Will a change in HECS save the government money?

by

A potential change in the HECS up-front discount from 20% to 10% has been flagged. A brief discussion is here. This is supposed to raise money for the government in the short term. Will it?

This is a nice little exercise for a first year economics class. There are two ways to pay for tertiary education in Australia – upfront with a discount or via a deferred payment scheme operating via taxes. So the real question relates to the elasticity of demand for ‘tertiary education paid upfront’. For the government to raise total revenue by raising the cost of paying upfront (and the reduction in the discount is just that – a rise in the ‘price’) the elasticity of demand for ‘tertiary education paid upfront’ must be less than unity (in absolute terms). In other words, the 12.5% rise in price  (i.e. the discount goes from 20% to 10%. So the rise in price from the current discounted level is 12.5%) must lead to a fall in quantity of less than 12.5%.

Is this likely to happen? I am not sure. The driver will be the marginal student/parent who pays upfront. There are some students/parents who will always pay upfront. There are some who will never pay upfront. The issue is those students/parents who are close to indifferent – who might pay up front with a 20% discount but not a 10% discount. I do not know how many students/parents are in this situation – and I am not sure the government has done the work on this either.

Now for this to be at a level for a first year class we need some interesting wrinkles. Here are three:

  1. The government could save money if some students drop out of university due to the change AND the government can reduce funding to the tertiary sector due to that reduction in student numbers. This could occur, but is probably only a very small effect. Much more likely, the student who no longer pays upfront will switch to the substitute product – tertiary studies with deferred payment.
  2. If students do substitute to deferred payment this will have a negative effect on the long term cost for the government. There are two reasons for this. First, the discount for upfront payment is generally less than the benefit from deferral in present value terms. In other words, on a sensible rate of discounting the government makes more money (in NPV terms) if students pay up front rather than defer. Also, deferral raises the risk of non-payment. Some students never pay back – for example because they never earn above the relevant income level. So any short term gain due to a reduced discount must be weighed against the long term cost of substitution to deferral.
  3. It is not obvious why most of the students/parents who pay upfront do so. The product (tertiary education) is the same. The difference is the way it is paid – upfront or deferred. Even at the 20% discount, work by Professor Bruce Chapman from ANU (and apologies – I do not have a link as I saw Bruce present this work a few years ago) suggested that for most students payment up-front was more expensive in net present value terms than deferral. In other words, if your parent (or you) is about to pay your HECS fees, tell them not to. Rather if you are a full-time student studying pretty much anything except law, take the money and put it in a term deposit (in the student’s name). Roll it over until the now-graduated-student earns above the income threshold, then take the money and payoff the HECS debt. In general, there will be money left over. So if the 20% discount is not great value, a 10% discount is even worse value. It will be interesting to see if this leads to a large shift to deferral – costing the government money.
6 Responses to "Will a change in HECS save the government money?"
  1. If indeed 20% is not great value (10% discount is even worse) but some are still doing upfront payments, then why doesn’t some financial institution offer an asset that can be bought now with say a 15% discount that pays future HECS tax liabilities? 

    I don’t get why this asset isn’t available.  I’d buy it for my kids.

  2. When it comes to paying for their children’s education, demand seems to be fairly inelastic. If the parents can afford it, they’ll probably pay up front because, let’s face it, what else are they going to do with the money?

  3. But it also depends on the discount rate applied by government. With a political cycle of 3 years and a government setting its objective function to maximise the probability of election in 2013, a government maximising its objective function may choose to do something in spite of the “obvious” nature of points 2 and 3 above.

  4. Yes, in the real world this could cost money.  But following Budget conventions it must be brought to book as a saving.  That no doubt is why DEEWR proferred it when asked by Finance for savings options.

    The Charter of Budget Honesty forbids counting “second round effects”, and the Dept of Finance  – full of accountants, not economists – treats virtually all behavioural effects as “second round”.  Usually this understates savings – for example, “welfare to work” measures are not allowed to count any reduction in payments or increased income tax that result.  Finance have just been hoist on their own accounting petard here – not for the first time, BTW. 

  5. My Finance lecturer at Melb Uni just set an assignment on discount rates not that dissimilar to what you have proposed….

%d bloggers like this:
PageLines