Last week we took a look at student loans and the Government’s deficit. Now the Office for National Statistics (ONS) has announced that it will change how these loans are recorded. The accounting change, which aims to ensure that the treatment of the loans better reflects how they work in practice, could increase the Government’s deficit by around £12 billion in 2018/19.

As we discussed last week, the ONS was reviewing the issue following concerns that the loans were being recorded in such a way that didn’t, at least in the short-term, fully reflect their expected losses.

Here we briefly look at what has been announced, when it will be introduced, what the impact could be on the Government’s deficit and how it might affect Government policy.  

Why was the ONS reviewing student loans?

Essentially the ONS was considering whether it is right that student loans are accounted for in the same way as conventional loans, despite their expected losses. The body compiles the public finances following international guidance, so it has been consulting with other international statistics bodies to work out the best way to account for student loans.

What’s been decided?

The ONS has decided that the best way to fairly account for the loans is to treat part as financial assets (loans) that will be repaid, and the part that will not be repaid as Government spending. The balance between the two will be calculated by modelling of expected repayments by graduates. The spending element will be deemed capital spending under international standards. The ONS call this the ‘partitioned loan-transfer approach’ – it has previously been referred to by the Office for Budget Responsibility (OBR) as a hybrid approach.

What’s the potential effect on public finances?

It is important to say that nothing real has changed to the loans. This is all about how the loans are accounted for and how they turn up in measures such as the Government’s deficit. That said, people will be interested in how the change affects headline measures such as the Government’s deficit.

The short-term impact on the deficit is likely to be relatively significant. The OBR previously estimated that the hybrid approach could add around £13-18 billion to the deficit over each of the next five years. The Chancellor has a target that the Government’s deficit, adjusted for the ups and downs of the economy, should be less than 2% of GDP in 2020/21. The ONS’s accounting change could potentially eliminate nearly all of the buffer the Chancellor has built up to help him meet this target.

Using the hybrid approach will see the government's deficit increase by £12 billion - £18 billion over the next six years

In the longer term, the accounting change largely adapts the profile of when the losses on the loans enter into the deficit. Under the current treatment, the losses don’t enter into the deficit until the loans are written off, in 30 years’ time. The new approach means that the losses are recognised largely when the loans are issued.

The hybrid approach counts the loan write-off as spending when issued. Under the old treatment loan write-offs didn't impact on the deficit for 30 years.

The new treatment of student loans has no impact on the Government’s debt. This is a cash measure, so is unaffected by whether the money being paid out is classified as a loan or spending.

When will the change be incorporated into the ONS’s figures?

It looks like the change will not be fully incorporated into the ONS’s figures until autumn 2019. There are still technical issues with the new method that require further work – estimating levels of future expected loans repayments will be particularly tricky.

Modelling needs to predict repayments by graduates over a period of more than 30 years after loans are first made to students. The Government’s estimates of the proportion of loans that will never be repaid have varied considerably in the past. Initial estimates at the time of the 2012 reforms were ‘around 30%’, these were revised upwards in steps to ‘around 45%’ without any changes in policy. Subsequent changes to loan repayment terms, accounting rules, modelling and cuts in grants have caused estimates to fall to as low as 20-25% before increasing again to around 45% in the latest forecasts. The briefing paper Higher education funding in England gives more detail.

The ONS is aiming to publish guidance, along with some provisional estimates, in June 2019. It has pencilled in September 2019 as a possible date for full implementation of the new approach, which will also have to be reflected in the historical data as well.

In spring of next year, the OBR will be producing forecasts for the economy and the public finances. Previously, the OBR has incorporated upcoming accounting changes into its forecasts even if the change hasn’t been fully implemented by the ONS. There is, therefore, a chance that the OBR may reflect the change to the treatment of student loans in its spring 2019 forecast.

How might Government policy change?

The current Review of Post-18 Education and Funding is expected to report in early 2019. The publication date has been put back so its conclusions could be informed by the outcome of the ONS review. Rather than policy made by accounting rules alone, it is possible that the ONS’s conclusions could influence the balance of reforms proposed by the review and in turn the Government’s response to these proposals.

With a fraction of loans counting immediately as Government spending, it makes delivering support through maintenance grants relatively less expensive than before. The same applies to cuts in fee levels (alongside smaller fee loans and more direct funding for universities). The difference in spending on maintenance grants and maintenance loans is likely to be particularly small. Means-tested grants could partially replace loans that have a very low likelihood of repayment. Here the marginal proportion of loans treated of spending will be much higher than the average rate; currently 45%.

The accounting changes also mean that reforms to the terms of loan repayments would have an immediate impact on spending. In general, policy changes where terms are made ‘softer’ (such as the 2017 increase in the repayment threshold) now count as spending when they are made and are hence relatively more expensive for the Government. Changes that make loan terms less soft would result in immediate savings/spending cuts. The exception is interest rates. Currently the theoretical interest accruing on loans counts as a receipt. With this not happening in the future it makes cuts in the interest rates on loans relatively less expensive.

Matt Keep and Paul Bolton are Senior Library Clerks at the House of Commons Library. Matt specialises in the public finances and Paul specialises in higher education.

Picture credit: CC0 Creative Commons

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