Eliminate Certain Tax Preferences for Education Expenses

Federal support for higher education takes many forms, including grants, subsidized loans, and tax preferences. Since the enactment of the Taxpayer Relief Act of 1997, however, assistance provided through the tax system has increased and expanded to families higher up the income distribution.

In addition to several tax-advantaged accounts that allow families to save for their child's postsecondary education, taxpayers can also benefit from several education-related credits and deductions. One of those allows taxpayers to deduct up to $4,000 from their taxable income for qualifying tuition and fees, whether they itemize deductions or not. That deduction, which expired at the end of 2009, was reinstated by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312). It is currently scheduled to expire at the end of 2011. Another tax preference, the American Opportunity Tax Credit (AOTC), covers up to $2,500 in educational expenses (100 percent of the first $2,000 and then 25 percent of the next $2,000) and is available for up to four years of postsecondary education. Up to 40 percent of the credit (or $1,000) is refundable for lower-income families. That credit is scheduled to expire at the end of 2012.

Three other tax preferences will be in effect through the end of the 10-year projection period under current law:

This option would eliminate the Hope tax credit and the Lifetime Learning tax credit beginning in 2013. The option would also gradually eliminate the deductibility of interest expenses for student loans. Because students borrowed money with the expectation that a portion of the interest would be deductible over the life of the loan, the interest deduction for student loans would be phased out in annual increments of $250 over a 10-year period. If implemented, this option would raise revenues by $20 billion from 2012 through 2016 and by $48 billion over the 2012-2021 period.

An argument in favor of the option is that the current tax benefits are not targeted to those who need assistance the most. Many low-income families do not have sufficient income tax liability to claim all--or in some cases, any-- of the education-related tax benefits. However, the cost of higher education may impose a greater burden on those families as a proportion of their income. Further, some research indicates that lower-income individuals and families may be more sensitive to the cost of higher education than those with higher income and thus more likely to enroll in higher education programs if tuition and fees are subsidized.

A second rationale in favor of the option concerns the administration of education benefits through the income tax system. Education benefits administered through the tax system are poorly timed because families must pay tuition and fees before they can claim the benefits on their tax returns. In contrast, federal spending programs such as the Pell Grant program are designed to provide assistance when the money is needed--at the time of enrollment. Further, providing education assistance through various credits and deductions, each with slightly different eligibility rules and benefit amounts, makes it difficult for families to determine which tax preferences provide the most assistance. As a result, some families may not choose the most advantageous educational benefits for their particular economic circumstances.

A drawback of this policy option is that some households would not receive as much assistance for educational expenses unless federal outlays for education assistance were expanded. The option would increase the financial burden on families with postsecondary students-- particularly middle-income families who do not qualify for current federal spending programs. Another drawback is that despite the current system's complexity--which creates overlapping tax benefits--some families may find it easier to claim benefits on their tax returns (on which they already provide information about their family structure and income) than to fill out additional forms for assistance through other federal programs.