An extra £12bn will be added to the UK’s annual deficit after the statistics regulator ruled student loans that are unlikely to be repaid should count as government spending.

The Office for National Statistics (ONS) has decided that the unpaid portion of loans should be included in official accounts.

The ruling comes amid concern that the current system – where loans for tuition fees and maintenance are not recorded in public finances – creates a “fiscal illusion”.

“This change will increase the government’s budget deficit, to ensure it properly reflects the true picture of government spending because student loan debt writeoffs that would have taken place in 2040 and beyond will be reflected as government spending now,” the ONS said.

The new approach will lead to the deficit being increased by around £12bn in the current year, the regulator has said.

The decision is likely to influence the government’s post-18 education and funding review, due to report early next year, amid pressure to reduce the cost of lending.

Tuition fees could be cut, or a cap on student numbers could be introduced, to limit the negative impact on the national deficit.

Angela Rayner, Labour’s shadow education secretary, said: “The Office for National Statistics has confirmed that the student loans system is a fiscal illusion which flatters the government’s record on the public finances. This does not give the public the full picture and must be fixed.

“With almost half the cost of the current system being subsidised by the government, it’s right that this should be made explicit rather than disguised in the official accounts.

“With a potential £12bn hit to the deficit coming, it is time for ministers to be honest with the public and tell them how they will meet the cost of funding higher education.”

She added: “The current system is creating a ballooning mass of unsustainable debt. Labour would scrap tuition fees and restore maintenance grants, being upfront and honest about what this costs and how we fund it, as we did in our fully costed 2017 election manifesto.”

The University and College Union (UCU) said the move exposed flaws in the current system and that the post-18 review, led by Philip Augar, should propose a radical new approach to funding.

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Matt Waddup, head of policy and campaigns at UCU, said: “Successive governments’ funding reforms have done nothing but raise fees and student debt.

“It’s crucial that any future changes don’t reduce university funding or lock potential students out of learning. What we need is a new approach which recognises that higher education is a public good and should be funded through taxation, including an increased contribution from business.

“For too long one of the key beneficiaries of our higher education system has contributed too little. Businesses benefit from the pool of talented graduates from universities and it is only right they start to pay their fair share.”

On the decision from the ONS, Nick Hillman, director of the Higher Education Policy Institute think tank, warned that students are likely to get hit because they look more costly to taxpayers.

He said: “Unless we are careful, we are at risk of sleepwalking into a triple whammy of fewer university places, less funding per student and tougher student loan repayment terms.”

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Alistair Jarvis, chief executive of Universities UK, said: “At a time when demand for highly skilled graduates is growing, it is essential that universities are properly and sustainably funded to ensure students receive the high quality university experience they rightly expect.

“That means avoiding kneejerk reactions to the ONS review which would reduce the amount universities receive per student or lead to fewer students being able to benefit from higher education.

“Cuts to fees or capping student numbers risks throwing the progress that government and universities have made on social mobility into reverse.”

Tim Bradshaw, chief executive of the Russell Group, said: “Ministers may now be tempted to cut university funding because it will look better for the deficit, but good policy shouldn’t be dictated by accounting rules.

“Universities should be funded sustainably because of the vast social and economic benefits they bring. If this change results in a cut to university funding then it will be students who suffer.”

The ONS is due to implement the decision in the government’s accounts in the autumn of 2019.

A Government spokesperson said: “This is a technical accounting decision by the independent ONS.