‘Angel’ bonds could mean salvation for universities

Source: Otto

Ed Miliband believes that his party’s promise to reduce student tuition fee loans from a maximum of £9,000 a year to £6,000 a year could prove to be a trump card come May’s general election.

But he may yet find that, by announcing his plans so early, he has left time for his opponents to develop more attractive proposals.

Miliband’s Tory opponents are attacking Labour’s proposals on grounds of cost. But that argument may not prove convincing.

If Labour increases grants to universities by an amount corresponding to their loss of tuition fee income, that will require about £2,500 per student, not £3,000, because not every institution charges £9,000 fees. But the net increase in public expenditure may average little more than £1,250 per student because the bad debt provision, or resource accounting and budgeting (RAB) charge, made in the national accounts will fall considerably.

The Conservatives need to come up with what the former Labour chancellor Denis Healey used to call “a ripping wheeze”, and they need to do so quickly.

A particularly attractive idea might be to scrap loans and substitute higher education “angel” bonds, which allow taxpayers to make an equity investment in the enhanced likely future earnings of higher education leavers.

Under such a scheme, graduates would pay dividends as a fixed or graduated percentage of their employment incomes, in a manner similar to current loan repayments.1

Dividend rates could be set below current loan repayment rates if students make a working-lifetime commitment.

The basic level could be set at £6,000 for UK and European Union students, provided that each student is covered by an undertaking from their home government to collect student dividends through a PAYE or equivalent system, or to supply a satisfactory guarantor of payment of the dividends due, such as an employer or a parent.

That basic level would apply mainly to those enrolling at public colleges and private providers, as is the case now with student loans.

The higher-level angel investment might remain at £9,000 for students who satisfy the basic conditions but have also received an enrolment offer from an institution, public or private, that has degree-awarding powers and has filed a satisfactory access plan.

A premium level of investment – which is lacking in the current system – might be set at, say, £12,000 for students who enrol at an institution that is itself willing to act as guarantor of payment of an individual student’s dividends and has a satisfactory credit rating.

This premium level would be particularly attractive to the UK’s most prestigious institutions. It would allow them, on a course-by-course basis, to increase fees substantially. But the institution acting as guarantor would need to be confident that the “value added” by its course made it a “safe bet” that most graduates would have exceptional lifetime earnings.

The idea of angel bonds is similar to that of a graduate tax, except that, as with loans, the amount invested in each student goes into the national balance sheet as an asset and therefore does not amount to public expenditure. However, bonds avoid a problem inherent in the introduction of a graduate tax: that public expenditure rises steadily until tax inflows begin to match the necessary increase in funding required to compensate universities for the loss of tuition-fee loan income.

Technically speaking, the value of angel bonds in the national accounts would be the discounted present value of future student dividend receipts, as calculated by the government actuary. This would fluctuate with the state of the economy – but fluctuations would be “smoothed” by the long-term nature of the investment.

In the national accounts, the scale of annual provisions required to cover diminution in the value of angel bonds would be much lower than the present bad-debt provision on loans. While some angel bonds will never pay a dividend, others will produce a stream of dividends rising steadily at a rate exceeding the national average rate of growth in salaries.

The requirement that a student’s government commit to collecting dividends in similar manner to HMRC would lead to a substantial drop in the proportion of UK funds flowing to EU students that are deemed irrecoverable.

For the Treasury, angel bonds should be much easier to sell than the student loan book.

The bonds would be likely to prove attractive to pension funds and similar large investors, particularly if they are sold in batches denominated by type of institution and academic discipline, or even by specific university – such as those of the “LSE 2018” vintage.

If the government underwrote angel bonds by promising to repurchase them on predetermined terms as “buyer of last resort”, the ease with which the Treasury might place the bonds in the market would be boosted further.

Higher education bonds would be a logical progression from reforms introduced by David Willetts in 2012. In particular, they support the idea that funds should flow to students as an investment, not to institutions as a subsidy.

Universities have many reasons to prefer the idea of angel bonds – not least because Miliband’s proposals raise the prospect that their budgets will be further squeezed in future years.

So, if David Cameron is looking for a ripping wheeze, I suggest that he propose changing the name of the Student Loans Company to the Student Investment Fund and charging it with administering Alfred’s angel bonds.