Should the upfront student contribution discount be halved?

According to media reports this morning, the government is planning to cut the discount on student contributions paid up-front from 20% to 10%.

According to The Age’s version of things, ‘the government will justify the cut on the grounds that the benefit goes mostly to wealthy families.’

But contrary to common impressions, the discount was not intended as a benefit to anyone other than taxpayers. Because it is very expensive to lend money at zero real interest, students paying up-front can save the goverment money. In a couple of scenarios I did last year, for male arts and law graduates earning median incomes in professional or managerial jobs, it was slightly cheaper for the federal government to pay the discount than to pay the interest subsidy on the HELP debt.

However, the economics of the discount depend on how long students would otherwise take to repay. For quick repayers (or people who would pay upfront anyway), the government would be better off not giving the discount. If students are going to repay slowly, the discount looks like a better deal for taxpayers. Another factor is that up-front payment removes the risk of non-repayment.

Whether or not halving the discount makes financial sense for the government depends on the behavioural response. If there is little reduction in current up-front payments – in 2009 about 17.5% of students received a discount, paying around $530 million at a cost to government of about $110 million (I have discrepancies between sources on these figures, but these numbers give the general picture) – then the decision to cut the discount is a good one.

A 2006 survey of student finances has some findings on who pays upfront. It includes both subsidised and full-fee students so it is a general guide (it reports higher rates of upfront payment than DEEWR).

For full-time undergraduates in this survey, most of those who did pay upfront received some or all of the money from their parents. My hypothesis would be that these payments are not heavily influenced by the up-front discount. It is a continuation of on-going parental support, with possibly some slight sensitivity around the total cost.

For part-time undergraduates, in 7% of cases parents pay and also in 7% of cases the student’s employer pays (17% for part-time postgraduate coursework students). Perhaps the increased cost without the discount would cause the employer not to pay in some cases as it makes the course more expensive, but I think this would be the minority situation.

The other major predictor of up-front payment is that the student has a full-time job (according to the ABS, about 14% of undergrads and 46% of postgrads work FT). About half of them in this survey make at least a part upfront payment. This group is the one that is most likely to have their incentives changed.

However it’s probably reasonable to assume that this group would be relatively quick repayers anyway, and so the government wasn’t going to save a lot by removing the risk of paying interest subsidies on a slow repayment loan.

Overall, my conclusion is that halving the discount is not likely to cause a major switch to deferral by students who might otherwise take a long time to repay, and therefore the government will get net savings from this change.

7 Responses to “Should the upfront student contribution discount be halved?

  • 1
    Mr Tiedt
    May 5th, 2011 15:19

    “halving the discount is not likely to cause a major switch to deferral”

    Respectfully, I disagree with this. I worked bloody hard during my uni holidays and saved hard during the year (studying F/T and working P/T) so that I could make big contributions upfront and reduce my HECS debt early, meaning I graduated owing only 1/5 of what I would have owed otherwise. Not sure I would have bothered if the bonus was only 10% – if memory serves it was 25% when I was at uni (2001-2005).

    Additionally, I had several friends whose parents loaned them the cash interest free so that they could take advantage of the bonus and then pay back when they could.

    To me, this seems like a dumb move – I reckon a lot less people will pay upfront and the Government’s HECS outstanding total will keep going up.

  • 2
    Em
    May 5th, 2011 15:25

    Great. I’m also a mature age student, working part time and only doing as many units as I can afford per semester (not many). Obviously I need to find me a sugadaddy instead.

  • 3
    Rajat Sood
    May 5th, 2011 16:26

    Andrew, you may be right that the upfront payments in respect of full-time undergraduates are relatively insensitive to the discount. Then again, one wonders why. The payments do not improve the current lifestyle of students. Perhaps parents see the up-front payments as helping their kids get a good ‘clean’ start in life or some such thing. Do you have any data on the prevalence of up-front payments from back in the days when the discount was 15%?

  • 4
    Andrew Norton » Blog Archive » The longer-term effects of upfront discount rates
    May 5th, 2011 18:32

    […] Rajat asks about deferral trends over time. The figure below is the percent of total student liabilities deferred 1989-2009. […]

  • 5
    Robert Wiblin
    May 6th, 2011 11:43

    I remember at the start of my degree calculating that on reasonable expectations about my future rate of income and a nominal discount rate of 6% (the bond rate which the govt will apply to its own calculations), the net present value of (paying back) a HECS debt of $1 was roughly equivalent to $0.80 today. That is, it was a tight decision with the 20% discount, but clearly a mistake with the 10% discount (ignoring my desire to smooth consumption).
    .
    I told my parents not to give me money rather than pay the fees, but they paid anyway, feeling it was virtuous to pay for education (even if the outcome is I buy more of other non-educational goods). So my experience matches your prediction.
    .
    Chapman says that around 2/3rds of HECS loans are recovered in real terms. That is, $1 of HECS debt is worth some $0.66 to the government today.
    .
    If people were rational I would expect the government’s total income (NPV) would be maximised with a *higher* discount than 20%, not a lower one. However, people who are able to pay upfront probably have better earning prospects than average. If they’re much better, a lower discount might be appropriate, though 10% seems implausibly low (that would be eaten up with just 4 years of 3% discounting!).

  • 6
    Sinclair Davidson
    May 7th, 2011 06:47

    Parents paying HECS is also a tax free gift that avoids some of the transactions costs associated with inheritance.

  • 7
    Andrew Norton » Blog Archive » More HELP reform – reduced discount for repaying early
    May 10th, 2011 18:31

    […] Last week’s budget leak about cutting the discount for paying student contributions upfront was only part of the HELP reform story. They are also going to cut the ‘bonus’ for repaying early from 10% to 5%. (For example, if you pay the ATO $1,000, they will now wipe $1,100 from your HELP debt, but only $1,050 if this reform passes). […]