Congress Should Cut Tuition Tax Breaks Before Cutting Pell Grants Again

Originally published by The National Association of Student Financial Aid Administrators

Commentary | February 13, 2012

With a new year starting in Congress, policymakers should make the following resolution:  No more cuts to the government’s main federal student aid programs in 2012. Such a pledge may seem far-fetched, particularly at a time when the Federal Pell Grant program is once again approaching a major funding cliff. Unfortunately, efforts by the Obama administration and Congress to shore up funding for Pell Grants over the last two fiscal years have reduced student aid funding targeted at low-income students, while they have ignored higher education tax benefits that are more likely to go to affluent families.

In order to maintain the maximum Pell Grant at its current level of $5,550, Congress has taken some significant steps to narrow eligibility for the awards (potentially kicking out as many as 100,000 recipients from the program), and to make the program less generous, by, for example, ending the ability of low-income students to obtain two grants in a single year. Lawmakers have also eliminated the Leveraging Educational Assistance Partnership (LEAP) grant program, which provided matching funds to states to entice them to spend their own resources on need-based financial aid. In addition, they have significantly scaled back the in-school interest subsidy the government provides on student loans for financially-needy students—eliminating it altogether for graduate students—and during the six-month grace period prior to repayment for undergraduates who take out loans between July 1, 2012, and July 1, 2014. 

This may just be the tip of the iceberg, as the supplemental funding that Congress provided in this summer’s debt ceiling deal to keep the Pell Grant program afloat is set to run out. As a result, lawmakers will need to find at least an additional $7 billion (and probably much more) to avoid slashing the maximum award in fiscal year 2014. Already there has been talk that Congress may consider eliminating the in-school interest subsidy on federal student loans entirely, or significantly reducing the amount of income students can earn before it counts against their Pell Grant eligibility—penalizing those who have to work while in college to support their families.

Luckily, there is a better place for policymakers to look to find savings needed to bail out the Pell Grant program: the tuition tax credits and deductions that the government provides to help students and their families offset the costs of higher education. According to the College Board, these tax breaks cost the government $14.7 billion in revenue that would have otherwise been generated in 2009. The U.S Joint Committee on Taxation has estimated that these tax breaks have a price tag of about $55 billion between 2010 and 2014. 

The largest of these higher education tax expenditures is the American Opportunity Tax Credit (AOTC), which Congress created in 2009 at the behest of the Obama administration. The AOTC is a $2,500 annual income tax credit that families with incomes up to $180,000 can claim for up to four years of college. The credit is partially refundable, meaning that low-income families who do not have any tax liabilities can receive a payment from the government of up to $1,000 a year for each student in college.

In addition to the AOTC, the government also offers the Lifetime Learning Credit,  a $2,000 nonrefundable tax break that is available to students who take at least one postsecondary education course; and until this year, a $4,000 tuition and fees tax deduction available to families making up to $160,000 a year.

Meanwhile, if the AOTC expires at the end of 2012, as it is currently scheduled to do, it will convert back to the Hope credit, a non-refundable $1,800 credit that is available only to the families of students in their first two years of college. (In his recent State of the Union speech, President Obama called for Congress to make the AOTC permanent, saying that it “saves millions of middle-class families thousands of dollars.”)

While these tax benefits are undoubtedly helpful for students and families that are facing ever-increasing college prices, providing financial aid through the tax code is ineffective and wasteful for the following reasons: 

  • As many student aid experts have pointed out, the tuition tax breaks are not well targeted, with a substantial share of the benefits going to affluent families who can afford to send their children to college without the aid. According to the College Board, 26 percent of the savings derived from the higher education tax credits in 2009 went to taxpayers with incomes over $100,000. In comparison, a U.S. Department of Educationreport shows that more than 90 percent of dependent students who receive Pell Grants come from families making less than $50,000.
  • The tax breaks arrive months after students and their families pay their tuition bills. This disconnect in timing is not only impractical but serves to obscure the purpose of the benefits as well. Suzanne Mettler, a professor of government at Cornell University, conducted a survey of tuition tax credit recipients and found that nearly 60 percent didn’t realize that they had received help from the government to pay for college. These types of “social tax expenditures,” Mettler wrote in an article in the Washington Monthly last summer, “are largely hidden from the public: through them, the government benefits people, providing them with opportunities and relieving their financial burdens, often without them even knowing it.” (Italics in original.)

The tax breaks are complicated and confusing. Because of the complexity of navigating the tax code, many families do not appear to know whether they are qualified for these benefits. The Government Accountability Office reported in 2008 that it had found that “hundreds of thousands of taxpayers fail to claim tax preferences to which they are entitled or do not claim the tax preference that would be most advantageous to them.” Meanwhile, the U.S Treasury Department’s Inspector General for Tax Administration revealed in Octoberthat more than two million taxpayers may have mistakenly claimed the AOTC in 2009. 

Trying to help make college more affordable for students and families is an admirable goal. However, at a time when the budget axe is falling on the Pell Grant program, providing billions of dollars in tax benefits to upper-middle-income families who don’t really need the help is a luxury that the government can ill afford.

For the sake of preserving access and equity in higher education, Congress should eliminate, or at least scale back, the tuition tax benefits and use the savings to put the Pell Grant program back on a sustainable path.

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