Universities Challenged: Funding Higher Education Through a Free-Market 'Graduate Tax'

Abstract

Levy on graduate earnings should replace state funding of universities Although graduates tend, on average, to earn more than non-graduates, the ‘graduate premium’ varies greatly by subject and by year of graduation. It also varies significantly between individuals. There is considerable uncertainty about how the graduate premium will evolve for the coming generation of students given rapid technological change and its impact on the labour market. The current student loans system is very badly designed. It is arbitrary; graduates who earn around £40,000 a year pay the highest amount as a proportion of their income while very-high earners pay much less. Furthermore, loans are forgiven, at substantial cost to the government, even if they could be repaid at a later date. Following the suggestion of Milton Friedman in 1962, higher education would best be paid for by an earnings-linked levy. This is the rationale for suggestions for a graduate tax. However, a tax is received by government, leading to many disadvantages which can be wholly overcome by a private scheme where payments are made directly to the university. Universities should individually or collectively offer contracts to their students, who would agree to pay to the university they attended a given percentage of their earnings. That percentage could vary by course and institution, though some agreement between universities could be helpful to achieve standardisation. Essentially, the university would be taking an equity interest in the graduate premium earned by the student, although any student who chose to do so could, alternatively, pay the full fees up-front prior to beginning their studies. If universities needed additional cash to finance their current expenditures, they could sell their rights to the graduate equity income stream through a securitisation mechanism. With or without securitisation, the risk of obtaining a low graduate premium will be reduced for students and be minimal for universities as their exposure will be diversified across many students. This approach will ensure that universities have a much stronger interest in the employability of their graduates. That interest will continue after graduation. As such, universities will have an incentive to invest in careers advice and related services and in continuing to provide such services after graduation. Given that universities would have entirely independent funding streams, they could be released from all regulation of undergraduate courses. Furthermore, they would be free to innovate, develop cheaper part-time courses using online provision, and so on. There would be competition between universities. However, competition would lead to a ‘race to the top’ and not a ‘race to the bottom’ because universities would have a direct economic interest in the success of their students. Private universities could therefore safely be allowed to participate in the scheme without the risks that have arisen in the US where government subsidy has led to moral hazard and poor-quality courses at some institutions. The current student loans scheme would be entirely abolished. Central or local government could, however, provide some funding to individuals to take courses in order to pursue wider objectives of government policy in relation to higher education. Some tuition-fee funding schemes have already been developed with the key elements described in this paper. It would therefore appear that the proposals are viable in practice.