Brian Fallow: Loans bribe under scrutiny

"I know it's a bribe," said a debt-laden colleague of Labour's student loan policy, "but I'll take it anyway."

If that reaction is typical, the policy may well prove electorally effective.

But it would also wrap extra explosive around a bomb ticking away in the Government's accounts.

Student loans are recorded as an asset in the Government's balance sheet, worth $6.6 billion at June 30.

But that figure already significantly overstates the value of the asset, and the gap between face value and fair value would only widen if Labour's policy of scrapping interest for non-emigrating student debtors is adopted.

National Party finance spokesman John Key has done the sums on the difference between what $6.6 billion, repaid over eight years (the median duration of a student loan), is worth if interest accrues at 7 per cent and what it is worth if no interest is payable.

At 7 per cent, the Government would get back $8.84 billion over the eight years, or $2.24 billion more than if the interest was nil.

In net present value (NPV) terms, the loan portfolio is worth only $4.93 billion in the interest-free case, $1.7 billion less than its face value.

"It amounts to a $1.7 billion transfer of wealth from taxpayers to students and that's before factoring the increased borrowing which will occur," said Key.

But Finance Minister Michael Cullen is unapologetic about that.

"We remain comfortable the principle that there should be some sharing of the cost of study between the individual and the taxpayer is still a sound one. After all, graduates draw significant benefit from their qualifications and the community draws significant benefit from having high rates of tertiary education," he said on Tuesday.

"It is a question of balance, and what many people have been telling us is that the burden was tipped too far towards imposing costs on individual students and their families, bringing the unwelcome effects of large amounts of student debt."

When International Financial Reporting Standards come into force in 2007 the Government will have to write down the student loans on its books to fair value.

The adjustment, which will also take a bite out of the Government's operating surplus that year, is likely to be more than $1.7 billion. The last Budget forecast that by June 2007 student loans would have increased by another $1.2 billion to $7.8 billion.

And that is without any increased uptake of loans arising from Labour's recently announced policy.

But much of the $1.7 billion, in fact most of it, cannot be laid at the door of that policy.

This is because the existing $6.6 billion in student debt does not earn in practice anything like the 7 per cent interest nominally charged.

The loan scheme's most recent annual report estimates that the effective interest rate for the 2004-2005 year would be only 2.8 per cent. The effective rate is the amount of interest actually received divided by the total debt.

Most of the interest which accrues is already written off mainly because of the policy, in place since 2000, of making the loans interest-free while borrowers are still studying.

In the 2003-2004 year, only 40 per cent of the interest which would have been paid if all the debt was earning 7 per cent was in fact paid - $204 million instead of $503 million.

But even using that 40 per cent ratio, the NPV value of the subsidy Labour proposes would be about $680 million.

The loan scheme's annual report tries to estimate its fair value under the existing rules. It reckons a buyer of its loan portfolio would pay 84c in the dollar of the face value.

National's argument is that that should be revised down to about 75c in the dollar, if the policy of entirely interest-free loans goes ahead. The cost to the taxpayer of every $1 billion increase in loans would be around $250 million.

Which leads one to wonder what the rationale of the policy is.

The Government says it is to make tertiary education more affordable and to encourage people to stay in New Zealand at the end of their studies.

But if the intention is to increase the taxpayer support to tertiary students, why limit it to those who take out loans? Why not just increase the subsidy to tuition fees?

The policy does not make life easier for students, who already pay no interest on their loans, only for ex-students.

And it does not do even that up-front. As soon as their income exceeds a relatively low threshold, now $16,600, they have to pay 10 per cent of their income above that threshold towards their student loan. In other words, they face a 10 percentage points increase in their effective marginal tax rate.

Labour's proposal does not change that. It just means that that money all goes towards reducing the principal of the debt, not paying interest on it, so that the repayment period will be shorter.

The interest-free concession is only available to borrowers who remain in the country.

But it is a moot point how much of a factor student debt is in the brain drain compared with the traditional drivers of OE and the gap which has opened up between New Zealand incomes and those overseas.

Only 25,000 of the 445,000 people with student loans are overseas.

In any case, it is not clear how a policy which makes no difference to the cashflow impact of loan repayments in the early years would encourage people to stay.

Cullen reminds us that the centrepiece of his Budget was the KiwiSaver scheme, designed to encourage savings.

The student loans policy, by contrast, encourages borrowing by introducing students to a world - cruelly unlike the real one - in which credit is free.

The Government has contemptuously brushed aside economists' warnings that making the loans interest-free will encourage students to maximise their borrowing under the scheme and minimise repayments.

It says the additional uptake was modest when the loans were made interest-free while borrowers are still studying and it extrapolates from that.

Price, we are asked to believe, doesn't matter. But if that were true, there would not be much of a case for a carbon tax.