July 28th, 2005 at 9:55 pm by David Farrar

The median loan balance is only \$15,000. If one starts off on \$45,000 and your salary goes up 5% a year, Labour’s calculator says at present you would pay the loan off in five years nine months (if no voluntary repayments) and under their policy it would be paid off in four years eight months.

What this means is that the 10% extra deduction off your income (over the threshold of around \$17k) would not occur for that 13 month period in around five years time.

The lifetime saving to you is around \$4,000 Labour predicts. It will actually be less than that, but we’ll ignore how a dollar tommorow is worth less in today’s dollars.

Now you may want to reflect the lifetime cost of Labour’s increase in the top tax rate to 39%. You’ll start paying it after six years, when you are probably 28, based on 5% annual income increases.

By the time you are 35 the 6% extra tax on over \$60,000 has cost you \$5,700.

By the time you are 40, the 6% extra tax in over \$60,000 income has cost you \$17,000.

And in theory by the time you retire at 65, that extra 6% may have cost you \$250,000.

Now it is not as simple as that, because the threshold for paying the 39% tax rate should move by inflation. Even allowing for 2% inflation adjustments to the \$60,000 level, one still ends up \$87,000 worst off over your woking life if you think the increase of the top tax rate from 33% to 39% was a good trade-off for getting your student loan paid off a couple of years earlier.

What is the moral of the story? There is no such thing as a free lunch.

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1. Sally () says:

Again DPF with the selective examples:

- Your estimate of 5% salary growth is unrealistic – you’re saying the person’s salary will grow at over three times the rate of inflation for forty straight years! It says the person will be earning over \$380k by the time they retire. That’s quite something to assume, even in nominal dollars.

- Your starting salary is also too high. If you’re going to assume the average loan, you should assume the average starting salary, which is about \$38k (NZVCC survey).

When you do this (Loan \$15k; Slary \$38k; salary growth 3% – giving a pretty reasonable final salary of \$140k; inflation 1.5% to keep DPF happy) with the threshold linked to inflation, then the total cost of the 39c tax rate (as compared 33c like in DPF’s example) costs \$9,200 over 45 years.

Now take off the \$4,000 the person made off Labour’s student loan policy, and the net cost of voting Labour is \$5k in cash over a lifetime. BUT the person is debt free four years sooner, making it easier for them to purchase a home/car/etc. five years sooner.

Especially for the home, this is five fewer years of throwing money away in rent. Then you just have to balance up \$5k against five years worth of making your money work better for you in home ownership rather than renting.

That is a pretty damn good deal, I’d happily give up \$5k for that.

(And don’t forget that the policies aren’t actually equivalent because the tax cut has about twice the fiscal impact of the student loans scheme.)

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2. Sally () says:

Quick addendum: With \$38k starting salary, you actually save about \$5,800 on the student loan, and pay off two years faster. (Apoligies for mistyping those figures earlier)

This means that the calculation now is: is costs you \$3,500 over 45 years to avoid renting and get into your own home 2 years sooner, thereby saving you a bunch of money and realising a Kiwi dream. Great deal!

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3. Graham watson () says:

While your calculations are interesting David the reality is many graduates on good salaries, myself included, will be financially better off, and can concentarte on paying off interest attracting mortgages rather than retiring student loans.

This will be at the expense of overtaxed workers on low to middle incomes. I find it hard to believe that Labour is dumping on its current and potential supporters to subsidise well paid professionals and the children of the well off (hold it everyone, there is no need to clarify this as a generalisation with many exceptions but the average socio economic background of students is well known).

The numbers are irrelevant, it is just very poor public policy. Of course borrowing will increase and repayments above the minimum decrease.

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Thankyou David, I have had that gut feeling for days that the lifetime tax costs of having shorter, lower interest student loans would actually cost more in the long run.

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5. Tristan () says:

thanks for showing us the massive problem national has trying to rally against this policy. its simply to hard to explain with out sounding like you are trying to wriggle out of it.

Labours message = no intrest on your loan

nationals message = ahh if you put these figures here a um devide it by this and carry the one then based on our unpublished tax policy you might be better of with us.

which one of these do you think the public will take to heart.

what ever you think of this policy economically, poltically its a master stroke.

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6. DC () says:

Does that mean if you have a student loan you’d be better to vote for Labour the next couple of elections, then switch to National? Is that what you’re recommending?

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7. Mike Collins () says:

I’ve already shown with ACT’s tax cuts how much better off you would be than with Labour’s grossly misleading election bribe.

Even factoring in the likely miserly tax cuts from National, it would be clear that tax cuts are much better for those with loans.

And if paying off your loan sooner is what you want Sally, let me say this: With tax cuts (ACT’s at least) by the time someone has paid off their loan with Labour, you will have paid off you loan, recouped the interest and still have a few thousand dollar head start. If you’re wanting to realise the Kiwi dream as you put it this is a far better scenario.

But of course this comparison is unfair. It assumes the Labour and ACT scenarios have the same income and SL debt. This would not be the case. With Labours policy there is no incentive to keep your loan low but every incentive to maximise it. So it would actually take a lot longer to pay off the loan than using current student loan figures.

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8. Tony () says:

Every independent financial analyst that the media hve contacted has said Labour’s loan calculator is ok.

Nice try to take attention away from a very popular policy.

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9. icehawk () says:

Let’s see.

DPF assumes that your earnings are like this:
age 21 \$45k
age 30 \$90k
age 35 \$115k
age 40 \$140k

age 60 \$240k

And that you never take a few years off work to look after the kids. Nor take any time off work, ever, to do something else.

And that the tax threshold of 60k never changes in the next 40 years (despite Labour having inflation-indexed it).

Pull the other one, mate.

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10. icehawk () says:

mea culpa,

DPF accounts for inflation.

But he’s still not got a more normal earnings profile, or someone taking time off work sometime in their life (as most of us do, thank god).

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Westpac Institutional Bank have costed Labour

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Tristan – “master stroke”? irresponsible bribes often are.

what will this really do to actual student behaviour?

What impact will this have on the tertiary sector – can the sector cope with more enrolments? what effect will it have on education quality? – as a student this should be quite important to you.

Are you sure the government knows?

If after considering all other uses for taxpayer money you decided you wanted to spend more money on tertiary education, what would be the best way to do it – more \$ for university courses? better salaries for uni staff? better equipment and facilities? better student allowances? All of these are valid choices with the ability to build a credible business case around them. All are capable of being assessed against rational objectives.

The reason the righties are reeling as you and others say, is because this “master stroke” is indeed stunning.

It truly is a straight out bribe.

As a way of improving tertiary education, or the skills of NZers it has no policy merit whatsoever.

It is also probably the very worst way to allocate more money to the education system.

If you qualify, enjoy, but as David points out, the short run gain is well offset by the long run costs of higher tax rates – university grads are pretty universally the people in the top of the top tax brackets incidentally – so they will be paying for this.

If it isnt coupled with more money spent on university infrastructure or course development or more and better teachers, it merely accelerates the demise of universities into diploma mills.

you want fries with that BA?

wonder how many more “master strokes” there are out there – not sure lil ol NZ can cope with too many more?

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