Effective marginal tax rates and HELP threshold reform

Media reports in the last few days have pointed out that some women face effective marginal tax rates above 100% under proposed changes to the HELP thresholds. But this is not new – the nature of the HELP repayment system is that for every HELP debtor, male or female, there are income zones that reduce take-home pay.

This is because as income reaches each threshold the debtor must repay a percentage of his or her entire income. Under the current thresholds, a debtor earning $54,868 in 2016-17 will repay nothing. But someone earning $54,869 will repay nearly $2,200. So up to an income of about $57,000 HELP repayments mean the debtor takes home less money than if he or she earned $54,868.

Of course, in most cases the debtor’s long-term financial position is not worse as their HELP debt is reduced. In this sense, HELP repayments are different from the welfare benefit phase-outs that normally contribute to high effective marginal tax rates – for the debtor, that is money lost to consolidated revenue, rather than improving their personal balance sheet. But for people concerned with immediate cash flow more than their long-term financial position, HELP repayments can cause problems.

Research by Richard Highfield and Neil Warren shows that HELP debtors manipulate their taxable income to avoid or delay repayment. They also make the point that this is costly for income tax revenues, even if the HELP debt is eventually repaid. Read More »

The boom in HELP debtors

The latest ATO taxation statistics come out today, giving us some new information on HELP.

Although growth in higher education student numbers moderated in 2015, VET FEE-HELP was still out of control in the period covered until mid-2016, contributing to a substantial increase in total debtor numbers. They grew by nearly half a million (a 24% increase) between 30 June 2014 and 30 June 2016. With big policy changes in vocational education taking effect in 2016 and 2017, along with continued moderate growth in higher education numbers, the rate of growth should slow substantially in the year to 30 June 2017.

On current policy settings, however, the number of debtors repaying is not likely to accelerate rapidly. Only 22 per cent made a repayment in 2013-14 and the number is likely to to be lower still in 2014-15 (there is a 2014-15 number in the chart, but these have a history of significant upward revision due to late tax returns, so it is too early to say exactly what proportion made a repayment).

The 2014-15 repaying share is likely to be lower because of the number of people who are still students, the high initial repayment threshold of nearly $55,000 a year is delaying repayment for recent graduates, and a large proportion of VET FEE-HELP borrowers are unlikely to earn enough to repay.

There is speculation that the initial threshold for repayment will be reduced in the Budget. These numbers explain why the idea needs considering.

Loan fees and the expert panel

As I expected, there has been comment (here, here, or here) about my release of a report on HELP student loan fees at the same time as I am on a government higher education policy advisory panel.

Due to the panel consuming my time for the last couple of months, the loan fee report has appeared later than originally intended. But other than that the report’s release follows a plan developed a year ago to complete reports on two weaknesses in HELP’s finances, the thresholds for repayment and interest costs. They are companion reports for our report on doubtful debt and recovery of HELP debt from deceased estates in 2014.

Loan fees are not new, and nor is my support for them something I suddenly arrived at after being appointed to the panel. I said in response to the proposed Pyne reforms that rather than abolishing loan fees we should extend them. What this week’s report does is work through in more depth whether interest subsidies are necessary to income contingent loan schemes (no); the relative merits of real interest, hybrid real interest and CPI indexation, and loan fees (loan fees better); and arrive at a method for setting a loan fee rate (likely interest costs over the life of HELP loans). It’s the detail that is appearing now, not the broad recommendation to use loan fees.

When the government asked me to be on the advisory panel I said I could only do it if I could also meet my existing Grattan commitments. They agreed to this. The panel is providing private advice to the minister and the department. It is a different situation from a review with a final report I need to agree with my panel colleagues and which the government will publicly accept or reject. So while the timing is not ideal, the loan fee report does not pre-empt other people’s decisions.

Should people use their superannuation to pay off HELP debt?

For some time former Liberal adviser John Adams and Senator Chris Back have been promoting the idea of using superannuation to pay off HELP debt. Adams put his case on Catallaxy last year, and Senator Back is in the AFR again today on the subject. At The Conversation, Geoff Sharrock has a different take on the same idea, proposing that annual superannuation payments by employers be diverted into meeting that year’s HELP repayments.

You would have to be a bit desperate use superannuation, on which you can reasonably hope to earn a 5-10% a year rate of return on average, to pay off a debt with 2-3% interest. But the proposals are about cash flow, not long-term financial advantage. Any HELP debtor who earns the repayment threshold has to repay more than $2,000 a year, and someone on $100,000 a year will have to repay at least $8,000. While people on these incomes are not poor by general community standards, they could reasonably regard their current needs as more important than additional wealth or consumption in the future.

There is good evidence that people manipulate their income to stay below the HELP repayment threshold (see for example figure 22 on page 40 of our recent report), even though many of them probably will repay eventually. So there would probably be some demand for trading in super for repaying HELP. The Sharrock plan is likely to have more voter appeal than the Adams plan, which will only have the desired effect for debtors who have enough accumulated superannuation to clear their entire debt (as HELP repayments are only based on current income, not outstanding balance*). Most new bachelor-degree graduates will have too little in their super accounts to clear the $20,000 to $40,000 they will typically owe after completing an undergraduate degree, but as Sharrock shows the 9.5% of income annual compulsory superannuation investment is always higher than the compulsory HELP repayment.

But should the government allow superannuation to be used in this way? The two big issues are whether superannuation should be diverted from its core retirement savings purposes, and whether it will save the government money as well as being more convenient for debtors.

Adams is aware of the criticisms, particularly around the long-term impact on retirement income. He says people could be required to make up the contributions later. As with HELP repayment on family income, this would be complex to administer and enforce. It needs a counter-factual amount that would have been saved, and a plan for how it is going to be reached. Sharrock just observes that in his plan most graduates would still have decades of work ahead of them. In part, how big an issue this is will also depend on the level of HELP debt.

Perhaps the bigger danger to retirement savings is the precedent using superannuation for HELP would set. While people who have not been to university don’t have HELP repayments, they do on average have lower incomes, so it is hard to say that HELP debtors have any unique cash flow issues (apart, perhaps, from those created by lifestyle expectations). Adams provides an intellectual differentiation between using HELP for other purposes, such as buying a house, and using it to repay HELP. But inevitably the details would be lost as other people tried to free their superannuation savings for more urgent uses.

The other big question is the effect on the government’s finances. There is value to the government in earlier repayment of HELP debt through lower interest subsidies, and possibly in reduced doubtful debt (although people who think they might not repay in full will be less likely to use their super for early repayment). But the government will lose the taxation it would receive on superannuation fund earnings. Super for HELP also seems open to rorting, by salary sacrificing into superannuation and then using the money to repay HELP debt. It would be a back door way of restoring the bonus for repaying ‘early’ that will otherwise be abolished next year. Many years in the future, there may also be additional issues with people whose super savings are too low for retirement who end up having to rely on government payments.

While I do want HELP debt to be repaid more quickly, on balance I don’t think diverting money from superannuation is the way to do it.
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*Unless HELP repayment is completed during the year.

Should HELP repayments be based on family income?

The Fairfax papers this morning have stories on a ‘push’ to repay HELP debtor from family income, in which I am quoted extensively. This idea is considered in our latest Grattan report on lowering the HELP threshold for individual debtors, but we did not propose it.

The appeal in the idea is that our analysis suggests that many HELP debtors who are not currently repaying, and likely a much larger proportion of debtors at risk of never repaying, live in reasonably affluent households. The reason they are not earning more than the $54,000 threshold is that they don’t need to, because another family member makes enough money that the household can maintain reasonable living standards without two full-time earners. It’s a little hard to read, but the slide below from the report shows the disposable (ie after tax and with non-taxable benefits) income of the households affected by our proposed $42,000 threshold. That’s not the whole situation – it excludes households where all HELP debtors earn less than $42,000, or over $54,000. But it illustrates how personal HELP debtor income is not a good guide to overall personal living standards.

family income

While repaying HELP from family income would make a big difference, it was not recommended for a range of reasons:

* How would we determine whether a couple was a couple for HELP repayment purposes? There are some clear potential markers, such as marriage or kids. But only about half the 20-something graduates who were living together as a couple in the 2011 census were legally married. What if you were legally married but had split?

* It would make life more difficult for employers, who currently deduct most HELP repayments. Now they can use their own payroll; in future they would have to know spouse or partner income as well. More people would make incorrect repayments during the year, and could be hit with major additional repayments at tax return time.

* Who would be legally liable to pay? Presumably it would have to be the debtor, with an assumption that partners would often choose to cover it. But that could mean people getting bills that exceed their income. If the principal income earner refused to pay, it would mean that HELP caused default, which it is not supposed to do. If the principal income earner was forced to pay, it would be an unusual case of someone becoming liable for debts they never took out.

While I would not say we should never, ever, consider a different basis for calculating repayment income, for this report I thought there were too many practical and philosophical issues for it to make the list of recommendations.

Polling on the initial HELP threshold

A headline in The Australian this morning reads “Student loan: Poll backs current repayment threshold”.

In a American-style voting system where the largest single minority wins, I guess that’s right. The current threshold is $54,126, and 27% of respondents chose the nearest $10,000 increment of $50,000 (slide below).

MetaPoll

But another way of looking at it is that half of all the sample, and about two-thirds of those who offered a view, came up with a number below the current $54,126. The 2014 Budget proposed reducing the threshold to $50,638. Nearly a quarter of respondents offered a number below the $42,000 we recommended in our report last week.

According to The Australian‘s article respondents were not told the current threshold. If they had been, I expect that there would have been stronger status quo bias. Still, for an issue that has not been prominent until recently I think these poll results are reasonably good, from a reformist perspective.

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The poll was conducted by MetaPoll. No precise details on the methodology were published, although younger people were less in favour of a lower threshold than older people.

Student debt repayment times: England compared to Australia

The Australian‘s higher education gossip column yesterday reported some (anonymous) objections to our plans to change HELP’s repayment system.

Some of these are based on the belief that HELP debtors are in a special category who should be treated much more generously than their contemporaries who did not do quite so well at school. For reasons outlined earlier in the week, I do not think this is a convincing point of view.

But there are some more interesting points about repayment times:

A reader contacted us to say it would “perpetrate some asymmetries in the system”. How? “Not all graduate jobs begin with the same salary and not all jobs have the same prospects for wage increases over the working life of a graduate. These two parameters (starting salary and wage trajectory) have a dramatic effect on repayments.” Indeed and both would much more dramatically impact women than men, no doubt.Our reader astutely pointed us to the UK’s loan repayment calculator which from which we can see an investment banker might pay of their debt in 12 years 5 months while someone in sales would take 18 years 11 months to pay off the same debt. Graduates on really low wages (teachers, child care workers, social workers) would take more than 30 years and still have 45 of their debt overhanging because of the power of interest. With a 30 year debt forgiveness model, doubtful debt in the UK looks set to skyrocket…. Our reader says it would be helpful if the Grattan Institute or some other interested body produced a similar modelling tool so we could look at the long-term effects of such proposals.

A loan repayment calculator website that helps students understand their repayment obligations is an excellent idea. However, the analogy with England doesn’t work for either the current HELP system or what we propose in our report. There are some important differences:

Underlying borrowing. In England, most undergraduate courses are a flat £9,000 a year. Given different occupational earnings, that inevitably produces very wide variation in projected repayment periods. In Australia, student contributions are roughly linked to likely future earnings. Admittedly, the amounts are based on a back-of-the-envelope calculation made 20 years ago, and need an update. But work we’ve done before suggests that it tends to cluster by-discipline repayment times much more around the median than would a system based on flat fees, costs, or a fixed proportion of costs.

Interest rates. In England, there is a 3% real interest rate, here it is zero except for the minority of students charged loan fees. But Australia’s system means that compounding interest is a minor issue for debtors compared to England. There, slow repayment can substantially increases the real value of the debt; here it won’t.

Repayment system. In England, debtors repay 9% of their income above the threshold. Here, at each threshold you repay a percentage of all your income that increases depending on how much you earn, from 4% to 8% now. Because their threshold is lower than Australia’s (coincidentally, about the $42,000 we suggest for here) more lower-income debtors make some repayment. But except for English debtors earning below the Australian threshold, this leads to lower annual repayment than here, as seen in the slide below from our report:

England repay

Point of write off. The English write off debts after 30 years if the debtor is still alive. Here it is only on death. Australia will get more repayment from women returning to full-time paid work after they finish their main childcare period.

So high original debts, slow repayments, and real interest on the debt all join to produce long repayment times in England, with the consequent higher risk of doubtful debt exacerbated by premature write-off of debt.

Under the new thresholds we propose in our report (including lower upper thresholds), Australian repayment times would be reduced. That would be the only effect for the vast majority of higher education HELP debtors, who will eventually repay even under the current system. Their total costs stay the same in real terms, and slightly decrease in nominal terms as they will incur less indexation of their debt.

A proportion of additional repayment will be from people who might not otherwise repay. As the report and associated coverage note, most of the personal debt holders in these cases will be female, but the actual effects are likely to be much more gender neutral. In our analysis, it is long-term part-time work by second-income earners that comes out as a major doubtful debt risk, and having some of those debtors repay 3% of their income in HELP repayment will reduce this. However, the repayment will be much less than 3% of household income, and the effects will in practice be shared by usually male partners and children. Using HILDA for analysis, the singles affected are 58% female, which is almost exactly their share of the student population.