts.

… The Institute for Fiscal Studies estimates that the freezing of the repayment threshold together with correcting the discount rate would reduce the RAB charge to about 15 per cent. Together with the structure of future quinquennial reviews, these measures would put an end to a sterile and confused debate about the RAB charge by showing that England’s model of higher education funding is flexible and sustainable.

I will make three quick points. For those interested, I discuss discount rates in more detail in my recent pamphlet for HEPI.

People tend to simply read the RAB charge as an estimate of ‘losses’ to government. If it were, then the IFS/Willetts point would be correct. But the RAB is really about budgeting and the discount rate is a long-term budgeting parameter rather than something specific to student loan estimates. Crucially, if the discount rate were lowered, then BIS would accordingly receive less resource to cover RAB.  That is, the headline figures might be lower, but BIS would, all else being equal, still face a budget shortfall and the problem of improving loan repayments.

The second is probably more important, but also more technical. We may well see a new long-term discount rate in the Autumn spending review, but maybe not one tied to index-linked gilts. In recent months, the Treasury has put forward several proposals to switch its discounting away from a proxy for ‘cost of borrowing’ to measures that track projected GDP growth. Those interested can browse the various papers put before the Financial Reporting Advisory Board. I have struggled to find authoritative commentary on this matter – largely because it’s even more arcane than RAB. But for loans if GDP growth is projected to return to trend and something like that is used for student loans, then we may see little difference in the discount rate figure. (I would welcome comment from anyone who knows about government discounting).

Finally, were the relevant discount rate to be revised down then it would present difficulties for government seeking to present a student loan sale as value for money. Although the ‘value for money’ test uses a separate rate based on ‘social time preference’, losses would be valued according to financial reporting and budgeting rate. A lower discount rate now would make a sale programme look pretty bad. (Again, I have treated this in more detail in a recent article for London Review of Books).