18 December 2018

By deciding to change the accounting treatment of student loans in public spending totals, the Office for National Statistics has given Philip Hammond a fiscal headache. Martin Wheatley says it is time for government to stop using misleading accounting to flatter the numbers.

The money government spends on student loans does not show up as public spending, even though as much as 60% of it will never be repaid. It only comes onto the books decades later, as debts are eventually written off.  

But the Office for National Statistics (ONS) announced this week that the Government needs to start counting student loans as public spending. This is a big change that, while making no difference to the cost of government support for higher education, does alter when those costs show up. And it has added to the challenges Philip Hammond faces in next year’s spending review.  

In our recent report, we warned that government has a history of using accounting tricks to flatter the numbers, and student loans was one example. Accounting devices may offer a short-term fix, but at the cost of distorting policy choices and adding to the list of problems to be handled in future.

Now that ONS has decided to adopt an accounting treatment more in line with economic reality, the consequences of the Coalition Government’s decision to raise university funding through higher tuition fees (financed by loans) will be faced by the current government rather than a future one.

The change in how student loans are treated matters

The ONS will confirm what the new approach means in hard cash next autumn, but the Office for Budget Responsibility has estimated the change will increase borrowing this year by £14bn, rising to £17bn by 2023/24.

The change increases the planned deficit and reduces the Chancellor’s headroom against his 2020/21 borrowing ceiling from £15 billion to £1 billion, leaving him with little more than a 50-50 chance of achieving his target. 

So if the Government wants to stick to its promise to reduce the deficit, it will have to increase tax or make additional cuts in areas like justice and local government.

The change also affects the apparent short-term costs of the policy. Currently, increases in the interest rate charged on student loans add to government revenues in the near term by a greater amount than they will do in future. This is because they are calculated as applying to the whole of the loan, rather than only that portion which is actually likely to be repaid. The new treatment will therefore remove some of the current disincentive for governments to lower interest rates on student loans.

Another result of the accounting change is that the net cost of Labour’s pledge to abolish tuition fees would also appear lower over the next five to ten years at least, because what are currently future loan write-offs would already be counted as public spending. 

There is an argument that, since the change is about accounting treatment, not the actual flows of cash in the economy, it should not affect the Government’s decisions about public spending and borrowing. 

In other words, Philip Hammond could just adjust upwards his borrowing target to accommodate this new accounting treatment and carry on as he said he planned in the Budget. That is certainly one of his options, and one which may appeal more than finding even more cuts to unprotected programmes, or raising taxes. 

But it would be awkward for a Chancellor who said in this year’s Budget speech “Fiscal Phil says: Fiscal Rules OK” to swerve away from the projections of borrowing which he announced so proudly then.

Spending review decisions should be based on what is really happening, not accounting illusions

In principle, a change in the treatment of loans should not affect government policy decisions. But in practice it might well do. The Government must use next year’s spending review to make policy choices on their underlying economic merits, not what this or that accounting treatment might achieve in the short term.