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June 24, 2011

Exploding the myths about tuition fees - some important facts for 2012 students

The new system of tuition fees and student loans has left many potential students and their parents confused and worried. So it is a good thing that the government has stepped in with a new website, Future Students, to explain how it will all work. It is also good that the popular independent website MoneySavingExpert.com has produced its own guide. Both websites place heavy emphasis on the size of graduates’ monthly repayments, a figure that the ministers David Willetts and Vince Cable also often return to. It is unfortunate therefore that both websites have produced guidance that is badly misleading and, in the case of Future Students, massively underestimates how much graduates will actually have to pay back each month.

Future Students

The government website has a page listing average starting salaries for different careers. Click your career and - bingo! - on the screen pops up a number telling you how much your weekly repayments will be. So if you’re aiming to be an accountant you can see that an average starting salary is £25,000 and that your weekly repayments would be £6.92.

Accountant 25k

Here’s how the government does the calculation.

Government Calculation

The threshold for repayments to begin is £21,000 a year. If you earn less than that, you make no repayment.

Above the threshold, you pay 9 per cent of your salary towards paying off your loan.

So if you start as an accountant earning £25,000, then you are earning £4,000 over the threshold

Of this £4,000, you pay 9 per cent - ie £360 a year

£360 divided by 52 is £6.92. So your weekly payment will be £6.92.

But this calculation mixes up 2010 money and 2015 money. The starting salary of the accountant comes from a survey done last year, 2010[i]. But the threshold of £21,000 only comes into play after you have graduated, in 2015 at the earliest.

Why is that wrong? Because inflation means that money in the future is worth less than money today. The further forward you go, the less the money is worth. And it works in reverse, too. Go back in time and money was worth much more than it is today. For example, in 1867 the USA bought the whole of Alaska for just $7.2 million, which today might buy you one farm.

As we’ll see, when you do the maths you discover that that five year gap makes a big difference.

So how do we get a better picture of what the impact will really be? Economists have a standard way to do it - convert all the figures into today’s, 2011 money. This is the money we are familiar with and have a good feel for. Here’s how to do it.

My Baseline Calculation

We start by converting everything to 2015 money.

Let’s assume that inflation over the next five years follows the trend suggested by the Bank of England and will be 3.5%, 2.1%, 2.0%, 2.0%, 2.0%. This equates to a total inflation over the whole five years 2010-2015 of 12.1 per cent.

Let’s also assume that salaries rise at the same rate.

Then the starting salary of an accountant will have risen by 12.1 per cent by 2015. That is £25,000 * 1.121 = £28,035.

£28,035 - £21,000 = £7,035. This is the amount liable to the 9 per cent levy.

So you would have to repay 9 per cent of £7,035, which is £633 a year, or £12.18 a week - in 2015 money.

Now let’s convert that into today’s 2011 money. Total inflation over the four years 2011-2015 is 9.9 per cent. So the deduction is 12.18 / 1.099 = £11.08 a week in today’s money.

In other words, the weekly deduction is 60 per cent bigger than the £6.92 the government told you it would be - and adds up to £575 a year.

I'm all in favour of simple, rough and ready calculations that get you into the right ball park. But this is not supposed to be a back of the envelope chat down the pub. It is supposed to be the number one authoritative source of guidance to students and parents. And it is a whopping 60 per cent out.

What would losing £575 a year mean to you? No summer holiday? Living in a worse part of town? Skipping treats like eating out? Maybe nothing at all if your parents are wealthy and willing to get out their cheque book. Possibly quite a lot if they aren’t.

Remember, this is not a worst case scenario. It is the government’s own scenario, done right.

Before we carry on, it is worth noting that the government employs literally thousands of economists and statisticians who know how these calculations should be done. It took me 15 minutes to look up the figures and do the arithmetic. The statisticians are scientists and are supposed to be bound by codes of conduct that ensure government publications are valid. But the government has still gone ahead and published this voodoo guidance.

Now, as you may have noticed, our calculations depended on some assumptions we made about what would happen to earnings and inflation in the future. Unfortunately, if those assumptions turn out to be wrong, you could end up spending a lot more cash on your loan.

Let’s look at those assumptions in more detail. There were two of them - for inflation and earnings. Let’s start with inflation.

I took the inflation forecast from the Bank of England’s Inflation Report issued in May 2011. Or rather, I took the first three years from there. The Bank of England does not issue inflation forecasts for more than three years, presumably because, like other forecasters, it thinks long-term inflation forecasts are unreliable. I then tacked on two years at an optimistic 2 per cent because that is what the Bank of England would like it to be.

But even the figures for the first three years are only what the Bank of England calls its “central projection”. Its forecast actually takes the form of a “fan” chart, and looks like this:

Bank of England CPI Forecast Fan Chart as at May 2011


The fan shows the range of possible inflation rates the Bank of England thinks likely. If you look at the dotted line you can see that in March 2013 these vary from under 0 per cent to just over 4.5 per cent.

So let’s see what happens when we use the inflation rates at the top end of the Bank of England’s forecast (and roll them forward for the last two years): 6.0%, 4.6%, 4.7%, 4.7%, 4.7%. This gives a total rate of inflation for the five years 2010-2015 of 27.3 per cent.

My High Inflation Calculation

In this scenario the starting salary of an accountant will have risen by 27.3 per cent by 2015. That is £25,000 * 1.273 = £31,814.

£31,814 - £21,000 = £10,814. This is the amount liable to the repayment levy of 9 per cent.

So you would have to repay 9 per cent of £10,814, which is £973 a year, or £18.72 a week - in 2015 money.

Now convert that into today’s 2011 money. Total inflation over the four years 2011-2015 is 21.5 per cent. So the deducation is 18.72 / 1.215 = £15.40 a week in today’s money.

In other words, if inflation is high, the weekly deduction is more than twice as big as the £6.92 the government told you it would be - and adds up to £800 a year.

Now, there are a several reasons for suspecting that first scenario is likely to underestimate inflation, including the fact that the Bank of England has frequently underestimated future inflation since the credit crunch hit. On the other hand, the second calculation may indeed be a worst case scenario.

Unfortunately, this is not the end of the story, because we still have to consider what might happen to salaries over the next five years.

In the examples above, I have assumed salaries keep pace with inflation. In recent decades (although not since the credit crunch) they have actually tended to outstrip inflation. So let’s assume that they actually rise 1 percentage point a year more than inflation - eg if inflation rises at 2 per cent, then earnings rise at 3 per cent.

Worst case scenario?

In this case the starting salary of an accountant will have risen by 33.4 per cent by 2015. That is £25,000 * 1.334 = £33,359

£33,359 - £21,000 = £12,359. This is the amount liable to the repayment levy.

So you would have to repay 9 per cent of £12,359, which is £1,112 a year, or £21.39 a week - in 2015 money.

Now let’s convert that into today’s 2011 money. Total inflation over the four years 2011-2015 is 26.2 per cent. So the deduction is 21.39 / 1.262 = £16.94 a week in today’s money.

In other words, the weekly deduction is two and a half times as big as the £6.92 the government told you it would be - and adds up to £881 a year.

So 60 per cent out at a conservative estimate. 150 per cent out if things go badly with inflation and salaries. I think in anyone's book that counts as a massive underestimate. And this is the advice the government is giving to students.


Now let's turn to MoneySavingExpert.com. It repeats a similar error to the government website, showing students a page with this table comparing deductions in 2010 (eg £112.50) with deductions in 2015 (£67.50) without dealing with the effects of inflation.

But it also goes further in its list of 20 key "facts", claiming that:

MSE point 7

Here's how it does the calculation.

MoneySavingExpert.com Calculation

Under the new system, someone on £22,000 a year would only just scrape over the threshold of £21,000 and would pay back 9 per cent of £1,000, which is £90.

But current students pay back to the Student Loans Company 9 per cent of everything they earn over £15,000

So someone on £22,000 pays back 9 per cent of £7,000, which is £630.

£630 - £90 is £540. So under the new system, someone on £22,000 a year would be £540 a year better off.

(And by the way, the figure always comes out at £540 whatever salary you start at.)

As well as mixing 2010 and 2015 money, this introduces a new error - it invents a completely fictional government policy. The calculation for the current system relies on the current threshold of £15,000 remaining unchanged in 2015. But doing that has never been a part of any government's policy. The idea that that is somehow "part" of the current system is a myth. But that £540 looks very concrete and convincing, doesn’t it?

Oddly, the website seems to be aware of the problems but hasn't done anything about it. It says: "Some advanced MoneySavers will argue that inflation will eat away some of this gain in disposable income and that's correct." It then goes on: "but even factoring that in, 2012 starters will have substantially more disposable income than 2011 starters."

Disposable income? Nowhere does MoneySavingExpert attempt estimates of disposable income under the new regime. The calculations are all about other things. I'm not going to go there except to say that disposable income would again bring the question of inflation in prices and earnings to the fore. Not to mention the regimes for income tax and national insurance. And whether graduates will indeed have more or less disposable income in 2015 than now depends on even more guesses.


Now, the point of these calculations is not just to illustrate that the government and somebody else have done their sums wrong. It is to illustrate the fact that any forecast of future deductions involves some huge guesses about what will happen to our economy in the future - guesses that no one knows the answer to.

To keep things simple, I have looked only at the one number the government is concentrating on, the size of repayments for graduates starting out on their career. But the other ways of looking at the issue - eg disposable income or the proportion of take home pay going on loan repayments - also show potentially huge variations.

We could go deeper into the modelling and think about repayments for people later in their career. Or take into account possible changes in rates of income tax and national insurance. But the main lesson from making the modelling more sophisticated is that the uncertainty increases with each new factor you add.

So when the government (or anyone else) creates a website that, at the click of a button, shows you how much you “will” be paying back in five years time, it obscures one of the distinctive features of the new system - that your repayments, and the impact on your life, are in fact quite uncertain.

Thank heavens we got a new task force this week devoted to tackling "the myths and misunderstandings – good or bad – about the true cost of university education under the new 2012 system". Oh hang on. That's the one cheered on by the government and led by... MoneySavingExpert.com's founder, Martin Lewis.


Just in case there are any 17 year olds reading this, and because the tone is all so negative, I'd like to add some of my own tips for potential students to the mix:

  • The new system probably will cost you more than your predecessors, especially in your 40s and 50s.
  • But just because university is now a worse deal than in the past does not mean it is a bad deal. Most of the good jobs out there are reserved for graduates.
  • Provided it keeps the promises made by ministers, the system planned by the government eliminates the most worrying aspects of a big debt. The debt can't balloon out of control and the repayments can't drive you into poverty. Even though you will feel the pinch, the repayments will always be affordable.
  • University is about much, much more than just how much you'll earn and how much you'll pay back.


Further reading Since writing this I've been alerted to this article by the philosopher Andrew McGettigan, which also cautions against neglecting the uncertainties in the scheme and points out some problems he has had with MoneySavingExpert.com. Importantly, to the risks from inflation, he adds a political risk - that the government could change the rules of the game after students have signed up for their loans and require them to make higher repayments than it has promised.

Update 26 June Martin Lewis has been in touch to clarify the distinction between the task force and the government (which I've reflected by slightly revising the final paragraph) and to promise to make some changes to his website to handle the inflation issues.

[i] The salary figures used at http://yourfuture.direct.gov.uk/calculate come from the AGR
Graduate Recruitment Survey 2011 Winter Review, which was carried out in November 2010. http://www.agr.org.uk/UserAccount/RoadBlock.aspx?contentid=1187&redirect=http://www.agr.org.uk:80/DisplayContent.aspx?id=1187&monetised=False&viewable=2


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Very nice analysis. But I guess you miss one thing-- inflation will also erode the "value" of the amount you're repaying. So the government site says £360 of £25000, or 1.44% of (gross) salary. Your analysis (the 1st one) says £575 of £28035, or 2.05% of salary. That's still bad on the government, but not as bad as the jump of 360 -> 575 would suggest (it's more like 360 -> 513, converted back to today's money).

Ish, I think, Doormat. I take your point. But I've spent 2,000 words just looking at the measure the two websites have chosen to highlight. If we start to look at other measures, then those also need to be thought through. Is percentage of gross salary really the right thing? What about net? What about disposable income? What are we trying to explain to students and why are we choosing that particular indicator? Those questions still need a lot of discussion.

Nice try.....but the earnings limit is being upgraded by RPI each year.

So no cigar with this story I'm afraid.

It would have been a great story if there were no upgrades which is why I called the BIS to check. But they are upgrading the earnings limit......

Tim, youre confused. The £21k threshold will be £21k in 2016. AFTER THAT, it will be uprated. Not before. Hence my reasoning stands.

Sent from my phone

Tim Worstall in wrong about something (that isn't scandium, to be fair) shocker.

Your article is extremely impressive.

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