Comment & Analysis
May 19, 2017

Income-Contingent Loans Would be a Risky Course of Action for Ireland

Dr Charles Larkin outlines his research, demonstrating the risks an income-contingent loan scheme would have for Ireland.

Charles LarkinOp-ed Contributor
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Sinéad Baker for The University Times

The work done by Peter Cassells and his team, supported by Dr Aedín Doris of Maynooth University and Prof Bruce Chapman of the Australian National University, did an excellent job of highlighting the challenges facing higher education. The sector is in crisis due to several years of budget cuts and asset sweating.

It is well established that the staff-student ratio has deteriorated, and this is having an impact on rankings and on the quality of education.

The economic reasoning for subsidising higher education, and education generally, is related to the idea of human capital and economic growth. Education is beneficial to the economy since it improves human capital and that therefore increases productivity. Productivity is what drives economic growth and improves material welfare.

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The education system has both public and private returns, and as a student progresses through the education levels private returns dominate. But education is also beneficial to society. Work performed in the US by Prof Walter McMahon of the University of Illinois and recent work by the Growing Up In Ireland project highlights that there are distinct public benefits for educating people up to the end of a primary degree, especially for the primary caregiver of children.

Our findings show that 61.5 per cent of the loans would be estimated to be junk status, therefore 38.5 per cent are investment grade

Based on research by myself and Dr Shaen Corbet of Dublin City University (DCU) and evidence from countries that have implemented income-contingent loans, our view is that such a loan scheme would be a risky course of action for Ireland. It has the potential to create large contingent liabilities for the exchequer. Such an approach would not rectify the resource per student issue without abandoning fiscal prudence and cannot solve the €5.5 billion capital expenditure deficit. The government would need to propose substantial legislative changes leading to the creation of an arm’s-length loan company and loan recovery regulation.

In the final analysis, you need money to pay for universities. Traditionally that revenue has come from the following sources: tuition fees, state grants in aid, endowment income, religious organisations, ground rents/real estate, commercial ventures/sale of intellectual property or earmarked revenue – ie directly assigned ad valorem tax or local taxation revenue.

Our findings show that 61.5 per cent of the loans would be estimated to be junk status, therefore 38.5 per cent are investment grade. Twenty-one per cent of the loans based upon the estimated data are found to be in the lower spectrum of junk status, denoted as either speculative or possessing extreme default risk.

The parameters required to create a window of effectiveness for an income-contingent loan scheme in Ireland are:

• Default rates below 15 per cent

• A minimum payment cap of €2,250 per year

•An interest rate of seven to eight per cent over the baseline sovereign

• In a perfect conditions environment, the model is running somewhere in the 25 to 30 per cent success zone with perfect conditions, which wil l mean GDP growth rates of around four to five per cent per annum.

• An European Investment Bank (EIB) loan of €500 million per annum will be insufficient. This model will need to be a structured Special Purpose Vehicle (SPV) generating in the region of €7 billion of net losses until year 18.

• To generate a profitable year for the income-contingent loan structure within a decade, students would be subject to an interest rate of 10 per cent on their loans or be subject to a default rate of zero per cent.

• While the interest rate is paramount to the system working, it has a damaging impact on inequality since it will place those within the €25,000 to €35,000 income band into a debt spiral.

There are ways of making this income-contingent loan system functional. One can begin by focusing on higher education institutions with low levels of grant recipients and high points and high-earning potential courses. By expanding the income-contingent loans to postgraduates, it will capture more high earners. The signing of the income-contingent contract in students’ second year, rather than their first, will eliminate most drop-out students, which constitute a large default risk.

A much higher interest rate would be required and the need to criminalise those who don’t comply with the regulation, most importantly for those that emigrate, would be necessary. In short ,the main purpose of the income-contingent loans will be cost recovery in order to prevent it from becoming a large liability for the exchequer. Issues of equity and social policy will, by necessity, become secondary.

As outlined above, there are ways of making this income-contingent loan system functional for certain levels and courses. However, for the majority of undergraduates entering the system, income-contingent loans will not be effective and will place a great burden on the exchequer.

I would like to quote here from the words of professors Bruce Johnstone & Pamela Marcucci in 2010:

Income-contingent loans, such as those modelled after the Australian Higher Education Contribution Scheme, would seem to work well when

• a government, by downplaying (or not mentioning at all) the politically treacherous concept of tuition fees, is able to get an element of cost sharing that it would likely be politically unable to implement were it to advocate openly even for the relatively modest, deferred tuition fees that such plans generally call for;

• a government, by stressing the deferred obligation of the student, is in a financial position to forego the potential of more up-front tuition and to minimize the role of parents (even affluent ones) as an important partner in sharing the costs of instruction;

• a state does not currently need the students’ deferred revenue, but is able to tax or borrow sufficiently to keep the universities open and the students fed and houses, and to accept payment only in the future – in essence becoming the lender – with a limited ability to tap private capital markets; and

• the majority of student borrowers – students who become obligated to future income-contingent payments – will have a single employer that will pay them a periodic and relatively regular salary and that is also sufficiently large, sophisticated, and legally compliant enough so it can be counted upon to take the correct amount out of the borrower’s paycheck, year in and year out.

Conversely, income-contingent loans would seem to be less applicable when:

• non-governmental revenue is needed immediately, making parental contributions to tuition (even with some discounting and excluding amounts from low-income families) an important source of necessary revenue at the beginning;

• the scarcity of government revenue precludes the government from being the sole lender, thus placing a premium on student loans that have some (albeit discounted) value in the private capital market;

• many graduates (borrowers) are likely to hold multiple short-term jobs, to be employed in the informal economic sector where records are most unreliable, or to be emigrating; and

• there is no tradition of voluntary, reliable self-reporting of income, and state systems for monitoring and verifying income – for the purpose of income-tax withholding or pension or social security contributions – are nonexistent or unreliable.

Corbet and I discovered in our research is that approximately 50 per cent of graduates will be unable to pay the full net present value of the income-contingent loan over a 20-year time horizon. Our modelling shows that we can be assured of repayment in only 31 per cent of graduates. Our estimations are based on post-crisis wage data from private sector sources and the public sector wage scales. Don’t underestimate the role of the State: the largest employer in the State is the State itself, with 294,000 staff and 39 per cent of GDP.

Approximately 16 per cent of graduates leave the country within six months of completing their degrees. In the case of Trinity, that can be in excess of 20 per cent depending on the course observed.

Any commentary on public policy in Ireland must include the simple statement of the reality of this being a small, open economy. This, put simply, means that Ireland is not the master of its own destiny. It can clearly destroy its prospects, as seen in 2008 to 2010, and assist the potential for success, as evidenced by an industrial policy directed towards Foreign Direct Investment (FDI).

The local economic crisis has left a legacy beyond failed banks, mortgage arears and political deadlock. Ireland’s Gini Coefficent (a measure of inequality) rose 6.6 points between 2007 and 2011 and remains one of the highest in the EU.
The reality is that three-quarters of the job destruction has been driven by technology. The race between technology and education has been highlighted as one of the major challenges for economies and education systems since the mid-19th century. Postsecondary education is at the core of the response to these economic and political challenges.

Our findings show that 61.5 per cent of the loans would be estimated to be junk status, therefore 38.5 per cent are investment grade

Ireland is the last of the EU countries in total gross government revenue as a percentage of GDP. Ireland’s Revenue Receipts were at 26 per cent GDP in 2015. Ireland is currently in the unpleasant position of having an economy which is participating in the recovery of the European and global economy, however tentatively, and simultaneously with declining operational flexibility as regards tax revenue when compared with international colleagues.

It is well documented that the national accounts of Ireland reflect distortion attributable to the presence of international sector in the domestic economy. The multinational sector as a whole employs 187,000 people according to the IDA out of a workforce of over two million. The foreign direct investment sector is an outsized part of the Irish economy – The top 20 firms for exports are all multinationals making up 60 per cent of exports and 13 per cent of employment. Forty per cent of all corporate taxes are paid by the top 10 FDI firms. Its presence directs part of higher education policy formation.

Assuming a 4.6 per cent growth rate for the economy in 2016, and Central Statistics Office data for 2015 GDP (€243,914 million) and gross national income (€195,169 million), Ireland’s’ tax revenue will be 20.7 per cent of GDP in 2016 and 25.9 per cent of gross national income – still considerably below the averages enjoyed by our colleagues. Ireland is not a high tax economy despite the commentary in the media.

Ireland has a revenue issue. If it wants a high-quality higher education system it will need to find ways to pay for it. There are only three options: the student, firms or the exchequer. In all circumstances it is about revenue and not debt, as debts ultimately have to be repaid by revenues generated from income, profits or taxes.


Dr. Charles Larkin is a research associate/adjunct lecturer at Trinity Business School.

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