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Education Tax Incentives

Congress is considering ways to improve and simplify education tax incentives, which have become an important complement to direct assistance programs. Pell Grants (means-tested grants for higher education) and subsidized student loans have provided aid directly to needy students since 1972. More recently, the Tax Code has offered educational subsidies through the lifetime learning credit, the Hope credit, and deductions for education expenses and interest on student loans. It also encourages taxpayers to save for college through several tax-free savings opportunities including Coverdell savings accounts and Section 529 savings plans.

Critics levy three major complaints about existing tax incentives: 1) they are complicated and redundant, 2) benefits often fail to reach those most in need (because low-income students don’t qualify and because benefits come long after tuition is due, ) and 3) colleges and universities could capture much of the subsidy by raising tuition. The Tax Policy Center has examined the interaction between the tax incentives and traditional spending programs and considered options to simplify and better target tax incentives on the neediest families.

This series of TPC papers explores the history of subsidizing higher education – once dominated by spending programs but more recently involving tax incentives. The tax incentives are generally targeted at middle- and high-income families, providing little benefit to low-income families – a stark contrast to traditional grant programs.

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This discussion paper provides the history of financing higher education through both direct spending programs and tax incentives.

The largest tax incentives are the Hope Credit and Lifetime Learning Credit – both in-school subsidies. Because they are not refundable and are subject to income caps, these credits mostly benefit middle-income families. Furthermore, families must choose among mutually exclusive credits, complicating decisions. Combining the credits, increasing funding slightly, and making the credits refundable would target more benefits on the neediest families.

We analyze several options for reform including combining the tax credits, making the tax credits refundable so that low-income families could benefit, and smoothing the transition from Pell eligibility to eligibility for the tax programs.
Source: The Distributional Consequences of Federal Assistance for Higher Education

The largest of the traditional spending programs, the Pell program, delivers 85 percent of its benefits to families with income below $30,000. In contrast, the tax programs deliver almost two-thirds of benefits to families with incomes of at least $50,000. Expanding the credits and making them refundable would direct more benefits to low-income families.
Source: Subsidizing Higher Education Through Tax and Spending Programs

At present few low-income families benefit from education credits.
Source: The New Safety Net: How the Tax Code Helped Low-Income Working Families During the Early 2000s

Other options for simplification would move all educational aid into the tax system, eliminating the separate application process currently used for direct benefits. That change would let students know how much aid they would get before they have to decide whether to enroll in college, potentially increasing the benefits’effectiveness in encouraging college enrollment.
Source: College Grants on a Postcard: A Proposal for Simple and Predictable Federal Student Aid

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The rising popularity of college savings plans makes it more important to understand whom the programs benefit. TPC analysis explains how college savings plans work and compares benefits of education savings and other savings vehicles. Data from the 2001 Survey of Consumer Finances describe the earliest users of tax-advantaged college savings plans. Most important, the analysis illustrates how education savings plans aid families across all income brackets.
Source: High-Income Families Benefit Most from New Education Savings Incentives

A Tax Policy Center conference on higher education discussed current government policies to encourage and fund college attendance as well as options to improve those policies.