10 July 2023

Time to abolish student loans and replace them with ‘ISAs’


There are too many students at university. UK universities churn out hundreds of thousands of students with little career preparation. Indeed, the number of students has doubled since 1992 with little growth in the graduate labour market. This is the consequence of a system where universities are paid on enrolment numbers, not the outcomes of its students. It is no wonder that half of UK graduates no longer work in the field they studied for at university and 34.6% of UK graduates don’t work in high-skilled employment.

The consequences of this are felt by the public purse, for close to 50% of graduates are unable to repay their student loans. Now, government estimates suggest outstanding student loan debt will reach £460bn by 2040. That is £460bn that could be spent on infrastructure, healthcare or, indeed, back in our pockets.

We need to disincentivise universities from taking on new students who will gain little from their degree. And we need to deter students who are unlikely to gain high-skilled employment from going to university. As so often, the solution may come from Milton Friedman. More specifically, from his idea of an Income Share Agreement (ISA), as an alternative to student loans.

Students would have a choice between self-paying tuition fees, as set by the university, or entering into an ISA. That agreement could take many forms, but at its most basic it would give universities a cut of a student’s future earnings in exchange for their education. It could be, say, 10% of annual income for a period of 15 working years (by way of comparison, current students pay 9% of their income over the repayment threshold).

The beauty of this system is that each university would have autonomy to set their own income share agreement in a time period of their choosing. This will motivate universities to make a competitive offer to their students. Too onerous an ISA, and fewer students would apply. 

But the real key to this proposal is that it would tie student performance to university earnings. It would be in the best interest of universities to provide the best education possible for their graduates. After all, the university’s income would be dependent on the incomes of their students. By the same token, universities would not accept applicants they considered unlikely to have significant earning potential as graduates.

Such a system might even encourage universities to settle the kind of pay disputes that have bedevilled our universities this year, as universities would be keen to make sure their students are getting a full education making them as competitive as possible in the labour market.

No solution is flawless, of course – and there are certainly some drawbacks to Friedman-style ISAs. The most obvious is that it may dissuade universities from offering courses that have a high value to society, but whose graduates aren’t necessarily going to be big earners. There is always a degree of subjectivity to ‘social value’, but it’s not that hard to envisage a situation where certain courses and subsidies are kept afloat with a degree of public subsidy – particularly if taxpayers are no longer footing so much of the eyewatering student loan bill.

These courses could include not just creative subjects that tend to have a lower earning premium, but also vocational courses in areas like nursing or social work, where salaries tend to be low but the work is enormously valuable to society. Universities could be subject to a legal requirement to offer a certain number of places for study on these courses. ISA rates for these courses could be capped to take into account the lower earning potential of particular graduates.

And for those who wish to study but do not wish to enter into an ISA agreement, fear not. Students will still be able to pay through self-pay, or even by taking out a private loan (again, there is ample scope for market-based competition to improve the offer to students here).

One thing is certain: the student loan system as it currently functions is not fit for purpose. Students are taking on huge amounts of debt that many will never pay back, while the taxpayer is being landed with a huge, seemingly ever-growing bill. If we want to end this impasse and get our universities back on a sustainable financial footing, we should be thinking very seriously about a whole new kind of ISA.

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