Policy Note Paying off HELP debts: case studies. August 2014

Policy Note Paying off HELP debts: case studies August 214

Policy Note Paying off HELP debts: case studies Key Points This note has demonstrated how HELP repayment is affected by labour market outcomes using case studies of graduates earning above, at and below the average for their age. How long a graduate will take to repay their debt is dependent on their income. Graduates with higher incomes will take less time to repay their debts than graduates on lower income. Safety valves exist to protect lower income graduates. Lower income graduates may not make any repayments for a number of years and then do so at much lower rates. The imposition of a real interest rate on HELP debts will see lower-earning graduates pay more in interest costs. In some cases the interest costs borne by lower-earning graduates are double that of higher-earning graduates. Applying a surcharge to university fees would equalise interest costs across all graduates, regardless of income, and thereby remove the regressive aspects of a real interest rate. The Government s proposals to deregulate university fees and introduce a real interest rate on debts accrued through the Higher Education Loan Program (HELP) have been a source of contention since they were proposed in the 214 Commonwealth Budget. The key concerns about the reforms regard their potentially regressive impacts. While most of the analyses that emerged since the 214 Budget focussed on the impacts of the reforms, 1 Chapman and Higgins 2 provided an assessment of alternative options that the Government could pursue. These being: a hybrid model based on the current English income contingent loan interest rate arrangements, which indexes loans in line with the CPI when debtors incomes are below the first threshold of repayment of the debt, and with the bond rate when debtors incomes are above the first threshold of repayment of the debt; and the application of a loan surcharge, assumed to be 25 per cent of the debt, after which the outstanding principal is indexed to the CPI. This paper compares how graduate outcomes, measured in terms of the payback period and interest cost, are affected by different income trajectories. This is achieved using case studies that based on data from the 211 Census. Modelling the impact of higher education reform The results of any modelling exercise can vary widely depending on the assumptions and methodologies employed. The key assumptions and parameters employed for this exercise are listed in Table 1. 1 See for example: NTEU (214), A 1st degree shouldn t cost a 2nd mortgage, Budget 214 Analysis, available at: http:// www.nteu.org.au/library/view/id/5161; http://www.whatwillmydegreecost.com.au/more; Universities Australia (214), The Impact of Changes to HELP Design on Students, available at: https://www.universitiesaustralia.edu.au/news/submissionsand-reports/the-impact-of-changes-to-help-design-on-students/the-impact-of-changes-to-help-design-on-students#. U882B_mSwxQ; and Alper, J. and Smyth, D. (214), The Cost of a University Degree Before/After Deregulation, available at: https://maths-people.anu.edu.au/~alperj/deregulation/model.pdf 2 Chapman, B. and Higgins, T. (214), HELP Interest Rate Options: Equity and Costs, available at: http://images.theage.com. au/file/214/7/31/5639573/help_interest_rate_options_report.pdf page 2

A key difference between this analysis and others in the public realm is that the figures reported here are in real 214$. Presenting the results in real, rather than nominal, terms removes the effects of inflation allows for the impacts of the policy change to be isolated. Nominal values, which are affected by inflation, tend to exaggerate total degree costs. 3 Table 1 Key modelling assumptions Item Assumption Real or nominal All values expressed in real 214$. Degree cost The mid-point between the amount necessary to break-even following the proposed reduction in the Commonwealth s contribution; and the average fee charged to an international student, less the Commonwealth s contribution. Reflecting recent developments, it is assumed that the current structure of funding clusters will be retained, and the reduction in Commonwealth funding will be 2 per cent across all fields. This differs from the proposals in the 214 Budget. Bond rate A nominal rate of 4. per cent, which is the equivalent of a 1.4 per cent real interest charge. Lifetime earnings Derived from the 211 Census for full time workers with a Bachelor degree. 4 Payback period HELP design The number of years required to clear debt after a student graduates. Three options: Bond rate HELP debts accumulate interest at the bond rate; Hybrid HELP debts accumulate interest at CPI while below the repayment threshold 5 and at the bond rate thereafter; and Surcharge Tuition fees attract a surcharge of 25 per cent and HELP debts accumulate interest at CPI. Alice, Billy and Cathy Forming the basis of the case studies are three hypothetical students. The students are the same in all respects except in regards to their earnings. The students are: Alice who is a top performer and earns an income equal to the top quintile for her age amongst those with the same qualification; Billy who earns the average income for graduates at his age with the same qualification; and Cathy who earns an income below the mean for graduates of her age with the same qualification but greater than 4 per cent of graduates. 6 Exactly how much each of the students can be expected to earn in both relative and absolute terms will depend on the course they study. As a guide however, the relative positions of Alice, Billy and Cathy can be seen in the figure below, which plots the income distribution of graduates from all disciplines, aged 3-35. It is assumed that the graduates remain at their relative positions throughout their working lives. 7 3 Year on year increases in the general price level caused by inflation decreases the purchasing power of a dollar over time. For example, $1, in 1 years time can be expected to purchase the same amount of goods as $78 would today (assuming an inflation rate of 2.5 per cent). 4 See https://go8.edu.au/publication/understanding-graduate-earnings 5 Note that in the Chapman Higgins paper, the bond rate is triggered at the second repayment threshold, when the graduate repays at a rate of 4. per cent. Our approach adopts a consistent assumption. 6 While gender will have an impact on expected earnings, incomes are for the purposes of this exercise, gender neutral. The data extracted from the Census refers to all persons. 7 All values are expressed in real 214$. This allows for the analysis to isolate the impacts of the proposed reforms from the effects of inflation. It is assumed that HELP debts accrue interest at a rate of 4. per cent. page 3

Figure 1 Average graduate Income distribution, ages 3-35 Cumulative Per cent 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % Alice Billy Cathy 2 4 6 8 1 12 14 Income Bachelor of Commerce In a deregulated market, competitive pressures will see universities distributed along a range of price points, just as has occurred in the markets for international students and for fee paying masters programs. How much a degree will cost will be institution and subject specific. Following the approach that has been employed elsewhere, 8 it is reasonable to expect that the cost of degree will fall within: the amount necessary to break-even following a 2 per cent reduction in the Commonwealth s contribution; and the average fee charged to an international student, less the Commonwealth s contribution. For the purposes of this exercise, we can assume that the average cost of a three year commerce degree is equal to the midpoint of these two bounds, approximately $45,747. It is worth noting that Torrens University Australia a newly established, for-profit university based in Adelaide has recently announced its proposed fees for their Bachelor of Commerce degree. Torrens University Australia will charge students $2,4 per unit, with a total program cost of $57,6. This is above our midpoint estimate for a commerce degree. HELP repayments are proportional to income. The pace of repayment is therefore dependent on the how much a graduate earns. A graduate with a low income, will make only small repayments, and take longer to repay their debt. Indeed, if incomes are sufficiently low, then the graduate may make no repayments at all. In the 214 Budget, the Government proposed a new repayment schedule to begin in 216. The new schedule would require repayment once an individual s income reached $5, (this is equivalent to approximately $47,59 in 214$). The income profiles for Alice, Billy and Cathy are reported in Figure 2. For comparison, the income profile for someone without post-secondary qualifications is also included. Both Alice and Billy earn incomes above the repayment threshold from year 1. It takes Cathy until year 5 however, before the repayment threshold is triggered. Until then, Cathy is not required to make any repayments. 8 This is the approached adopted by both Alper and Smyth (214) and Universities Australia (214). page 4

Figure 2 Commerce graduate lifetime earning profiles Figure 2 Commerce graduate lifetime earning profiles 14 12 Annual income, 214$ 1 8 6 4 2 21 22 23 24 25 26 27 28 29 3 31 32 33 34 35 36 37 38 39 4 41 Based on these income profiles, the graduates make repayments subject to requirements under the HELP Based repayment on these thresholds. income Alice s, profiles, Billy s and the Cathy s graduates repayments make repayments under the three subject scenarios to requirements are discussed below. under the HELP repayment thresholds. Alice s, Billy s and Cathy s repayments under the three scenarios are discussed below. Alice First, as can be seen in Figure 3, the differences between the scenarios for graduates like Alice are only very Alice subtle. Alice spends most of her career above the repayment threshold, so there is little difference between the First, repayments as can under be seen the Bond in Figure Rate 3, and the Hybrid differences scenarios. between The exceptions the scenarios being that: for Alice s graduates HELP like debt Alice does are not only accrue very (real) subtle. interest Alice while spends she is studying; most of no her repayment career above is required the repayment in her first year threshold, of work (the so Hybrid there is scenario little assumes a higher repayment threshold); and she is able to pay off her debts slightly faster. Despite being a more difference between the repayments under the Bond Rate and Hybrid scenarios. The exceptions generous model, Alice s total repayments are reduced by only about 4 per cent when compared to the Bond Rate being scenario. that: Alice s HELP debt does not accrue (real) interest while she is studying; no repayment is required in her first year of work (the Hybrid scenario assumes a higher repayment threshold); and Under the Surcharge scenario, the Alice s repayments reduced (in total) because her debt is indexed to CPI. Her she repayments is able to increase pay off however, her debts because slightly of the faster. Surcharge Despite levied being on the a more tuition generous fees. The net model, effect, Alice s is an increase total in repayments total are of reduced around 1 by per only cent about (relative 4 per to cent the Bond when Rate compared scenario). to the Bond Rate scenario. Under the Surcharge scenario, the Alice s repayments reduced (in total) because her debt is indexed to CPI. Her repayments increase however, because of the Surcharge levied on the tuition fees. The Figure 3 Commerce graduate HELP repayments Alice Figure 3 Commerce graduate HELP repayments Alice net effect, 1 is an increase in total repayments of around 1 per cent (relative to the Bond Rate 9 scenario). Annual repayments, 214$ 8 7 6 5 4 3 2 1 Alice Billy Cathy Yr 12 21 22 23 24 25 26 27 28 29 3 31 32 33 34 35 36 37 38 39 4 41 42 43 44 45 Age Bond rate Hybrid Surcharge Alice s payback period is roughly the same under each scenario. It takes her the most time to repay 4 page 5

Alice s payback period is roughly the same under each scenario. It takes her the most time to repay her debt under the Surcharge scenario (11.7 years), which is almost a full year longer than would be Alice s payback period is roughly the same under each scenario. It takes her the most time to repay her debt under required the Surcharge under scenario the Hybrid (11.7 years), model. which is almost a full year longer than would be required under the Hybrid model. Billy Turning our attention now to Billy, whose salary is commensurate with the average commerce graduate. Billy Turning In all scenarios, our attention Billy now takes to Billy, longer whose to repay salary his commensurate loan than did with Alice. the This average is a commerce function of graduate. the HELP scheme s In all scenarios, progressiveness. Billy takes longer Again to repay the scenario his loan than with did the Alice. longest This is payback a function period of the is HELP the scheme s Surcharge at progressiveness. 14.8 years. The Again payback the scenario period for with the the Hybrid longest scenario payback period is the shortest is the Surcharge at 14. at years; 14.8 years. and the The payback period for the Hybrid scenario is the shortest at 14. years; and the payback period for the Bond Rate scenario is period for the Bond Rate scenario is 14.2 years. Notably, Billy makes no repayments in the first two 14.2 years. Notably, Billy makes no repayments in the first two years of employment. years of employment. Figure 44 Commerce Commerce graduate graduate HELP HELP repayments repayments Billy Billy Annual repayments, 214$ 1 9 8 7 6 5 4 3 2 1 21 22 23 24 25 26 27 28 29 3 31 32 33 34 35 36 37 38 39 4 41 42 43 44 45 Age Bond rate Hybrid Surcharge Stretching repayment over a longer period of time has an impact on the relative differences between the scenarios. The Hybrid model is more generous for Billy than it was for Alice, providing a 5 per cent reduction in total repayments. The Surcharge, while still more costly than the Bond Rate, is less punitive than was the case for Alice, increasing total repayments by 7 per cent. 5 Cathy Finally, Figure 5 reports how Cathy, our below average graduate, is affected by the three scenarios. Cathy does not earn above the repayment threshold until she is 25 so for the first four years of employment, she is not required to make any repayments. (She makes no repayments for six years under the Hybrid scenario.) Because she earns less than Alice and Billy, she pays off her debt in smaller amounts and as a result takes longer to repay off the debt in full. Cathy s average annual repayments are about $2,67, whereas Alice and Billy pay $4,54 and $3,57 respectively. It takes her about 2 years to pay off her debt under each of the scenarios. As we saw with Billy, the Hybrid and Surcharge become more attractive options. She would pay 11 per cent less under the Hybrid scheme. page 6

As we saw with Billy, the Hybrid and Surcharge become more attractive options. In fact, under the Surcharge, Cathy would pay about 1 per cent less than under the Bond Rate scenario. She would pay 11 per cent less under the Hybrid scheme. Figure 55 Commerce Commerce graduate graduate HELP HELP repayments repayments Cathy Cathy Annual repayments, 214$ 1 9 8 7 6 5 4 3 2 1 21 22 23 24 25 26 27 28 29 3 31 32 33 34 35 36 37 38 39 4 41 42 43 44 45 Age Bond rate Hybrid Surcharge It should be noted that compared to Alice, Cathy pays more in total under each of the schemes except the It surcharge. should be Both noted the Bond that compared Rate and Hybrid to Alice, models Cathy apply pays a real more interest total rate and under as such each penalise of the schemes those who take longer to repay their debts. except the surcharge. Both the Bond Rate and Hybrid models apply a real interest rate and as such penalise those who take longer to repay their debts. Time out of the workforce Time out of the workforce Taking time off work for, say, family or health reasons, will clearly have an impact on how much a graduate pays off Taking their debt, time the off amount work time for, say, required family to pay or health off the reasons, debt and the will total clearly interest have paid. an impact on how much a graduate pays off their debt, the amount time required to pay off the debt and the total interest Scenario modelling around part time employment however, is highly dependent on the assumptions employed for paid. that particular scenario. This includes: how much time is taken off; when the time is taken; and how the worker will transition back into the workforce. For example, consider the differences between recent modelling by Universities Scenario Australia (UA) modelling and the around National part Tertiary time Education employment Union however, (NTEU). is highly dependent on the assumptions employed for that particular scenario. This includes: how much time is taken off; when the time is UA assessed a scenario in which a graduate worked part time at.5 full time equivalent (FTE) for six years after six years of working full time, before returning full time. 6 The NTEU considered a scenario in which a graduate takes a break of eight years and then transitions back to work over another three years (first working.4 FTE then.6 FTE). Indeed, because scenarios are so experience specific, it is difficult to generalise about how the policy will affect a part time worker. That said, we can say the following. For those years spent out of the workforce (or earning below the repayment threshold), graduates will not be required to make any repayments on their HELP debt. Each year spent out of the workforce (or earning below the repayment threshold) will add at least one year to the payback period. The amount of interest that accumulates each year depends on how much HELP debt a graduate has accrued. In real terms, a debt of $1, attracts around $14 (assuming the long term bond yield is 4 per cent). As a rule of thumb, graduates can expect their HELP debts to grow by around $4 per annum due to interest costs. page 7

Based on the assumptions of the UA scenario, it can be expected that a graduate would take at least an additional six years to repay their HELP debt and incur additional interest costs of around $2,4. And under the assumptions of the NTEU scenario, the payback period would increase by at least 11 years and incur additional interest costs of $4,4. 9 Summary Differences in the time to payback a HELP loan are ultimately determined by differences in lifetime earnings. Under each of the scenarios, Alice takes less time to pay back her loan than do Billy and Cathy. In the presence of a real interest rate, the longer it takes a graduate to payback their loan, the more they will pay in interest costs. HELP has in-built safety valves that protect those on lower incomes and ensure repayments are not overly burdensome. In the Bond Rate example, Cathy takes an extra 9.5 years to repay her debt, however she is not required to make any repayments for the first four years of her career. Moreover, the rate at which she repays, $2,734 a year, is substantially less than that of Alice s, $4,321. Even graduates who take time out of the workforce are protected as repayments are not required while ever a graduate s earnings are below the repayment threshold. For Alice and Billy especially (but also Cathy), there is little real difference between the Bond Rate and Hybrid scenarios. While ever a graduate is above the income threshold, differences between the two schemes are indistinguishable. It is not clear that at 25 per cent, the surcharge is revenue equivalent with the Bond Rate. (Revenue equivalence could however, be approximated.) Nonetheless, the effects of the Surcharge are clear: a surcharge would equalise interest costs across all graduates and remove regressive aspects of a real interest rate. Under the surcharge the total repayments made by Alice would be the same as made by Cathy and the Government would still recoup the costs of the interest rate subsidy. These results are summarised in the table below. Table 2 Commerce graduate summary results Graduate Income assumption Tuition fee Payback period Years before first payment Average annual HELP repayment Total interest paid 214$ Years Years 214$ 214$ Bond rate Alice 8th 45,747 11.1 Payback 4,321 4,817 Billy Mean 45,747 14.2 Payback 3,546 6,173 Cathy 4th 45,747 2.6 4 2,734 1,411 Hybrid Alice 8th 45,747 1.9 1 4,52 4,92 Billy Mean 45,747 14. 2 3,359 4,645 Cathy 4th 45,747 19.8 6 2,547 5,253 Surcharge Alice 8th 45,747 11.7 Payback 4,765 11,437* Billy Mean 45,747 14.8 Payback 3,812 11,437* Cathy 4th 45,747 2.6 4 2,723 11,437* * Paid as a surcharge, added to principal Appendixes A and B provide a similar analysis for graduates with degrees in Science and Law respectively. 9 UA and NTEU employed different methodologies which impact on their estimates. As estimated by UA, taking time out of work would add 8 years to the payback period and increase interest costs by 54 per cent. Similarly, the NTEU estimated 13 years would be added to the payback period and interest costs increased by 88 per cent. page 8

Appendix A Bachelor of Science Suppose instead that our three graduates chose to undertake a Bachelor of Science. The midpoint Appendix between the breakeven A Bachelor and the average of international Sciencefee for a three year science degree is about Suppose $52,27. instead that our three graduates chose to undertake a Bachelor of Science. The midpoint between the breakeven and the average international fee for a three year science degree is about $33,343. On the whole, incomes incomes for for science science graduates graduates are lower are lower than for than commerce for commerce graduates, graduates, however science however graduates earn science slightly graduates more in the earn first slightly few years. more The in profiles the first of few the graduate s years. The incomes profiles would of the be graduate s as depicted incomes Figure 6. As would with be the as commerce depicted degree, in Figure Alice 6. and As with Billy trigger the commerce the income degree, threshold Alice in their and first Billy year trigger of work; the but income again Cathy does not trigger the threshold until year 5. threshold in their first year of work; but again Cathy does not trigger the threshold until year 5. Figure 6 Science graduate lifetime earning profiles Figure 6 Science graduate lifetime earning profiles 14 12 Annual income, 214$ 1 8 6 4 2 21 22 23 24 25 26 27 28 29 3 31 32 33 34 35 36 37 38 39 4 41 Source: Go8 analysis of 211 of 211 Census data. data. Graduates make repayments in line with line with these these profiles. profiles. The payback The payback period and period interest and costs interest for science costs for graduates science graduates under each under of the each scenarios of the are scenarios summarised are in summarised Table 3. in Table 3. Table 3 Science graduate summary results results Alice Billy Cathy Yr 12 Average Total interest paid 214$ Years Years 214$ 214$ Graduate Income Tuition fee Payback Years Average Total Income Payback Years before annual HELP Graduate assumption Tuition fee period before first payment first repayment annual interest payment HELP paid Bond rate repayment 214$ Years Payback Years 214$ Alice 8th 33,343 9.1 Bond rate 214$ Alice 8 th 52,27 12.1 Payback 4,444 5,521 Billy Mean 33,343 11.6 Billy Mean 52,27 15.6 Payback 3,722 7,329 Hybrid Cathy 4 th 52,27 24.3 Payback Alice 8th 33,343 9. 4 2,617 13,17 Hybrid Alice 8 th 52,27 12.1 Payback 4,444 5,521 Surcharge Billy Mean 52,27 15.7 Payback Alice 8th 33,343 9.9 1 3,678 6,627 Cathy 4 th 52,27 23.5 6 2,49 7,519 Billy Mean 33,343 12.3 3,59 2,556 3,65 3,436 Cathy 4th 33,343 18.4 4 2,14 6,628 3,982 2,495 Billy Mean 33,343 11.5 1 3,17 2,865 Cathy 4th 33,343 17.7 6 2,25 3,1 Payback 4,17 8,358* 3,28 8,358* Cathy 4th 33,343 18.6 4 2,195 8,358* * Paid as a surcharge, added to principal 9 page 9

Appendix B Bachelor of Laws Appendix B Bachelor of Laws Finally, suppose our graduates chose to undertake a four year Bachelor of Laws. The midpoint between Finally, suppose the breakeven our graduates and chose the average to undertake international a four year fee Bachelor for a of four Laws. year The law midpoint degree between is about the breakeven and the average international fee for a four year law degree is about $65,417. $65,417. Alice and Billy trigger the income threshold in their first year of work, starting on salaries of $59, and $51, Alice respectively and Billy (see trigger Figure 7). the Cathy income can expect threshold to trigger in their the first threshold year of in year work, 3. starting on salaries of $59, and $51, respectively (see Figure 7). Cathy can expect to trigger the threshold in year 3. Figure 7 Law graduate lifetime earning profiles Figure 7 Law graduate lifetime earning profiles 14 12 Annual income, 214$ 1 8 6 4 2 21 22 23 24 25 26 27 28 29 3 31 32 33 34 35 36 37 38 39 4 41 Graduates make repayments in line line with with these these profiles. profiles. The payback The payback period and period interest and costs interest for law costs graduates for under each of the scenarios are summarised in Table 3. law graduates under each of the scenarios are summarised in Table 3. Table 4 Law graduate summary results results Alice Billy Cathy Yr 12 Average Graduate Income Tuition fee Payback Years Average Total Income Payback Years before annual HELP Total interest Graduate assumption Tuition fee period before first payment first repayment annual interest paid 214$ Years payment Years HELP 214$ paid 214$ Bond rate repayment Alice 8th 214$ 65,417 Years 11.3 Years 214$ 5,533 214$ 6,55 Bond Billy rate Mean 65,417 13.6 4,93 8,2 Alice Cathy 8 th 4th 65,417 65,417 11.3 17.6 2 5,533 5,641 6,55 11,533 Hybrid Billy Alice Mean 8th 65,417 65,417 13.6 11.3 4,93 5,533 8,2 6,55 Cathy 4 th 65,417 17.6 2 5,641 11,533 Billy Mean 65,417 13.6 1 4,839 7,247 Cathy 4th 65,417 17.3 3 4,936 8,75 Hybrid Surcharge Alice 8 th 65,417 11.3 5,533 6,55 Alice 8th 65,417 12.1 5,641 16,354* Billy Mean 65,417 14.2 3,866 16,354* Billy Mean 65,417 13.6 1 4,839 7,247 Cathy 4th 65,417 17.8 2 4,156 16,354* Cathy 4 th 65,417 17.3 3 4,936 8,75 * Paid as a surcharge, added to principal Surcharge Alice 8 th 65,417 12.1 5,641 1,92* 11 page 1