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ONS decision imminent on student loan treatment

Here are my slides from my recent talk at wonkfest.

wonkhe nov 2018 fiscal illusions & ONS review

The talk was given on the day that the Office for National Statistics announced that Monday 17 December would be the day when it announces its decision on the new treatment of student loans in the national accounts. All indications are that we will get a new system and we might therefore be able to wave goodbye to “fiscal illusions”. ONS has alerted us to the fact that it expects to take a year to implement the new convention. As I joked on the day, this shortens the odds on a 2019 General Election, since the Chancellor will get to use his current deficit figures until the new convention comes in – and then they are likely to be exploded.

The slides include some assessment by the Office for Budgetary Responsibility for the deficit impacts of different alternatives. They do not though assess “Option 2” – treating loan repayments first as repayments of principal, rather than interest. My penultimate slides offer an assessment of Option 2 using OBR figures.

Option 2 has less impact on the deficit in 2023-24 than the OBR’s other alternatives, but it still comes in at £8billion. By 2023-24, that adds nearly 50% to the deficit.

The accounting treatment doesn’t change the cost of student loans, only the presentation of that cost. But the government’s fiscal mandate targets such headline figures to the detriment of sound economic policy.

If you do find the slides helpful, please consider donating.

More detail on fiscal illusions can be found here.


PAC report on student loan sale: some conceptual errors

The Public Accounts Committee report into the sale of student loans garnered some good headlines today and contained some good quotes, but in truth it failed to get at the real issues around the securitisation and made some odd errors. People interested should go back to the National Audit Office report or my own writing (a new, “long read” article will hopefully be out shortly).

PAC’s confusion can be summed up with the one chart it provides in the report.


The line in blue shows cumulative, cash repayments representing the income stream associated with the loans sold.

Unfortunately, you can’t use simple cash figures to decide whether the sale price of £1.7bn was too high or too low. The value of cash is not stable. £1 today is not worth the same as £1 next year or £1 in 2026 or 2045.

When PAC claims that the sale price could have been recouped within eight years it is demonstrating its fundamental confusion. £1.7bn received today is not the same as £1.7bn received over the next eight years. Instead the government has to make a decision about how to “discount” future income received to translate it into today’s equivalent. This is known as a “present value” calculation. You can see that a number of factors come in to play: inflation and the reliability of repayment being the main ones.

These factors get wrapped up into a “discount rate”, giving me the means to translate a future cash payment into an equivalent value today. If I adopt a discount rate of 5%, I am saying that I think that £1 today is equivalent to £1.05 received in a years’ time, £1.10 in two, £1.16 in three, £1.28 in five etc. The calculation is analogous to calculating compound interest.

The government sold student loans at a loss – that’s not in dispute. But what PAC has confused is that the loss is determined by government’s decision to use two different discount rates: one to record the value of loans in the Department for Education’s accounts (loans are on the balance sheet!) and another to determine what price it would accept on the sale.

The financial reporting rate used by DfE is RPI plus 0.7%; the “retention value” rate used to determine a price is RPI plus … well somewhere between 2.5% and 3.5% – the exact rate is “commercially confidential”. You can see though that the difference in rates is substantial and a higher discount rate puts a lower value on future money. With a discount rate of 6% I would sell the promise of £1.05 for less than £1.

Since it doesn’t demonstrate an understanding of discounting, PAC gets confused as to how the sale could be de-risking. Once you have discounted the cashflow, you have to wait much longer to get repayments equivalent to £1.7bn today. The longer you wait, the more likely it is that actual repayments diverge from those projected in 2017.

What PAC should have concentrated one here is how the government justifies using two different rates and whether the higher rate is at all appropriate in this case. The higher rate is based on the “social time preference time rate” (STPR), which has been unchanged since 2006, despite dramatic reductions in the government’s cost of borrowing (circa 1.6% at the time of the sale last December, but closer to 2% now – that is, below RPI).

When PAC does discuss the STPR, its brevity is unhelpful.

p. 12 paragraph 17:
Government works on the assumption that if the money is not tied up in an asset it can be reinvested at return equal to or greater than the STPR … . This rate is significantly higher than market risk free interest rate of 1.6% and therefore meant that government’s retention value was lower than: what investors were likely to pay, how the Department valued the loans in its accounts, and the other valuations the Department calculated. It also demonstrates the impact of government’s stated counterfactual: to think about the return which could be made by utilising the money raised from selling student loans, rather than borrow more money. In effect, government does not consider borrowing more money at 1.6%, but pays a return of 6.5% to the private sector for £1.7 billion (see above) as government believes it can reinvest this money and get a return of at the very least 5.5%. (my emphasis)

The STPR is meant to express “the public’s” preference for cash today over the returns associated with assets and investment. It is sometimes called the “hurdle rate” as infrastructure projects have to demonstrate that the associated future benefits outweigh the costs today using this discount rate.

In this particular case, the public’s preference for having a lower Public Sector Net Debt figure is meant to justify using the higher rate. Asset sale programmes are aimed at reducing debt, despite what Jonathan Slater, permanent secretary to DfE, told the committee in September. I include a rather long passage from his evidence to illuminate PAC’s summary:

Thirdly and finally, when we are working out what Charles [Roxburgh] rightly calls the retention value—what it is worth to keep the thing—the alternative, in this context as opposed to accounting, is not borrowing more. That is not an alternative at this point because the way the Government does it is to set its overall fiscal strategy on the basis of a certain level of borrowing, as you know; it sets its targets for borrowing. If we were not to sell the student loan book, we would not have the opportunity to borrow more.
What would we be doing? We would be spending less. The whole point of selling the student loan book is to enable you to spend things without increasing debt or taxing more. That is the whole point of it.
When we consider the alternative—this is the last bit, I promise—what would it be? It would not be borrowing more, so we do not use a borrowing interest rate. The alternative would be not spending the money. What we do to calculate the retention value is to say, “Okay, if we do get the money in from the student loan sale, we could spend it on roads, schools, hospitals or whatever, and they would generate a rate of return for us. How much of a rate of return? It would be 2.5% plus RPI, because that is the amount the Treasury requires as a rate of return before it will let me spend anything on a school.” That is the calculation I am doing. If I get the money now, Government can spend it on something with at least 2.5% plus RPI, so as long as the discount I am paying is not more than that, it is value for money.
It all rests, critically, upon the fact that Government cannot increase its level of borrowing. It has set a policy framework that sets it as it is. That is why it is different from borrowing the way you do in the accounts, because that allows borrowing.

Slater is not an expert and what he is trying to explain is that the decision to sell loans is seen through this investment frame. The government though has been explicit that the aim of asset sales is to bring down debt; there is no investment programme to which the £1.7bn is being funnelled. And as the reference to schools, hospitals, roads makes clear, we shouldn’t be left with the impression that the government thinks it has an alternative financial investment which is going to deliver more cash than the loan repayments.

It is a shame that PAC didn’t try to shed some light on the STPR discount rate as it really is central to government policy. That is so high doesn’t just mean that loans are sold cheaply, but that too many infrastructure and investment projects are rejected.

HE review & lower tuition fees

PDF: Costbased outcomes for HE review Leciester May 2018

Earlier this year I gave a series of talks on the likely outcomes for HE from the government’s current review of tertiary education (which is to be informed by the independent panel chaired by Philip Augar).

Above is a pdf of the talk showing how all the evidence points to lowering tuition fees by subject as the most likely outcome given the politics and terms of reference. I do not believe any reduction of fees to £6500 or £7000 for classroom subjects will be offset by the restoration of grants in this instance. The principal motivation is to remove the incentive to cross-subsidise other subjects and activities through the surplus that people believe is there to be made on what used to be classed as “Band D” subjects.

If you do download the pdf, please consider donating. I do this HE work as a freelance writer – I am not a salaried academic.

October 2018 Budget – OBR continues its accounting commentary

Since we are awaiting the outcome of the Office for National Statistics review into student loan accounting and the government review of tertiary education, expectations for HE announcements in today’s Budget weren’t high.

In the end I only spotted two relevant to this blog:

  • the maximum level for undergraduate tuition fees will be frozen at £9,250 pa in 2019/20 (though OBR expects them to rise in line with inflation thereafter);
  • the government announced an additional year for its current plan of selling pre-2012 student loans, with the expectation that £3billion will be raised in 2022/23. This brings the planned total revenue to circa £15billion (£1.7bn was raised in last year’s sale, a second sale is expected to conclude in December). Philip Hammond decision to end the nonsense of PFI schemes hasn’t extended to this policy that also makes long-run losses for presentational gains.

Of more interest is that the Office for Budgetary Responsibility, in its accompanying Economic & Fiscal Outlook, chose to continue its commentary on the perversity of the accounting treatment of student loans and their sale.

Two new “boxes” in its regular report gave pithy summaries of the problems and the likely impact of the ONS review.

Box 4.3 included the chart below which shows how the current figure (in blue) for Public Sector Net Borrowing (“the deficit”) would be changed by two contrasting approaches: treating student loan outlay as expenditure and loan repayments as income (the graduate tax model) in yellow; or a hybrid approach (green) that treats student loans as a mixture of loan (the part repaid) and grants (the part written off). Even the second would add £10billion per year this year to PSNB.

Chart A impact of interest changes on PSNB

Note that the interest illusion on student loans (interest accruing is booked as income even though it might not be received) means that not issuing loans at all worsens PSNB over the forecast period, even though loans are subsidised.

OBR has previously indicated a preference for the “hybrid treatment”. It concludes:

The difference between the current treatment and our estimate of the hybrid treatment illustrates the extent of the fiscal illusion created by the current approach. It suggests the current treatment flatters the deficit by £12.3 billion in 2018-19 and £17.1 billion in 2023-24. In the Government’s fiscal target year of 2020-21, the difference is £14.4 billion – just less than the margin by which it is set to meet its self-imposed ‘fiscal mandate’. (my emphasis in bold)

My own view is that the ONS is unlikely to recommend the “hybrid treatment” or the “revenue / expenditure” approach.  The most likely outcome will be that the “interest illusion” will be removed in isolation. That will affect PSNB, but not by as much as the options shown above.

OBR also provides the relevant figures to calculate an impact focused solely on accrued interest (Table 4.36):

student loan interest accruing

Removing these amounts from government income still has a substantial impact on PSNB:

interest illusion removed

This would undermine Hammond’s claim today to have met his targets three years early. From his speech today:

Borrowing this year will be £11.6bn lower than forecast at the Spring Statement… just 1.2% of GDP…and is then set to fall from £31.8bn in 2019/20…

…to £26.7bn in 2020-21…

…£23.8bn in ‘21’-‘22’…

…£20.8bn in ’22-‘23’

…and £19.8bn in 2023-24, its lowest level in over 20 years…

We meet our structural borrowing target 3 years early and deliver borrowing of just 1.3% of GDP in 20-21 maintaining £15.4bn headroom against our 2% Fiscal Rules target. … Both our fiscal rules met; both of them three years early. So, Mr Deputy Speaker, Fiscal Phil says: Fiscal Rules OK.

It remains to be seen how the Fiscal Rules Rule once the ONS report in December. (Apologies for the formatting above but “Ellipses rule OK” for Punchline Phil too.)


May’s largesse costed & the end of RAB?

Last week, the Department for Education (DfE) published its financial report and annual statement for the year ending 31 March 2018.

With regard to “English” student loans, it confirmed one thing we already know: December’s securitisation of the first tranche of income contingent repayment loans meant a loss of £900m had to be booked. The loans sold were worth £2.6bn; the government received £1.7bn. DfE had received assurances that this would not affect its budgets. As we saw the week before last, the National Audit Office had some criticisms: chiefly that the aim to reduce PSND was leading to losses that the government was assessing inconsistently. 

In the absence of further announcements from government, the DfE accounts provide one nugget of new information about the sale programme, which was originally meant to raise £12bn in cash over five years. It appears that these prospects have dimmed as we are offered a new range: ” The loan sale programme aims to generate between £9.2 billion and £12 billion in proceeds by 2021-22″ (p. 8). This revision was not communicated to the Office for Budgetary Responsibility: the latest edition of their long-range Fiscal Sustainability Report, published annually, appeared in June and still based its projections on the £12bn figure.

The second piece of news is that we have an official estimate of the cost of Theresa May’s decision to raise the repayment threshold from £21,000 to £25,000 in April.

Read more…

And National Audit Office makes it 3

NAO published a value for money review into December’s securitisation of student loans on Friday.
I have written about for *HE. The article forms a pair with last week’s one for wonkhe. The new one covers discussion of NAO’s view of the sale alongside OBR and ONS takes on that specific aspect of loans in the national accounts.


OBR join the discussion on student loan review

I have written a piece for wonkhe on two reports that were published on Tuesday. One from the ONS covering some aspects of its review into student loan classification in the national accounts and a complementary working paper from Office for Budgetary Responsibility on how alternatives would impact on the headline fiscal statistics – the deficit and the debt.

The wonkhe piece is also effectively a write-up of my recent presentation at “Proceed with Caution”.

I will be covering some of the more technical issues here after the weekend. We’ve another key report to arrive on Friday!