The Government's proposal to increase the proportion of 18-year olds staying on in higher education to 33 per cent by the end of the decade has brought the cost of this subsidy high up the political agenda. The Committee of Vice-Chancellors and Principals last week published a study evaluating four schemes under which students would bear more of the cost of their education.
Michael Portillo, Chief Secretary to the Treasury, who is searching for long-term cuts in public spending, is expected to be sympathetic if the vice- chancellors back this sort of scheme. The Department of Education spends about pounds 5bn a year on higher education, and the targeted rise in the staying-on rate from its current 28 per cent would add pounds 900m.
The current system is both inefficient and unfair because the costs of higher education are not borne by the same people that receive the benefits. Higher education can be seen as an investment by an individual in his or her future earning power. The student spends three years at college or university, during which time their income is lower than if they went straight into a job. But after college they will be able to earn more.
The graphic illustrates the financial value of higher education to a woman on median earnings, which means that half the female workforce earns more than her and half earns less. Adjusted for inflation, she would start work at 19 on around pounds 8,000 a year after tax. Her salary would rise to about pounds 14,000 by the time she was 49, before falling as she neared retirement.
If she went into higher education she would earn less for the three years she was at college, but her income would then rise rapidly. By the age of 49 she would be earning about pounds 24,000, around 70 per cent more than her non-graduate equivalent. Assume this were an investment like a building society account, in which money was 'saved' during the three years in college and then paid back with interest. The rate of return would be over 20 per cent, well above that on most investments.
Part of the reason why the rate of return is so large is that the taxpayer is subsidising it. The Government pays an average of pounds 6,000 per year per student to cover the cost of tuition. The state also pays a maintenance grant of up to pounds 2,845 and offers a subsidised top-up loan of up to pounds 940 a year.
The Central Statistical Office argues that this sort of welfare state 'benefit in kind' - which also include sudsidies for schools, health care and housing - helps the poor more than the rich. This depends on the assumption that student financial support accrues largely to the poor, because students have very little income when they receive it.
But, as we have seen, graduates earn much more than non-graduates after they leave college, so most students are only temporarily on low incomes. A recent analysis by the Institute for Fiscal Studies argued that the distributional consequences were more accurately reflected if the subsidy was assumed to be paid to the student's parents. The graphic shows the results - the benefits of state- subsidised higher education are nearly five times as large on average for the highest-earning 20 per cent of households as for the lowest-earning 20 per cent.
So why could the Government not pull out of higher education altogether and let students pay for it themselves in the knowledge that they would benefit in the long run?
First, the rest of society may also benefit from having students go through higher education. A highly educated workforce is likely to increase the rate of technical progress and innovation in an economy, boosting its long-run growth rate. But this effect may not be very large. Martin Weale, a Cambridge economist, has estimated that raising the staying-on rate from 30 to 50 per cent might increase the growth rate of an industrialised economy by only 0.08 per cent a year, with the full effect not feeding through for a generation.
Second, and more importantly, it is almost impossible for students to borrow from the private sector to cover tuition costs and living expenses. This is because banks will not accept expected future earnings as collateral. It is this problem that the schemes under consideration by the vice-chancellors attempt to tackle. They argue that graduates could be asked to pay an extra 'graduate tax' of 2 or 3 per cent on their incomes to pay for their higher education. However, this would deter people who expected to be very high earners because they would repay far more than had been spent on them.
A better solution would be for students to take out loans to cover tuition costs and living expenses on the understanding that they did not have to pay them back until their incomes had risen above a certain level. The Government would collect the loan repayments through the national insurance system. The debt could then be sold in blocks to commercial banks with the Government guaranteeing against default and paying any interest subsidy. This would reduce the public sector borrowing requirement in the same way as privatisation proceeds.
If colleges and universities were free to set their own tuition fees, this would introduce a blast of competition into higher education. Students could opt for high-priced institutions with top academics and upmarket facilities or for cheaper ones providing a more basic service. Competition would keep costs down and students would be forced to consider more carefully what benefit they expected to derive from higher education.
But would this sort of scheme deter young people from disadvantaged backgrounds - who might be more worried about debt and less sure of their earning potential - from entering higher education? Evidence from schemes in Australia suggests not.
In fact the problem of ensuring equal access to higher education in Britain has little to do with the question of grants versus loans, as evidence suggests there is little difference between the performance of working-class and middle-class children either in sixth forms or in higher education itself. The crucial decision is taken at 16, when young people can get a job, start training or stay on for A-levels. Sixteen-year olds with poor or uneducated parents are far less likely to stay on in school than children in educated, middle- class families. They face pressure to work or join a training scheme rather than take a two-year A-level course which pays them nothing in the short-run and does little to boost their earning power in the long-run except if they go on to higher education afterwards.
A government concerned about giving all young people an equal chance of a university education would give financial support to 16-18- year-olds, so they came under less pressure from their parents to go out to work. Extending loan schemes for university students - most of whom are safely en route to lucrative jobs - would be a good way to pay for it.
Gavyn Davies is on holiday.
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