Should Tax Credits as an Incentive for Higher Education be Eliminated?

by Philip Rukosuev December 20 2013, 15:45

One of the biggest contributors to rising disparity in America today is the widening earnings gap between workers with college degrees and those without.[1] Higher education remains a good investment, even though some new grads are currently struggling to get jobs. Over the past two decades, lawmakers have progressively asked the tax code to direct all manner of social and economic objectives (e.g. home buying, adoption, attending college, trading in a clunker for a newer car, etc.). In regards to federal assistance for higher education expenses, tax credits and deductions are relatively new.[2]

 

Lawmakers have increasingly used tax credits to aid students in covering the cost of college. From 1997 [3], the first year these credits came into existence, to 2010, the use and cost of these credits has increased significantly. [4] Currently, there are three tax benefits for higher education expenses. Each of these has different benefit sizes, income limits, income definitions, and qualifying expenses.[5] This means that a taxpayer must calculate a plethora of tax related components to determine which one would provide a greater benefit.

 

Nevertheless, it isn’t in fact clear whether tax credits for higher education expenses actually promote college attendance. One of the first papers analyzing the behavioral effects of such credits found that the credits did not increase the likelihood of college attendance. Instead, the primary beneficiaries of the credits were those who were already likely to go to college. [6] Another paper found that “there is some evidence to support that public two-year colleges responded to incentives created by the tax credits by raising tuition price beyond what can be explained by fluctuations in state support, and the responses were stronger for schools with a greater proportion of credit-eligible students.”[7] Other research found that “recent increases in financial aid have not improved affordability” and argue that this is due to the fact that colleges are able to “capture the aid” by increasing their tuition. In other words, schools know that students receive this tax subsidy, raise their prices, and capture most of the subsidy. [8] Another study has found that despite sharp price increases at private colleges, the amount that students actually pay has barely changed over the last decade due to discounts, grants and tax benefits. [9] However, one fact is clearly indisputable, student debt in America has surpassed credit card debt. [10]

 

So, is the tax code the right means for increasing access to higher education and making college more affordable? Generally speaking, the answer is no.

 

What do the health care, housing, and now higher education sectors all have in common? They receive the most government intervention through the tax code and other mechanisms. Perhaps it is of no surprise that “[e]ducation and health services were by far the largest private industry, as measured by employment, to add jobs during the recession." [11] The cost of health care is soaring due to many factors, related and unrelated to government regulation, and housing suffers a similar problem in part due to overabundance of tax subsidies intended to promote home ownership.[12]

 

Are we subsidizing student debt too generously? Subsidized student loans and education credits are fueling higher college costs by disconnecting student-consumers from the true cost of higher education. [13] The cost of attending college has increased 439% since 1982 (more than four times the rate of inflation), even with federal involvement in student loans. [14]

 

While there is an undisputed value and financial benefit in getting a college degree, using the tax code to make college more affordable produces serious unintended consequences. These tax “incentives” are likely contributing to the rising costs of higher education. Economist Richard Vedder argues that “some of these financial aid programs have contributed mightily to the explosion in tuition and fees in modern times.”[15] With ever more government money pouring in and no profit motive or accountability to shareholders, public colleges have no pressure to use resources efficiently, not to mention that compensation for college presidents now rivals corporate CEO salaries.[16]

 

As with any tax provision, the economic cost of these tax incentive programs will exceed its budgetary cost. First, the cost of compliance for taxpayers and the IRS icreases, and so does the heightened risk for fraud and abuse. As the complexity of provisions increases, so does the cost to society. Second, and perhaps a more serious consequence, continuing to increase federal subsidies for college raises questions of equity. Increasing federal subsidies for higher education, whether in the form of government grants or student loans, shifts the responsibility of paying for college from the student, who directly benefits from college, to the taxpayer.[17] Transferring the burden of student loan financing from university graduates who earn, on average, twice that of someone with a high school diploma, to the three-quarters of taxpayers who did not attend college is unjust.[18] Recently, Senator Rubio and Representative Schock[19] proposed to eliminate the current tax preferences for higher education expenses, replacing these provisions with a single new tax credit for higher education expenses. Doing so would reduce the complexity in the tax system, save taxpayers money by limiting these credits, and attempt to make them less susceptible to fraud.

 

Nevertheless, the fact remains that tax credits for higher education may not be the best way to encourage college attendance. In fact, according to a recent case study, eliminating the various education credits and trading the static revenue gains for individual rate cuts would: allow for an across-the-board rate cut of 0.9%; boost GDP by $19 billion per year; boost federal revenues by $4.5 billion on a dynamic basis; increase employment by the equivalent of approximately 121,000 full-time workers; and produce little change in hourly wages.[20] Helping low-income individuals attend college should be a top priority. However, Congress needs to find the most cost-effective way to do so. The current practice of issuing grants and tax subsidies may fail the efficiency test.[21]

 



[1]The median income for a worker with a 4-year college degree was $75,568 in 2010. By contrast, the median income for a worker with only a high school diploma was $38,976. http://taxfoundation.org/article/are-tax-credits-proper-tool-making-higher-education-more-affordable

[2] See Elaine M. Maag and Katie Fitzpatrick, “Federal Financial Aid for Higher Education: Programs and Prospects,” Urban Institute, January, 2004.

[3] IRS Notice 97–60. http://www.irs.gov/pub/irs-tege/notice97-60.pdf

[4] Scott Hodge, Are Tax Credits the Proper Tool for Making Higher Education More Affordable? Testimony before the U.S. Senate Committee on Finance, July 25, 2012, http://taxfoundation.org/article/are-tax-credits-proper-tool-making-higher-education-more-affordable.

[5] The American Opportunity Credit is a refundable tax credit of up to $2,500; The Lifetime Learning Credit gives taxpayers a non-refundable credit up to $2,000 on qualifying expenses and has an income limit of $124,000 for married taxpayers. However, unlike the American Opportunity Credit, it has no lifetime limit; The Deduction for Education Expenses is an above-the-line deduction, which means that instead of reducing an individual taxpayer’s tax bill, it reduces their taxable income. Although there are three, taxpayers can only claim one of the three available tax benefits.

[6] Bridget Terry Long, The Impact of Federal Tax Credits for Higher Education Expenses (National Bureau of Economic Research, Working Paper No. 9553, Dec. 2006), http://www.nber.org/papers/w9553.

[7] Id.

[8] Robert E. Martin & Andrew Gillen, How College Pricing Undermines Financial Aid, Center for College Affordability and Productivity Policy Paper (Mar. 2011), at 13. http://centerforcollegeaffordability.org/uploads/How_College_Pricing_Undermines.pdf.

[9] http://trends.collegeboard.org/college-pricing

[10]http://libertystreeteconomics.newyorkfed.org/2012/03/grading-student-loans.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+LibertyStreetEconomics+%28Liberty+Street+Economics%29

[11] http://www.bls.gov/opub/mlr/2011/04/art1full.pdf. p. 8.

[12]Canada does not have a mortgage interest deduction, yet its rate of homeownership is equal to that in the U.S.

[13]The Obama administration has significantly increased federal involvement in the student loan industry, effectively nationalizing student lending through language buried in Obamacare, by continuing to increase federal subsidies. See http://www.cbsnews.com/news/who-will-benefit-from-obamas-student-loan-plan/

[14] http://www.heritage.org/research/reports/2010/11/pell-grant-increase-would-not-solve-the-college-cost-problem

[15] Richard Vedder, “The Real Costs of Federal Aid to Higher Education,” Heritage Foundation Lecture No. 984, January 12, 2007, at http://www.heritage.org/research/lecture/the-real-costs-of-federal-aid-to-higher-education.

[16] http://chronicle.com/article/Income-Gap-Widens/129980/

[17] For example, “Under Georgetown’s Loan Repayment Assistance Program , students take out Grad PLUS loans to cover the full cost of attending law school (around $75,000 per year, which includes living expenses). After they graduate, they enroll in Income-Based Repayment. If they work in government or non-profit jobs, Georgetown pays 100 percent of their loan payments for 10 years, after which IBR’s loan forgiveness wipes away the remaining balance. The students pay nothing for their education.” http://www.washingtonmonthly.com/college_guide/blog/go_to_law_school_for_free_let.php.

[18] Dan Lips, “Ways to Make Higher Education More Affordable,” Heritage Foundation WebMemo No. 2785, January 29, 2010, at http://www.heritage.org/research/reports/2010/01/ways-to-make-higher-education-more-affordable.

[19] http://schock.house.gov/news/documentsingle.aspx?DocumentID=336645

[20] http://taxfoundation.org/article/case-study-8-education-credits

[21]http://taxvox.taxpolicycenter.org/2012/07/27/do-higher-education-tax-credits-make-sense/#sthash.msJznVfd.dpuf

 

 

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