New directions forhigher educationfunding

Funding options review groupFinal report

Universities UK

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Contents

Preface

Rationale for the Review

Who benefits?

How has the Review proceeded?

The requirement for increased funding for teaching and learning

Identifying the sources of increased funding

The funding options

Criteria for analysis of the options

Analysis of strengths and weaknesses of the main options

Conclusions

Annex A : Additional Options

Tables & Figures

Figure 1 : An approach to funding options

Figure 2 : Higher education funding (1) : Funding per student 1998-99prices, £, England, 1993-94 to 2001-02

Figure 3 : How the funding needs can be met

Table 1 : SR2000 implications for the funding of teaching in highereducation (England)

Table 2 : Fee contributions from government and students with andwithout income contingent loans

Annex B : Membership

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Preface

This is the Final Report from the Funding Options Review Group, chaired by Sir William Taylor. It isthe culmination of intensive work by the Group over the last ten months. I welcome the report as asubstantive contribution to the rigorous debate on higher education funding that the Secretary of Statefor Education and Employment called for at the time of his February 2000 speech at the University ofGreenwich.

The report analyses the funding requirement for higher education within the context of the public’sand the Government’s aspirations for the sector. It examines the range of options for meeting therequirement and considers the strengths and weaknesses of each.

As the report says, both individuals and society at large benefit from higher education. A widerunderstanding of the continuing investment needs of the sector is essential if we are to keep at theforefront of international competitiveness and universities and colleges in all the constituent parts ofthe United Kingdom are to remain confident, dynamic and diverse.

The report is being presented to the membership of Universities UK in early March and will help informour consideration of the way forward as we prepare for the General Election and beyond.

On behalf of Universities UK, I would like to record our thanks to Sir William Taylor, the FundingOptions Review Group, and its Expert Panel for their enormous contribution to this important anddifficult subject.

Professor Sir Howard NewbyPresident, Universities UK

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1. Rationale for the Review

The Review was undertaken because of a widespread conviction among the membership ofUniversities UK that:

• current levels of funding for teaching and learning in higher education, from all sources, wereinsufficient to enable universities and colleges to achieve society's aspirations for maintaining andenhancing quality, to compete successfully in the global market place and to create a sociallyinclusive system in which a greater proportion of individuals from traditionally under-representedgroups participate in higher education.

• insufficient political and public attention had been paid to the reality of what has been happening.In part this is attributable to the universities and colleges themselves. Although relying mainly onpublic funding to survive and to prosper, they are also legally independent corporations, required,somehow, to make a modest surplus. However inadequate the money received, each institutionmust produce a balanced budget. When resources are short, institutions reduce their cost baseand seek new sources of income - often earmarked and making little if any contribution to generalfunds.

• significant damage has been done by many years of underfunded expansion, which since 1989have seen resources per student fall by 38 per cent, following a decrease of 20 per cent between1976 and 1989; staff-student ratios decline to an average of 1 to 17 (1 to 23 if funding for researchwhich is included in the average unit of funding is excluded); the academic labour market madeuncompetitive by institutions' inability to pay their staff adequately; the quality of the teaching andlearning infrastructure diminished by insufficient investment; increasing levels of non-completionexperienced particularly by universities offering access to the disadvantaged, and a realisation thatwithout additional funds the cost of legislation on disability and on equal pay for work of equalvalue will not be met.

• a willingness to halt the decline that threatened teaching and learning would be welcome, but in alllikelihood would be insufficient to remedy underlying problems. This has proved to be the case.The increased funding announced while the Review was in progress does reflect a shift in fundingpolicy, but too little will come to institutions in the form of per capita core funding for teaching andlearning to give confidence that underlying weaknesses can be addressed. And again, thosewhose mission is to widen access will fare worst of all.

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2. Who benefits?

2.1 Both individuals and society at large benefit from higher education. One of the key benefits is thecontribution of a highly qualified workforce to the UK's international competitiveness and its capacityfor innovation and product development. Other countries accept that increased investment, not only inresearch, but also in higher education teaching and learning, is essential to remain internationallycompetitive. Whilst the importance of this objective has often been referred to in the United Kingdom,it has not always been reflected in government funding of teaching and learning. As the report byLondon Economics commissioned on behalf of the Group illustrates, after excluding researchexpenditure, the UK's level of investment per student is low compared to many of its principalcompetitors.

2.2 Individuals also benefit. Graduates enjoy higher average salaries than non-graduates. Theindividual rate of return to possession of a degree remains significant. Some of this benefit contributesto the public purse through differential taxes on incomes. However, we have lower direct taxes thanmany other countries at comparable levels of economic development. It is arguable that the scale ofthe benefit to individuals from higher education justifies a direct contribution from them to the cost oftheir courses. This argument led to up-front, flat-rate tuition fee contributions being introduced in 1998.

2.3 In negotiations with governments, university leaders have not always emphasised the broadersocial benefits of offering post-secondary study opportunities to a larger proportion of the population,partly no doubt because such benefits are difficult to quantify. Some are a direct consequence of asimultaneously higher and broader-based level of personal competence. Others are associated withthe lifestyles that can be maintained by improved earnings and better occupational prospects. Difficultto measure as they may be, failure to recognise such benefits reflects an excessively narrowconception of what influences economic performance and suggests education is seen as having nopurposes beyond the instrumental.

2.4 The following need to be considered in devising a broader conception of the benefits of tertiaryeducation :

• higher levels of education have a positive impact on the readiness to learn of successivegenerations; those who benefited from higher education for the first time in the 1960's also wantedtheir children to benefit.

• a wide range of possibilities for full and part-time study, open to men and women of all ages,reduces differences in inter-generational opportunity and enhances social justice.

• there is a clear negative correlation between educational level and criminal conviction.

• higher education encourages a longer time perspective, essential to assessing the significanceand recognising the origins of an issue or problem.

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• overall, educational level is positively correlated with the cultural tolerance and understanding thatare necessary (if not in themselves sufficient) conditions for harmonious social life in multi-ethnicand multi-faith societies.

• better educated people make a more active and effective contribution to the development of thevoluntary sector.

• the well educated tend to be more flexible and innovative in response to the unexpected, betterable to cope with problems in family and community, less dependent upon services supplied by thestate, and inspired with that “passionate inquisitiveness to continue learning through life” (Councilfor Industry and Higher Education) that lies at the heart of so much educational and socio-culturalendeavour.

• a worthwhile higher education can help to reduce the excessive and unrealistic expectations thatconstitute one of the downsides of technological and scientific advance and of consumercapitalism, and thus counter the socially and politically disruptive consequences of suchexpectations remaining unfulfilled.

• a higher overall level of educational achievement in a population can help to protect and enhancehigh standards of publication, production and performance in literature, music, theatre, film,painting, sculpture, private and public architecture and fashion, and to encourage creativity andimagination, which are also major factors in attracting inward investment and invisible earnings forUK plc.

• good higher education can thus increase the overall quality of life of a population, enabling citizensto live more creatively, more fully, more responsibly.

• the cumulative effects of a larger proportion of the population experiencing higher education arelikely to create a more informed and responsible electorate, better able to appreciate thecomplexities of governing modern societies and to play a fuller part in the democratic process. Inthe words of John Stuart Mill in On Liberty, a good national education is essential to

“...the training of a citizen, the practical part of the education of a free people, taking them outof the narrow circle of personal and family selfishness, and accustoming them to thecomprehension of joint interests, the management of joint concerns - habituating them to actfrom public or semi-public motives, and guide their conduct by aims which unite instead ofisolating them from one another”.

When Mill wrote these words, it was primary and secondary education he had in mind. The complexity of today's world requires a longer period to be available for effective political education.

2.5 These benefits will not be best secured for society by institutions that struggle to make ends meetand have problems planning ahead; which devote too much of their already limited resources todevising and submitting competitive bids for short-term support and meeting increasingly complex

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compliance requirements; which must cope with low staff morale consequent upon inadequate pay; inwhich classes are too large and classrooms, laboratories and resource centres inadequately equipped.

2.6 The Review, then, is about more than money. It is about the willingness of society and itsgovernments to recognise that universities and colleges are now responsible for educating, socialising,training and realising the human potential of not just a narrowly selected minority, but a majority ofcitizens. Performing those tasks to a high standard requires fresh thinking and the assurance of anupward trajectory not just in numbers but in the overall resource base.

3. How has the Review proceeded?

3.1 The then Committee of Vice-Chancellors and Principals (now Universities UK) set up the FundingOptions Review Group at its residential meeting at Heriot-Watt University in March 2000. The remitspecified that the Group's work would be in two stages. In Stage 1 a range of options for the futurefunding of higher education would be identified. In Stage 2 the strengths and weaknesses of theseoptions would be assessed against a number of key objectives and criteria.

3.2 Stage 1 was completed with the presentation of a discussion paper to the CVCP residentialmeeting at the Stockton-on-Tees campus of the University of Durham in September 2000 (available atwww.universitiesuk.ac.uk) and, following the meeting of Universities UK on 1 December 2000, bypublication of a report commissioned from London Economics. (Review of funding options for highereducation in the UK. London: Universities UK on behalf of London Economics). The Review Groupwas then authorised to proceed with Stage 2.

3.3 This final report from the Group is self-standing, and does not repeat all the analysis andarguments used in earlier documents, particularly in the London Economics report.

3.4 On the basis of advice from the Review Group and its Expert Panel, Nigel Brown Associates wascommissioned by Universities UK to carry out the Stage 2 analysis of options, which is incorporatedinto this report.

3.5. There are a number of points to be made about the scope of our work:

• We have been principally concerned with the funding of teaching and learning in universities andcolleges of higher education, in particular the amount of funding per student, using England as thebasis of our calculations. It is lack of resources for these purposes that constitutes the core ofmany universities current difficulties and which has the greatest effect on the quality of the studentexperience of higher education. The funding of research raises different issues. In particular the

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outputs from research are either public goods or intended to provide specific benefits to thoseproviding research funds. There is, however, a close correlation between high quality research andteaching and learning, with the one informing the other. Although the report addresses theimplications for institutions of student support arrangements, it does not consider in depth thewhole range of issues relevant to students' living costs. These have been examined in the recentDfEE study of student income and expenditure1 and are currently the subject of a major study ofstudent debt commissioned by Universities UK.

• The detailed assessment of strengths and weaknesses in the main body of the report is confinedto four distinct options. This is in line with the decision made at Universities UK’s December 2000meeting that the number of options subject to detailed scrutiny should be reduced. It is also, in ourview, the most effective basis for discussion of the issues during the period leading up to and afterthe forthcoming General Election. The options selected include the main levers for bringing inadditional funds to institutions, and are considered further below. The strengths and weaknessesof the options originally identified and now excluded are examined in Annex A.

3.6 This report addresses, first, the requirement for additional funding for teaching and learningidentified in the then CVCP's Spending Review 2000 (SR2000) submission, and on the internationalcomparisons and analysis of the additional funding requirement in the London Economics report. Theanalysis also takes into account the implications of the additional public funding made available tohigher education under the SR2000 settlement.

3.7 The sources from which additional money could potentially come are then identified - generaltaxes; students and their families; graduates, including both required and voluntary contributions, andproceeds from sales of public assets. Four central options based upon these sources are thenassessed in relation to stated objectives and criteria, which are also used in considering the widerrange of options in Annex A.

1 Changing Student Finances : Income, Expenditure and the Take-up of Student Loans Among Full andPart-time Higher Education Students in 1998/9 by Claire Callender and Martin Kemp, DfEE Research ReportRR213 (2000)

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3.8 Our approach to funding options is represented in Figure 1 below.

Figure 1 : An approach to funding options

FUNDING REQUIREMENTS (Teaching and Learning)

Sources of Funds

Exemplar Funding Options

Impact on Students Impact on Institutions

4. The requirement for increased funding for teaching and learning

Context

4.1 When the review began in Spring 2000 our basis for assessing the funding requirement was thethen CVCP's submission to the Government's Spending Review (SR2000)2. Since then we havereceived the detailed analysis of the additional funding requirement undertaken by London Economics3

and the outcome of SR2000 for higher education institutions in England, set out in detail in theSecretary of State's letter to the Chairman of HEFCE of 29 November 2000. In the light of these andsubsequent developments in other parts of the UK it is appropriate to review the requirement foradditional funding.

Resources to achieve the Government's objectives

4.2 The case for improved investment in higher education has been set out in broad terms in Section 2above. Government has also set its own priorities - research and teaching excellence, social

2 Investing in universities and colleges for global success, Spending Review 2000 - the UK submission of CVCP,(December 1999)3 Review of funding options for higher education in the UK, a report for Universities UK by London Economics,(November 2000) - see especially Chapters 2 and 4

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inclusiveness, and success in the market place for higher education. These all have additional costs.They cannot be achieved simply by diverting and reallocating money within a diminishing or level total.

4.3 The cumulative effect of the economies that universities and colleges have had to make over thelast decade has given rise to real concern for the continued reputation for quality of our highereducation system. Institutions have had to make cuts in staffing and in other areas of support forstudents with implications for the quality of the student experience and therefore ultimately the qualityand performance of graduates in the workforce and in social and political life.

4.4 Another of the government's principal aims is to secure increased participation of individuals fromthe lower socio-economic groups in higher education. There is a significant extra cost in recruiting,motivating, teaching, supporting and meeting the specific needs of such students whilst at the sametime maintaining academic quality. This cost is not fully matched by the size of the so-called ‘postcodepremium’ applied in England. The argument that increased numbers can be educated at a lower unitcost by the more efficient use of existing infrastructure will not work. True, the UK is one of the mostsuccessful countries in the proportion of students who successfully complete their courses. Non-completion rates have been remarkably stable for many years at around 18 per cent, although thisaverage conceals significant variations between different types of students. They are highest amongstthe access students to which Government wishes to see attention directed. The recruitment ofadditional students from the lowest socio-economic groups followed by their premature exit is noservice to them, to the institutions that admit them or to the taxpayer. We welcome the Education andEmployment Committee’s recommendation that “immediate consideration should be given to raisingthe existing 5 per cent participation premium to at least 20 per cent”4 but funding to achieve this mustbe genuinely additional and we would advocate a more sophisticated approach than that based on thecurrent postcode analysis.

4.5 The government wishes universities and colleges in the UK to secure a significantly greater shareof an expanding international demand at a time when the world academic marketplace is increasinglycompetitive. The ability of institutions to recruit students rests on sustaining their reputation for quality.As levels of funding per student have continued to fall that reputation is at risk. Academic reputationsare hard to earn, all too easy to lose.

The consequences of reduced funding per student

4.6 While the total resources available to institutions is undoubtedly a major factor in their ability tomanage successfully, the key factor in their ability to fulfil academic and social objectives is the unit offunding per student. To repeat what has already been said - and can hardly be repeated too often -funding per student has fallen by 38 per cent in real terms since 1989 following a decrease of 20 per

4 House of Commons Education and Employment Committee, Fourth Report, Higher Education: Access (30January 2001).

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cent between 1976 and 1989. These figures do not, however, tell the full story. The impact of thereduction has been exacerbated because a significant proportion of funding is now tied to specificinitiatives, allocated on the basis of bids from institutions and not always directly relevant to teachingand learning. In 2000-01 HEFCE allocated £520m, over 10 per cent of its total funds, to specialfunding and earmarked capital funding. Some of this is for inherited activities such as extra Londoncosts and sector wide activities such as the Joint Information Systems Committee, but the costs ofbidding for funds and the earmarking of the funds do add to the downward pressure on the unit offunding. We were interested to hear of the intention of the Scottish Higher Education Funding Councilto seek as far as possible to absorb special initiative funding into its core block grant during the nextspending review period and hope this approach will commend itself more widely.

4.7 A 38 per cent fall in funding per student over the decade since 1989 inevitably led to a deteriorationof staff student ratios and of the teaching infrastructure such as libraries, laboratory equipment,workshops and computer facilities, especially in relation to student expectations from their experienceoutside higher education. Making good this deterioration and providing to students the benefits of newapproaches to learning is a significant part of the cost of retaining the reputation for quality of ourhigher education system. It will require major infrastructure investment over the next ten years.

4.8 Given the normal level of turnover of academic staff, institutions need to be able to recruit andretain men and women of high calibre to fill vacated posts and to address equity issues if they are toretain their international academic reputation and educate and train a workforce that can ensure theUK's competitiveness in a global economy.

4.9 Institutions incur considerable costs in responding to the increased demands for accountability,transparency and compliance that have accompanied democratisation, heightened risk-aversion andincreased social complexity. This exacerbates reductions in funding per student. The HEFCE report“Better Accountability for Higher Education” (August 2000) identified £250m per annum transactionand compliance costs for higher education.

4.10 There are additional costs to institutions in pursuing the non-payment of fee contributions andadministering funds to deal with student hardship under the new student financing arrangementsintroduced from 1998-99.

4.11 Because of the high proportion of funding necessarily spent on the costs of employing staff, theprincipal and inevitable impact of the reduction in core funding per student has been to increase theratio of students to staff, both academic and non-academic. The ratio of students to academic staffincreased from an average of about 9 to 1 in 1980 to 17 to 1 in 19985. (If funding for research which isincluded in the average unit of funding is excluded the SSR for teaching worsens to approximately 23

5 Funding Universities to meet National and International Challenges, David Greenaway & Michelle Haynes,University of Nottingham School of Economics Policy Report 001 (2000)

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to 1). The impact on the ratio of students to non-academic support staff is likely to have been similar,although growth in accountability and compliance requirements has almost certainly over the sameperiod led to an increase in the numbers of non-academic staff. At these staffing levels it is verydifficult to provide the level of feedback and support that students have the right to expect, and inparticular to offer those from the lowest socio-economic groups the kinds of help that will enable themto complete their courses in good standing.

4.12 Real terms comparisons of funding levels between different years are carried out using theannual GDP deflators to bring the funding on to a common basis. GDP deflators measure the changein prices in the economy as a whole and, since pay rises faster than prices generally, the GDP deflatortends to underestimate the impact of inflation in labour intensive sectors like higher education. Realterms comparisons between years using the deflator therefore underestimate the annual reduction inthe level of funding per student. The cumulative combined impact of this effect and the continuing yearon year reduction in the unit of funding on the ability of universities and colleges to sustain quality havebeen very significant over time. Recent modelling work undertaken by the British Universities FinanceDirectors Group (BUFDG) shows that over ten years, the combined effect of salaries rising faster thaninflation by 1 per cent per annum and a real terms reduction in the level of funding as measured by theGDP deflator would require institutions to find over £900m to maintain their financial position.

4.13 Universities and colleges faced with the impact of these factors on their budgets have tried tomaintain a healthy financial position through seeking economies and increasing income. This is wellillustrated by trends in income and expenditure for the UK higher education sector as a whole takenfrom data from the Higher Education Statistics Agency6 for different activities between 1994-95 and1998-99. Over that period the income of UK higher education institutions from funding council grantsfor teaching and from home and EU full-time fees fell by 3.4 per cent in real terms as measured by theGDP deflator. However, total teaching income increased by 0.7 per cent because fee income fromother sources, including international students, increased by 24 per cent, although the increase ininternational numbers obviously increased the workload of staff. Over the same period institutionsincreased their research income by 12.5 per cent and their income from other activities by 19 percent7. This additional income from other sources has, however, only a marginal impact on universityand college finances since the contribution to general funds is usually quite small. For example the netcontribution to general funds from research contracts is only about 14 per cent, and increases in thiscontribution have generally not been sufficient to cover the increased workload as overheads do notnormally cover full costs.

6 Resources in Higher Education 1994-95 to 1998-99 - Statistics Focus, HESA (to be published Spring 2001)

7 ibid.

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Previous Assessments of the Funding Need

4.14 Such evidence of the impact of the continued downward trend in funding per student onuniversities' ability to deliver high quality teaching and learning led the then CVCP in its SR2000submission to argue that the then planned reduction in public funding of 1 per cent in real termsbetween 2000-01 and 2001-02 should be rescinded and funding per student be held constant in realterms thereafter. The position as at December 1999 is illustrated in Figure 2, which also shows theimpact of individual contributions to fees from 1998-99.

4.15 In addition, the then CVCP's SR2000 submission argued for targeted additional funding forteaching and learning of more than £2bn over the three years for widening opportunities andexpansion in student numbers, for additional investment in the teaching infrastructure and for improvedpay and conditions for staff to address the issues highlighted in the Bett report8.

8 Independent Review of Higher Education Pay and Conditions - the Bett Report (1999), HMSO

Figure 2 : HIGHER EDUCATION FUNDING(1) : FUNDING PER STUDENT 1998-99 PRICES, £, ENGLAND, 1993-94 to 2001-02

4200

4400

4600

4800

5000

5200

5400

5600

5800

1993-94 1994-95 1995-96 1996-97 1997-98 1998-99*(plans)

1999-00*(plans)

2000-01*(plans)

2001-02*(plans)

including student fees contribution

excluding student fees contribution

Source:DFEEFinancial year(1) HEFCE/TTA grant and tuition fees. From 1999-00 excludes

earmarked grant for capital investment and research infrastructure.

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4.16 The analysis of the additional funding requirement in the London Economics report was broadlyconsistent with the CVCP's SR2000 submission, although with the important difference that the formerassumed the 1998-99 level of funding per student for teaching would be maintained in real terms. Themodelling work undertaken by London Economics used out-turn data from 1998-99. The report did notseparately estimate what the cost would be of restoring the then planned funding per student in 2001-02 and later years to the 1998-99 level in real terms.

4.17 Overall the London Economics report estimated that the additional funding requirement at 1998-99 prices would be £1.6bn per annum by 2009-10, but at least half of this could be attributed either tomeeting the costs of projected growth in student numbers or to the requirements of research. Theadditional funding needs of research are excluded from this report. The main issue with growth instudent numbers is that it should be funded at the average cost and not impose a further reduction infunding per student. London Economics estimated that the cost of such growth would requireadditional funding of nearly £200m per annum by 2009-10.

4.18 The London Economics report concluded that to meet the costs of additional investment in theteaching infrastructure, to enable institutions to recruit and retain high-calibre staff, and to educate toan appropriate standard students from lower socio-economic groups, would require additional fundingof about £800m per annum at 1998-99 prices. The report emphasised, however, that this should beregarded as a minimum figure. It took no account of the emerging implications of the TransparencyReview for the level of infrastructure investment required, of 'Third Mission' activity, the impact of staffsalaries and other costs rising faster than general inflation, or of the cost of implementing disabilitylegislation.

4.19 The full details of the outcome of SR2000 for higher education institutions in England onlybecame available with the publication of the Secretary of State for Education and Employment's letterof 26 November to the Chairman of HEFCE. The figures for the later two years of the survey remainprovisional, but the Secretary of State made clear that he hopes that institutions will be able to plan onthe basis of the figures.

4.20 The key figures from the settlement are set out in Table 1 overleaf.

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Table 1 SR2000 Implications for the Funding of Teaching in Higher Education (England)

Financial Year 2000-2001 (£m) 2001-2002 (£m)

2002-2003(£m)

2003-2004(£m)

Grants to HEFCE and TTA 4,445 4,702 4,897 5,088

WideningParticipation*

92 115 122 128Lessspecificfunding

HEFCEadministration costs

12.4 14.5 - -

Net grants to HEFCE and TTA 4,341 4,572 4,775 4,960

Public contributions to fees forfull time undergraduates

517 498 493 500

Student contributions to feesfrom full-time undergraduates

302 350 376 400

Total funding 5,160 5,420 5,644 5,860

Total funding at 2000-2001prices**

5,160 5,288 5,372 5,441

Planned student numbers (fte) 1,064 1,087 1,101 1,115

Funding per student (£) 4,850 4,865 4,879 4,880

Year on year change ( per cent) +0.3 +0.3 0

* The Select Committee has since recommended that the HEFCE premium be raised to 20%.** Assuming a deflator of 2.5 per cent per annum (Treasury figures, December 2000)

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4.21 There are a number of points about these figures to bear in mind: (All the figures in the table areEngland only)

• The planned growth in student numbers is funded at average unit funding levels.

• No account is taken of the impact of staff pay costs and other higher education costs rising fasterthan the GDP deflator.

• The increase of £50m in 2001-02 rising to £170m in 2003-04 for staff recruitment and retention isincluded within the general grant. Although this makes a contribution to quality, higher pay for keystaff does not of itself release additional staff to provide improvements in meeting the needs ofindividual students.

• These figures for average funding per student include HEFCE's core research support, which isdistributed on a very selective basis between institutions, and most of HEFCE's current specialinitiative funding, apart from items identified in the Secretary of State's letter as separatelyearmarked. Hence many universities with a focus on widening access will receive less than theaverage increase in funding per student provided by the settlement.

• The grant letter includes specific funding of £106m in 2001-02 rising to £206m in 2003-04 for ITand infrastructure capital which is not included in the calculations above. Not all the fundingidentified in the Table for widening participation of £115m in 2001-02 rising to £128m in 2003-04will go to universities and colleges. The basic grant figures in Table 1 do, however, include £8m in2001-02 rising to £10m in 2003-04 for "disadvantaged students".

• The full cost of implementing disability legislation is not reflected.

The funding need re-assessed

4.22 There has been some variation in SR2000 settlements across the UK with Scotland showing asignificant uplift in 2001-02 of 3.2% followed by level funding as in England, and Wales receiving atighter settlement throughout the SR2000 period. The outcome of SR2000 is clearly welcome as a firststep. It recognises most of the items requiring additional investment identified in the then CVCP'ssubmission. But there remain a number of unmet needs. In particular the impact of increases in payand other costs in universities and colleges above the assumed level of inflation will, over time, lead toa significant additional squeeze on institutional funding, with the consequence of further reductions instaffing and deterioration of the infrastructure as institutions continue to manage their finances byeconomies or by raising increased short-term external income. To be able by the end of 2003-04 andthereafter to retain the purchasing power of current levels of grant the total additional requirement from

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this source would be about £75m in 2004-05 for UK9 higher education, with increasing amounts insubsequent years.

4.23 The funding for recruitment and retention of staff of £170m by 2003-04, identified in the Secretaryof State's letter as within the main grant for higher education in England, is about £100m short of theestimate in the Bett report for the whole of the UK of 4% of the pay bill or about £275m. It has to berecognised that competition for staff is international, and may be with industry as well as otheruniversities.

4.24 This additional funding, while welcome, makes no contribution to the pressures on staff timearising from reduced student staff ratios nor does it provide any contribution towards meeting thestatutory requirements on institutions to offer equal pay for work of equal value or towards improvedstaff development. These latter were estimated by the Bett Report to cost more than £400m perannum for the UK.

4.25 The additional funds provided for investment in IT and infrastructure, including the funds to assistinstitutions meet the requirements of the Disability Discrimination Act 1995, go some way to meetingthe identified need. They clearly do not take full account, however, of the under-investment identified inthe emerging results of the Transparency Review and in earlier enquiries. The £27m over three yearsincluded in the main grant funding for "disadvantaged students" is also well short of the figure of£100m per annum which would be required to meet the recommendation of a 20 per cent premiummade in the February 2001 Report of the House of Commons Select Committee on Employment andEducation.

4.26 This analysis suggests that the continuing minimum additional funding need for higher educationin the UK above the new baseline provided by the SR2000 settlement at 2000-01 prices for teachingand learning is at least £620m per annum. It is made up as follows:

• Maintaining funding per student in real terms at 2000-01 levels - £75m;

• Selective improvements in pay and conditions to recruit and retain staff and to provide forimproved staff development - £195m;

• Improved the funding premium for disadvantaged students - which could cost up to an additional£100 million if the suggestion of an increase in the premium to 20 per cent is implemented.

9 The UK figure has been obtained by grossing up the England figure required to keep the real value of funding atits 2000-01 level after taking into account the impact of pay rises of 1 per cent above the GDP deflator of 2.5 percent. Pay represented 57.8 per cent of total expenditure in 1998-99 and English institutional income from fundingcouncil grants and academic fees was 81.9 per cent of the UK total

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• Meeting the need identified in the Transparency Review to put right the shortfall in investment inthe infrastructure. If the 8 per cent adjustment for infrastructure revealed in the early TransparencyReview data is applied to the costs for teaching, the total need would be some £500m which net ofexisting plans would leave an unmet requirement of £250m per annum.

4.27 The analysis of the level of recurrent funding per student over the next three years in Table 1excludes the increased capital funding for infrastructure which was also provided in the SR2000settlement. To make a direct comparison with the figures for recurrent funding per student in Table 1 itis also necessary, therefore, to exclude the outstanding funding requirement of £250m for the teachinginfrastructure from the total funding requirement of £620m per annum.

4.28 The net figure of £370m in 2004-05 or £272 per student at 2001-02 prices is equivalent to a 5.6per cent increase in the funding per student compared to the settlement figure for 2003-04 in Table 1.This takes no account of the further costs of meeting the requirements of the Disability DiscriminationAct or the costs of expansion beyond those included in the settlement from SR2000. Nor does itinclude funding for the additional costs of meeting the equal pay for equal work requirement whichwould, on the basis of the estimate in the Bett report increase the net figure to £650m and the totalfunding requirement to £900m per annum.

4.29 We now consider the available levers to generate additional funding at these levels.

5. Identifying the sources of increased funding

5.1 In order to simplify the range of options that could provide the necessary extra support for teachingand learning we have reviewed five different sources available for levering in additional funds toinstitutions.

• Increased public funding through increased block grants to institutions (the public funding option).

• Increased up front means-tested payments with or without income-contingent loans to assistindividuals meet their fee contributions (the market fees options).

• Contributions from graduates through capped income contingent contributions (the graduatecontributions option).

• Voluntary contributions from alumni, employers and other benefactors.

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• The endowment of some - and eventually perhaps all - universities and colleges through the saleof public assets (the endowment option).

5.2 The way in which these funding channels can be combined is represented schematically in Figure3.

Figure 3 : How the funding needs can be met

Government Support Student Support Students and Parents

Subsidised Income-Contingent Loans

Graduates

Block Grants Fees

Contributions to Endowment Fund

Additional Funding For Teaching

6. The funding options

6.1 This simplified classification of the available sources of additional funding for teaching and learningprovides a base for identifying particular funding options. We have selected four which could meet thefunding requirement. In selecting the options we have also had in mind the costs of the Government'saspirations for the sector. The four exemplar options we have chosen are as follows:

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• Option 1 - Increased Public Funding

The required increase in funding would be met from public funds, raised by general taxation, throughan increase in the block grant funding for teaching from the higher education funding councils withinthe current funding approach. Thus this option would combine the current student number based,subject banded block grants from the funding councils, but at increased levels, with means-tested feecontributions maintained at their present level in real terms. The current system of income-contingentloans for student maintenance with repayments through the tax system would be retained. It could bemodified to make grant support available, beyond that now proposed through opportunity bursaries forstudents from the poorest families and/or to increase the proportion of the loan that is means-tested.

• Option 2 - Market Fees

The required increase in funding would be met through differential fees paid directly to institutions. Thecurrent student number based, subject banded block grants from the higher education funding councilswould be retained at their present level.

As identified in the London Economics report and in the report prepared by Professor DavidGreenaway and Dr Michelle Haynes for the Russell group of universities, there are at least three kindsof fee differentiation possible - by subject cost, by prospective rate of return to the individual (as in theAustralian system) and by deregulation.

Although deregulation is sometimes identified with "top-up" fees, it could in practice enable someinstitutions to reduce their fees for subjects where recruitment is very difficult. It is better definedtherefore as a market fees approach, as is already the case for part-time undergraduate and mostpostgraduate fees.

We have chosen to focus our assessment on this last type of differential fee option. To enablestudents to pay fees it would need to be accompanied with institutional funded scholarships for thepoorest and publicly provided income-contingent loans for the remainder. As with option 1 it could becombined with the current or a modified system of income-contingent loans for student maintenance.

• Option 3 - Graduate Income-contingent contributions

The current system of means-tested fees would be replaced by a system of capped income-contingentcontributions paid by graduates after the completion of their courses. The loss by institutions of thecurrent up-front means-tested fee contributions would need to be compensated by increased publicfunding. Such a system will be implemented in Scotland for Scottish domiciled and EU students fromSeptember 2001, based on decisions made by the Scottish Executive in response to the Cubie Report.

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Cubie recommended that an endowment fund should support institutions as well as students, while theExecutive decided to give priority to the latter. However, in the option being proposed here graduatecontributions would form a second stream of funding for teaching and learning to meet the increasedfunding need. Publicly funded income-contingent loans would be available to graduates to meet theircontribution. As with options 1 and 2 this option could be combined with the current system of incomecontingent loans for student maintenance or a modified system.

• Option 4 - Institutional Endowment

Under this option institutions would receive on submission of an acceptable proposal a one-offendowment from public funds to replace their current block grants from the funding councils forteaching and learning and the public contribution to fees. This is essentially the proposal recently putforward by the Conservative Party. Since the endowment would come from public funds it can beargued that this option is simply replacing an expected flow of future grants with an immediate singleblock grant. It could, however, offer institutions more autonomy in the investment and spending of thefunds than the current arrangements, though this would depend on the nature of the regulatory regimeadopted. Although the Conservatives have indicated that they do not support fee de-regulation, thusremoving many of the potential benefits of the proposal, this option could be combined with options 2or 3 above.

6.2 As previously indicated, we have not included all the options put forward during our discussionsover the last twelve months. Many are essentially variants on the four we have selected: others havebeen excluded because they do not of themselves raise increased funds to meet institutions' fundingneeds. The strengths and weaknesses of a selection of these additional options are set out in AnnexA.

7. Criteria for analysis of the options

7.1 We have identified eight criteria against which each of the options has been assessed. All of theseare relevant to any properly informed decisions about future funding strategy. However, given thataccount must be taken of the ability of higher education institutions to meet the Government'saspirations for the system at current levels of funding, the first three criteria identified below are judgedto be the most important. We have indicated under each heading some of the considerations we havehad in mind in introducing and using the criteria.

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7.2 The eight criteria are:

(a) Additional funding for teaching and learning

Will the option provide institutions with additional core funding for teaching and learning to maintain orimprove the level of funding per student at 2000-01 levels in real terms and meet the additionalrequirements costed in the London Economics report? Will the funding be truly additional or will it beoffset by reductions in existing taxpayer support? Improved core funding is essential if the quality ofthe student experience is to be maintained and UK universities are to retain their capacity to respondspeedily and effectively to the emergent demands of the knowledge economy.

(b) Quality of the student experience

Will the option contribute to maintaining and enhancing the quality of teaching and learning? Areadditional funds generated by the option likely to be available to enhance the core funding of teachingand support infrastructure investment as opposed to being tied to specific initiatives? Will increasedpurchasing power in the hands of the students create greater incentives for institutions to improve theirteaching performance?

(c) Social inclusion

Will the option assist or hinder an increase in the participation of people from the lower socio-economicgroups? What impact will it have on the financial calculations of these individuals and their families? Isthe size of the future debt burden a disincentive to participation? Is there a disparity between the realityand individuals' perceptions of the changes envisaged?

(d) Implications for employers

Will the option be likely to lead to an increase in the salary premium employers pay to graduates? Willit offer increased opportunities or incentives to employers to support undergraduates financially? Will itincrease the compliance burden on employers of collecting income-contingent loan repayments fromgraduates?

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(e) Institutional flexibility and innovation

What impact will the option have on institutional autonomy and mission? Will it promote or inhibitdiversity of mission or new approaches to teaching and learning? Will it encourage or discourage part-time provision? Will it discourage postgraduate study, if, for example, students graduate withsubstantially higher loan debt than now? Will it promote or inhibit institutional competition andcollaboration? Will the option be capable of coping with significant changes in demand and the patternof provision?

(f) Political feasibility

What will politicians think of the option? How will it be viewed by potential and existing students andtheir families and by taxpayers generally? Is something similar being considered by one or more of thepolitical parties? Are there particular European Union considerations? Will it tend to promote furtherdivergence across the constituent parts of the UK or restore greater coherence?

(g) Transparency

Is the option transparent? Will institutions and students readily be able to understand what they willreceive or have to contribute towards the costs of their education?

(h) Administrative implications

Will the option be likely to increase the administrative burden on public bodies, institutions orindividuals? Can it be incorporated into existing systems and is that desirable? Is it likely to provide aready means of control over the total annual public funding of higher education?

8. Analysis of strengths and weaknesses of the main options

We now analyse the strengths and weaknesses of the four options identified above against the criteriain Section 7.

8.1 Option 1 - Increased Public Funding

Commentary. This option would retain the present pattern of block grant funding and individualmeans-tested contributions to fees, but with increased public funding for teaching and learning

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provided via the block grant. Contributions to fees from individuals would be held at their present levelin real terms. This option is consistent with the arguments in the Dearing Report for limiting individualcontributions to 25 per cent of the average funding per student for teaching and learning.

Variants on this option might include a higher maximum, means-tested contribution to flat rate feeswith or without income-contingent loans to assist individuals make their contribution. Examples of suchvariants are included in Annex A. This option might also accommodate a system of voluntary income-contingent graduate (alumni) contributions as discussed in the Funding Options Review Group's firstreport.

Strengths. Additions to funding through increased block grants are readily identifiable. TheGovernment would be keen to acknowledge what additional funding it had provided. Notwithstandingthe policy changes in Scotland and the commitment by the Liberal Democrats to abolish feecontributions, they appear in practice to have been accepted at their present level, even if grudgingly,by a majority of electors, parents and students. The study of student attitudes to debt recentlycommissioned by Universities UK should, however, shed further light on this issue.

Fees at their present level make a modest contribution to equity by charging most to those best able topay. In theory this option ought to have no impact on the participation of those from the poorestfamilies since they would continue to be exempt from paying contributions. In practice, especially whencoupled with the use of loans to finance maintenance, this approach appears to have had somedisincentive effect on participation by poorer students because of the widespread misperception thateveryone pays fees. The combination of tuition fees and replacement of maintenance grants by loansalready discourages mature students from entering full-time higher education. Here again, theresearch commissioned by Universities UK into the impact of debt on student participation andacademic performance should shed further light on the impact of means-tested fees on participation.

Weaknesses. This option is wholly dependent on how favourably the Government of the day isprepared to look upon the funding needs of higher education. There can be no guarantee, if additionalfunding is secured in the short-term, that it will not be subsequently eroded as economiccircumstances become less favourable or following a change of government to one less favourablydisposed to higher education. Equally there can be no guarantee that the existing level of individualcontributions to fees will not be matched by erosion of public funding at some time in the future.

The option increases the dependency of institutions on public funds and is therefore likely to add torather than decrease the demands for scrutiny and accountability. As noted above, the current patternof up-front means-tested fee contributions may also be having a disincentive effect on participation bymature students and those from the poorest backgrounds. The absence of a maintenance grant forthese students and their dependence on loans may also constitute a disincentive. For some otherstudents parental contributions are not always forthcoming. Institutions will continue to face the

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additional administrative costs of developing approaches that maximise fee payments while alsodealing with those who will not or cannot pay.

8.2 Option 2 - Market Fees

Commentary. This option is essentially the reverse of option 1 in terms of how the additional fundswould be raised, in that it assumes that block grant would be fixed at its present level and the requiredadditional funding would be found through increased fee income by allowing differential fees to becharged.

There are in practice several approaches to differentiated fees :

(i) They can be differentiated by subject on the basis of the supply cost of provision as was thecase for publicly funded fees prior to 1998-99.

(ii) They can be differentiated by demand or assumed private return - higher fees for law andmedicine and lower fees for history - as the Australians have attempted to do.

(iii) They can also be differentiated by subject and institution on the basis of market forces.Greenaway and Haynes point to the emergence of differential fee levels within the internationalstudent market as a guide to what might happen if home fees were deregulated.

As with the Greenaway and Haynes model, students from the poorest families would receivescholarships funded out of the increased fee income. Other students could apply for income-contingentloans to meet fee costs but would be charged a positive rate of interest, unlike current loans formaintenance which charge a zero real rate so that repayments include interest at only the rate ofinflation.

Strengths. Fee deregulation would in principle allow institutions to set their fees at levels that, subjectto the pressures of market forces, more nearly reflected the costs of providing teaching. To meet thelevel of funding need of some £620m identified in Section 2 would require average fees per person toincrease by about £700 per annum before taking into account the need to fund scholarships for thepoorest students.

It is, however, difficult to model with any confidence the yield of additional income from a full marketsystem of fees. There would be a complex interaction in practice between the level of fees that the

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market would bear and the amount of fee support the Government was prepared to provide throughmeans-testing or the provision of subsidised income-contingent loans.

The mixture of scholarships or bursaries for the poorest students funded out of total fee income andincome-contingent loans for remaining students is difficult to cost. At private institutions in the USAtypically 20 to 25 per cent of fee income is used to support students from the least affluentbackgrounds.

In time an alumni contribution scheme where individuals effectively contracted at the time of theirundergraduate study to make regular contributions to the institution they attended once their incomereached a certain level could be used, at least in part, to widen the range of students who could beassisted with fees, but it would be several years before such schemes would begin to yield substantialannual income.

Income-contingent loans would ease the immediate burden for individuals and their families required tomake higher contributions compared to the current position or that under option 1. Such loans arelikely to be a significantly less expensive option for government than the increased grant support formeans-tested fees with a higher maximum contribution. (See the discussion of option 5 in Annex A).

Under the resource accounting treatment applied to loans funded from public funds, only the elementof the loan funding that represents a continuing public subsidy counts as public expenditure. Forincome-contingent loans there are two main elements of subsidy. First, the amount never repaidbecause of death, default or forgiveness for those who never earn enough to repay, and second, theinterest rate subsidy if the interest rate applied is less than the Government's cost of borrowing.Existing maintenance loans are estimated to contain between 40 and 50 per cent of subsidies, themajority of which comes from charging interest at the rate of inflation (zero real interest). Charging aninterest rate of 6 per cent would be likely to reduce the subsidy to below 20 per cent. The savingswould be even greater if a positive interest rate discouraged wealthier students from taking out studentloans solely to benefit from the higher interest they can earn by depositing the funds into IndividualSavings Accounts (ISA) and other high interest bearing accounts.

Deregulation of fees would also encourage diversity amongst institutions and potentially offer greaterchoice to students. Higher average fees could also be expected to increase the pressure oninstitutions from individuals and their families to meet their expectations about levels of support andfeedback from staff and quality of resources more generally, and thus could improve value for moneyin the provision of teaching and learning.

Weaknesses. Differential fees with public funding support was the system in operation prior to 1998,albeit with the whole fee being paid from public funds. There can be no certainty of the extent to which

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any government would be willing to use public funds to support, through income-contingent loans,deregulated fees that permitted differentiation by institutions.

On the assumption that scholarship schemes would be in place to enable the poorest students to paytheir fees, any move on the part of a future government to set the maximum fee levels that it wasprepared to meet from public funds and to leave individuals to pay the balance would have substantialconsequences for students from families with intermediate incomes.

It is unlikely that at least in the short to medium term the UK market would bear fees for homeundergraduates that allowed many institutions to set aside funds to meet the fees of all those whocurrently pay no fee contribution (50 per cent of all students from next year). Expecting anycontribution from such students beyond the maximum value of the income-contingent loan would belikely to put their participation at risk. This is before taking into account any impact arising from loanaversion of increasing substantially the total indebtedness of graduates, especially if the debt were toattract a real rate of interest.

Furthermore, there is already evidence from the DfEE study that many parents in 1998-99 were notmaking their contribution to fees. Even though that was the first year of the current scheme there mustbe a risk that higher fees, even with support arrangements in place, would exacerbate the problem ofindividuals whose parents refuse to contribute.

The financial implications for different institutions and subjects would also be very uncertain andpotentially damaging. Those institutions that have been most successful in attracting students from thepoorest families would be least well placed to charge substantially higher fees and might also be underthe most pressure to reduce fees in certain subjects. They would then find it even more difficult toprovide for the additional needs of those students from the poorest backgrounds. At the very least thisoption would risk further increasing differentiation within the system without necessarily adding todiversity.

If there was substantial fee differentiation by subject for full-time undergraduates, institutions wouldalmost certainly wish to reconsider the pattern of fees charged to part-time undergraduates,particularly where part-time students were following similar programmes to full-time students.Furthermore there could be a substantial shift towards part-time study if the part-time fee regime wasmore manageable for individuals than that for full-time enrolments. This would tend to increase thetime taken for students to qualify.

If income-contingent loans were made available to home students to meet the cost of fees, under EUlaw such loans would also have to be offered to EU undergraduates from outside the UK. Becauseloan repayments are collected through the national tax system there is likely to be a much higher levelof default by graduates from outside the UK. This would tend to increase significantly the public

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subsidy in the loans and increase the resource cost that counts as public expenditure. On the otherhand this would be in the context of loans that had a substantially lower public subsidy and hencelower resource costs than the current maintenance loans, due to charging a real rate of interest.

From their pre-manifesto statements on higher education funding, it appears that none of the majorparties is currently prepared to countenance higher fees. Labour has moved from stating that it had noplans for the introduction of higher fees to a commitment that if elected, 'top-up' fees would be ruledout for the duration of the next Parliament. The Conservatives have stated that universities endowedunder its proposals and those outside the scheme would need to share a level playing field. TheLiberal Democrats would abolish up-front fees altogether in favour of a graduate contribution.

It is also important to remember that Scotland has abolished up-front fees and now has a system ofgraduate contributions. The Welsh Assembly is currently considering the issue, although under presentlegislation policies for student support in both England and Wales are a matter for the Secretary ofState for Education and Employment. The Minister for Education in Northern Ireland has made clearthat he opposes the abolition of contributions, but this is still subject to consideration by the NorthernIreland Assembly.

8.3 Option 3 - Income-contingent Graduate Contributions

Commentary. This type of option involves no up-front contribution from individuals, either means-tested or supported by income-contingent loans. Instead graduates and those not completing theircourses are required to make a fixed contribution into an endowment fund shortly after graduation.

Individuals could choose to pay the money directly or take out an income-contingent loan. From theperspective of students this is essentially the same as the approach recommended by the Cubiecommittee on student finance in Scotland and to be implemented from autumn 2001. (See option 6 inAnnex A). The key difference between this option and the Scottish approach is that the endowmentfund here proposed would principally be used to meet shortfalls in funding teaching and learning ininstitutions rather than providing additional support for students, although the latter would not be ruledout.

As well as the original Cubie proposal, which is considered in Annex A, another variation on this optionwould not require any contribution on graduation from individuals but only once graduates startedearning above the threshold for payments. This would be what is usually spoken of as a 'graduate tax',although the total of expected contributions could be limited. This would, however, delay verysignificantly the build-up of the fund and make it more likely that the relationship between graduatecontributions and institutional funding would be broken.

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Strengths. With a graduate contribution at the level proposed in Scotland of £2,000 this option couldgenerate some £600m a year for an endowment fund with current annual numbers of graduatesacross the UK. Much of this would, however, come from publicly funded income-contingent loans,although the resource cost would be substantially lower than the cash cost with the actual leveldependent on whether the loans charged a real rate of interest.

The loan for the graduate contribution could be rolled up with the existing maintenance loans, as is tobe done in Scotland. This would offer the clear advantage of minimising the additional administrativeimpact of the option on the Inland Revenue, employers and the Student Loans Company alongside themaintenance loan repayments.

Because of the absence of any requirement for up-front fee contributions, this option minimises thedisincentive to participation amongst all groups, including those who would almost certainly be means-tested out of making a contribution in the current system but nevertheless are worried by the prospectof fees. The flow of money from the endowment fund, provided it was allocated with a light touch,might encourage institutional diversity and provide specific assistance to those institutions that recruitthe largest number of students from the poorest backgrounds. This option could also provide anincentive to employers to pay the graduate contribution as a form of "golden hello", especially in fieldswhere competition for graduates is strongest.

Weaknesses. This option would require additional public funds to replace the current privatecontributions to fees. This would put institutions at greater risk of further reductions in the level offunding per student as a result of changes in economic circumstances or from other and strongerclaims on public expenditure. The need for government to make good the loss of individualcontributions to fee income also makes it more likely that over time that public funding will be reducedas funds flow from an endowment fund and this source of funds will cease to be truly additional.

Although the abolition of the up-front fee would remove the apparent disincentive to students frompoorer families who under current arrangements believe, mistakenly, that they will have to pay a fee,the extension of loans to cover individual contributions might act as a similar disincentive, given theimpact on applications of existing loans for maintenance and the increased level of debt.

As noted above the removal of the link to a specific loan by contributions being paid on an income-contingent basis significantly delays the flow of money into the endowment fund. It would also risklosing the connection between the payments and the funding of higher education institutions.

A further weakness of this option is that it would make alumni contribution schemes a less attractivepossibility for individuals. It would also reduce equity, in the short term at least, since it would requireadditional funding up-front from the general taxpayer to replace means-tested contributions from well-off families.

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Finally, the option would not provide incentives to students to put pressure on their institutions toprovide improved value for money - although such pressure might come from graduates.

8.4 Option 4 - Institutional Endowment

Commentary. This option is primarily motivated by the desire to find a means to deregulate at leastsome universities and it is currently being investigated by the Conservative Party.

The Conservative proposals would raise interest rates on student loans to a market level, assumed tobe 4.5 per cent real and 7 per cent nominal, and through securitisation accelerate Exchequer receipts.These receipts would permit sale of securities representing the loans at £1.6bn, which would be usedto offer universities endowments (‘perpetual loans’). By investing these endowments in broad,pension-fund type portfolios, universities would obtain about 4.5 per cent real returns, which wouldreplace their current income from funding council teaching grants.

The income threshold for the repayment by graduates of their loans would be raised to £20,000, but anew £3,500 tax allowance would be available, the value of which is estimated as £700 per annum.

A number of issues need to be addressed in appraising this initiative :

• Could the option eventually apply to the whole sector of universities and colleges? At present ithas been seen as voluntary, requiring institutions to apply on as yet unspecified terms andconditions.

• What criteria would be used for deciding - and who would decide - whether an institution whichapplied to opt-out should be allowed to do so?

• What would be the endowment (‘perpetual loan’) required to enable an institution to operatewithout further recourse to direct public funding? On the assumption of a consistent 4.5 per centreal return on investments, an institution would need 22.2 times its annual teaching grant fromthe funding council plus publicly funded fee income in order to maintain funding at current levels.If endowment was limited, at least in the first instance, to the twelve universities with the largestfunding council research grants, a total of £24bn would be needed to replace the funding councilteaching grant plus publicly funded fees. The endowment of all universities on this basis wouldrequire £101bn.

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• How far in practice would deregulation go? Governments will continue to be concerned that feeregimes do not discourage participation amongst those from the poorest families and the PublicAccounts Committee will surely continue to be concerned about the financial health of opted-outinstitutions, especially when so much public money has been invested.

• How will those institutions not opted-out be funded? Will the cost of opt-out be excluded fromfuture assessments of the needs of the publicly-funded sector?

Strengths. This is one of the few schemes that could give universities increased autonomy andindependence of action if the right terms are agreed. It would enable the most competitive and popularinstitutions and maybe also those specialist institutions operating in a niche market fully to exploit theircomparative advantage, and facilitate the further development of world class universities and specialistinstitutions. It could facilitate the development of a 'culture of giving' such as exists in the USA.

Weaknesses. The scheme is very sensitive to the assumptions made about returns on investmentsand, as indicated above, to the kinds of income loss for which endowments would compensate. Giventhe sums involved, it would be many years before the whole sector could be endowed, and in themeantime there would be a return to an explicit dividing line between institutions. Before such ascheme became universal, Governments with different ideas about the relation of universities and thestate might be elected.

It also has to be asked if any Government would be willing to give universities the degree of freedomthat, theoretically at least, this option entails. Indeed, as we have seen, the Conservatives havealready stated that even endowed universities would not be free to determine their own undergraduatefees. It must be uncertain how many universities, if any, would seek to opt out if deregulation stoppedshort of fees.

Such a scheme might have a negative impact on widening participation. Furthermore, the risks inbeing dependent for income on the vagaries of the financial markets, as opposed to the whims ofpublic expenditure, may make opted-out institutions less willing to innovate. However, against this itshould be noted that Harvard and some other American universities have been huge beneficiaries ofthe high performance of the Stock market in the USA over the last eight years, although the size oftheir endowments makes direct comparisons problematic.

9. Conclusions

9.1 The Funding Options Review Group was not asked to identify a single preferred funding option forthe higher education sector. We have set out the strengths and weaknesses of a range of approaches,selected principally for their capacity to generate additional funds.

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9.2 Any of the options discussed is capable of meeting the funding requirement identified in Section 4by setting appropriate levels of public support and of upfront and deferred fee contributions fromstudents and their families or from graduates.

9.3 It is now for Universities UK to decide what position to adopt vis-a-vis these and any otherpossibilities that may be identified. In doing so, Vice-Chancellors will no doubt wish to take intoaccount the evidence of recent studies of student support, and issues relating to the effects ofresearch funding on institutional finances, considered in several recent reports but not dealt with here.Given the differences that now exist between the higher education policies of the major political parties- and increasingly between the different constituent parts of the UK - there is much to be said for usingthe time before the General Election to develop and refine the structural and institutionalconsequences of the major options in the context of manifesto commitments, with a view to earlyinitiation of an active dialogue with the incoming government.

9.4 Such a dialogue needs to focus on ways in which the effects of a long decline in the resourcesavailable for teaching and learning can be reversed and significant additional money made available toimprove staff-student ratios and enhance infrastructure. Resources for these purposes impact onprospects for achieving every one of the objectives that government and the universities share,including social inclusion, the maintenance of world-class excellence, a high quality studentexperience, and provision of a sound basis for life-long learning.

9.5 We hope the Group’s work over the last ten months will contribute to a wider understanding of thecontinuing investment needs of maintaining the UK at the forefront in international competition. Suchunderstanding, and the action that needs to flow from it, is essential to the existence of a well-founded,confident, dynamic and diverse system of universities and colleges in the United Kingdom.

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Annex A: Additional Options

This Annex examines the strengths and weaknesses of four other options that have been consideredby the Group:

• Increased maximum fee contribution with income-contingent loans;

• The Cubie/Scottish Parliament scheme;

• Full cost fees and scholarships;

• Individual learning accounts.

Option 5 - Undergraduate teaching funded by block grants and means-tested feecontributions as currently but with higher level of fees, and income-contingent loansavailable to meet fee as well as maintenance costs.

Commentary. A fee maximum of £2,100, twice the current level, would produce additional income ofsome £800m for English institutions. However, the financial implications for individuals andgovernment would depend on the precise features of the income contingent loan scheme selected, aswas discussed in the main paper for the market fees option.

Strengths. There would be no requirement on students or their families to pay their means-tested feecontribution up-front, although they could choose to do so. Individuals could alternatively elect to takeout an income-contingent loan to cover their means-tested fee contribution and then repay the loanonce they have graduated (or left higher education, if they failed to complete their course) providedtheir income reached the threshold for repayments.

Although government would have to find much more cash initially to fund the loans for means-testedfee contributions than under Option 1, the true public expenditure costs would be significantly lowersince, as noted in relation to option 2 in the main text, Governments apply 'resource accounting' tostudent loans. This means that the only elements of the loan that count as public expenditure are thesubsidies to those who die or default on their loan repayments and to those who never earn enough intheir working lives to repay the loan, together with any interest rate subsidy if the interest charged onthe loan is below the government's cost of borrowing.

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The resource cost of current maintenance loans is forecast to lie in the range 40 to 50 per cent.However, with the poorest students already excluded by means tests, the chance of loans for tuitionbeing repaid might be higher and thus the resource cost would be correspondingly less. Nevertheless,using a conservative estimate of 50 per cent for the resource cost of the loans, with a maximum feecontribution of £2,000 and with 80 per cent of those means-tested to make a contribution taking outincome-contingent loans, the comparable contributions of individuals and government to the feesunder options 1 and 2 are as shown in Table 2. As with current maintenance loans, the loans areassumed to have zero real rate of interest.

Table 2: Fee contributions from government and students with and without income contingent loans

No loans With income-contingent loans

Student contributions (upfront) (£m)

700 140

Student contributions(income-contingentrepayments net ofsubsidies) (£m)

n/a 280

Governmentcontributions- publiccontributions to fees pluspublic loan subsidies(£m)

900 1,180

Total 1,600 1,600

The loans would have only marginal additional administrative costs compared to the current systemprovided the systems and collection parameters that have been established for the collection ofrepayments through the tax system were used. Cubie investigated the possibility of having a separatecollection system for contributions to the endowment fund but concluded it would be more expensivethan existing arrangements.

The downside is that the repayment parameters - income threshold and repayment rate and maybethe interest rate as well - have to be common for the whole of the system to minimise burdens onemployers and the Inland Revenue, who will collect most repayments through PAYE.

For students from families with modest incomes, the removal of any requirement to make acontribution to fees before graduation might be expected to increase financial confidence evenamongst those who in practice under the current arrangements will not be required to pay up-front

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fees. Nevertheless, it is possible that the addition of more debt beyond the student loan formaintenance may merely replace one financial concern with another.

Weaknesses. Although the required increased contributions from government could be reducedfurther by charging a real interest rate at the government's cost of borrowing rather than a zero realinterest rate on the loans, this option still requires an increased public contribution compared to currentarrangements as well as an increased contribution from those individuals who pay currently. Thismakes it more likely that the government would seek to claw back some of the additional funds. Thecombination of means-testing and income-contingent loans would also make the system lesstransparent and therefore it would be more difficult to track precisely what was happening to funding.

Some of the risks might be reduced through a phased increase in the maximum contribution coupledwith a commitment from government during the initial period of increasing maximum contributions notto reduce its share of funding. The annual increase in available funds would be correspondinglymodest at about £80m year-on-year. The incorporation of income-contingent loans would also transfersome of the cost from individuals to government.

Charging a real rate of interest, while attractive as a means of reducing the level of public subsidy inthe loan, would increase very significantly the size of outstanding debt of those whose earnings werebelow or only marginally above the income threshold for repayments. This would be a particularproblem if, as might well be the case, the real rate of interest had to be applied to all income-contingent loans, including those for maintenance.

People who are loan averse could find the prospect of further increasing their indebtedness ongraduation from a current figure of £12,500 to say £18,000 a further disincentive to study. Furthermore,in most cases the up-front fee has an immediate impact, whereas living costs can be budgeted andspread more readily and other sources of income brought to bear. Tuition fee loans may thereforeappear more threatening. It remains an open question whether income-contingent loans to support feecontributions would contribute to improving access for those from the lowest socio-economic groups.

Simply paying a higher fee contribution but with a loan available to meet the cost is unlikely to providesubstantial additional motivation to students to put pressure on institutions to provide improved valuefor money. The substantial risk of clawback of at least the government's contribution to the higher fee,unless the sort of compact with the government envisaged in our first report can be secured, gives littleconfidence that this option alone could lead to an improvement in quality from raised levels of corefunding.

Under European Law, the benefits of providing subsidised loans to home students to meet their tuitioncontributions would have to be extended to EU undergraduate students as well. The problem for theUK government is that it will be significantly more difficult to collect loan repayments from EU

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graduates than UK graduates whose repayments will be collected through the tax system. This willtend to increase the resource cost of income-contingent loans for tuition as compared to loans formaintenance for which most EU students are not eligible.

Option 6 - The Cubie/Scottish Parliament scheme

Commentary. The Cubie Committee's recommendation for the establishment of a Scottishendowment fund is an attempt to secure the advantages of abolishing up-front contributions withoutthe disadvantages for public funds from delaying graduate contributions until graduates reach a certainlevel of earnings. The contributions would either be made directly or by means of an income-contingent loan. Under the Scottish Executive’s modification of Cubie the money collected from thegraduate endowment goes into the general income with Ministers ensuring that an amount equivalentto that collected from the endowment is applied to student support.

Strengths. The creation of a specific endowment fund as recommended by Cubie is a means ofovercoming the problem of hypothecation of graduate contributions. Without the creation of such afund, while contributions could be collected through the tax system as with existing income-contingentmaintenance loan repayments and there would be clear advantages in terms of administrative costs indoing so, there would be no necessary home, other than the Exchequer itself, for the funds to flow to.There would be a strong risk of the contributions being lost in the internal workings of publicexpenditure. A full-scale graduate tax, which differs from the Scottish model in that the contributionswould be uncapped, would be particularly vulnerable. The revenues would simply form part of theproceeds of general taxation since there is no system of hypothecated taxes in the UK.

The legislation currently before the Scottish Parliament provides for individuals to pay the contribution,set at a lower figure (£2,000) than that Cubie proposed, by the April following graduation or be deemedto have received an income-contingent loan for the same amount to be incorporated with theirmaintenance loan. Because the loan repayments will be collected in the same way as the maintenanceloan repayments, the repayment parameters of income threshold and repayment rate have to be thesame. This minimises the additional administrative cost. As with other option types involving theextension of income-contingent loans beyond maintenance it remains to be seen from the outcome ofthe current research study being undertaken for Universities UK what the likely impact on participationwill be.

Because of the absence of up-front fee contributions, this type of option minimises the disincentive toparticipation amongst all groups, including those who would almost certainly be means-tested out ofmaking a contribution in the current system but nevertheless are worried by the prospect of fees. EUstudents would not be required to contribute.

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Weaknesses. This option raises no extra money for institutions. Under the Cubie proposals, asamended by the Scottish Executive the endowment fund is to be used primarily to support studentsfinancially.

In addition, whereas up-front fee contributions were immediately available to institutions, noguarantees have been given that the compensating sums provided by the Scottish Parliamentfollowing their abolition will be continued in future years. Under this option institutions are moreexposed to the risks of future reductions in public expenditure.

There is a further downside to this kind of option in that it would make alumni contribution byindividuals less likely.

Option 7 - Funding for Undergraduate teaching abolished, fees deregulated, andsupport for needy students provided from publicly endowed bursary fund

Commentary. This is one of two radical options put forward by those politicians primarily motivated bya desire to see less state involvement in the control of universities, and in broad terms is similar tooptions involving state scholarships.

In May 2000 Lord Owen proposed in a lecture to the Social Market Foundation that current publicfunding for teaching be diverted into a bursary fund to be administered by an independent trust, whichwould support needy students on a means-tested basis. In principle a scholarship scheme of this kindcould be administered by a public body, but Lord Owen believes that this would simply allow the DfEEto reassert its current hold on the higher education system.

Strengths. The main strength of this option is that it would increase the autonomy of institutions andenable them to exploit their comparative advantage. It would also have the effect of giving studentsgreater influence, through their choice of institutions and courses, on the value for money provided byinstitutions.

Weaknesses. It is difficult to gauge precisely how the funding for individuals would change in movingfrom a system where a fixed and high proportion of the cost is met for everybody from public funds toone where the full cost is means tested. One would envisage, however, that if the scheme is to be atleast as socially inclusive as the current system it would be necessary for:

• all those who currently make no contribution to fees continue to have their fees paid in full;

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• the contribution of those who pay a partial fee currently be limited to that amount;

• those who currently pay the maximum contribution to be subject to an extended means test sothat their contribution rises with family income.

Without attempting a detailed model it is not clear whether the current level of public funds couldsupport these requirements. However, it is of interest in this context that the modelling of an extendedmeans-test by London Economics showed that with the current average full cost as the maximum tobe paid by the wealthiest households the additional funding for institutions would only total about£250m per annum. If the average full cost fee were higher this amount would rise, but the amounttransferred into the bursary fund would be insufficient to meet the first two criteria above.

If as Lord Owen proposed, income-contingent loans were available to assist those individuals facedwith substantially higher fees, the government's contribution would increase through the inherentsubsidy. Furthermore, because of the potential magnitude of these loans coupled with existingmaintenance loans the resource cost might rise not least because of the total indebtedness whichsome students, in particular those undertaking clinical subjects would face.

Other weaknesses of the scheme are:

• it is likely to increase the psychological disincentive to participation to those from poorerbackgrounds even though they may well be eligible to receive a full bursary;

• in common with all student-based funding options there is no ready way of providing in advanceassurance that the total of public expenditure on higher education can be controlled. This wouldbe especially an issue if the bursary fund were managed by an independent organisation. Theprincipal difficulty is rationing in the face of higher than anticipated demand. Students now enteruniversity with a wide range of qualifications, which would preclude a simple test of eligibility;

• more generally it seems unlikely that any government would be prepared to put so much publicfunding outwith public sector control. The nearest model of independent bodies that managesubstantial amounts of public funds are the pension funds for public sector employees;

• at least in the form proposed by Lord Owen, this option would cover all publicly funded teachingprovision - postgraduate and part-time undergraduate as well as full-time undergraduate. It is notclear how they could be readily brought together nor how demands for trained manpower in publicsector employment such as the medical profession and teaching would be met.

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Option 8 - Individual Learning Accounts

Our first report included the use of Individual Learning Accounts (ILAs) with certain of the options thenproposed. However, ILAs do not constitute a true funding option, more a method of building up anddistributing many different types of funding to and from individuals.

ILAs can encompass publicly funded contributions - vouchers, credits or scholarships - loans towardstuition or maintenance costs, including income-contingent loans and personal contributions either fromsavings or from family members or employers. The present system of one million accounts is,however, very modest and primarily aimed at supporting low-level training and not individuals in highereducation.

The potential strength of ILAs as a vehicle for channelling the funding of higher education is that theycould provide greater transparency for individuals, who by this means would be made aware of thetotality of funding supporting their learning. ILAs also offer the potential for simplifying administration byreplacing several systems with one principal system. Finally, they offer the prospect of providing a fullframework for all post-compulsory education and training and giving real meaning to lifelong learning.

The main weakness, if ILAs are to be applied to the funding of the whole of teaching and learning inhigher education, as well possibly as the funding for maintenance support, is that like all individualisedsystems there is no ready means of controlling in advance the demand without complex rationingsystems. Furthermore there are, unlike in the USA, currently no incentives for individuals to savetowards their own higher education or for their relatives to do so. This makes the individual contributionelement of the account difficult to bring into play.

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Annex B: Membership

Funding Options Review Group

Sir William Taylor, ChairProfessor Ivor Crewe, Vice-Chancellor, University of EssexProfessor Sir Graeme Davies, Principal, The University of GlasgowProfessor Roderick Floud, Provost, London Guildhall UniversityProfessor Diana Green, Vice-Chancellor, Sheffield Hallam UniversityDr DeAnne Julius, Member of the Monetary Policy Committee of the Bank of EnglandMr Christopher Kenyon, William Kenyon and SonsProfessor Sir Christopher Llewellyn Smith, Provost, University College LondonLord Oxburgh, former Rector, Imperial College of Science, Technology and MedicineProfessor John Tarrant, Vice-Chancellor, The University of HuddersfieldProfessor Adrian Webb, Vice-Chancellor, University of GlamorganProfessor Michael Wright, Principal, Canterbury Christ Church University College

Funding Options Review Expert Panel

Mr David Allen, Registrar and Secretary, University of BirminghamDr Nicholas Barr, Department of Economics, London School of EconomicsMr Nigel Brown, AdviserMr Tony Clark, AdviserMs Deborah Findlay, Finance Director, South Bank UniversityMr James Hunt, Finance Director, University of WarwickMr Ken Sproston, Secretary, Staffordshire UniversityProfessor David Westbury, Vice-Principal, University of Birmingham, and Chair Costing andPricing GroupMs Maggie Woodrow, Director, EU Access Network, University of Westminster

Universities UK officers:

Dr Tony Bruce, Director Policy DevelopmentDr Antoinette Titchener-Hooker, Senior Policy AdviserMr John Parrett, StatisticianMr Rene Kinzett, Policy OfficerMs Hazel Flynn, Executive Assistant

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