Eurostat alternative – a possible resolution

In the previous post, I offered some analysis of Eurostat’s written submission to the Economic Affairs Committee, which seems to have pushed ONS into a review of the presentation of student loans in the national accounts.

Here I suggest a way to resolve what remains unclear in partitioning loans between a paid and an unpaid portion. All comments welcome.

First, we determine that all loan repayments are first made against principal.

Second, we recall that the government’s cost of servicing its debt, includes the cost of issuing gilts to create student loans, and is recorded separately in Public Sector Net Borrowing (PSNB) – “the deficit” -.

We then argue that loan repayments from a cohort (or any particular year) of borrowers is expected to match the outlay on the cohort in cash terms. The principal is expected to be repaid. In which case, loans can be treated as loans in the accounts.

Interest, though, is expected not to be repaid. In order to deal with the “fiscal illusion” of interest accruing counting as income, we instigate annually an equal and opposite capital transfer (expenditure) into a “write-off fund”. These two transactions net to zero for the purposes of PSNB, thus removing the illusion.

The write-off fund will be offset against actual write-offs when they occur, reducing capital expenditure, or even eliminating the impact of write-offs on PSNB.

Under these circumstances, interest as income is removed from the deficit and write-offs will accordingly be reduced. This preserves the accounting identity that means that the difference between interest and write-offs for any loan cohort equals the cash loss on loan (excluding the government’s cost of borrowing). Any surplus would be booked as “unexpected recovery” or income for government, when the accounts are closed.

Using this method, we have also preserved the symmetry between creditor and debtor: write-offs and interest accruing will match in both cases. We have instead introduced a new mechanism – the write-off fund – at the government’s end for removing the resulting fiscal distortions.

Should additional unexpected payments be made over and above principal, these would be recorded as unexpected “recoveries” and be treated as capital transfer into government, and thus recorded as income when they occur (instead of being classed as loan repayments).

I would need to look further into the treatment of “contingency funds” of this sort, particularly as in this case we are dealing explicitly with a paper exercise, with “non-cash”. Interest accruing has not been received and therefore nothing may need to be actually going into the “fund”. If cash did have to be transferred to the fund, it would probably count as a liquid asset to government and thereby have no effect on statistics like public sector net debt.

When the government revises policy and thus changes the valuation of existing loans, additional capital would have to be transferred into the fund. This would equate to spending in the year the policy changed.