The Lifecycle Impact of Alternative Higher Education Finance Systems in Ireland

Darragh Flannery1, Cathal O’Donoghue2

European meeting of the international Microsimulation Association,

May 17th, 2012

1:University of Limerick2: National University of Ireland Galway, Rural Economic Research Centre, IZA

Background and Objectives• Tertiary education in Ireland is heavily reliant on

State subsidisation with 85% of all expenditure coming from public sources in the year 2008 (OECD, 2011)

• Both a graduate tax scheme and an income contingent loan system have been suggested as possible alternatives to the current free fees scheme

• The National Strategy for Higher Education to 2030 (2011) recommending that the latter system be introduced in Ireland in the near future

Background and Objectives• In an international context, empirical work has been

carried out most notably for the UK and Australia to gauge redistributive and fiscal implications of introducing such systems using dynamic microsimulation models (LIFEMOD and HARDING)

• To date, no study has been conducted that attempts to analyse the implications of an alternative higher education finance structure in an Irish context

• Here we utilize a dynamic microsimulation model for Ireland and explore the fiscal and redistributive implications of a number of alternative higher education finance structures, with varying assumptions regarding the parameters of these systems

Higher Education Context• When considering optimal choice of funding (private

versus public) for higher education , the concepts ofefficiency and equity are important

• With regard to efficiency, students derive private benefitfrom education and so should contribute to its cost

• However the state and society also benefit and so shouldcontribute

• Difficult to determine the exact breakdown of who shouldpay what, but the key notion is that students shouldcontribute!!

Higher Education FinanceOptions

Income Contingent Loans:• Students face no up front fees• Instead, students generally borrow to cover the cost of their

education; the loan is then repaid as the individual movesthrough his/her lifecycle with the repayments ending once theloan has been repaid in full or upon retirement

• Repayment generally takes the form of x per cent of theborrower’s future income

• Also, if the individual's income is below a certain threshold,they do not make any repayments

• Any default on debt is met by the taxpayer

Higher Education Finance OptionsGraduate Tax:• This is similar to an ICL system in that students do not

face an upfront charge when they enter higher educationand so the credit constraint is removed; however there isno loan aspect in the design

• Instead, the graduate tax acts as a supplementarytax/compulsory payment on graduates throughout theirworking life.

• In its simplest form this system may obligate graduates topay a fraction of their taxably income, in addition toincome tax, to the government until they retire

• Some individuals may end up paying more then the costof their education

Ex-Ante Studies on HigherEducation Finance Systems

• Harding (1995) a dynamic microsimulation model forAustrialia and predicts that under Australian ICL system80%c of total debt is repaid by graduates by retirement

• Glennerster et al (1995) investigate the impact of an ICLsystem and graduate tax system on the repayment patternsof British graduates using the LIFEMOD micro simulationmodel. They conclude that an ICL system is favorableover the two from an equity standpoint and show thatwomen on average pay back less then men.

• Dearden et al (2007) estimate the impact of the 2004reforms in UK higher education finance and find positiveredistributional aspects to the changes

Methodology• We utilise the LIAM dynamic microsimulation model for

Ireland (O’Donoghue et al, 2009)

• Using an ageing module, combined with a collection ofsimulated processes, the output of the LIAM model provides asimulated forward life history of all units of the population fromthe Living in Ireland survey data (1994-2001) up to 2050 (discrete time model)

• The processes involved include demographic processes such asbirth, marriage, having children and death, education, labourmarket processes such as employment and unemployment andthe simulation of incomes and interactions with the tax/benefitsystem at the individual level

• LIAM is a dynamic (closed) population model

Methodology

• We first identify those that have tertiary education by the end of their 22nd year

• The simulated population runs form the years 2000 to 2050, this allows us to track the life cycle of eight cohorts of graduates until their point of retirement.

Present Value of Total Gross Lifecycle Earnings (€) across Education level and Gender (all in

year 2000 values)

Gender Education level Lower

secondaryUpper secondary

Tertiary

Male 427,826 748,078 988,813

Female 155,901 340,624 658,120

Methodology• First system simulated is an ICL loan system• For the purposes of this analysis, our sample were assumed

to have completed 4 years of full time tertiary educationbetween the ages of 19 and 22 inclusive, and in the contextof an ICL system, the each received, loans of €2500 perannum (in 2000 prices) during each of those years’ .

• Therefore, each graduate is assumed to incur a debt of€10000 by the end of his/her stay in higher education. Weassume payment begins as soon as their graduate with nograce period

• We also assume there is a 2% real interest rate on theloan

Methodology• We set the income threshold as the average income of those

working for pay in our population for any given year.• Individuals will pay 10% of any income earned above this

threshold to service their loan.• Also, to incorporate more progressivity in the system, we also

set a second threshold at 1.25 times initial threshold and if anindividual earns more then this they must pay 5% on anyincome earned above this second threshold (as well as 10%on all income above the first)

• We also simulate a graduate tax system through the socialinsurance contributions system, with graduate forced to payan additional 1% on their pay related social insurance (PRSI)contributions until they retire.

Results: ICL System% of Average Average AverageBorrowers Repayment NPV of Subsidywho Repay Period in Repayments as a %in Full Years (€) of loan

Females 63% 16.2 7,300 27%

Males 85% 15.4 8,976 10.2%

Total 74% 15.7 8,141 18.6%Average

Results: Redistributive nature of IC system

Decile of graduate lifecycle earnings distribution

% of Borrowers who Repay in Full

Average Repayment Period in Years

Average NPV of Repayments (€)

Average Subsidy as a % of loan

1 29% 23.0 4,545 54.5%2 31% 19.75 4,935 50.6%3 61% 24.7 7,579 24.3%4 72% 23.0 8,230 17.7%5 76% 21.5 8,415 15.8%6 85% 17.6 9,195 8.0%7 88% 14.6 9,051 9.15%8 100% 9.2 10,000 0.0%9 100% 9.6 10,000 0.0%10 100% 7.5 10,000 0.0%

Results: Graduate Tax Repaymentsas per cent of Total Simulated Loan

Liability Yield of 1%

Graduate Tax Yield of 2% Graduate Tax

Females 52.3 104.0

Males 67.4 132.5

Total Average 60.0 118.3

Results: Redistributive nature ofsimulated GT System

Graduate Tax revenue as per cent of Total Simulated Loan Liability with 2% Real Interest Rate

Decile of lifecycle earnings distribution

Average NPV of Repayments (€)

Graduate Tax Rate = 2% 1 4,7322 8,1593 10,2164 10,5805 11,5246 12,8747 14,0528 14,9789 15,62510 16,753

Conclusions• Simulated ICL suggests a substantial amount of graduate

repay debt in full with men more likely to repay debt in fulland repay quicker

• Simulated CL system exhibits equity in terms of repaymentpatterns

• However, we also see a significant government subsidy

• Simulated graduate tax system within PRSI contributionsseems to hold progressive qualities but entails graduatesrepaying significantly more then the amount theireducation cost them.

• All graduates pay back more under graduate tax schemerelative to the ICL system.