Philip Booth: How to raise fees the painless way

The case for requiring undergraduate students to contribute to the cost of their tuition is now widely accepted. Lifetime earnings premiums of between £100,000 and £200,000 from undergraduate study are typical and, whatever the merits of government support for specific groups of students, it is difficult to make a case that all students should have all their fees financed by the taxpayer.

Unfortunately the Government's mechanism for charging students has hit the buffers. Fees are now capped at £3,225 and the Treasury is frightened of the cap being raised. There are sound educational arguments for raising it. The fee cap leads to overseas students paying much more than home students, and this distorts university recruitment policies.

The cap leads to direct government subsidy of university places and this, in turn, leads the Government to restrict the number of places on particular courses, preventing successful courses from expanding and others from contracting. There is also an equity argument in favour of raising the cap – why should poor taxpayers pay for the education of those with much better prospects?

But the Treasury fears that, if the cap is raised, there will be an explosion of spending on higher education. The Government has to pay the fee up-front and only recoups it from students via a loan repayment over many decades. Thus, raising the fee paradoxically raises current government spending. It is not just this government that is trapped by this dilemma – understandably, given the state of the public finances, the Conservative Party has no appetite for raising student fees either.

Neil Shephard, a professor of economics at Oxford University, may have found a way to overcome Treasury opposition. In a proposal he made at a British Academy forum, and which will be refined in a paper for the Institute of Economic Affairs, he argues that universities themselves should be able to charge an additional fee that is paid back through the current student loans system. This would not count as government borrowing because the university would take the risk of default.

There are several benefits that could flow from this. Currently, all universities charge the same fee for all courses because it is capped at such a low level. Someone with a degree from a former polytechnic learning in huge classes pays the same as a Cambridge undergraduate with, more or less, personal tutorials.

If universities could charge their own additional fees there would be competition between courses and universities. Yes, mass tuition in a course of doubtful academic rigour may not lead to such high potential earnings as a course in economics at the LSE – but the fee would be less too.

As such, the Government would have to set the maximum additional fee at such a level that some universities will want to come in below the maximum – perhaps at about £3,000. Over time, the maximum additional fee could be raised and, indeed, uncapped. After all, there is no cap on fees for Masters degrees – competition determines the fees in a very effective market serving a variety of needs.

The mechanism for repaying the additional fee is important. Shephard argues that it should be subordinate to the current fee so that students do not start to repay it until they have paid off the government-set fee. Graduates would also repay the fee only if they earned £15,000 per annum or more.

It would be a long time before universities received significant income from this new funding stream but they could borrow against it, and Shephard also suggests that parents or students could be allowed to pay the fee up-front if they chose to.

Either way, the universities would receive a long-term, ring-fenced revenue stream from the repayment of deferred fees. This income would more realistically reflect the cost of higher education. Incentives would also be aligned in ways that were beneficial to both universities and students: if universities had a poor reputation for teaching, students would go elsewhere – possibly taking courses with lower fees.

Even more pertinently, if a university did not have a good reputation for academic standards, the long-term job prospects of its students would be poorer and the university would be less likely to receive the income-contingent, deferred fee.

Overall, this mechanism seems like a sound, pragmatic way forward: competition should be effective; standards should rise; universities will be more independent of government funding and the poor will still be subsidised. Not only that, Sir Humphrey in the Treasury will be happy – whoever wins the election.

Professor Philip Booth is the editorial and programme director at the Institute of Economic Affairs