Australia & Japan in the Region

Volume 5, No 6, June, 2017

Access to university education and affordability of tuition are important to any advanced economy. Japan is not alone in facing major challenges on both fronts. In some countries like the United States, urgent reform is needed as the lack of access to and affordability of higher education increases inequality in society and creates hardship for many graduates.

The income contingent loan (ICL) system for financing higher education provides an innovative solution. This general idea was conceived by the economist Milton Friedman to overcome the market failure that banks won’t offer loans to students. First implemented in Australia and adopted now in England, New Zealand, Hungary, the Netherlands and South Korea, among other countries, it is designed to improve access to university for all students; limit the burden on the government budget; avoid hardship for graduates and be fairer for society.

Most countries subsidise university tuition because of its external benefits to society. But high or full subsidisation comes at a large cost to the government. And students from high income backgrounds receive much of the benefit at the expense of ordinary taxpayers. Unsurprisingly, those who are fortunate enough to attend university on average earn more in the future. So it is reasonable to expect them, rather than all taxpayers, to pay for that. Full subsidisation is very expensive for the government and is simply inequitable, a point now widely recognised and accepted.

But if fees representing a proportion of the costs are to be charged, how will this work for students from disadvantaged backgrounds? It is important to understand that for those without financial resources, banks and other commercial credit organisations will not generally offer loans to prospective students because the risk that students will default is high and banks have no collateral to offset the lost loan revenue.

This problem is handled in some countries (such as the United States and Canada) through the offer of government guarantees to lenders. But there are two problems with this. In the event of default all taxpayers must pick up the bill and these costs can be high. And debtors defaulting will experience major damage to their credit reputations and thus access to other loans in the future. The associated fears can be enough to discourage prospective students from going to university altogether.

A related problem for people with a bank-type student loan is that these debts need to be repaid according to a set period of time, the same as happens with a mortgage on a house. But many graduates can find themselves with repayment difficulties, perhaps due to unemployment, or other responsibilities such as child-rearing or caring for an ill parent. And these repayment hardships are exactly what lead to default.

All of the major problems of ‘normal’ student loans scheme can be resolved with ICLs.

Under an ICL scheme, students face no up-front charges, but they commit to paying back a certain proportion of their course costs in the future. Repayment of the debt is required only when and if a graduate’s income reaches a certain level — about US$40,000 in Australia and about US$30,000 in England. No repayments are ever made if a debtor’s income never reaches the first threshold of repayment.

The proportion of a graduate’s income used to repay the loan is set at a maximum which is 8, 9 and 10 per cent of incomes for Australia, England and New Zealand, and 20 per cent in South Korea. This critical feature of an ICL means that students with ICL debts cannot face repayment difficulties, no matter what their incomes are. No repayments are needed below the income threshold and the maximum proportion also protects more fortunate graduates. ICLs protect people from the adverse consequences of bad luck and in doing so eliminates default.

Payments are typically collected by employer withholdings based on income, in the same way as income taxes are collected throughout the world, including in Japan. In Australia, no interest is charged on the loans and the government recovers about 80 per cent of the loans. The loan recovery target could be higher or lower and is easily adjusted by parameters in the scheme. In England interest is charged — resulting in higher earning graduates repaying a larger amount — but the debts are wiped clean after 30 years, limiting the repayments of lower income graduates.

In April this year, Japan introduced a form of an income contingent loan program, but it suffers from several problems. Most importantly, and similar to the system operating in South Korea, the loan is only available to students depending on family income. This means that in Japan less than 10 per cent of new university students will be eligible for the current ICL scheme.

The ICLs operating in Australia, England and New Zealand are universal — all students are eligible. And this is the way it should be. The South Korean and Japanese systems leave large numbers of people who could benefit from an ICL without one, and thus face either the prospect of having no financial assistance or taking loans that do not protect borrowers from repayment hardship and default. For Japan to be following the South Korean ICL example is unfortunate when there are other applications around the world that work much better.

The current Japanese funding system is complicated and its direction is difficult to understand. Even with this small movement towards ICLs, significant problems remain and the system would benefit from change. There are systems elsewhere that are much simpler and fairer.

The authors are involved in a collaborative project with the Japan Center for Economic Research to study an income contingent loan scheme for Japan.

A longer version of this article was published in the Nikkei Newspaper in Japanese.

About the authors

Shiro Armstrong

Shiro Armstrong is Director of the Australia-Japan Research Centre at the Australian National University.

Bruce Chapman

Bruce Chapman is Professor of Economics at the Australian National University and the architect of the Australian higher education financing system.