As noted yesterday, graduate taxes and income-contingent loans have many similar features. They both defer payments until after graduation, and they are usually payable as a percentage of marginal income above a given threshold. In England right now, the payment scheme on ICR loans is that students pay 9% of whatever income they earn over £21,000 (roughly C$38,000). The difference between the two is that with a loan you have a set amount to pay, and when it’s paid you’re finished. With a graduate tax there is no principal, so you just keeping paying that fraction of your income for as long as the tax lasts.
That sounds like a simple and clear delineation, right? Well, here’s a twist: what if the loan were so big that you had no practical chance of ever paying it off at the set repayment rate? What would the difference between an ICR and a grad tax be then? The answer is: practically nothing – and that’s exactly where England finds itself right now.
Let’s step back a bit: in 2010, the UK government decided to let institutions charge tuition up to £9000. They also decided to allow students to borrow this amount for tuition (plus more, again, for living expenses) under the repayment scheme described above. When they did this, they were under the misapprehension that universities might actually try to compete for students on price, and hence assumed an average tuition of about £7000. Rather predictably, average tuition shot straight to £8500. As a result, it’s quite common for students to be borrowing £12-13,000 per year, or £36-39,000 for a degree (that’s C$66-72,000 – yes, really).
Crazy, right? Cue all the “intolerable debt burden” stuff. But wait: these loans aren’t like the ones we’re used to. Repayment is based on your income rather than size of debt – no graduate is ever required to pay more than 9% of their income over £21,000 in any given year, so the burden in any given year is pretty limited. And – here’s the kicker – the loan gets forgiven after 30 years. So, if you don’t finish paying, your obligation disappears without you having any debt overhang. Exactly like a Graduate Tax.
How many won’t pay it off? Well, these things are difficult to predict, but even over 30 years, paying 9% of your income over $38,000 isn’t likely to completely pay off very many of these loans. The government’s own financial forecasts are that 35-40% of the total net present value of the loans will have to be forgiven (others put it 8-10% higher). At a rough estimate, that probably means 70 to 80% of all borrowers will see some loan forgiveness.
At this point you start to wonder if debt numbers really matter in this system. Forget ICR: for most people, the current system is simply one in which government transfers billions of pounds in 2014 to institutions using student loans as a kind of voucher system, then turns a portion of those loans into student grants in 2044 via loan forgiveness. In the meantime, graduates pay a 9% surtax on income over £21,000.
Altogether, a very wacky system. Not a model for anyone, really.