Do Higher Education Tax Credits Make Sense?

By :: July 27th, 2012

Higher education is a good investment, even though some new grads currently struggling to get jobs don’t think so. But does it make sense for the federal government to subsidize college with both tax incentives and direct grants? And if it doesn’t, which program should it dump?

There is a strong case that the government should keep and enhance the Pell Grant program, which is the main form of direct assistance for low-income kids. At the same time,  it may be time to eliminate  or at least consolidate some of the confusing collection of education tax credits.  

That, at least was the consensus among witnesses at a recent hearing at the Senate Finance Committee. Experts ranging from Sue Dynarski of the University  of Michigan, Scott Hodge of the Tax Foundation and James White of the Government Accountability Office all argued that the credits needed to be reformed.   

There are currently 14 tax benefits available for college students and their parents.  These include three broad classes – tax benefits for tuition and related expenses , tax benefits for student loans, and tax benefits for education savings plans.  Basically benefits for before, during and after college attendance. JCT estimates the cost to the federal government  of these tax benefits to be $95.3 billion between 2010 and 2014.

The size of these programs and direct federal grants have rapidly expanded in the last few years. Spending on Pell Grants has doubled – from $18.3 billion in 2008 to $36.5 billion in 2010, reflecting more generous programs and expanded enrollment during the recent recession.  Likewise, spending on education tax credits doubled from $9 billion in 2008 to $18 billion in 2009. 

Increasing enrollment and encouraging students to complete college, especially for students from low-income families, is one of the best ways to address growing income inequality. According to Dynarski, college attendance rates vary dramatically by income group, with only 9% of children born in the lowest income quartile earning a BA compared to 54% of children born in the top quartile. This gap has increased in the last 20 years.   

Does the current panoply of programs, including grants and tax incentives, further the goal of increasing college attendance?  While there is some evidence that Pell Grants help, there is little evidence that tax credits do.

The current programs and options are too complicated and families regularly select the wrong tax credit or program or fail to apply at all. The other problem is timing: A student may not see see the benefit of the tax break for  up to 18 months after she must pay her tuition.  While Dynarski thinks the solution is to simplify the credits and change the timing of delivery, I agree with Hodge that we would  be better served by eliminating the tax credits. We could use some of the savings to protect the recent expansion of  Pell grants. While we’re at it, we should simplify the Pell application process too.  

Unfortunately, we are flying blind in our efforts to reform these subsidies. There are limited data to help  evaluate the effects of these programs, including  recent expansions.  We know little about what the grants and credits mean for students over time. A key question is whether either or both programs result in higher tuition.

One big step forward: The IRS and Department of Education could coordinate their data so we could better understand how these programs work.  More importantly, coordination could result in  simpler forms for students and their families.

Helping low-income kids get to—and finish--college should be a top priority. But Congress needs to find the most cost-effective way to do that. And the belt-and suspenders approach of grants and tax subsidies may fail the efficiency test.

8Comments

  1. Jack B  ::  9:56 am on July 27th, 2012:

    Tax subsidies to education are an incentive to spend more on education.
    More spending means more demand. More demand leads to higher prices. Student debt now eclipses credit card debt.

  2. Tax Roundup, 12/27/2012: Congressional preening, California refund dreaming; corn squeezers squeezing. « Roth & Company, P.C  ::  10:00 am on July 27th, 2012:

    […] Any more questions? Do Higher Education Tax Credits Make Sense? (Kim Reuben, TaxVox).  Unfortunately, we are flying blind in our efforts to reform these […]

  3. Michael Bindner  ::  1:36 pm on July 27th, 2012:

    I submitted comments on this to the committee (they were put in the mail yesterday but are online now). The short answer is that the credit should be shifted from personal taxes to employer taxes, with the employer hiring students while in school, paying them a salary and paying their tuition in a group package (lowering the price) with funding from a tax credit on a VAT-like Net Business Receipts Tax and a service obligation (with a federal loan program in case the work relationship does not work out so that no one has to keep a bad employee or bad job).

  4. Michael Bindner  ::  1:40 pm on July 27th, 2012:

    http://fiscalequity.blogspot.com/2012/07/education-incentives-and-tax-reform.html

  5. AMTbuff  ::  12:53 pm on July 30th, 2012:

    College subsidies are one of the largest components of our system of income redistribution. Financial aid is skewed radically against savers, rewarding affluent parents who spend every penny (including on private K-12 schooling) and save nothing for college. Parents of similar income who send their children to public schools and otherwise live beneath their means to save for college receive little or no aid.

    If the parents’ Expected Financial Contribution were stated as a marginal tax rate, it would be in the neighborhood of 35% of pretax income (it’s 47% of after-tax income in the affluent range). Stack that on top of 40% to 50% combined marginal tax rates on affluent couples and you have a huge disincentive. Compute it yourself starting at http://studentaid.ed.gov/sites/default/files/2012-13-efc-forumula.pdf

    The only saving grace that helps retain incentives to work and save is that most college aid is not free money. Loans must be repaid. In this respect large student loans benefit society. Otherwise affluent savers might decline to play their role as cash cows for non-savers.

    Regarding college financial aid I have often wondered where the limit of redistribution is. It may be very near. For second tier private colleges we may already have passed it.

  6. Around The Dial – July 31, 2012 | South By North Strategies, Ltd.  ::  3:04 pm on July 31st, 2012:

    […] TaxVox asks if “higher education tax credits make sense.” […]

  7. Mielczarek  ::  5:19 am on September 4th, 2012:

    Agree that low-income students should be subsidized. If they aren’t subsidized there will be no movement between the classes, i.e. education will only be possible for middle/high income classes.

  8. Optimism about President Obama’s higher education tax reform proposals  ::  11:27 am on January 26th, 2015:

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