The punitive hidden tax killing young people's ambition

Telegraph

25-04-2025

When Tony Blair laid out his goal of sending half of the British population to university in 1999, tuition fees were just £1,000 a year.
Now, 25 years later, costs have ballooned, and Britain is reckoning with the disastrous consequences of his arbitrary target.
Millions of young people are now trapped in a punitive student loan repayment system that functions as an additional, hidden tax on anybody earning a decent wage. As your pay increases, so does the proportion of it you pay on the loan.
This is helping to punish ambition in young graduates. What's the point of working hard to get a pay rise when so much of it will be swallowed up by interest on your student debt?
When a pay rise leads to soaring repayments
Under the current system, existing graduates with Plan 2 student loans – those who began university in September 2012 or later – repay 9pc of everything they earn above £28,470 a year. This effectively makes it a graduate contribution tax.
As those graduates earn more, the proportion of their salary that they lose towards student loan contributions grows.
For example, a graduate earning an average UK salary of £40,000 a year repays £95 a month or £1,143 a year towards their loan, just 2.8pc of their full earnings. But somebody earning £70,000 a year would repay £320 a month, or 5.4pc of their pre-tax salary.
This has a tangible effect on ambitious graduates, for whom the prospect of a pay rise becomes even less worthwhile with student loan repayments thrown into the mix.
Say, for example, that a graduate earning £70,000 is offered a new role paying 20pc more. Thanks to the 40pc rate of tax that kicks in on earnings above £52,000 and the growing proportion of their income eaten up by their student loan, their take-home pay will only increase by 14pc.
This is because their monthly student loan contributions will rise from £311 to £416 overnight, a 34pc increase – almost twice that of the pay rise itself. This is hardly a strong incentive to take on more work.
For higher earners, the numbers are starker. A graduate with a Plan 2 student loan on a £100,000 salary would need a 23pc pay rise in order to receive the same take-home pay as somebody on the same salary with no student debt.
'The tax system is punishing for pretty much all taxpayers, but recent graduates definitely bear the brunt of the very worst parts of it, given the way student loan repayments only add to already cripplingly high marginal tax rates,' says John O'Connell, of the TaxPayers' Alliance.
This problem will only become worse in the future – anybody that started university in 2022 or later will make student loan repayments once they earn £25,000 or more. With the annual full-time minimum wage around £23,800, it won't be long before all working graduates are dragged into making student loan repayments.
This also means that future graduates earning above the existing threshold will pay an additional £312 a month in repayments.
'We already have a progressive tax system based on the more you earn the more you pay in tax, so the 'graduate tax' is a form of double taxation on incomes which anyone over the age of 57 did not have to pay,' says Liz Emerson, of the Intergenerational Foundation charity.
Higher interest rates for larger salaries
The real kicker is that even if that graduate on £70,000 does take the pay rise, which would see them earning a salary of £84,000, they would barely be clearing the annual interest accruing on their student loan, let alone the underlying balance itself.
The interest rate on Plan 2 student loans is set at the retail price index (RPI) inflation rate, plus up to three percentage points. Anybody earning below the repayment threshold is charged the RPI-linked interest rate of 4.3pc.
For anybody earning between £28,470 and £51,245, the interest rate increases gradually from 4.3pc to 7.3pc – the higher the salary, the higher the interest rate. Anybody earning over £51,245 is charged the maximum interest rate of 7.3pc.
O'Connell adds: 'The simple reality is that someone has to pay for these degrees, and it's absolutely right it is the graduates that benefit from it. But having differing levels of interest based on income is completely indefensible.'
Not only does this punish ambition, it lies in stark contrast to traditional lending methods. Generally, the more you earn, the lower the interest rate you qualify for, because lenders view you as less of a risk.
But simply because it can, the Student Loan Company slaps an interest rate on student debt that is far higher than any you would see on a residential mortgage loan. For example, HSBC charges average annual interest in the region of 4.1pc on its two-year fixed rate home loans.
'I'm paying a higher marginal tax rate than my boss who earns 10 times more than me'
Paul*, 25, earns six figures as an investment banker. But he feels that the punitive student loan system means it is not worthwhile for him to work harder and pursue the higher bonuses on offer at his firm.
'The combination of effectively an extra 9pc tax and 7.3pc interest on £50,000 of deb t feels heavily penalising, and creates a real divide between those who have and those who don't have a student loan,' says Paul, who made student loan repayments of £13,000 last year.
'My colleagues who don't have a student loan receive an extra £600 a month. It feels crazy that I'm paying a higher marginal tax rate than my boss who earns ten times as much as me.
'I definitely have not worked as hard to try and achieve a top bucket bonus; the incremental gain between this and a middle bucket bonus after my marginal tax rate is just not worth it.'
The SLC has ditched the punitive three-percentage-point interest rate premium for those who began university in 2022 or later, though graduates will instead be forced to contend with the lower repayment threshold and loans that will be written off after 40 years rather than 30 years, as they are for current graduates.
But for anybody who began university between 2012 and 2022, they will remain trapped in the current interest rate system, which adds three percentage points.
'The allure of dodgy degrees'
Blair's target of getting half of young people into university meant that instead of entering the workforce, they are encouraged to pick a degree – any degree – and worry about the consequences later.
This gave rise to a culture where so many people are university educated that having a degree becomes essential for muscling into the job market, fuelling the cycle of pushing even more young people into university, and into decades of debt.
The majority of employers (57pc) still mainly look for degrees or post-graduate qualifications when recruiting staff, according to 2022 research from The Chartered Institute of Personnel and Development (CIPD).
But that doesn't mean they will be good hires – it also found that 33pc of employers think candidates from higher education are poorly prepared for the workplace. And according to YouGov, 46pc of employed, degree-educated Britons said that their university education was not applicable to their job.
Lizzie Crowley, of the CIPD, says: 'Employers need to stop thinking that generic university degrees are always the best indicator of a person's potential at work.
'They think they're getting 'off the shelf' capability rather than assessing the specific skills needed for roles, then wondering why they have ongoing skills gaps.'
With apprentices in subjects such as engineering and construction earning higher salaries than their university-educated peers – and avoiding tens of thousands of pounds of debt to boot – an adjustment in the emphasis placed on the importance of university education could go some way in solving the problem, argues O'Connell.
'There needs to be a wider societal rethink about what society, and young people, should expect from university,' he says.
'Along with reforms to interest rates and the lifting of tax thresholds, ministers should consider restricting certain courses or universities from being eligible for student loans, and should make universities liable for unpaid student loans to ensure young people aren't being tricked by the allure of dodgy degrees.'
A spokesman for the Tony Blair institute said: 'The most successful countries in the world have a high percentage of young people going to university. But it is a choice. No one is forced to do so. The reason they choose to do so is because graduates earn more than non graduates.
'The student loan scheme the Tony Blair Government introduced was at a much lower rate of interest. And by introducing student loans Britain's university sector was saved from financial crisis. That sector remains absolutely critical to Britain's future. There should be good non-university options open to young people as well.'
The Student Loans Company was contacted for comment.