Table of Contents

1.0 Introduction................................................................................................................................2
1.1 Financing Higher Education in the United Kingdom................................................................2
1.2 Participation Rate and Funding Per Full Time Equivalent (FTE) Students...............................2
1.3 Student Loan Schemes...............................................................................................................2
1.3.1 The 1998 Reform................................................................................................................2
1.3.2 The 2006 Reform................................................................................................................2
1.4 Higher Education and the OECD Average................................................................................2
1.5 The Main Source of Financing Higher Education.....................................................................2
2.0 Advantages of Financing Higher Education through Taxation..................................................2
2.0.1 Merits of a Graduate Tax.....................................................................................................2
2.0.2 Demerits of a graduate tax..................................................................................................2
2.1 Advantages of Fees (Loans) in Financing Higher Education....................................................2
2.2 Effects of tax financing versus tuition fees, lessons abroad......................................................2
3.0 Policy Recommendation to the Minister...................................................................................2
References:......................................................................................................................................2

LIST OF FIGURES
FIGURE 1: Degree accepts (volume) by academic year.5

FIGURE 2: Expenditure on Higher Education Institutions as a percentage of GDP in

2009.9

EXECUTIVE SUMMARY
The UK economy until recently 1998, financed its higher education through taxation.

The tax

system of financing higher education has the advantage of ensuring equity and fairness where
taxpayers with the greater ability to pay, pay more tax, favouring the redistribution of resources
among the population. It also helps to minimize losses to the state, however, critics argue that
receipts from graduate taxes would flow to the Treasury and cause a blow to universities
autonomy.
Tuition fees was then introduce as an alternative source of financing higher education. Tuition
fees tend to reduce the pressure on the public finance. Accordingly, as public attitudes changed
and understanding of education as an investment increased, then financing higher education
through self-financing (loan) is a better way. However, introducing fees deter individuals from
poor background to participate in higher education.
It is therefore recommended that a financing system that charge a moderate level of tuition fees
combined with student financial support systems that offer loans with income-contingent
repayments and grants may stand a better chance of promoting access, equity, completion, and
positive outcomes for students. This is because it would reduce the pressure on public finance
and help reduce deficit and therefore a decline in the national debt.

1.0 Introduction
Higher education has undergone considerable expansion in recent years in a number of countries
and its expansion is necessary and desirable for growth. Thus higher education is no longer a
consumption good enjoyed by only the elite group of a society or country. Higher education,
however, can be viewed as an investment. Thus the creation of human capital through the
expenditure of time, energy and money to obtain increased knowledge and skills that are
marketable and produce a higher income which causes growth in the long run.
Indeed, the debate on higher education finance has become a world-wide debate, and is not
confined to Europe. In the United Kingdom, expansion in higher education has been dramatic
where aggregate student numbers have doubled in 20 years. However, over the same period,
funding per student has halved in real terms (Greenaway and Haynes, 2003). This means that
financing higher education is costly, and faces competing imperatives for public spending
This paper sets out the merits and demerits of available options of financing higher education.
The first section sets out the main possible ways of financing higher education in the United
Kingdom and drawing on experiences abroad. The second section examines critically the merits
and demerits of the available ways of financing higher education, that is, taxation versus fees in
financing higher education. Based on the second section, the third section make deductions,
policy recommendations and suggest tentative reforms to financing higher education. It is
therefore argued in this paper that financing higher education by charging a moderate level of
tuition fees, combined with student financial support systems that offer loans with income
contingent repayments is a better way of financing higher education.

1.1 Financing Higher Education in the United Kingdom

During the 1960s, the UK government through the taxpayers money paid for the entire cost of
higher education. This included teaching, tuition fees and generous maintenance grants, as well
as the cost of maintaining buildings and the other numerous expenses associated with the higher
education. During that period, higher education was a privilege of only a small proportion of the
population and as such funding per student was high, with a relatively small cost to the taxpayer
given the low volume of students (Mayhew* et al., 2004). According to the Barr (2004),
government at that time became concerned that the UK higher education sector was relatively
small compared to the rest of the developed world. Thus the UKs Higher Education
participation rate which was around six per cent, was one of the lowest in the OECD. The
government saw this as threat and a decline in long run growth and as such commissioned a
committee which recommended the universities to be expanded. The expansions were in two
folds, thus, all Colleges of Advance Technology were given university status which resulted in
many students being reclassified as higher education students. This recommendations of the
commission also led to about thirty five polytechnics been classified as universities. The
committee also recommended that new universities be built to increase the enrollment. This also
saw seventeen new universities been established (Dearden et al., 2011). The overall impact of the
recommendation saw a large increase in university attendance which was however not matched
by increases in university funding and as such led to financial crisis in the higher education in
1997 and 1998. This led to the introduction of several reforms which included the introduction of
tuition fees, where individuals were made to pay their own tuition fees either through loans or
contributions from parents.

1.2 Participation Rate and Funding Per Full Time Equivalent (FTE) Students
The recommendations of the committee which led to various reforms brought about a dramatic
increase in student volumes, rising from around 50,000 full-time equivalent (FTE) students in the
1960s to 400,000 by 2007/08, as illustrated in Figure 1.
Figure 1. Degree accepts (volume) by academic year

Source: All UK-domiciled HE students (Higher Education Statistics Agency HESA). Full-time equivalent data
represent the institutions assessment of the full-time equivalence of the student instance during the reporting
academic year.

This large increase in university was as a result of the already discussed issues of establishment
of new universities and the conversion of polytechnics into universities which was in accordance
with the 1992 Higher Education Act. The participation rate in 1963 was around 6% where
funding per FTE was 8,818. Beside the increase in participation of higher education, funding
per FTE student had fallen to a historic low amount of 4,850 from 8,000 per student at the end
of the 1980s. Moreover, the gap in university participation between the rich and the poor was
very wide in comparison with other developed countries as noted by Barr and Crawford (1998).
There were also concerns that it was even growing to be wider (Blanden et al., 2005). In the late
6

1980s, the Government felt the need to intervene in the sector once more, for several reasons.
This led to an increase in participation at around 15% which was still one of the lowest in any of
the advanced industrial countries. Funding per FTE was also around 9,530 at that time. The
Government then recognized the need to grow the higher education sector from an elite system
to a mass system, partly in response to rapid technological change, which necessitated a highly
skilled workforce, as well as recognizing the equity problems associated with the sector.
According to Barr (1998), expanding the sector was however problematic. The real value of
maintenance grants had fallen by nearly 20 per cent between 1963 and 1982 as student numbers
increased, while real wages for school leavers had risen considerably which led many to go
straight from compulsory education into the workforce. This did not necessarily decrease the
participation rate. Besides the rising number, the sector was still government funded and to avoid
the financial crises that had arisen before, there was the need to reduce the number of places
available. This was because the government could not afford increasing the number of places
available without cutting funding elsewhere, which it was unwilling to do (Barr, 1998). The
government then began to examine student loan systems to cover part of the grants and thus
enable further expansion of the sector. The UK higher education participation rate by then 2003
was 43 per cent, which stood in the middle of the OECD range. However, other countries had
expanded its participation in higher education, and the UK was then lagging behind participation
rates in the USA which was 63 per cent.

1.3 Student Loan Schemes

The UK government in 1998 implemented the first ever student loan scheme which saw student
maintenance been split into two grants and loans. Student maintenance was initially made up of
7

50 per cent grant and 50 per cent loan (Wyness, 2010). According to the scheme, repayments was
to be made once the student was in the workforce and earning over 85 per cent of average
earnings. Accordingly, Barr and Crawford (1998) noted that students repaid a flat rate every
month, regardless of income.
This scheme in part increased participation rate in higher education to 17 per cent and a
corresponding funding per FTE student of 8,928. There were several problems with the
administration and recollection of repayments of the loans. This led to the government covering
the students costs of borrowing (Barr, 2004). This also led to two major reforms in the sector.
The 1998 and the 2006 reform.

1.3.1 The 1998 Reform

The 1998 reform brought about the introduction of the first ever upfront tuition fees of
1,200.This
reform which resulted in the elimination of the maintenance grant affected all but the least well
off
students as of 1998 and for that reason led to the increment of maintenance loans (Wyness,
2010).

1.3.2 The 2006 Reform

By 2004 participation had risen to around 40 per cent and a corresponding funding per FTE
student of 5,489. Even though overall participation had increased significantly, the government
was still concerned that participation from the working class had not risen. It was also widely
agued that the student support package was still too small (Barr, 2004).The government was also
concerned about the UK universities which were still underfunded compared with the rest of the

OECD (Greenaway and Haynes, 2003). To address these concerns, a new set of reforms arose
from the Higher National Educational Act 2004. Thus instead of an upfront payment of tuition
fees, all fees were deferrable until after graduation, with loans available at a zero real interest
rate, repayable according to an individuals income. The reform also saw an increase in
maintenance grants for the poorest students.
1.4 Higher Education and the OECD Average
Between 2008 and 2010, GDP in the UK fell by 2%, the same as the average across Organisation
for Economic Co-operation and Development (OECD) countries. Nevertheless public
expenditure on education in the UK rose by 8%. The total expenditure on education in the UK
stood at 12-13% of GDP in 2012 and 2013. UK spends less on higher education compared to
countries like Finland, Germany, Norway, Denmark and Sweden.
The figure below shows that the expenditure on higher education in UK was around 0.7 per cent
of GDP in 2009. Over the same period the OECD managed an average of 1.6 per cent on GDP.
Figure 2. Expenditure on Higher Education Institutions as a percentage of GDP in 2009

Higher Education

Public expenditure on education institutions

OECD average

Source: OECD. Argentina, India, Indonesia: UNESCO Institute for Statistics (World Education Indicators
programme). South Africa: UNESCO Institute for Statistics. Table B2.3. (www.oecd.org/edu/eag2012).

The figure implies that, even though the UK government is spending much on higher education,
it is still below the OECD average.
1.5 The Main Source of Financing Higher Education
From the forgoing premise, it can be deduced that, the main sources of financing higher
education in the UK and most OECD countries has moved from payment through the taxpayers
money to student loans (self-financing) where students are made to pay their own tuition fees.
Thus tuition fees which were entirely paid from taxation has moved to a system where students
are charged fixed amounts with exemption for poor students and, more recently, the introduction
of variable fees and income contingent loans to cover living costs and fees.
10

2.0 Advantages of Financing Higher Education through Taxation

Taxation is a way by which government finances its spending by imposing some charges on its
citizens and business entities. It uses taxation to promote or discourage certain financial
decisions. It is a way of raising revenue by the government to support the institutions in the
economy. The primary goal of taxes is to raise enough revenue for government activities such as
financing higher education which has a positive external effect on the UK economy in the long
run. Thus the public benefits which higher education confers on the UK economy are substantial
and wide-ranging, justifying a significant level of public investment in recent years. Therefore
higher education is a profitable social investment and therefore should be financed from public,
not private funds.
Until 1998 there were no tuition fees for students in the United Kingdom. Tuition fees and living
expenses were covered by a mixture of a tax-funded grant, a loan with mortgage-type
repayments and contributions from parents.
There have been a wide range of arguments, some been in favour of financing higher education
through taxation (and more recently a graduate tax) whiles others believe higher education
should be funded by the individuals through loans. Below are some of the reasons that justify
why taxation is a good source of funding higher education.
Funding higher education through taxation is seen as redistribution of funds towards the less
endowed individuals in the society. If money gained from the tax is returned to the funding for
the universities, then the middle class students by being taxed are in effect paying for the lower
income students. So they are paying to equalise the system and give the same opportunities to
others and mostly those individuals from deprived backgrounds. This means that it ensures
11

equity and fairness where taxpayers with the greater ability to pay, pays more tax, favouring the
redistribution of resources among the population.
Financing higher education through taxation makes it convenient for the taxpayer. Unlike
financing of higher education through the payment of tuition fees which is collected at point of
registration, or going for a loan to finance ones education which accumulates interest in the long
run. Because of the flexibility and timing of the tax payment system, it helps to ensure
compliance with the tax system. Thus the more difficult a tax is to pay, the more likely that it will
not be paid and vice versa. This also means that, the more difficult it is to pay for a loan or selffinancing (tuition fees), the more people will try to default and the more those from poor families
or the less privileged will not participate in higher education.
Financing education through the tax system, be it the graduate tax helps avoid losses to the state.
This is because when the person is out of educational system or becomes an ex-student and gets
employed, he or she starts paying or contributing to the state through income or graduate tax.
The problem arises when higher education is financed though loans. If such individuals migrate
to other countries, the fail to pay and then such loans are written off making the repayment rate
low which causes losses to the state.

2.0.1 Merits of a Graduate Tax

A graduate tax would mean it is levied for the whole of one's working life after graduation. This
would also imply that the more you are paid the more you pay back to the nation. Thus
graduates would start paying the costs of their university tuition when they leave school, enter
the job market and start earning. This makes a graduate tax be easier to administer.
12

Below are some of the merits of a graduate tax.

Introducing a graduate tax would be fairer than the current system where individuals pay tuition
fees, because lower-income graduates would bear less of a burden than if they paid a fixed price
for fees. Thus, it will create an incentive for students from a low-income background to strive for
higher education, increasing social mobility. It is a known fact that higher-income graduates
might end up paying more under the system but then, they can afford to.
The graduate tax will also prevent huge debts in interest payments accumulating, making it an
efficient way of funding higher education. And it will also prevent the creation of a market in
fees, which would force students to choose their university based on price. Undoubtedly,
graduate tax would fall hardest on those whose education costs were high and salaries were low,
however, this would include those in vital jobs such as teaching, social work and nursing. But
this can be counteracted by reducing the rate of graduate tax in these sectors of employment.
After all, such a tax would raise more revenue in the long run than the self-financing tuition fees
system.
A graduate tax may be progressive. This is because those who will or have benefited most from a
university education would pay most. It also however remove the spectre of graduating with
large debts, which could deter those from poorer backgrounds from going into higher education.

2.0.2 Demerits of a graduate tax

The fact that a graduate tax will prevent huge debts in interest payments accumulating and allow
students from low-income background to strive for higher education does not mean that it does
not have demerits. Below are some of the demerits of a graduate tax.

13

It is argued by the Russell Group of top universities that a graduate tax would be unfair, as those
graduates who are most successful would be charged far more than the cost of their education,
subsidising others. The Russell Group of top universities claim that high earners could end up
paying 16,000 a year in extra tax. High earners might also be more likely to work abroad to
avoid paying the graduate tax, causing a brain drain. (Russell Group, 2010)
Following the analysis of Harris (2010) on his paper 20 reasons why a graduate tax is a bad
idea, suggests that receipts from graduate taxes would flow to the Treasury, thereby
strengthening higher education institutions reliance on public funding and perpetuating central
planning. According to Harris, this would, rather obviously, be a devastating blow to universities
autonomy. It would also run strangely counter to the emphasis in the Governments policy in
primary and secondary education. Accordingly the more diligently a student spent his or her time
at university, and the more effectively he or she laid the foundations for a successful and wellremunerated career, the more they would ultimately contribute towards the cost of their studies.
Conversely, a student who enjoyed the same opportunity, at the same university, but wasted it,
would likely contribute less. For the same reasons, it would act as a dampener on career
development once in the workplace.
Harris also noted that attendant difficulties in collecting the tax across international boundaries
would presumably act as a disincentive to domestic, European Union (EU) and international
students from remaining in the UK following graduation. By making the UK a less attractive
destination for international students, a graduate tax could impair UK universities ability to
compete for the brightest and the best and damage what is currently a big export earner.

14

Furthermore a graduate tax would remove incentives to improve quality. Just as with fixed fees,
a pure graduate tax would offer no encouragement to institutions to deliver enhanced quality
over the minimum level as there would be no opportunity to recoup the costs. That is, a graduate
tax will also removes incentives to competition and, by extension, to potential efficiency gains
(Harris 2010).
2.1 Advantages of Fees (Loans) in Financing Higher Education
Financing higher education creates competing imperatives for public spending. Thus higher
education might cause shortage of resources which arises, in economic terms because mass, and
high-quality higher education is incompatible with fiscal constraints caused by longer-term
factors like international competitive pressures and population ageing. In political terms, tax
funding leads to under-resourcing because higher education will always lose out to competing
and politically more popular claims such as the National Health Service (NHS) (Barr, 2003)
Secondly, the fact that higher education is a basic right does not mean it should be free. The basic
idea underlying this notion is that, the equity objective is not free higher education but a system
in which no brilliant individual is left behind because he or she is from a poor family or poor
background. Tuition fees for higher education are fees for a service, from which the graduate
may derive substantial financial gain in the long run. It would be a mistake not to squeeze to
some extent those families or individuals through the payment of state and local taxes.
Mayhew (1973) noted that higher education today will as rapidly move as possible toward the
equalization of opportunity to attend college. Thus the achievement of universal access, in the
first instance, will require some shift in the share of direct costs borne by the family to the
taxpayers as more low-income students enter higher education dependent more on public aid and
less on parental support. In the longer run, however, particularly as family incomes keep rising
15

and as college attendance becomes more widespread at all income levels, it is anticipated that,
somewhat greater reliance will again be placed upon personal resources and somewhat less
reliance on government source as disposable incomes and ability to pay improve. This is to say
that, Mayhew forty-one years ago, believed that the financing of higher education would and
should change, and a higher share of costs shifted to students and their families, as public
attitudes changed and understanding of education as an investment increased.
Although it is essential to note that when people are asked to contribute even a nominal amount
towards the cost of a service, they tend to value that service more highly, be more careful about
the choices they make, and show greater commitment to those choices. People also often do not
act strictly rationally (in economic terms) when faced with a zero price or a free good. This is
not to say that students and graduates need to pay towards the cost of higher education in order to
attach value to the benefits they derive from it. However, having made a clear financial
contribution, students can become more empowered participants. They are likely to become
more demanding, seeking to have more input into, but also receive more from their education
and student experience (Barr, 2003).
There is also a factual evidence to suggest students have indeed become more demanding and
expect a higher quality student experience since the introduction of graduate contributions.
Evidence from the Higher Education Academy shows that students tend to expect a higher
overall quality of service, including facilities such as Information Technology (IT) and libraries,
and to expect more comprehensive access to these services.
According to Harris (2010), tuition fees are not a poll tax. They are a fees for which a service
is rendered, and also they are fees from which the graduate may derive substantial financial gain

16

in the long run. This is because higher education is an investment for which the individual
expects to recoup his investment.

2.2 Effects of tax financing versus tuition fees, lessons abroad

When it comes to higher education, many countries have similar goals, such as strengthening the
knowledge economy, increasing access for students, encouraging high completion rates and
assuring the financial stability of their higher education systems. Yet OECD countries differ
when it comes to how the costs of higher education is structured and in financial support they
provide to students. For example, countries with more progressive tax structures like Denmark,
Finland, Iceland, Norway and Sweden, students pay low or no tuition fee a t all and have access
to generous public subsidies for higher education. But tuition fees are much higher in Australia,
Canada, Netherlands even though there are available financial support in these countries.
Countries like France, Ireland, and Portugal among others have lower tuition fee or nothing at all
but also have limited access to financial aid.
Until a few years ago, Nordic countries (Denmark, Iceland, Norway, Finland etc.) had a long
tradition of free higher education financed by the taxpayers money. The situation has changed to
the introduction of payment of tuition fees by individuals coupled with grants and scholarships.
Denmark was the first to introduce tuition fees in 2006. Finland then launched a five-year trial
period running from 2010-14, while Sweden brought in tuition fees from 2011.
Before the introduction of tuition fees in Sweden, there were significant increase in international
student numbers in Swedish higher education, notably from outside the EU-EEA, up to 2010.
After fees were introduced there has been a dramatic fall in in the number of non-EU-EEA
students from about 8,000 to 2,000 from 2010-11 (University world news, cited in Myklebust,

17

2013). This suggest that, introducing tuition fees deter individuals from poor backgrounds. Not
only those from poor backgrounds, it also leads to a situation where individuals who can even
afford to pay make comparative analysis of the tuition fees options between Swedish University
and or abroad. But the question that needs to be asked is, what led to the abolition of fees paid
through taxation?
In both Sweden and Finland, until 2010 when they introduced the tuition fees, most non-EUEEA students were from Asia and Africa. These statistics also declined after fees were
introduced. This is attributed to the shock effect when going from no payment (financed
through taxation) to full costs payment.
During the 1990s, new loan schemes were introduced in several developing countries, including
China, Thailand, and Vietnam and loans are gradually being introduced or considered in Eastern
Europe and the former Soviet Union and some parts of Africa. Despite the problems of
nonpayment of loans, there are still guarded optimism about student loans. If subsidies for
student support are well targeted and efficiently administered to ensure the effective use of public
funds and to achieve equity, then loans will serve as a better way of financing higher education.
3.0 Policy Recommendation to the Minister
To conclude, the UK, with her presently high levels of budget deficit, is spending too much on
higher education even though below OECD average. At present, the economic priority of the
country should be to reduce its sizable public debt and this may results in large cuts to education
spending. By 201415, education spending is expected to fall to its lowest level since the mid1990s.
From the forgoing analysis, it is realized that the main ways of funding higher education in the
United Kingdom has been taxation, loan with mortgage-type repayments and contributions from
18

parents. Financing higher education through taxation has the advantage of ensuring equity and
fairness where taxpayers with the greater ability to pay, pays more tax, favouring the
redistribution of resources among the population and also helps to ensure losses to the state,
however, critics argue that receipts from graduate taxes would flow to the Treasury and cause a
blow to universities autonomy. Furthermore, a graduate tax believed would offer no
encouragement to institutions to deliver enhanced quality over the minimum level as there would
be no opportunity to recoup the costs.
On the other hand, financing higher education through fee payment (loans), will reduce the
pressure on the public finance. Accordingly, as public attitudes changed and understanding of
education as an investment increased, then financing higher education through self-financing
(loan) is a better way. However, introducing fees deter individuals from poor background.
Lessons abroad also show that, introducing tuition fees leads to a decline in international student
participation. Thus, it leads to a situation where individuals make comparative analysis of tuition
fees between the home country and the rest of the world. In such a situation, countries with lower
tuition fees attract the best student.
Higher education financing systems that charge a moderate level of tuition fees combined with
student financial support systems that offer loans with income-contingent repayments and grants
may stand a better chance of promoting access, equity, completion, and positive outcomes for
students. The central argument is that a mixture of tax funding and deferred charges is the most
effective way of improving national economic performance and promoting access. This is a
policy that improves efficiency and equity simultaneously.
Likewise financing higher education through moderate tuition fees (which at least the poor can
afford) and loans will help release pressure for competing imperatives on the public finance
19

which in turn will help reduce the budget deficit. As such financing of higher education through
moderate tuition fees and loans becomes a viable policy.

References:
Barr, N. (2003). Financing higher education: Comparing the options. London School of
Economics and Political Science.
Barr, N. (2004). Higher education funding. Oxford review of economic policy, 20, 264-283.
Barr, N. & Crawford, I. (1998). Funding higher education in an age of expansion. Education
Economics, 6, 45-70.
Blanden, J., Gregg, P. & Machin, S. (2005). Educational inequality and intergenerational
mobility. Whats the Good of Education, 99-114.
Dearden, L., Fitzsimons, E. & Wyness, G. (2011). CEE DP 126.
Greenaway, D. & Haynes, M. (2003). Funding Higher Education in the UK: The Role of Fees
and Loans*. The Economic Journal, 113, F150-F166.

20

Harris Mike, (2010). 20 reasons why a graduate tax is a bad idea. Available at
http://www.iod.com/influencing/policy-papers/education-and-skills/20-reasons-why-agraduate-tax-is-a-bad-idea
Myklebust J.P (2013). Fees and international students in Nordic nations. Available at
http://www.universityworldnews.com/article.php?story=20130503125808195
Mayhew, L. B. (1973). The Carnegie Commission on Higher Education. Jossey-Bass Publishers.
Mayhew*, K., Deer, C. & Dua, M. (2004). The move to mass higher education in the UK: many
questions and some answers. Oxford Review of Education, 30, 65-82.
Russell

Group.

(2010).

Objections

to

graduate

tax.

Available

at

http://www.russellgroup.ac.uk/russell-group-latest-news/121-2010/4317-objections-to-agraduate-tax/
Wyness, G. (2010). Policy changes in UK higher education funding, 1963-2009. Department of
Quantitative Social Science-Institute of Education, University of London.

21