Was the OECD right after all?

Somewhat to my surprise, the feistiest part of Sunday night’s debate (“pathetic!”, “dishonest!”) was a discussion about whether an OECD report on public education spending had properly taken account of Australia’s HECS system. I had always assumed that this was because taking account of the implicit interest rate subsidy was technically difficult. But I’m told that actually there isn’t an implicit interest rate subsidy under HECS. Apparently, the way it works is that the university gets the HECS amount less 20%. So if the student pays upfront and takes the 20% discount, the money is channeled directly to the university. If the student pays later, 80% of the money goes to the university, and the remaining 20% goes into government coffers to compensate for foregone interest. So if this is right, then the OECD approach (ie. ignoring HECS) is a perfectly accurate way to calculate the Australian government’s contribution to education.

Update: Andrew Norton (who knows far more about the details of this than me) writes that the university gets the full 100%, not 80%. Apologies for the incorrect information on this point. However, Andrew argues that the OECD comparison is nonetheless reasonable, since other countries run budget deficits to pay for higher education - an interest rate cost akin to the one that the Australian government incurs via HECS.

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15 Responses to Was the OECD right after all?

  1. Bring Back CL's blog says:

    I am only going on memory but didn’t Howard object to the fact they had changed some things after 2005 ( I think) the final year of the time period of the report.

  2. Robert says:

    Homer’s right. The other objection is that the OECD report stops before the HELP system was introduced.

  3. a student says:

    OK, now I’m on shaky ground here, but isn’t the money taken out of pre-tax income rather than post-tax income when you defer payment? My impression is that there is actually very little, if any benefit to paying up front, and may actually be more expensive depending on your marginal tax rate. In which case there is a subsidy for the people who did not pay up front early.
    Am I mistaken?

  4. spog says:

    As far as I know, if payment is deferred it is coming out of after-tax income. The withholding schedules for recovering HELP/HECS impose it as an additional impost, ie, tax is not calculated after HELP/HECS is deducted.

  5. Andrew Leigh says:

    Homer/Robert: it’s true that Howard also made the argument that the OECD figures were outdated. But given the OECD works at the speed of the slowest member, this critique will always be true of any OECD report, so it doesn’t pack much punch.

  6. Sinclair Davidson says:

    But that was Howard’s point, if the data are outdated then why bring it up, when you know it’s outdated?

    Of course, the answer is to score a cheap debating point, and rattle the opponent – something Rudd did well.

  7. The OECD data is certainly out of date; there has been a surge in higher education funding since. But I think Andrew L is right that the OECD comparison is reasonably valid, though not for the reason he states, though this is a confusing issue. I have tried to work through it here.

  8. a student says:

    Thanks spog.

  9. cba says:

    Nice analysis Andrew Norton (BTW, your blog doesn’t get through our web-filter at work – apparently its a sex site 🙂 ). One thing you might be neglecting is that the inflation based accumulation of HECS debt is not tax deductible, unlike other debt accumulated for investment. Suppose you finish uni with $20,000 in HECS debt, have $20,000 in cash from a rich uncle and are about to start a job landing you in say a 40% tax bracket. Now you can use the $20,000 to pay your debt today or invest it for a year at, say, 5% with your HECS debt growing at, say, 3% (ignore the payroll deductions through the year). After tax, those funds invested at 5% will just be keeping up with your HECS debt.

    I would say the OECD education subsidy numbers are not just dubious in the case of Australia’s HECS program, but also for countries that use regular (instead of income contingent loans). Take the US: students can take loans from the federal govt or a private lender (whose exposure is backed by the federal govt). Those loans are standard amortizing loans with a 6.8% interest rate (some low income/wealth borrowers receive an interest rate subsidy while they remain in school so they pay less, but lets ignore that). Is a 6.8% amortizing loan a subsidy to the student? It depends on your definition of subsidy. 6.8% is enough to cover losses on default and interest at treasury rates so in budget documents those loans are recorded as money makers (i.e. they have a negative subsidy). But, without guarantees, private lenders would charge significantly more than 6.8%. So from the private market perspective there is a subsidy. I assume the OECD simply takes the US budget numbers.

  10. cba – There is a bonus for early repayment, so it may be worth repaying with the rich uncle’s money as you will still have some left.

    I’m not sure of the tax deductibility point. If it was deductible, it would decrease the cost of holding higher education debt and further weaken the incentive to repay (other than the compulsory repayments, of course).

    There is a larger issue about whether it would be better to abolish subsidy to higher education in favour of tax deductions; if the sex filter allows see the discussion here and especially the critical analysis by Mark Harrison at comment 12.

    BTW, what is the name of this filter? This is the third recent report that my sex-free site is being caught by a filter.

  11. Bring Back CL's blog says:

    Andrew,

    I was merely illuminating Howard’s objection not agreeing with it.

  12. cba says:

    Andrew N:

    “cba – There is a bonus for early repayment, so it may be worth repaying with the rich uncle’s money as you will still have some left.”

    yes, but that only reinforces the point of the example.

    “I’m not sure of the tax deductibility point. If it was deductible, it would decrease the cost of holding higher education debt and further weaken the incentive to repay (other than the compulsory repayments, of course). ”

    Re-reading my example, it was probably unnecessarily convoluted and slightly off course. What I wanted to say was that a loan with an interest rate linked to inflation (but not deductible) could be less valuable to the student than a loan with a nominal but deductible interest rate. This affects cross country comparisons. For e.g. in the US, borrowers can deduct the interest on federal student loans (although for most US tax payers, the deduction has no value because they are better off taking a standard deduction)

    “There is a larger issue about whether it would be better to abolish subsidy to higher education in favour of tax deductions; if the sex filter allows see the discussion here and especially the critical analysis by Mark Harrison at comment 12.”

    I used my cell phone to take a look on my train ride in this morning. interesting discussion and Mark’s comments were spot on.

    “BTW, what is the name of this filter? This is the third recent report that my sex-free site is being caught by a filter.”

    websense (enterprise). Maybe your web-site provider also hosts some “not so nice” sites?

    Last question: I don’t understand the point about financing education with deficits (see Andrew Ls update). If the govt provides each student with $1000 for education today, the value of that subsidy is $1000 irrespective of how it is financed. What am I missing?

  13. On the deficits point: The value to the student is $1,000 either way. But if the government borrows the money, they have to pay interest on it. Even if you accept the argument that the government eventually gets a positive return, via additional taxes, on investment in higher education it will take some years for that to occur, and they will have to pay interest on the $1,000 in the meantime. The cost to the taxpayer will therefore be more than $1,000.

    The Australian goverment correctly argues, in my opinion, that there is a cost in lending money to students via HECS. However, my point is that the same is true of other OECD countries, which are financing higher education subsidies on borrowed money.

    So I think all the OECD figures understate the true cost to taxpayers of higher education, but I am not convinced that that this would significantly change the relativities between them.

  14. cba says:

    “However, my point is that the same is true of other OECD countries, which are financing higher education subsidies on borrowed money.”

    only if they pay an above market rate on that money?

    with HECS, student receives $10,000 but makes a future payments stream that is worth less than $10,000 in present value say $9,000 leaving them with a $1,000 subsidy.

    an outright grant of $1,000 instead is equivalent to that subsidy. it doesn’t matter if the grant is financed by deficit (assuming the govt financing rate is a market determined rate)

  15. Rajat Sood says:

    cba, I think I made a similar point over at Andrew N’s blog (not sure how to do trackbacks). Could you have a look there and tell me whether you agree?

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