Using the Tax Code to Promote Postsecondary Education: We Might as Well Do It Right

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Several members of Congress are considering how to improve tax provisions that are designed to help people obtain postsecondary education and training, and recent reports on this topic has been issued by the Center on Budget and Policy Priorities and the Tax Policy Center. The Senate Finance Committee is expected to mark up legislation on education tax benefits after the Memorial Day recess. Currently taxpayers paying college or training expenses, including those who are not itemizers, can deduct up to $2,000 ($4,000 for married couples) for tuition and fees. Also, the Hope credit is available at a maximum of $1,650 per student this year (indexed for inflation) and the Lifetime Learning Credit (LLC) is available at a maximum of $2,000 per family. There are also several tax-preferred savings vehicles for education (Coverdell Education Savings, Accounts, Qualified Tuition Programs, and education savings bonds).

Lack of Progressivity

There are several problems with these tax benefits. For one, they're not very progressive. This is particularly troubling because we usually think the whole point of these tax breaks is to encourage people to obtain postsecondary education who otherwise would not, and wealthier families will typically send their children to college regardless of what tax benefits are available. Lower-income families, who are more likely to respond to subsidies for education, are not well-targeted by the tax benefits.

The tuition and fees deduction and the Hope credit and LLC are unavailable for people without income tax liability, so a sensible reform would be to provide a refundable credit. Most families of modest means pay federal payroll taxes but are not wealthy enough to owe federal income taxes (a family of four with an income of $42,000 won't pay federal income taxes in 2007). For these families, only a credit that is refundable (that results in negative income tax liability and a check from the IRS) can help.

The maximum LLC cannot be used unless a family spends at least $10,000 on education (because it credits 20% of the first $10,000 in expenses, up to a maximum credit of $2,000). One speaker at a forum on this topic hosted by the Tax Policy Center on Wednesday pointed out that 90 percent of students have expenses below $10,000. The tuition and fees deduction is regressive because its value depends on the tax rate the taxpayer is subject to. A family subject to a 35% tax rate can deduct $4,000 and reduce their taxes by $1,400, but a family subject to the 10% rate could deduct $4,000 and reduce their taxes by only $400.


Another problem is that many families may find the rules governing these tax breaks too confusing and may not even realize that these benefits are available. A taxpayer must choose to use either the tuition and fees deduction, the Hope credit, or the LLC. A GAO report in 2005 found that over a fourth of taxpayers eligible don't take advantage of any of these tax benefits, and those who do use them often don't use the most advantageous tax break for their situation.

New Proposals Could Solve Some of These Problems

A bill sponsored by Rahm Emanuel (D-IL), Dave Camp (R-MI) and others in the House and Evan Bayh (D-IN) in the Senate would combine the three main tax benefits into one credit of up to $3,000 for postsecondary education expenses, including a much broader range of expenses (such as room and board, books, supplies and transportation). These expenses other than tuition often make up the bulk of costs for students of modest incomes in community colleges. The credit would cover 50% of the first $3,000 and 30% of the next $5,000 of these expenses. Up to half of the credit calculated based on expenses would be refundable, adding to the progressivity of the proposal.

Other proposals are being discussed, including one from Senator Charles Schumer (D-NY) for a simplified credit that would not be refundable, and which the Finance Committee is likely to consider. Advocates for making postsecondary education more accessible are hopeful that the Finance Committee can be pushed to move in the direction of the bill being sponsored by Emanuel, Camp and Bayh.

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