Graduates should pay universities a proportion of their earnings rather than take out loans to fund their studies, according to a report.

It argues that the current student loans system is "very badly designed" and should be overhauled.

Reforming how students pay for their degrees would benefit not just the students, but also universities and taxpayers, the study says.

Under the current system, which saw tuition fees at English universities trebled to a maximum of £9,000 in 2012, student can get a government loan to cover their fees, with the money paid back once they have graduated and are earning at least £21,000 a year.

The debt is written off after 30 years.

But the new report, published by the Institute of Economic Affairs (IEA) think tank says that this system should be changed.

"The current student loans system is very badly designed," the study claims.

"It is arbitrary; graduates who earn around £40,000 a year pay the highest amount as a proportion of their income while very high earners pay much less.

"Furthermore, loans are forgiven, at substantial cost to the Government, even if they could be repaid at a later date."

The report calls for a new system in which students agree to pay a percentage of their future earnings directly to the institution that is providing their degree course.

A university would offer a contract in which the student would commit to paying a proportion of their income, above a certain threshold for a set number of years, it suggests.

There could be a cap on the level of income on which the percentage is paid, or a maximum repayable amount, the report says.

If they wanted to, students could still choose to pay their fees upfront, it adds.

"Universities would be free to charge whatever they liked so that they could develop a wide range of courses, from advanced, high-cost courses that require significant contact time to low-cost online courses that can be completed quickly," it says.

"There would be incentives to provide courses that were better value for money and which led to higher earnings potential under the graduate equity scheme and universities would be free to develop such courses and take on as many students as they wished."

Philip Booth, IEA editorial and programme director said: "The current system of student finance will fail. It combines all the worst features of a graduate tax and a student loan system and gives little incentive for universities or students to succeed.

"The proposals laid out in this report will free universities from stifling regulation, and ensure that they offer students more variety in the duration of courses and give greater consideration to the future success of their students."

Pam Tatlow chief executive of million+, said: "Instead of addressing the principal challenge of supporting a wide range of students into a well-funded, sustainable, higher education sector, this report argues for students to be commercialised and securitised.

"The proposals would effectively mean privatising universities and prioritising those students who will generate the highest economic return."

Megan Dunn, vice president (higher education) at the National Union of Students (NUS), said: "It's good to see that this report further discredits the current student loan model, but it offers a substandard alternative. These proposals will only really benefit richer students, who can pay upfront fees and protect their future income, or those who could 'buy themselves out' of future repayments."

A Business Department spokeswoman said: "Our well-designed reforms have put higher education on a sustainable footing. The changes to university funding are driving up the quality of the student experience and helping to stimulate economic growth.

"But don't just take our word for it. The OECD has said that our funding reforms are a text book example of how to ensure a healthy funding flow to support the demand for higher education."