Monday, September 20, 2010

Funding university education

A bunch of British universities have mooted the idea of a graduate tax, where college graduates pay a slightly higher tax (on incomes over a certain threshold) for the rest of their working lives. [The idea is that their college education would either be free or cost very little].

This is a variant of the Australian model in which graduates pay a slightly higher tax (on their income exceeding a certain threshold) only to the extent of what they owe the government for the cost of their college education.

In his recent speech at IISc, HRD Minister Kapil Sibal talked about the creation of an Education Finance Corporation (or some such entity) that will guarantee bank loans for higher education; the idea, then, is that banks would feel far more comfortable lending to college students -- even without a collateral. The educational loan would come at a low interest rate -- Sibal mentioned the possibility of 4%.

I have been a fan of the Australian model, myself. (a) It has the virtue of making college education affordable for everyone -- especially the poor. Decisions about going to college would no longer involve the financial implications of the move (other than, perhaps, the opportunity cost of spending four years pursuing a degree). (b) The burden of repayment is light. (c) Repayments kick in only when incomes exceed a certain amount (which is pegged to the median salary). (d) Unlike an educational loan, this model doesn't penalize those who are forced to drop out of college. And (e) it has lots of flexibility in terms of inflation adjustment, quicker repayment schedule, etc.


  1. Ankur Kulkarni said...

    Hi Abi,

    I don't know much about the Australian model. I have only read about it here. I want to point out that there is a slight subtlety here, which perhaps has already been taken in to account in the model.

    Does the tax graduates pay also depend on which university they attend, ie does it depend on the university fees which the govt foots the bill for? If yes, then the Australian model is equivalent to an assured education loan for all, financed by the govt. If the tax does not depend on fees, then it is a combination of a loan and insurance - the govt pools in a large number of loans and decides one rate for all of them. And that I think spells trouble.

    In a setting where loans are easy to come by, the only reason for universities to strive to keep their fees low is the possibility of losing students to lower-charging competitors. If the students pay the same rate of interest regardless of the university they attend, this possibility is wiped out. What results is a license for all universities to hike their fees indefinitely treating the govt as a bottomless pit. The emergent behaviour would be that which we see in other sectors where mass-insurance is offered for services of private entities, eg, the US health-care system which has seen sky-rocketing prices and premiums. For students this will mean higher and higher interest rates. When higher rates become politically non-viable, the govt will simply print money to get itself out of trouble, thereby sowing the seeds for some other trouble later. And in countries where copious unemployment benefits are offered, and second consequence is likely: many graduates might find it more attractive to not work and not repay the loan at all.

    Common interest rates are politically attractive, but I think they are myopic tactics. They have to be combined with a control on fees too, or their consequences could be akin to the current Euro-zone problems.