Vince Cable right to abandon penalties on early student loan repayments – Tim Leunig
Vince Cable has done the right thing, for the right reasons.
The new student loan system requires well off graduates to pay a higher rate of interest on their loans – up to three percent above inflation. This helps to cover the government losses on loans to graduates who end up on low incomes – overwhelmingly women working part time after having children – as well as making the system more progressive.
Cable was worried that well off graduates would pay off their loan early, to avoid paying the interest charges. He commissioned his department to look into creating early repayment penalties. As the consultation said:
We are committed to the progressive nature of the repayment mechanism. It is therefore important that those on the highest incomes after graduation are not able unfairly to buy themselves out of this progressive mechanism by paying off their loans early.
Having looked at the evidence, the government has decided not to proceed. That is the right decision.
Surprisingly, people who make additional early repayments are not, typically, well off. The average person making an early repayment is aged 25 and earns less than £20,000 a year. The average repayment is £900. These people repay because they don’t like being in debt. Once in a while they find that they have £500 or £1000 spare and decide to pay off some of their student debt. To penalise these people would be bizarre.
The government could have applied the repayment penalty only to those earning (say) more than £40,000 a year. But a penalty like that would have affected only a small minority of borrowers. It would have been gesture politics. In any case, a rich person faced with paying interest at three percent above inflation every year, or a one off charge of five percent would still choose to repay. The penalty would raise little money and fail to change behaviour.
Finally, a penalty would have sent out a bizarre signal – that the government wanted people to stay in debt, so that it could make money from them. It is hard to see that as ethical, or in keeping with Cable’s long standing belief that debt has been too big a feature of the economy.
On this occasion, ministers consulted, looked at the evidence, and made the right decision. Wouldn’t it be great if they always behaved like that?
Tim Leunig is chief economist at CentreForum and co-author of the report Early repayment of student loans: should government impose early repayment penalties. This blog article originally appeared on Liberal Democrat Voice.