No doubt about it – the new student loans scheme is a tax

Don't be fooled - the new scheme from the Student Loans Company is a tax. And for some, it's a pretty high one at that.

I wrote recently that the new scheme to finance students from next year looks more like a tax than a loan system. Not everyone agreed. Several readers wrote in to point out that the system is really no different to that for a mortgage in that it is taken out voluntarily and has interest-bearing repayments. The only real difference is a good one: that those who are relatively unsuccessful never have to pay the loan back.

I don't buy it. So in last week's Spectator, I looked at exactly how the system works. It goes like this.

From 2012, all student tuition fees will be automatically paid by the Student Loans Company. When the students graduate, and are earning more than £21,000, they will start to pay 9% of their income over to the Student Loans Company via the PAYE system.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The interest rate starts at the RPI (retail price index) inflation rate and steadily rises as you earn more: once you are earning £41,000, the interest rate will be RPI plus 3%. You will pay every year, regardless of how much your original loan was and you will not be able pay the whole thing off early - even if you have the cash to do so.

This isn't a bit like a mortgage. For starters, while some degrees are clearly voluntary, the important ones aren't: if you want to be a lawyer, a doctor or an engineer you will have to have a degree, and you will have to pay the 9%. You can rent a house as and when you need one. You can't rent an education it has to be paid for in full up front.

Next, note that the payments on your mortgage don't go up as you earn more they are absolute, not relative to income.

Finally, the fact that the relatively unsuccessful never have to pay a penny towards their tuition is a vital part of the puzzle. I'd go so far as to say that's it's the clincher in defining these charges as taxes rather than loan repayments. I have never yet heard of a case in which a mortgage lender has decided against repossession, and let someone off paying back their debt, because they aren't doing as well as everyone else in their office. But that is exactly how a progressive tax system works: the successful pay more and the unsuccessful pay less.

Here we have a charge on graduates taken via the income tax system; that there is no way out of; and that goes up with your income. There are elements of a loan in here but for most people, these kinds of repayments are going to feel more like a tax. And for those who end up paying it for the full 30 years, a pretty high one at that.

From 2015, if you are a graduate and you earn £21,000 you will end up paying a marginal income tax rate of 41%. If you earn over £42,475, you'll be paying 51%. This may not matter (after all, what is the alternative?). But it does explain why there is such a scrum to get into university this year.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.