What would a graduate tax change?

It may be part of Theresa May’s review but are students effectively paying a graduate tax already, asks James Connington

Theresa May has pledged to overhaul student loans and tuition fees, which could lead to the fifth funding system in 20 years. Among possible changes are freezing fees at £9,250 a year and raising the earnings repayment threshold for students who started university from September 2012 onwards from £21,000 a year to £25,000.

However, the Prime Minister said the whole system would be reviewed, and a move to a graduate tax instead of the current system appears to remain a possibility. Other radical changes such as lowering fees, cutting interest rates on student debt and bringing back maintenance grants are all reportedly being considered.

It has been 19 years since tuition fees were introduced, 13 years since they were put up to £3,000 a year and five years since they were increased to £9,000. The outcome in terms of debt, interest and repayments for those who went to university during these years has effectively been an age-based lottery.

Those who fell on the wrong side of one of these changes saw the financial burden of university multiply compared with someone one year their senior (see box, right).

But how would the most radical of the potential changes – a move to a graduate tax system instead of loans and repayments – differ from the system as it currently stands?

The controversial idea of a graduate tax has been discussed since tuition fees were introduced. It would involve a tax on all graduates that increased with earnings. There are numerous criticisms concerning how a graduate tax would affect university funding – but from a student perspective, what would change?

Many argue that today’s system is already more akin to a tax than a loan. Currently, graduates pay back 9pc of the amount they earn over £21,000. The interest rate goes up with their earnings, and is also linked to inflation.

As things stand, the Institute for Fiscal Studies has estimated that 77pc of students will never pay their loan back. If the repayment threshold is raised to £25,000, the IFS expects that figure to rise to 83pc.

For these individuals, a student loan debt is arguably a 30-year tax. How much it costs them depends entirely on the repayment rate, not the interest rate.

The interest rate does make a difference to those who are likely to pay off their loan, or to come within sight of doing so, as it affects the size of the debt and therefore how long they’ll take to make repayments.

There are some elements that distinguish the present system from one based on taxation, however.

First, those who benefit most from the current system are the lowest and highest earners. Graduates whose career earnings remain low will make minimal repayments and have a large amount of debt written off after 30 years. Very high earners, meanwhile, will pay down their debt quickly, minimising the amount of interest – which can be significant – that they need to pay.

Those who sit in the middle pay the most. They earn enough to make significant repayments, which can easily eclipse the total borrowed by a significant margin. But they do not earn enough to clear the debt quickly, meaning that they can pay punishing amounts of interest. It is individuals from poor backgrounds going on to earn reasonably high salaries who are punished the most, as they build up the biggest debts because of the recent replacement of maintenance grants with larger means-tested loans.

Under a system of taxation, the advantage of being a very high earner would disappear, as the highest earners would pay the most back. In effect, the pain of footing the biggest bills would be shifted from the middle to the top. The best-paid graduates would potentially pay back far more than the cost of university.

Those from poor backgrounds who went on to high-paying careers would pay the top rate, but would not pay more than counterparts from wealthier backgrounds over their lifetimes because they would no longer take out larger loans at the outset. Well-off parents would also no longer be able to pay up front to prevent their children facing the tax burden.

A key difference is how each system treats graduates based on the cost of the education they obtain. Under both systems, someone who receives an expensive education and then doesn’t end up in a high-earning career pays the least relative to the amount spent on educating them.

However, under a progressive tax system someone who studies part-time on a cheap course and then goes into a high-paying career would end up paying a far higher rate of tax relative to the cost to the public purse of educating them.

Overall, while there would be differences for some, the borrower’s experience of a graduate tax would be fundamentally the same as now. In both cases, there is no upfront cost and graduates face long-term payments linked to earnings.

The biggest difference, and the focus of criticism, stems from how a system of graduate taxation would affect university funding and the Government’s finances. There would be huge upfront costs, as it would take decades for new graduates to earn enough to pay the top rates of tax. Attempting to incorporate existing graduates to combat this would be extremely difficult.

Additionally, the money would go first to the Treasury, not universities, raising questions about how the money would be shared. Then there are problems of tax evasion, graduates leaving the country and determining liability for those who didn’t complete their degree.

Sam Meadows, 24

Aberystwyth Univ Graduated: Annual fees:

£3,225

Debt at graduation:

£20,733

2014

Interest rate:

currently 1.25pc James Connington, 23

UCL Graduated: Annual fees:

£9,000

Debt at graduation:

£44,000

2015

Interest rate:

currently 3.5pc

In both cases, there is no upfront cost and graduates make long-term payments

Graduates may face yet another funding system after a loans and fees overhaul