Ensuring Higher Education Tax Benefits Work Better for Students

What would you say is the largest form of federal student aid, excluding loans? If you guessed Pell Grants, you’d be wrong. In 2012, the federal government spent nearly $34 billion on tax-based student aid—a billion more than it spent on Pell Grants. In fact, tax-based aid has more than quadrupled ever since its inception in the 1990s. This rapid growth has occurred with very little oversight to determine whether it improves our national goals of college affordability, access, and success.

Today the Consortium for Higher Education Tax Reform, of which New America is a member, has issued a new paper—Higher Education Tax Reform: A Shared Agenda for Increasing College Affordability, Access, and Success—that explores the growth of tax-based aid and recommends how to better target and deliver it to families who need it most. Other members of the Consortium include CLASP’s Center for Postsecondary and Economic Success, Young Invincibles, and the Education Trust.

As the report highlights, tax-based student aid currently suffers from four critical flaws that limit its impact on college affordability, access, and completion:

1. Poor targeting: A substantial share of tax-based aid goes to higher-income families. For example, nearly 25 percent of American Opportunity Tax Credit (AOTC) benefits and Student Loan Interest Deduction benefits go to families making more than $100,000 per year. In 2012, close to 80 percent of American families made less than $100,000.
2. Complexity: Student aid delivered through the tax code includes multiple credits, deductions, and exclusions. Many of these tax breaks overlap, and taxpayers often do not choose the provision that would benefit them the most. The Government Accountability Office (GAO) found, for example, that 40 percent of those who claimed the Tuition and Fees Deduction in 2009 would have been better off claiming the Lifetime Learning Credit.
3. Bad Timing: Students and parents receive this aid only after filing their taxes, not when college bills are due. For families who have difficulty paying college up front, these benefits come too late in the process of college decision-making
4. Lack of awareness: Many are not aware that tax-based student aid is available. The same GAO study mentioned above found that in 2009 one out of seven taxpayers—or 1.5 million tax filers—who were eligible for either the Tuition and Fees Deduction of the Lifetime Learning Credit failed to claim those benefits.

The Consortium’s reforms ensure better targeting, simplification, timely delivery, and improved outreach. The recommendations can be read in detail here, but in summary they are:

Better Targeting

1. Make the AOTC Permanent.
2. Phase out the AOTC between $80-120,000 for joint filers and $40-60,000 for single filers.
3. Make the AOTC fully refundable.
4. Better coordinate AOTC benefits with Pell Grants.
5. Phase out the Exemption for Dependent Students at the same levels as the AOTC.
6. Phase out the Student Loan Interest Deduction at the same income levels as the AOTC.
7. Better target the tax benefits of Qualified Tuition Programs (529s) through income limits and other reforms.
8. Limit the Exclusion for Employer Provided Education Assistance to undergraduate certificates and degrees only.
9. Adopt a new institutional eligibility threshold for higher education tax benefits to colleges and universities.
10. Limit the tax exemption for interest earned on qualified 501(c)(3) bond for private higher education institutions.
11. Improve transparency around institutional receipt of tax benefits through expanded reporting.

Simplification

1. Eliminate Lifetime Learning Credit.
2. Eliminate Tuition and Fees Deduction.
3. Eliminate Coverdell Education Savings Accounts.
4. Adjust the AOTC for inflation starting in 2018.
5. Replace the four-year limit on the AOTC with an equivalent dollar cap.
6. Eliminate the taxation of Pell Grants.
7. Remove the lifetime ban on the AOTC for individuals convicted of a drug felony.

Timely Delivery of Tax Aid

1. Create a mechanism for delivering the AOTC at the time that college expenses are incurred.

Outreach

1. Increase take-up and awareness of the AOTC through expanded outreach.

The Tax Policy Center estimated that the proposed changes would result in $16.2 billion in savings from 2014 to 2023.[1. The Tax Policy Center (TPC) estimates cover the impact of recommendations 1-3, 5-6, 12-13, and 15. Please note that TPC is unable to estimate the revenue impacts of the other recommendations. The Congressional Joint Committee on Taxation, however, estimated the cost of the two Pell Grant provisions combined as 168 million over ten years (2011-2020).] This savings can be reinvested in students, including through funding the Pell Grant program. Additionally, more than 80 percent of families who are currently eligible for AOTC would continue to be eligible for the reformed AOTC.

This reform package is feasible, fiscally responsible, and aligns the enormous investment in tax-based student aid with national goals of improving college affordability, access, and completion. As Congress considers an overhaul of the tax system, the Consortium hopes that these proposals will inform its actions.

Stay tuned to Ed Central for further analysis of higher education tax benefits from the Consortium for Higher Education Tax Reform.