Guest Post: Integrating Student Aid and Tax Benefits

By Art Hauptman

Both Sens. Barack Obama (D-IL) and Hillary Clinton (D-NY) have made achieving greater college affordability a high profile issue in their Presidential campaigns. To reach this goal, the two Democratic candidates have proposed expanding Pell Grants and consolidating the current set of tax breaks for college into a single refundable tuition tax credit. Sen. John McCain (R-AZ) has thus far been strangely silent on the topic, despite its importance to so many millions of Americans.

The reach of the Democratic contenders’ proposals does not match their rhetoric, however. To truly make college more affordable, the next President will need to push for a much fuller integration of student aid and tax provisions for higher education, as I suggested in my guest post last week.

Any effort to change the current system (or non-system) of student financial assistance should first recognize that federal higher education policy has two distinct goals. The first is to eliminate the chronic gaps in the rates at which students from low-income and high-income families (and between minority students and white students) enroll in and graduate from college. Call this the accessibility problem. The second big goal is to make college more affordable for millions of students from middle class and upper middle class families who have found the ever growing price of college to be a real strain on their budgets. Call this the affordability problem.

The differences in these goals can be readily seen in looking at the history and current array of student aid and tuition tax benefits. The federal student aid programs were created primarily to help improve accessibility for low income students, although over time, they have been used to address affordability issues as well. Starting in the 1990s, policymakers began creating tuition tax credits and various tax incentives for savings principally to address concerns about affordability for the middle and upper middle class, as well as for older students already in the work force going back to school to further their education.

In proposing to consolidate the existing tax breaks for college, and make them refundable for students whose families do not pay taxes, the Obama and Clinton campaigns are seeking to address the accessibility and affordability issues simultaneously. But in taking this approach, they will probably fall short of achieving either goal.

I make this prediction for a couple of important reasons. First, these proposals would undo key tax reforms of the last several decades by requiring millions of low-income Americans who don’t now have to file tax returns to reenter the tax rolls in order to quality for the benefit.

More importantly, making tuition tax credits refundable will only make the current structure of student financial support in this country more redundant and less well targeted. By providing an overlap in benefits for some students, it would raise the government’s costs significantly without solving the basic underlying problem that college tuition and other charges are going up much faster than many families’ ability to pay them.

A Better Approach

A better approach would be to more fully integrate the tax system with student aid in several key ways. One form of integration would be to allow the government to use information from families’ income tax forms to determine their eligibility for student aid. Both Obama and Clinton have endorsed this proposal, and it looks like Congress will adopt this change if and when it finally reauthorizes the Higher Education Act. This would be a welcome beginning of the end to the FAFSA and would greatly simplify the much too complex student aid application process.

What is also needed, however, is for Congress to permit students from families who are eligible for welfare, Medicaid, food stamps, and/or the Earned Income Tax Credit (EITC) to be fully eligible for federal student aid. This would be in sharp contrast to the current system in which nontaxable forms of income such as welfare are used as a means to reduce student aid eligibility.

Making these students eligible for the maximum amount of federal financial aid available could yield much greater benefits for at-risk students than making tax credits refundable. This would particularly be so if policymakers are willing to make an important tradeoff: eliminating middle class and lifelong learner eligibility for Pell Grants and in-school interest subsidies in the federal student loan programs in exchange for a much expanded tuition tax credit. Congress could use the savings derived from making the eligibility changes in the Pell Grant program to significantly increase the maximum award for the lowest-income students. Meanwhile, the government could use the savings it would get from better targeting in-school interest payments to pay for the expansion in the tuition tax credit.

A further step in the direction of integration would be to use the 1040A income tax rules to calculate eligibility for Pell Grants for students whose families pay taxes. The income tax rules would then be used to calculate eligibility for both Pell Grants and tuition tax credits (as the amount of a nonrefundable tax credit actually received cannot exceed the amount of tax paid). Using the 1040A rules to calculate Pell Grant eligibility would also eliminate the current practice in the federal methodology that allows tax write-offs for business losses and other above-the-line deductions to increase middle class eligibility for Pell Grants.

These changes would clarify the federal role in helping a broad range of families pay for college. Pell Grants and federally subsidized loans would be used to improve accessibility. Unsubsidized loans and expanded tax benefits would be the principal vehicles for addressing affordability concerns.

In my next two blog items, I will discuss how a more aggressive federal early intervention strategy and finally the creation of a seamless student-centered loan system as key steps to achieving a well functioning federal student support system.

Art Hauptman is an independent consultant on higher education finance issues. His guest blog column will continue to appear each Tuesday in the month of May. Views expressed herein are his own and do not necessarily reflect the positions of the New America Foundation.