Trading HOPE for Opportunity

Barack Obama’s signature higher education campaign proposal was the creation of a new $4,000 fully refundable American Opportunity Tax Credit. Now with the former Illinois Senator in the White House, Congress is poised to implement a modified version of the credit as part of the stimulus package that is being fast-tracked this week.

Congress proposes that the new credit would temporarily replace the existing HOPE higher education tax credit, which was created during the Clinton administration. While it would be a marked improvement over existing tuition tax credits and deductions, the American Opportunity Tax Credit still has some flaws, especially with regard to targeting low-income students and interacting with other federal aid.

As outlined in the U.S. House of Representatives and Senate versions of the stimulus bills, there are several ways the American Opportunity credit would be preferable to the HOPE credit:

• Length of Eligibility: The new credit would be available for the first four years of higher education — two years longer than is currently allowed by HOPE.
• Deductible Amount: Students and parents would be able to take a deduction of up to $2,500 for tuition, fees, and qualified expenses — $700 more than the maximum HOPE award.
• Refundability: For the first time, filers would still receive some benefit from the credit, even if they have no tax liability. The House bill would make 40 percent, or $1,000, of the American Opportunity refundable, while the Senate bill would make 30 percent, or $750, refundable.
• What can be deducted: Filers claiming the American Opportunity credit would be able to count course materials in their higher education spending. This is a change from both the HOPE and Lifetime Learning credits, neither of which can be used for higher education expenses beyond tuition and fees.
• Income Caps: The American Opportunity credit would be available for individuals making up to $90,000 ($180,000 for joint filers). HOPE, by contrast, phases out completely at $60,000 for individuals ($120,000 for joint filers).

We are happy to see that Congress is considering including some refundable money and expanding the types of expenses that would be covered. Currently, low-income filers derive little to no benefit from the existing higher education tax credits because their tax liability is either small or nonexistent. Making the American Opportunity credit at least partially refundable would make some of these benefits available to less affluent individuals. Meanwhile, allowing filers to claim the credit for textbook and course material expenses should help financially needy students attending low-tuition schools who don’t qualify for the full benefit now.

We remain unconvinced, however, that tuition tax credits are an efficient way to deliver limited student aid resources. They are ill-targeted and arrive long after tuition bills are due. They are very expensive too — the Congressional Budget Office estimates the new credit will reduce federal revenues by $10 billion and increase government outlays by $3 billion just over the course of two years. In addition, they are very confusing — a Government Accountability Office Report found that the presence of multiple, complex credits leads hundreds of thousands of filers to either take no credits or an incorrect one on their tax returns. The new tax credit does nothing to address these concerns.

Moreover, the American Opportunity Tax Credit would still be poorly coordinated with student grant aid. This leads to a situation where increases in assistance such as Pell Grants lower students’ higher education expenses, in turn reducing the size of the tax credit for which they qualify. Both bills call for a study of this issue, but that is a far cry from taking real concrete steps to fix the problem.

The complexity issue certainly begs the question of why lawmakers are not using the American Opportunity credit to replace the HOPE and Lifetime Learning Credits. The savings from consolidation could be used to make the American Opportunity credit fully refundable — improving targeting — and possibly to increase the maximum award. Eligibility rules could be rewritten so that filers take a smaller award after the first four years of postsecondary education. It would be important, however, to make sure that students who can afford to attend only part-time or less, due to work and family commitments, are eligible for at least a partial credit, as is currently the case with the Lifetime credit.

The opportunity credit certainly is far from perfect, but it is an improvement over the current iterations of the HOPE and Lifetime Learning credits. As Congress moves forward, however, it should give more thought to the question of whether tuition tax credits are really the best way to help low income students who truly need a better opportunity.

Image used under a Creative Commons license by flickr user prognatis