Saturday, June 11, 2011

Quest to make uni fees a heck of a lot fairer

One measure in the May budget's tightening up on ''middle-class welfare'' drew surprisingly little debate: the decision to cut the rate of discount offered to people who pay off their university HECS debt up front from 20 per cent to 10 per cent.

When the higher education contribution scheme was introduced in the late 1980s, the discount for paying up front was 25 per cent. Now it's falling to 10 per cent. And the discount for making voluntary repayments of $500 or more is to be cut from 10 per cent to 5 per cent.

Wayne Swan says the move will save the government almost $300 million over four years and will make the scheme fairer.

But why would it save that much? And how would it make things fairer? That the shock jocks didn't bother debating these questions probably means people bright enough to go to uni don't ring up talkback radio.

It is a bit of a puzzle. The first question is, why would the government give any discount to people paying their HECS up front rather than paying it off over the years as their income rises and the taxman extracts it from their pay packet?

Well, the government's better off getting the money up front rather than having to wait maybe 10 or 15 years for it all. So it makes sense for the government to give people an incentive to pay up front.

But, if that's the case, why does it make sense to reduce the incentive? Surely the rational response to a reduced incentive for early payment would be for fewer people to pay up front. And if that's the case, wouldn't that leave the government's coffers worse off rather than better off?

Well, it seems the econocrats are expecting some of those who'd otherwise pay up front to be put off, but not many. But see what this means? They're not expecting a rational response to the move.

This is one case where the econocrats aren't proceeding under the assumption we're all like Homo economicus - economic man - carefully calculating and self-interested in all we do.

And I've no doubt they're right: there won't be a rational response to the cut in the discount. Why not? Because paying HECS up front has never been a rational thing to do. It follows that the response to the cut in the discount isn't likely to be rational, either.

Perhaps we should start from the beginning. The wider community benefits when young people go to university and get a degree. But the greatest benefit goes to the graduate. On average, possession of a degree causes workers to earn a lot more over their working lives.

So HECS was introduced to require graduates to make a greater - though still far from full - contribution towards the cost of their education, reducing the subsidy they receive from other, less fortunate taxpayers.

You can think of higher education as an investment. You make an initial outlay (the main cost being not for fees or books, but the income forgone while you study rather than work) in return for lifetime earnings that are higher than they would have been.

According to one study in 2002 by Professor Jeff Borland, of the University of Melbourne, uni graduates earn an average of almost $10,000 a year more than high school graduates do. After allowing for the initial outlay, this was equivalent to an investment return of about 20 per cent a year.

That was without including HECS. Allowing for HECS (which was then at a lower rate than it is today), cut the annual return to about 14 per cent - still a very good deal.

But wouldn't charging fees discourage bright young kids from poor families from going to uni and bettering themselves? That was the risk. But HECS was carefully designed (by Professor Bruce Chapman, of the Australian National University) to avoid this happening.

Rather than simply levying tuition fees, the government would allow people to defer payment of the fees until they'd graduated and were earning a reasonable salary. Then they'd have to pay a small proportion of their salary in repayments, with the proportion rising as their salary grew.

So the government was, in effect, lending students the cost of their uni fees. It didn't charge interest on the loan, but did index the value of the balance outstanding to the inflation rate. In other words, it changed people a real interest rate of zero.

By contrast, any loan you get during your life from a bank or finance company will involve a high real interest rate and a fixed repayment schedule that takes no account of how hard or easy it is to meet the payments (it's not ''income-contingent'' like HECS is).

See what this means? HECS is the best loan - the cheapest money - you're ever likely to get. So the rational response is not to pay it off any earlier than you have to, thereby avoid having to borrow as much commercially for other purposes or being able to keep more money in the bank earning interest.

This is true even with a discount - 25 per cent, let alone 10 per cent - for repaying the loan up front.

(You can check this by working out the ''present value'' of the debt by discounting the flow of repayments over the life of the loan, so as to take account of ''the time value of money''. Don't know what all that means or how to do it? Go to uni and do an economics or business degree and they'll tell you.)

But if it makes no sense to do the government a favour and repay HECS debts up front, why do people do it?

I doubt if many students do it. It's much more likely to be well-off parents who do it (one of whom is very well known to my good self) so their little darlings don't have to worry about being in debt.

If this is the motive of those people who pay HECS up front, they're unlikely to be

deterred by a cut in the rate of discount.

Thus the government probably will make significant savings.

And since those savings will come from the pockets of well-off parents, it's probably right to see this measure as an attack on middle-class welfare that will make the scheme fairer.

A last point: in the real world, a lot of the things we don't do aren't strictly ''rational'' - but all that does is make us human.