Fiscal illusions, HE funding and the politics of the deficit

The Office for Budget Responsibility and the Office for National Statistics have both set the cat among the pigeons by raising the prospect of treating student loans differently in the government’s accounts. 

Robert Chote, chairman of the OBR, chose to concentrate on the NHS and student loans as his two themes in the OBR’s 2018 Fiscal Sustainability Report, with both looming ever larger in future government spending. He reported that net outlays are forecast to reach £20 billion by 2022-23 and that the value of the outstanding loan book is set to rise to about 20 per cent of GDP by the 2040s.

That is a lot. So how loans are recorded and accounted for matter and both the OBR and ONS agree. The ONS is in the midst of a review prompted by Eurostat’s discussions with the Lords during its recent inquiry.

It has recently published a report saying that “it could be argued that student financing fails to meet the definition of an unconditional debt”. This is essential if normal loan accounting rules are to be used. 

Chote added that the current accounting methods don’t record the transactions in “a way that captures well their underlying impact on the public finances”, resulting in “fiscal illusions” of the size and timing of the transactions.

So what are these “fiscal illusions” and why do they matter? Recording them as normal loans means that they count as assets and therefore are not included in Public Sector Net Borrowing, the government’s headline measure of the budget deficit. 

A second illusion occurs because the government gets to count the interest as income. That flatters the deficit further even though most of it won’t ever be repaid. And a third illusion allows any loan book sales to also count as additional income even if they are a really bad deal.

All matter for a range of reasons. The most obvious are that it distorts accounting, spending and policy. It means that higher education is being driven by spurious accounting methods in order to help overarching government objectives on the economy. That is partly about graduates in the labour market, but also about how fiscal competence is measured and described.

Reducing the deficit has been the major target through which Conservative ministers have hoped to demonstrate their economic reputation. It was the headline promise of both the 2010 and 2015 elections and the 2010/11 reforms were designed after the Browne Review landed. 

The system, including its accounting principles, has remained more or less intact since that time. Until now, at least. Chote has said that in an ideal world, “the accounting treatment would record expected losses up front, only record income that the government is likely to receive...and remove perverse incentives to sell the loan book”.

Both the OBR and ONS now speculate about a range of approaches, favouring a hybrid option where they can treat a portion as normal loans, where interest can be charged and repayment expected, and the rest in effect as grant (where there is no expectation of repayment). 

As Chote observes, this has “practical difficulties” such as making tricky 30-year forecasts and adding up to £15 billion a year in “spending” today. 

None of this might matter quite so much if current higher education policy were widely supported. But this is a system and a sector under pressure. Poor value for money, questionable outcomes, high debt and v-c pay all continue to dominate headlines alongside questions about declining part-time numbers and neglected technical education. 

All feature in the post-18 review and the panel led by Philip Augar. They will need to know the precise financial consequences of any accounting changes before they make their recommendations. The same goes for DFE ministers as they prepare bids for the 2019 Spending Review.

A requirement in Augar’s Terms of Reference is “to be consistent with the Government's fiscal policies to reduce the deficit and have debt falling as a percentage of GDP”.

This financial straitjacket has previously made radical recommendations much more difficult. But these changes will mean that maintaining the current system could be just as expensive if the government has to account for more spending up front. 

This raises a series of fundamental questions. First is that even if the government decided to keep spending the money – and abandon the political optics of sound fiscal policy – there is no guarantee that they would want to spend it in exactly the same way. For example, they may prefer to shift subsidies to different priorities such as technical education.

But a second and much worse scenario is that government decides to retain its economic story at the expense of maintaining the current system and the level of resource in higher education. It might decide that loans need to be more conventional so that they do comply with accounting standards. That would involve more certainty over repayments and possibly lower earnings thresholds and fewer write-offs. Or it might opt to lend less by bringing fees down and reducing overall write-offs via a different approach. 

But this would also mean less tuition fee income for universities and only a small possibility of increased grant in a 2019 Spending Review already dominated by the NHS. It is this last option that will most worry universities.

The key test will be what is more and less politically acceptable. Resetting the deficit narrative and significantly increasing spending will be among the least palatable. So too might be increasing student loan income if via reduced thresholds and longer repayment terms. Reducing fees and debt – as well as increasing loan repayments and better complying with any revised accounting standards – might be seen as a big win in the circumstances. Especially for a post-18 review that has been launched with high expectations. 

Andy Westwood is vice-dean for social responsibility in the Faculty of Humanities and professor of government practice at the University of Manchester.