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Rethinking the model

Combining free higher education with privatised universities might sound like a bad joke. TIM CURTIN explains why it’s not only legitimate but a realistic option.

July 7, 2004

Combining free tuition with universities wholly dependent on fee income for their teaching costs would seem as difficult as turning lead into gold, but is, in fact, much easier. All that is required is for the government to complete its gradual withdrawal from funding university teaching since 1988 and allow the universities complete financial autonomy in terms of charging and collecting fees. This would save budget expenditure of $5 billion, and create a moral imperative for an equal reduction in tax, for a zero change in the budget balance. The tax cuts however should take the form of tax credits of equal amount to fees paid to the universities by their customers (students and parents).

If that is done then there would be, in principle, complete user pays in line with the Hawke government’s apparent objective when it introduced HECS fees in 1989. But that government never reduced taxes in line with the switch to fees. This time the government should complete its withdrawal from financing university teaching by allowing those paying fees to claim equal credits from their income tax. For example, if average fees were say $8000 per student year, then those paying them would be credited with that amount as tax paid.

Special arrangements would be necessary to ensure that the minority of students (probably not more than 15 per cent) whose parents do not pay enough in income tax to be able to claim back the tuition fee in full would not be excluded from higher education. However the government should accept responsibility for awarding grants or scholarships to those students whose family circumstances are such that the tax credit would be inoperative. The basis for that responsibility is broadly the same as that the government already accepts by providing income support to all households whose income falls below a prescribed threshold, namely in this case total income on which income tax of less than about $8000 is payable. That basis is quite different from the lingering principle by which the government still funds university teaching costs above the amounts notionally generated by HECS fees, since in effect the grant would be providing income support for a particular purpose, undergraduate study, and a purpose moreover unlike general income support that is likely to ensure that beneficiaries themselves escape the poverty trap (by becoming graduates).

In the space available it is not possible to do justice to all the fine detail of implementation of this proposal. But it should be noted that the US already has a limited tax credit scheme for university tuition fees, so there is nothing new in what is being suggested here for Australia, except in the scale proposed. Moreover the ATO already administers some tax credits, such as that for a third of private medical insurance premiums.

Bruce Chapman’s claim there are no checks on universities’ power to charge whatever they please under the Nelson reforms seem implausible. There are many more universities in the higher education sector in Australia than there are firms in most other sectors of the economy, such as banks, insurance companies, supermarkets, bottle shops, pharmacies, motor vehicles, newspapers, television, oil refineries, power stations. It is hard to think of a sector conforming more closely to the competitive model, and it is already evident that many universities are engaging in price competition now that is permissible, with some raising fees, and some not.

However the argument here should not be about not the virtues of price competition but the return of higher education to the common pursuit of knowledge for its own sake. Ian Chubb has put this very well, “a civilised society has an obligation to provide at public expense an education system for its people and it should be as good by international standards as we can make it” but seems to be a lone voice in the AVCC.

With all governments since 1989 having signalled their determination to increase phase out public financing of university teaching, there seems to be no choice but to follow the logic of the Nelson reforms and treat universities as if they were profit-maximising businesses (some of their overseas campuses are already wholly for profit ventures). Then there is a strong case for their customers to be allowed to claim tax credits on fees paid. Tax credits already exist for part of private medical insurance per premiums, and tax deductions have always been available for financing costs of other forms of investment, such as purchases of investment properties and shares bought with margin loans, so no new tax principle is required. This would remove the clear discrimination against investment in human capital that would be present without some form of tax credit or deductibility for fees paid.

The potential for negative consequences from such discrimination is very real. A US study has shown that “a one-percentage-point increase in [just the ordinary] income tax rate causes the long-run stock of human capital to decline by 0.97 per cent under the most plausible set of parameters ... the quantitative conclusion that taxation significantly discourages investment in human beings is robust”. It follows that replacing HECS, which is from the graduates’ viewpoint just a surcharge on his or her income tax, by tax credits would be likely to offset the reduction in the demand for higher education in Australia that may well have resulted from HECS at its present level, whereby the repayment amounts to an increase in the top marginal rate of income tax to as high as 54.5 per cent.

Now it can be imagined that the Treasury would resist any move to allow fees to be tax deductible, if only out of sheer bureaucratic inertia, or refusal to acknowledge that when the government withdraws from funding a certain activity, it should reduce its tax collections pro rata. But with a bit of effort one should be able to see that the potential advantages are large.

Under fee deregulation, universities’ teaching functions would be funded directly by their fee income. Research activities would as now be dependent on a mix of government grants, channelled through the ARC and the private sector. Tuition fees would be charged first to those means-tested out of government grants and second to the government, paying only on behalf of those means-tested as unable to pay upfront - for surely governments of all persuasions would be as willing to provide a safety net for the lower income groups unable to claim tax deductions as they are already for other aspects of their welfare. Governments should be more than willing to fund attendance by students from these groups at university since that is the best way to move the next generation into middle and higher income groups.

One possible objection to allowing tax deductibility for tuition fees paid upfront is that it gives a greater benefit from the deduction to those at the higher end of the income scale, and that is regressive. But there are already tax deductions for depreciation and interest costs of property investment, shares bought on margin loans, and small business operations in general. Another is that simply allowing tax deductibility never recovers the full cost, saving only 19 to 48.5 per cent of the fee depending on taxpayers’ top rate of income tax.

Tax credits would deal with both problems. With all would-be students whose parents paid enough tax to claim credits for the full cost fee amounting to possibly as many as 80 per cent of all potential students, it could be expected that there would be a large increase in the take-up of up-front fees, from only about 8000 who paid full cost fees in 2002 and the 100,000 who have been paying HECS fees upfront, to at least 300,000 domestic undergraduates. That means the government itself would have to provide grants for the fees of only about 15 per cent of students. But because of the dynamics of the case even those obtaining grants would in time repay more than the cost of their tertiary education through the excess of their taxes over what they would have paid had they not had tertiary education.

The long run outcome is likely to be a large increase in demand for university places, probably to about the year 12 continuation rates into higher education as they were in 1989, for as the supply of places increases in response to rising demand, average fees should fall, because of the declining marginal costs of teaching larger student bodies. Later on as the existing unmet demand is satisfied there will also be keener competition between universities for a more slowly growing demand for higher education, which would also lead to lower fees - and crucially, for the government, a lower sacrifice of revenue from the tax credits. The extra income tax flowing from the enlarged output of graduates will soon more than compensate the government for the initial net “loss” of perhaps $200 million from funding grants for the lower income groups (before administrative savings) in the early years of the new model.

The model would require universities to give careful consideration to their pricing policies, particularly in regard to the more costly degrees such as medicine. Even so it might be necessary for the Commonwealth government to offer scholarships for those more costly courses for which demand constrained by available tax credits would be socially insufficient. Finally, the model would bring university financing very close to John Stuart Mill’s ideal compromise, privately financed universities that did not exclude those from whom social benefits accrue in excess of what they could themselves afford to pay in fees.

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