An analysis of Labour’s proposed £6,000 undergraduate degree cap

Tim Leunig, CentreForum

Contact details:

Tim Leunig: [email protected] , 07941 238 740 Tom Frostick: [email protected] , 020 7340 1160

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An analysis of Labour’s proposed £6,000 undergraduate degree cap

Tim Leunig, CentreForum

Executive summary

Ed Miliband has proposed capping university fees at £6,000 per year, replacing the coalition’s plans for a £9,000 cap. This will be paid for by reversing the planned cut in corporation tax from 28% to 23%, and by increasing the interest rate charged to graduates earning more than £65,000. The plan has been presented as a first step towards a graduate tax.

We investigate the impact of this proposal on graduates, using government data on earnings trajectories based in turn on the Labour Force Survey. We find that the biggest beneficiary is the government – who will end up forgiving fewer loans, and forgiving lower amounts when they write off the loans. Over half of the apparent gain to students from this proposal is illusory.

Since no student has to pay upfront under either system, the proposal makes no student better off or worse off while they are studying.

Over half of the gain to former students goes to the richest 20% of graduates: those with lifetime earnings of over £2m in today’s money.

The winners are also disproportionately old. Less than 1% of graduates will gain from this proposal within 10 years of graduation. The typical winner will have graduated 28 years earlier, and will earn £72,500 at the point at which they benefit from this proposal.

In addition, there is a significant gain to students with well-off parents who pay their fees upfront, rather than borrowing from the government. European students also benefit, as they must make repayments under the loan system but would not be liable for a UK tax.

The proposal is clearly regressive.

Since this proposal leads to an increase in the number of people who repay their loans in full, it also represents a step away from a graduate tax.

Finally, we show that the proposal has short term contractionary effects on the macroeconomy, owing to the way in which it is funded.

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Introduction

Ed Miliband made an eye-catching announcement in an interview with the Observer newspaper to mark the start of the 2011 Labour Conference in Liverpool.1 He stated that a Labour government would limit the fees paid by students to £6,000, rather than the £9,000 limit set by the coalition.

Miliband refused to confirm on the Andrew Marr show that it would appear in Labour’s 2015 general election manifesto, noting that “If we can do more at the time of the election, we will”. John Denham, Labour’s shadow business secretary, confirmed Labour’s support for a graduate tax. 2 A Labour source told the Guardian that "This is a step towards a graduate tax. We would like to go further but we can only do what is affordable." 3

The change would be paid for by reversing the coalition’s policy of cutting corporation tax on banks from 28% to 23%, and by raising the interest rate paid by graduates who earn more than £65,000 per year.

Although the policy was designed to be an eye-catching vote winner, the initial reactions have been mainly negative, with the Guardian, for example, noting that they “came under fire from across the political spectrum”. 4

The Government was quick to claim that this announcement represented a capitulation by Labour. Having noted that “Labour MPs were whipped to vote against higher fees at the end of last year”, , the Universities Minister, commented that “Ed Miliband has now accepted that tuition fees should be doubled to £6,000 a year.” 5

Perhaps more surprisingly, the National Union of Students also opposed the move. They noted that the changes would do nothing to help students who enter relatively lowly paid work after graduation. This is because low earning graduates have their loans written off in any case after thirty years whether fees are capped at £6,000 or £9,000. 6 The NUS argued that the policy would make no difference for students earning under £35,000.

This paper looks in detail at the implications of this policy. It sets out the distributional aspects of the policy. Is it, as Labour claim, progressive, or is the National Union of Students correct to say it offers nothing to the less affluent?

In addition, this paper investigates whether this announcement can be seen as a step towards a graduate tax, or whether it is in fact a step away from Labour’s declared objective.

1 http://www.guardian.co.uk/education/2011/sep/24/labour-tuition-fees-cut-miliband 2 http://www.bbc.co.uk/news/uk-15050334 3 http://www.guardian.co.uk/politics/2011/sep/25/miliband-accused-uturn-student- fees?newsfeed=true 4 ibid 5 ibid 6 ibid

3 In addition to a conventional static analysis, this report also comments on the implications of Miliband’s new policy announcement in a dynamic context, by looking at the implications for social mobility and access to higher education. It also looks at issues around implementation, and finally at the macroeconomic impacts of the policy.

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Background

After the last election, Liam Byrne, Labour’s outgoing Chief Secretary to the Treasury wrote a candid letter to his successor. He wrote simply that “I'm afraid to tell you there's no money left.” In that context government needed to cut something, and a significant part of the axe fell on universities and other higher education institutions. Since government did not actually want spending on universities to fall, it allowed them to increase the fees that they are allowed to charge students from the previous level of £3,375. All universities were allowed to raise their fees to £6,000, and those that satisfied Office for Fair Access could raise them further, up to a maximum of £9,000.

Students pay off their debt at a rate of 9% of their income above a threshold. company debt, therefore, has the unusual property that monthly repayments do not increase if the person has a larger debt. Rather, the monthly repayments are set by the level of income, not the level of debt: those who owe more, pay for more months. Those who do not pay off all of their debt have any outstanding debts written off after thirty years.

In order to make the system more progressive, despite the higher fees, the government raised the minimum earnings level at which a former student has to repay their debts, from £15,000 to £21,000. This means that a large number of former students will not have to repay their debts at various points in their working lifetimes. For example, a parent who decides to work half time may well see her income fall from £40,000 to £20,000. Under the old system they would still have paid £450 a year in graduate loan repayments, whereas under the new system they will have stopped paying. Equally, there are many former students who will pay less each month, particularly when they are earning relatively little at the start of their careers. Thus a new graduate earning £24,000 will pay £360 a year, rather than £810. For these reasons, the Institute for Fiscal Studies found that the new system was more progressive than the previous system. 7

47 of the 123 English Higher Education Institutions (which we refer to as universities hereafter, for brevity) have announced that they will charge the maximum, and the average fee is £8,393. Notwithstanding the expert evaluation that the new system is more progressive than the old, the new system is clearly not a vote winner, and student fees remain a live political issue.

7 “Higher education reforms: progressive but complicated with an unwelcome incentive”, Haroon Chowdry, Lorraine Dearden and Gill Wyness, IFS Briefing Note 113, 8 December 2010. In addition supplementary interest charges are added for those above the basic threshold.

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Analysis

We begin by analysing the effect on students from the who take out a loan from the student loan company. In order to analyse who in this group gains and who loses from a change in the maximum fee cap for undergraduate degrees we need to know the earnings trajectories of graduates. It is, of course, impossible to know for sure the earnings trajectories of those who will start university in 2012, graduate in 2015, and pay off their loans between that date and 2045. (Note that we use the word university as shorthand for all English Higher Education Institutes). Nevertheless, the Department for Business Innovation and Skills has produced a relatively authoritative “ready reckoner” to allow people to investigate the effects on graduates of changes to the fee regime. 8 The spreadsheet is publically available and straightforward to use. It is based on data drawn from the Labour Force Survey, which has data on, among other things, earnings and education. From this we can get a sense of the earnings trajectories of graduates over their careers. A good discussion of the merits and pitfalls of the ready reckoner can be found on the department’s website. 9 That the department has published such a spreadsheet and made it available to all is commendable, and allows both government and opposition policies to be subjected to evidence-based scrutiny. The could also have used this spreadsheet to perform the analysis presented here, prior to launching their policy. The Institute for Fiscal Studies have their own database setting out their estimates of graduate earnings, but this database is not publically available. Nevertheless, judging by previous IFS reports in this area, it is unlikely that their data and methodology would lead to significantly different results.

Baseline position

The baseline position used in this analysis is that under Coalition policies the average university will charge £8,393. This analysis therefore assumes that all universities charge this amount. In addition, we assume that students take out a maintenance loan. All students are able to apply for a maintenance loan of £3,575, which students from poor and middle income backgrounds being eligible for a “higher level” maintenance loan of £5,500. These figures assume that the student is living away from home while at university, but not in London. Students living at home are eligible for smaller maintenance loans, and those living in London are eligible for larger loans. It would, of course, be possible to run the spreadsheet 473,796 times, in order to cover each university separately, with their own fees, and covering whether the student is living at home or away from home, and covering every level of maintenance loan from £3575 to £5500. The results could then be weighted by the size of each institution to come up with a very accurate answer.

Such a result would be an example of false accuracy, however: the main issue in any modelling work of this kind is about our ability to predict graduate earnings between now and 2045. For that reason, we content ourselves with modelling the sector as a simple

8 http://interactive.bis.gov.uk/studentloan/BIS-Student-Loan-Repayment-Ready-Reckoner-model.xls 9 http://www.bis.gov.uk/assets/biscore/corporate/docs/b/10-1249-student-loan-repayment-ready- reckoner-background-note.pdf

6 average. Since we are concerned primarily with access, we look first at those eligible for the higher level maintenance loan.

Our baseline, therefore, consists of a student who pays fees of £8,393 and receives a maintenance loan of £5,500. This means that each year they take out a total of loan £13,893. We assume that they are on a three-year degree programme, so in total they borrow £41,679. The government adds interest while they are studying, so given current conditions the BIS ready reckoner shows that they will graduate with a debt of £46,658.

Under these circumstances, 30% of students will repay their debts in full, with the remaining 70% having some part of their debt written off. This 30% figure includes some who make voluntary early repayments, rather than being required to pay off their debt given their level of income. Taken as a whole, the government typically receives £28,022 of the £41,679 originally loaned to the student. The government therefore writes-off an average of £13,657 per student. This is an important figure, as we shall see later.

Clearly, those who earn more, generally pay more, although two factors mean that this link is not as automatic as it might be. First, some people make voluntary overpayments, even when their incomes are low. 10 Second, some people might earn significant amounts and make significant payments for a short while, but then fall back and end up in a low income decile over their lifetime. This would be true for those who die young, or drop out of the labour market.

Table 1: The distributional effects of the Coalition’s current plans.

Lifetime Minimum Average Earnings lifetime Repayments Decile earnings 1 - 5,971 2 478,128 13,264 3 736,638 17,474 4 955,344 20,860 5 1,096,329 25,420 6 1,254,265 29,808 7 1,446,713 38,518 8 1,748,713 41,580 9 2,004,885 43,578 10 2,290,432 43,742

Table 1 shows the minimum lifetime earnings necessary to fall in each of the 10 income deciles, from 1 (poorest) to 10 (richest). Note that “lifetime” means 35 years in this case, in line with BIS modelling. Thus someone who earns £1m over their lifetime would be in the fourth decile. Note that these are deciles of graduates – someone earning £1m would be in a

10 Leunig and Wyness, Early repayment of student loans: should government impose early repayment penalties? http://www.centreforum.org/assets/pubs/early-repayment.pdf

7 higher decile of the population as a whole. As is usual in this sort of analysis, both the average earnings and average repayments are in “net present terms”, that is, discounted back into “today’s pounds”.

Table 1 shows that the system is generally progressive, in that the richest generally pay more than the poorest. Those in the bottom decile pay half as much as those in the second decline, and a third as much as those in the third decile. The system is less progressive among the most successful graduates: the top third pay similar amounts – in essence these people pay off all of their loans, plus a small interest premium, irrespective of whether their earnings are “high” or “very high”.

Labour’s proposal

We now turn to our analysis of Labour’s proposal: a cap of £6,000 rather than £9,000. There are two alternative ways to model this. First, we can assume that as all universities currently plan to charge more than £6,000, they would charge £6,000 were such a cap to be introduced. An alternative would be to say that since Labour will effectively be paying universities £3,000 per student, we would expect fees to fall by £3,000.

We will assume here that all universities charge £6,000. The reason is that universities who are worried that fees of £9,000 will put students off attending university are less likely to be worried that fees of £6,000 will do so. Thus it is likely that there will be less pressure, internally and externally, on universities to cut their fees below £6,000. We report the results using an average of £5,393 in the appendix: there is no significant difference in the results.

Cutting the maximum fee to £6,000 clearly reduces initial levels of indebtedness. Rather than borrowing £13,893 per year, the student borrows “only” £11,500 per year. Rather than graduating with a debt of £46,658, the student leaves university owing “just” £38,622. The student appears to have saved around £8,000. As we shall see, this is not in fact the case. We shall also return later to the issue of whether debts of £38,622 and £46,658 are qualitatively different.

As we noted earlier, monthly repayments are related to income, and not to the level of debt. This means that a fall in fees will not reduce the amount that a graduate will pay back each month, but will instead lead them to pay off their debt more quickly. In some cases this means that a debt that would have been repaid in any case will be paid off earlier. In other cases a debt that would not have been repaid in full will now be repaid. Finally, and most commonly, a debt that would not have been repaid still won’t be repaid, although the graduate will pay off a greater proportion. In the last case the winner is the government, who has to write off a lower amount.

A fall in fees from £8,393 to £6,000 appears to make the student £7,179 better off over three years. Students in fact gain much less than this. This is because the student would not have paid back all of the £7,179 in any case, since many students have a proportion of their debt forgiven. Under the current system £4,126 of that £7,179 would be forgiven under

8 Coalition plans in any case. As such, that £4,126 is a “gain” to the government, rather than the student, since loan write-offs fall by this amount. Thus Labour’s proposal makes graduates £3,053 better off in total, rather than £7,179. Over half of the apparent benefit to graduates is therefore illusionary.

In addition to working out the average effect, we can also look at the effects on people by income level. Table 2 includes the baseline average repayment results given in table 1, as well as those for Labour proposal.

Table 2: Comparing the Labour proposal with Coalition plans

Lifetime Minimum Average Average Earnings lifetime Repayments Repayments Decile earnings (Coalition) (Labour) 1 - 5,971 5,791 2 478,128 13,264 13,034 3 736,638 17,474 17,122 4 955,344 20,860 20,503 5 1,096,329 25,420 24,673 6 1,254,265 29,808 28,219 7 1,446,713 38,518 33,772 8 1,748,713 41,580 35,024 9 2,004,885 43,578 35,679 10 2,290,432 43,742 35,872

Table 2 shows that both the Coalition plans and Labour’s proposal are broadly progressive. In both cases the lowest earners pay less than those in the middle, who pay less than the highest earners. Broadly speaking, the Coalition’s plans cease to be progressive once we reach the 8 th decile, whereas Labour’s plans cease to be progressive once we reach the 7 th decile. Thus someone in the top decile pays £5,000 more than someone in the 7 th decile under coalition plans, and only £2,000 more under Labour’s proposal.

Table 2 also shows that the gains from Labour’s proposal are unevenly spread. Those in the bottom decile gain £180 in total – or around 50p per month – while those in the top decile gain £7,871, over forty times as much. The bottom decile gainers are made up overwhelmingly of those who voluntarily pay off all of their debt: they obviously have less to pay off, and therefore gain. Those “regular” graduates who simply exist in the system and who enter low paid employment will not be a single penny better off.

We have already noted that the biggest single beneficiary of this proposal is the government, which gains a majority of the cost back in the form of lower loan repayments. We can also calculate the distribution of the remaining gain according to the income decile of the graduate. The results are given in Table 3.

Table 3: The distribution of gains by income decile

9 Lifetime Minimum Percentage Earnings lifetime of total Decile earnings gain 1 - 1% 2 478,128 1% 3 736,638 1% 4 955,344 1% 5 1,096,329 2% 6 1,254,265 5% 7 1,446,713 16% 8 1,748,713 21% 9 2,004,885 26% 10 2,290,432 26%

Table 3 shows that a majority of the gains go to graduates who are in the top 20% of the graduate earnings distribution, and who have earnings of over £2m in the 35 years after graduation. 11 IFS figures show that even with a non-working partner and two children, this income level would be sufficient to place this person in the top 14% of the overall income distribution. If they have no partner, and no children, they would be in the top 2% of UK households by income. 12 The gains of Labour’s proposal go, in short, overwhelmingly to some of the richest people in Britain.

Finally, we can compare the effects of Labour’s proposal by the length of time since graduation. Labour’s proposal does not reduce monthly repayments, only the duration for which the loan has to be repaid. As a result, the beneficiaries are primarily middle aged rather than young. In fact, for the first ten years after graduation, fewer than 1% of all graduates receive any benefit from this proposal. The largest reductions in monthly loan repayments occur 28 years after graduation. It is at this point that reasonably significant numbers of graduates – around 1 in 6 – would still be paying under Coalition proposals, but escape paying under Labour proposals. This group have an average income of £72,509. We can see the proportion of people who gain by length of time since graduation in figure 1.

Figure 1: The proportion gaining from Labour’s proposal.

11 We give figures for the first 35 years after graduation because this is the basis on which the BIS ready reckoner classifies graduates by income decile. 12 http://www.ifs.org.uk/wheredoyoufitin/

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As figure 1 shows, the proportion who benefit is not large at any point in a graduate’s career, but is trivially small in the years immediately after graduation.

An analysis of an additional interest rate for those earning more than £65,000

This analysis does not include the effects of the higher interest rate charge on outstanding loans for people earning more than £65,000. This is because we do not have the full details of the plans. Clearly that will have an effect, but as we shall show, the effect will be very small. There are many reasons for this, but the principal one is that few graduates earn more than £65,000 and still have significant levels of outstanding student debt. First of all, few people earn this amount and are still paying off their student debts: according to the BIS ready reckoner, and assuming university fees of £6,000 and an additional maintenance loan of £5,500 per year, only 3% of monthly repayments will be made by people whose income is £65,000 in today’s terms. Second, even those 3% tend to be close to having paid off all of their debts by the time that they earn £65,000. Thus we find that 0.07% of graduates earn more than £65,000 in their first year, rising to 3.5% after 10 years. It is only in years 25 and up that a significant proportion of graduates earn £65,000 or more. These people have usually paid off the bulk of their student loan. The peak year for earning more than £65,000 and still having outstanding student debt is in the 26 th year of repayment. In this year such people represent 10% of all graduates in the BIS sample. But they owe only £3,900 on average, in real terms. Thus for each 1% interest surcharge levied by the government, the debt on each high earner would increase by £39 per year.

In addition, this group pay off their debt at a rapid rate. Someone earning £65,000 will repay £3,960 of student debt automatically each year; someone earning £100,000 will repay £7,110 per year. At these rates of repayment, the interest surcharge will not be applied for many years, so the total yield will be low.

11 Furthermore, the government’s ability to levy a significant surcharge is limited by this group’s ability to borrow from other sources, and to repay debt from their income. The person with an income of £65,000 and a debt of £3,900 is almost certainly in a position to repay the debt immediately, if the terms imposed by government are onerous. Were the government to impose a significant interest rate penalty, therefore, the person would avoid it by repaying the debt. In this case the tipping point on the “interest rate Laffer curve” is likely to occur at a low interest rate.

The effect on those who pay their fees upfront.

In 2009-10 895,000 English students were eligible for a loan from the student loan company. Of those 895,000, only 755,000 actually took out a loan. The remaining 140,000 were from disproportionately wealthy families who were able to pay the fees for their children from savings or income. These 140,000 will benefit from the proposal, as they will pay £2,393 less in fees each year that their child is studying at university. Given the numbers involved, Labour’s proposal spends £335m per year reducing fees for this group.

The effect on EU students

European Union students from outside of the United Kingdom are also eligible for loans from the Student Loan Company. Around half choose to pay up front instead of taking the loan. Again, it is likely that these students are from disproportionately affluent backgrounds. This group also gain from the fall in the tuition fee. There are 25,000 in this category, and therefore Labour’s proposal would spend £60m on reducing costs for affluent students from outside of the United Kingdom. It is hard to imagine that this group should be a priority for UK policy makers.

It is worth noting that were Britain to move a graduate tax the effects on non-British EU students would be significant. At the moment this group either have to pay up front, or repay their loans after graduation. Under a graduate tax there would be no up front fees, and only those resident in Britain would be required to pay the graduate tax. Replacing a fee of £8,393 with a graduate tax involves the British government giving a free education to EU students who currently pay. In the case of the half who pay upfront, that is a straightforward loss of £8,393 per student. In the case of those who take the loan, the loss is the amount that they would otherwise repay over their careers. We do not have good data on European student repayment rates as yet. That said, moving from fees that are prevailing under Coalition plans to a graduate tax would, as an order of magnitude, cost the government around £335m per year. This represents a major disadvantage of a graduate tax.

A note on the short term macroeconomic effect

At present universities set fees which students are liable to pay. Students in turn are eligible to borrow those fees from government, and most do. In the short run, therefore, universities are funded by the government, although of course the government hopes to recoup that money later. Thus a proposal to reduce fees by creating a direct payment from

12 government to universities has no macroeconomic effect: in the short run the government pays the same amount, and the universities receive the same amount.

The only exception is that some students – generally from richer backgrounds – pay fees themselves. For these students the government is paying an additional amount in both the short term and long term. This represents a very small rise in government expenditure, and in the current circumstances represents a Keynesian pro-growth action.

The policy is fiscally neutral, in that the increase in government expenditure – which manifests itself in the form of lower repayments from graduates in years to come – will be covered by the rise in the interest rate on those earning more than £65,000, and by abolishing the cut in corporation tax on banks. We have already seen that the rise in the interest rate will have only a trivial effect, so it is the rise in tax on banks that matters.

This has potentially large effects on the macro economy. First, the rise in tax is immediate, but the additional government spending will occur as and when student repayments to government no longer fall due. The policy is thus strongly contractionary: Labour’s proposal would take money out of the economy now, and put it back when graduate repayments fall in around 30 years time. Whatever the other merits of the policy, this cannot make sense.

Furthermore, banks currently have to increase their asset base, prompted both by domestic and international regulation. This is to make it less likely that banks will be “caught short” in the future, and have to turn to taxpayers to be bailed out. There are a number of ways in which banks can gain more capital – including retaining profits. Reducing profit, by increasing the tax take, reduces banks ability to build up their capital base. This in turn hampers their ability to lend, including to personal consumers and small and medium sized enterprises. There is, therefore, a second reason why this policy is contractionary: not only does it take money out of the economy in the short run, it does so in a way that is likely to reduce lending.

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Conclusion

The proposal to cap student fees at £6,000 rather than £9,000 may appear superficially attractive, but has little or nothing to commend it. Given the way that the student loan system works, the majority of the gains are illusory – what government gives with one hand, it takes back with the other.

Of the actual gains, over half go to the wealthy. The typical beneficiary is someone in their 50s, earning £72,500 a year. Over half of the gains go to people who earn more than £2m in the first 35 years after graduation. Virtually no-one in the bottom half of the earnings distribution, and virtually no-one aged under 35 gains.

The only circumstances in which a version of this policy should be considered are if we find that students are being dissuaded by the new fee regime from entering university. Even then, if debts of £46,658 are acting as a deterrent, it is not clear that a debt of £38,622 would greatly improve matters. Since would-be students have not yet been able to apply to university under the new regime we cannot tell whether there will be any disincentive effects from the higher debt levels, or whether they will be outweighed either by students understanding of the returns to education, or by the more progressive repayment system.

Furthermore, the policy is contractionary – banks will be taxed now, in order that former students pay back less, with the reductions in repayments occurring primarily in 25 years time. And insofar as taxes reduce banks capital, the policy will also reduce bank lending. There are therefore good macroeconomic reasons to oppose the policy in current circumstances.

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Appendix: Sensitivity analysis

We noted earlier that instead of assuming that under Labour’s proposal, fees would be £6,000 we could instead assume that fees fell by £3,000, to £5,393.

Appendix table 1 compares the results for the two scenarios

Decile Repayments: Repayments: £6,000 fee £5,393 fee 1 5,791 5,729 2 13,034 12,972 3 17,122 16,975 4 20,503 20,328 5 24,673 24,263 6 28,219 27,310 7 33,772 31,815 8 35,024 32,628 9 35,679 33,218 10 35,872 33,435 Average 24,969 23,867 Write off 9,531 8,383 Gain to govt 4,126 5,275 Gain to student 3,053 4,154

There is no important difference between the two different scenarios. With the lower fee, affluent graduates who repay their loan in full will repay less than they would were fees to be higher. Those in the bottom five deciles are close to unaffected. The proportion of the apparent gain that is illusory is also similar in each case – 57% and 56%. Similarly, the distribution of gains across the income deciles also changes only very slightly. In the £6,000 scenario, 52% of the gains go to the top two deciles, this falls slightly to 50% when the assumed fee falls to £5,393.

An analysis assuming that students take out a maintenance loan of only £3,575 – the amount available to all, irrespective of the wealth of their parents – gives much the same picture. The gains go predominantly to the most successful graduates – in this case with half the gains going to those with lifetime earnings of £1.85m or more.

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About the author

Tim Leunig joined CentreForum in January 2011, from the London School of Economics. As well as his academic work, he has served on the academic advisory board to the Barker Review of Land Use Planning, co-authored a research paper for the Eddington Review on transport and the economy, and has written widely in the press and for think tanks on planning, housing, transport, pensions, university access and economic issues more generally. He is the author of Universities Challenged , for CentreForum, and will shortly be launching a new paper on funding postgraduate education.

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