Over at his blog, Andrew Leigh asks whether the OECD was right not to count an implicit subsidy in HECS-HELP in its figures on how much the federal government spends on higher education. The federal goverrnment argues that because the OECD only counts direct subsidy paid to higher education institutions, it understates total spending on higher education. This is a complex issue; I would welcome feedback on my analysis.
There are two possible subsidies in the income contingent loans scheme. There is the writing off of bad debt, about which I have written extensively (pdf). Lending to students that won’t be repaid should be classified as a higher education expense. And there is an interest rate subsidy, because HECS-HELP debts are indexed to inflation, but otherwise no interest rates are charged. There are direct and/or opportunity costs to the federal government in not charging interest on HECS-HELP debt.
Andrew L is questioning the implicit interest rate subsidy point. These are not his words that follow, but the reasoning goes like this:
The real price of going to university is not the advertised maximum student contribution amounts. This is because there is a 20% discount for paying up-front. For example, a year of law subjects is advertised at $8,333. But if you take the 20% discount, the cost is $6,666. Another way of looking at it is that if you don’t pay up-front you incur a surcharge of $1,666, or 25%.
That $1,666 could be looked at as a form of interest on HECS debt. What rate of interest it converts to depends on how long the student takes to repay the debt. Using the ATO report on HECS debtors, and assuming law graduates earn between $50,000 and $100,000 a year while repaying, people in that range repaid an average of $3,300 in 2004-05. At that rate, it would take 2.5 years of work to pay off one year of university debt, which would convert to an interest rate of about 10% on a loan of the real price of $6,666. But if the debtor was in the $35,000 to $50,000 bracket, on the ATO’s data on average it would take 4.3 years of work to repay one year of education, and convert to an interest rate of 5.8%. (There are simplifying assumptions here; for example if there was a real rate of interest it would be compounding on the debt).
From the student’s perspective, there is certainly an implicit interest rate, though one that gets lower the longer he or she takes to repay. Because most students take a while to repay – most law students do 5 year courses, so full-time students probably won’t make any repayments until 5 years after they first incurred debt – typically interest rates would be low, but not zero in real terms as implied by the indexation system.
However, there is a problem with the argument that because students pay an implicit interest rate there is no additional subsidy built into the HECS-HELP scheme. The federal government doesn’t put the $1,666 in our example aside to cover the cost of holding the debt. It pays the full $8,333 to the university (plus its tuition subsidy of $1,643). If the student pays up-front to the university, the federal government pays the $1,666 and the tuition subsidy to the university.
If there is some serious actuarial work behind the up-front discount, it implies that there is an additional subsidy, on top of the tuition subsidy, of at least 25% of the real course price in having somebody defer the cost of their course. Or in other words, it is cheaper for the Commonwealth to write off the $1,666 now by paying it to the university than to lend $8,333 to the student and have it hanging around unpaid for a large number of years, or perhaps never repaid if the student dies, lives overseas, or does not earn very much.
Andrew’s point works, I think, for undergraduate full-fee students who take out a FEE-HELP loan. For them, the university or higher education provider sets a fee. Say it is $10,000 a year. The student incurs a 20% surcharge (not the 25% paid by HECS students, curiously). So their debt to the federal government is $12,000, and it pays $10,000 to the higher education institution. In this example, the government charges $2,000 to cover its expenses, a feature absent from the HECS-HELP system.
Does this invalidate the OECD’s comparisons? In the years in which the Budget was in deficit, the government was borrowing at real interest rates to lend at zero real interest rates. So that was an added expense of higher education not included in official higher education spending. But many OECD countries run budget deficits now, so their borrowing to subsidise higher education directly (rather than lending to students) is also an expense of their higher education policy that would not be caught by the OECD education publications (though there is plently on public debt in other OECD publications). So the OECD understates the public cost of higher education generally, but it is not clear to me that it disproportionately understates Australian expenditure compared to other countries.
In these days of huge surpluses, I’m not sure how we should count the cost of the HECS debt. Is it not the direct cost of interest on government debt, but the opportunity cost of not investing in the various surplus-stashing funds? (Nice irony here – one of these funds is for higher education.) If this is the right way to look at it, a time of good investement returns increases the total (opportunity) cost of higher education to the government.
The OECD comparison is a polemical point. Polemics aside, highlighting how direct higher education subsidy understates the true cost of higher education is worthwhile. If there are only limited funds for higher education, do we want to spend them providing discount interest rates and letting people taking repayment holidays in London and New York?
Low interest rates or debt write-offs for people who genuinely don’t benefit financially from their degrees are part of the original design of the HECS system. It was intended to take some of the risk inherent in higher education investment. But other aspects of the system, like not collecting from people overseas, seem to me to be misusing money that could be spent more productively on other higher education-related activities.