Stop giving student loans to those who will never repay them

Telegraph

19-04-2025

You might imagine that student loans – now a familiar feature of young people's lives – are actually loans. It's true that the Government will write them off if not repaid after 30 or 40 years, but surely the 2010 settlement was designed to fund higher education by loans, not grants? Maybe that was the intention, but it's not what has happened...
If you started at university on or after September 2012 but before September 2023, you would have been offered a 'Plan 2' student loan. Its key characteristics are that you repay the loan at a rate of 9pc of your future annual pay over a threshold (around £25,000, but variable), and interest accrues on the balance of your debt at the Retail Price Index (RPI) + 3pc.
Borrowers don't pay interest as it accrues – they just pay 9pc of their pay over the threshold, and the interest rolls up and compounds in the loan. Any outstanding balance left on the 30th anniversary of your leaving university is written-off by the Government without any effect on the borrower's finances or credit rating.
Early on in the life of Plan 2 loans, the Government realised that a significant percentage of loans would never be paid off because the interest rate was too high to allow modestly paid graduates' repayments to cover the compounding interest. The relatively high salary threshold for starting to repay (double the tax threshold), and the reality that many modern graduates do not go into high-paying careers meant this effect was exaggerated. It's an odd system, but this is how it had been designed (by Messrs Cameron and Clegg in 2010).
Once the Government realised that a significant proportion of the loans would not be repaid, it became clear that the Government was, in effect, paying a proportion of undergraduate students' fees and maintenance from the public purse.
So, under pressure from the Office for Budget Responsibility (OBR) and the National Audit Office, the Government statisticians at the Office of National Statistics (ONS) recommended that only a proportion of student loans be categorised as 'loans', and treated as assets on the Government's balance sheet; while the remaining portion, even though formally Plan 2 loans, should be accounted for as public expenditure on higher education in the year in which the student took out the loan.
This was called the partition principle: splitting each cohort into loans on the one hand, and grants to students on the other.
When this new accounting treatment was adopted in September 2019, it increased public spending (through accounting some of the loans as grants), and hence increased public sector deficit and net debt, even though nothing had changed in the cash changing hands and what students thought they owed.
The impact on public debt was huge – the ONS reported in 2020 that the impact of re-calculating the end-March 2019 Public Sector Net Financial Liabilities (PSNFL – the Chancellor's preferred new measure of public sector debt) was a debt increase of £55.9bn.
In their 2020 calculation of the 2018-2019 financial year, what proportion of student loans were the Government statisticians expecting to be written off, and hence were treated as current expenditure rather than a loan? The answer is astonishingly high – 52pc.
Government statisticians had studied loan repayment rates and overall graduate participation in the UK labour market for the previous 20 years. They concluded not just that 52pc of loans would not be fully repaid in 30 years' time, but that writing off 52pc of the loans at the point they are loaned – which includes writing off all the future interest that would have been accrued, and also all the repayments that these loans will still attract – means that about half of all the money supposedly loaned is in fact going to turn out to be a grant, not a loan.
But here's an oddity. Students themselves are certainly not being told that half of all student loans are being written off as they are granted. So all students are still being discouraged by the 9pc 'tax' rate that will be applied to their earnings for 30 years; and indeed no loans are actually being cancelled – everyone still has to pay.
Which brings us to another anomaly. The Student Loans Company (SLC) isn't concerned with how the Government is treating loans at the national fiscal level. It is concerned with accurately recording the student loans that are outstanding. So the SLC reports that the outstanding loan balance at March 31 2024 is £236bn. By contrast, the Government reports that the assets it deems to be student loans are valued at only £158bn.
This is not the end of the story. From September 2023, new student loans became Plan 5. This had two very significant differences from Plan 2. Firstly, the Plan 5 interest rate is just RPI, not RPI + 3pc p.a. This enormously reduces (by about half) the speed of accumulation of interest, and hence debt, run up by students. Secondly, Plan 5 debt is written off 40 years after graduation, not 30 years.
With the lower interest rate, and the longer period for repayment, the forecast of un-repaid debt at maturity falls dramatically. This has a large knock-on effect on the Government's fiscal position, increasing its student loan asset accumulation, and reducing current public expenditure (the c. 50pc write-off) that it was booking to current account.
The effects of what seems like somewhat esoteric changes are in fact large in public spending terms: the Institute for Fiscal Studies (IFS) forecasts that the proportion of loans treated as current expenditure will fall from 61pc in 2021-22 (under Plan 2) to 34pc in 2026-27. Since student loans advanced in 2023-24 totalled £19.9bn, that is an apparent fall of 27pc (61pc-34pc), or just over £5bn. All at the stroke of a pen.
The Government itself can't agree on the valuations to place on written-off debt, because the calculation is sensitive to interest rates and other assumptions, and they can't agree on the appropriate interest rate. So the Department of Education and the Office National Statistics work with differing numbers in the government accounts. Hence you may have noticed that both 52pc and 61pc were presented above as the scale of the loan write-offs. Different years; different methodology.
Instead of this muddle, and the strong disincentive that the 9pc tax rate has on the graduate workforce, wouldn't it be better to give grants to those that need them, and smaller volumes of loans, with no write-off, to those who would be able to afford them? And perhaps a smaller proportion of the cohort going to university?