Student loans and the Government’s deficit

Student loans are the main method of Government support for university students. Money is loaned to students under subsidised ‘terms’ to help towards their maintenance costs and to cover the cost of tuition fees.

Following concerns from parliamentary committees, the Office for National Statistics (ONS) is re-examining how student loans are recorded in the Government’s deficit (which is the difference between the Government’s spending and its revenues from tax receipts and other sources). The ONS will announce its decision on 17 December 2018.

The committees say that the expected losses of the loans (the subsidy) should increase the deficit when they are issued, rather than 30 years down the line when they are written-off, as is the case now. They are also concerned that the current treatment of the loans allows the Government to sell them without the losses ever being reflected in the deficit.

Here we look at how the loans work in England (where they form a greater share of support for fees and living costs and average debts are much larger), why their classification in the public finances is of concern and what the ONS is doing about it.

How do the loans work?

Subsidised loans are provided to students who repay them, along with interest, once their earnings are sufficiently high enough (currently £25,000 a year). Any loans – and their accumulated interest – still outstanding after 30 years are cancelled, or written off. The Department for Education (DfE) forecasts that only 30% of full-time undergraduates from England will earn enough to repay their loans in full. Some graduates will not earn enough to make any repayments.

The DfE estimates that currently 45% of the value of loans to full-time undergraduates will not be repaid, when future repayments are valued in present terms. Around £15 billion was loaned to students in England in 2017-18, this is expected to increase to £20 billion in 2022-23. The total size of outstanding loans in England was just over £100 billion in April 2018.

How are the loans treated in the public finances?

The ONS – which calculates the Government’s deficit – classifies student loans as financial assets for the Government, as it provides a student with cash in return for a series of future payments. The ONS’s classification of the loans is in keeping with international accounting guidance but it is the source of concerns about how the loans are recorded in the public finances.

Those arguing for a change say that treating subsidised student loans in the same way as traditional loans, despite their expected losses, means that their true implications are not reflected fully in the public finances.

How are the loans recorded in the deficit?

The deficit only records transactions when the underlying activity takes place, rather than when cash is exchanged. For example, the cost of office lighting is recorded throughout the year as the lighting is used, rather than when the bill is paid. The initial issuance of the loans are therefore not included in the deficit, as the Government is simply swapping one financial asset (cash) for another (the loan). For similar reasons, cash repayments of the loans are not included in the deficit.

The deficit does, however, record the theoretical interest accruing on the loans and the value of loans eventually written off, in 30 years.

In contrast, the full cash value of loans, less any repayments is added to the national debt each year. The OBR has said that student loans currently increase net debt by 5.5% of GDP and this will increase to more than 12% in the early 2040s.

This way of recording the loans in the deficit leads to a situation that the Office for Budget Responsibility (OBR) – the UK’s public finances watchdog – calls a ‘fiscal illusion’.

What are the illusions?

Two illusions arise from student loans being treated as financial assets in the deficit:

• The deficit doesn’t recognise the subsidy elements of the loans until they are written off, in 30 years. This means that the expected losses from the loans do not come with an upfront cost to the Government’s deficit, even though the Government issues them fully expecting losses.
• The deficit is flattered in the 30 years leading up to the loans being written off by the payable interest theoretically accruing on them. This is despite the fact that little of the interest will actually be repaid. Any unpaid interest will be eventually written off, but significant time will pass between when the interest first starts accruing and it being written off.

These illusions relate to the timing of when the loans’ expected losses affect the deficit – they don’t mean that the true impact of the loans is never recorded in the deficit, just that the true cost isn’t recorded until much later. However, a real illusion is introduced to the deficit when the Government sells the loans to the private sector.

The sale of the loans has no direct impact on the deficit, but selling them means that future losses will never affect the deficit and the deficit will have benefited from the never-to-be-paid accrued interest on the loans. Over the past year the Government has raised around £3.6 billion from two sales of student loans. The Treasury Committee said this creates: “a huge incentive for the Government to finance higher education through loans that can be sold off.”

What’s the ONS doing?

The ONS is working with international agencies and other national statistical institutes to agree a better statistical treatment for assets which have a significant expected loss, such as student loans.

At this stage we can’t say whether the ONS will be able to agree an alternative approach with international partners. If they do, it seems likely that a more appropriate treatment would result in the subsidy element of the student loans impacting on the deficit much earlier.

The OBR has considered alternatives ways of accounting for student loans and found two that improve on the current treatment while still being compatible with the ONS’s wider framework for producing the UK’s accounts. Both would result in the deficit being higher than currently forecast in the short-term, but lower in the long-term as the subsidy would no longer fully be accounted for in 30 years’ time.

The ONS will announce its decision on how the loans will treated on 17 December 2018. If an international agreement is reached, the deficit will be revised accordingly, but any change may not be reflected until the end of 2019.

Other potential implications of changes

If loans start to count against the deficit again it could affect the Government’s policy on student support, particularly the balance between loans and grants. The difference in impact on the deficit between the two types of support would be smaller. This could make it more likely that maintenance grants are reintroduced and/or other areas of direct support for universities are increased. The current Review of Post-18 Education and Funding is expected to report in early 2019.

Matt Keep is a Senior Library Clerk at the House of Commons Library, specialising in the public finances. 

Paul Bolton is a Senior Library Clerk at the House of Commons Library, specialising in higher education. 

Picture credit: CC0 Creative Commons