Accounting for loans – the plot thickens!

After an unexpectedly busy term teaching maths, philosophy, coding and chess (including stints in primary and secondary schools as well as a young offenders institute), I am returning to student loans before next Tuesday’s big wonkhe event on HE financing and value for money.

There have been some significant behind-the-scenes developments in the last month or so to do with both the government HE review and the separate ONS review into accounting for student loans. As this blog has long argued, accounting for loans matters insofar as costs are obscured and alternative policies regarding financing study are sidelined because of presentational disadvantages.

The government recognises that it subsidises the student loan scheme – with full-time undergraduate study costing an estimated 45% of loan outlay in net present value terms. The government lent £15billion last year and expects to get the equivalent of £8.25billion back (discounting is done using the financial reporting rate of RPI plus 0.7%). But the national accounting convention it uses means that it can recognise interest accruing as income (even though it might not be paid) and only recognises losses when it writes off loans (in c.35 years’ time for the majority of loans).

This practice flatters the deficit for years (interest as income is a benefit!) until write-offs occur and reveal the net position.

I want to stress that this is a presentational matter – a ‘fiscal illusion’ according to the Office for Budgetary responsibility. But, when the government presents its macroeconomic competence to the public through a mandate that targets “eliminating the deficit”, such presentational issues are very important politically.

Unlike company accounts (under IFRS), the government does not have to record its expected loss when it makes a loan; it does so when the loan account is closed.

It’s easy to get confused here and mistake when the cost is recognised with when a bill falls due. The government lent the money today and repayments come back over the next three decades and more; the government has not asked someone else to lend the money with the promise that a future government will cover the losses in 35 years’ time.

This mistake is frequently made and can be see in the recent House of Lords Economic Affairs Committee report on tertiary education.

Paragraph 379 reads:

Future governments will have to adjust spending plans to recognise historic student loan losses: in today’s money, that would mean the 2047/48 government having to find an extra £8.4 billion to cover expected losses on the 2017/18 student loans. Alternatively, a future government may attempt to abandon the use of public sector net borrowing as a measure of the strength of the economy. It is unacceptable to expect future taxpayers to bear the brunt for funding today’s students.

No future government will have to find any cash to cover expected losses. Loans are one of those cases where the deficit does not drive cash requirement. As I’ve said the cash flows will already have occurred and all that happens in 2047/48 is that the loss is formally recognised.  (It’s another matter if repayments are lower than expected, but the normal horizon for worrying about that is much shorter. )

Here’s how Eurostat explain it:

The write off has no impact on government debt or government financial requirement (cash outflow has already been recorded when the loan has been disbursed).

The cash flows have already happened – what’s at issue is when and how the associated loss is recorded. (If you have some familiarity with company accounts, we are discussing the equivalent of reconciling the cash statement with the income/expenditure statement.)

The Economic Affairs Committee, like the Treasury Committee, earlier in the year has called for the Office for National Statistics to review the national accounting treatment of student loans.

Intriguingly, the ONS rebuffed both committees in January when it insisted that:

ONS is firmly of the view that the economic nature of student loans closely matches the definition of a loan in National Accounts and should be recorded as such in both the National Accounts and the UK fiscal aggregates.

It suggested that the only alternative was the equally bad option of treating loans like a graduate tax.

On 2 February, Eurostat wrote to the Economic Affairs Committee expressing a difference of opinion with ONS suggesting that there was another third alternative that ONS should be utilising where there are significant losses expected against issued loans. The Committee does not seem to have realised the importance of that written submission. I will turn to that third alternative in a subsequent follow-up post this weekend. At the very least, Eurostat seems to have prompted a volte face from ONS, which announced a review into loan accounting at the end of April.