Dump interest-free student loans

This past year alone, the government lent $1.5 billion under the student loan scheme, and immediately wiped $602 million from the value of that asset.

The train-wreck was utterly predictable but we should still look back to see how it happened, how bad it was, and how we can keep it from happening again.

This week, The New Zealand Initiative released its decade-on retrospective look at the government’s interest-free student loan policy.

Ten years on, the government has provided billions of dollars in interest rate subsidies. Writing interest off of existing loans in 2006 cost over $1.4 billion. Since then, the government has written $5.75 billion from the value of its $13.4 billion in loans to students. This past year alone, the government lent $1.5 billion under the student loan scheme, and immediately wiped $602 million from the value of that asset.

Big numbers – in the hundreds of millions per year – need benchmarks for scale. In 2015, the government provided $504 million in means-tested student allowance and accommodation benefit programmes for students. The interest rate subsidy, provided indiscriminately to any student wanting a student loan, exceeded that means-based spending by almost $100 million.

What good has the government accomplished with the billions in subsidies offered under the interest-free student loan scheme? Not much. But there have been rather a few downstream consequences that are less than laudable – even if they were entirely predictable.

Student numbers flat
Tertiary participation rates peaked in 2005, when Labour announced the ‘zero percent’ loans policy. It declined every year since then and now stands at 10.2%. The number of full time students plateaued in 2004/2005 and has been roughly flat since. Work by Nigel Healey and Philip Gunby at the University of Canterbury showed that age-standardised university participation rates did not improve with the policy change. Rather, existing increasing trends flattened a bit.

The policy also did nothing to reduce students’ debt burden. If anything, the fortnightly repayment burden increased.

All else equal, loans attracting no interest should be faster to pay off than loans on which interest is charged. In 2005, before the interest-free policy was adopted, half of all student debt was repaid within 6.7 years. By 2011, the most recent year for which figures are available, that repayment time had increased to seven7 years. Why the longer repayment time?

New Zealand runs a sensible income-contingent student loan repayment scheme. Every dollar earned over a set income threshold, currently $19,084, attracts a repayment tax until the debt is paid off. Students can voluntarily pay more than that minimum requirement.

Because graduates can be reluctant to pay off debt that attracts ‘zero percent’ interest when saving for a house deposit or when starting to pay off a mortgage that does carry interest, the government had to increase the repayment tax from 10% to 12%. Consequently, student loan repayments, for those preferring to make only the minimum repayments, take a bigger chunk out of fresh graduates’ paycheques now than they did before the interest-free policy.

Students have borrowed more and have less reason to pay off their loans quickly, so repayment times lengthened.

The policy has also had a few negative implications for the tertiary sector.

Every dollar borrowed by a student to cover tuition costs is forecast to cost the government, in 2016, 42.2 cents. That’s the immediate writedown on the value of the loan asset. And so whenever tuition rates go up, the government bears a substantial part of the burden of tuition hikes through the student loan scheme. To mitigate those costs, the government restricts universities’ tuition increases through annual fee maxima.

Tuition caps are not new but more universities cluster around the maximum – the caps now seem more binding. Capping tuition fees can be important if borrowing at ‘zero percent’ makes students less price sensitive. But it also constrains universities against differentiating themselves on quality. If a university wanted to market itself as a higher-cost, higher-quality option, that route is barred.

It isn’t hard to see the links from the ‘zero-percent’ loans policy to other government controls on borrowing.

Because students only repay if earnings are above the threshold, no interest accrues, and debt is expunged on the borrower’s death rather than being covered by the borrower’s estate, the government has had to restrict access to loans by those nearing retirement. Some would be taking the loans out, knowing they would never need to be repaid, because taking university courses can be a pleasant way of spending one’s retirement – and not cannot. Others would be trying to re-train in a changing job market and can no longer access student loans to do it.

Similarly, without caps on borrowing for living costs, students may be tempted to borrow rather a lot of money at ‘zero percent’ and put the money into term deposits. The scheme would collapse without caps on borrowing. But with caps on borrowing for living costs, students without family resources to rely on have to take on part-time work to cover rising accommodation costs. They would often be better off if they could take on more debt, even at interest, and pay it back when in employment. Instead, these students struggle to juggle employment and study.

The Child Poverty Action Group’s report on student debt, released last week, reaches some similar conclusions. It has further found some students at the bottom have turned to credit card debt to make up the gap between living costs and what they are allowed to borrow at zero percent. The constraints established to keep rich students from rorting the system have real costs for those at the bottom. And more than twice as many students from decile 9-10 schools go on to tertiary study as do students from decile 1-2 schools. Does this make sense?

Interest on new loans
New Zealand is also an outlier internationally. Government-backed loans are common. Lending at ‘zero percent’ is not.

If the government introduced interest on new loans issued starting in two years, it could afford to do many other nice things. Most obviously, it could relax some of the restrictions it has had to put on lending to avoid the rorts that would inevitably follow if students could borrow without limit at zero percent. Student loan repayment times would increase – by about a year for a graduate with a bachelor’s degree on the typical earnings path. But the student’s university experience could be rather better.

Importantly, some of the resources used to provide interest rate subsidies to university students could instead be directed to measures that could really improve access to tertiary study.

Labour has suggested improving guidance and career counselling at secondary school but that is only a start. Subsidies provided through the interest-free student loan scheme cost over $600 million a year. If even half of that were reallocated to primary and secondary schools to help improve preparation for tertiary study, that could cover over $100,000 a school. What sorts of programmes could be piloted, trialled and rolled out with those kinds of resources?

It is time to stop seeing the government’s interest-free student loan policy as simply being “bad economics, but good politics.” It is bad for a lot of students, bad for the tertiary sector, bad for tertiary accessibility, and bad for equity. Train-wrecks should not be good politics.

Dr Eric Crampton is head of research at The New Zealand Initiative

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