Eliminate Certain Tax Preferences for Education Expenses

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

(Billions of dollars) 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2014-2018 2014-2023
Change in Revenues 5 23 23 23 21 11 12 12 12 13 95 155

Source: Staff of the Joint Committee on Taxation.

Note: This option would take effect in January 2014. The estimates include the effects on outlays resulting from changes in refundable tax credits.

Federal support for higher education takes many forms, including grants, subsidized loans, and tax preferences. Those tax preferences include several types of tax-advantaged accounts that allow families to save for their child’s postsecondary education as well as education-related credits and deductions. The major credits and deductions in effect in 2013 or scheduled to be reinstated under current law are the following:

  • The American Opportunity Tax Credit (AOTC) replaced and expanded the Hope tax credit starting in 2009. Although it was scheduled to expire at the end of 2012, the AOTC was extended through 2017 by the American Taxpayer Relief Act of 2012. Unlike the Hope tax credit, which was nonrefundable, the AOTC is partially refundable—that is, families whose income tax liability (before the credit is applied) is less than the total amount of the credit may receive all or a portion of the credit as a payment. The AOTC is available to cover qualifying educational expenses for up to four years of postsecondary education. In 2013, the AOTC can total as much as $2,500 (100 percent of the first $2,000 in qualifying expenses and then 25 percent of the next $2,000). Up to 40 percent of the credit (or $1,000) is refundable. The amount of the AOTC gradually declines (is “phased out”) for higher-income tax filers. In 2013, the AOTC is reduced for married couples who file jointly and have modified adjusted gross income (MAGI) between $160,000 and $180,000 and for single filers with MAGI between $80,000 and $90,000. Neither the credit amount nor the income thresholds are adjusted, or indexed, for inflation over the 2009–2017 period in which the AOTC is in effect.
  • The nonrefundable Lifetime Learning tax credit provides up to $2,000 for qualifying tuition and fees. (The credit equals 20 percent of each dollar of qualifying expenses up to a maximum of $10,000.) Only one Lifetime Learning credit may be claimed per tax return per year, but the expenses of more than one family member (a taxpayer, spouse, or dependent) may be included in the calculation. The Lifetime Learning credit can be used after the first two years of postsecondary education and by students who attend school less than half-time. Taxpayers may not claim the Lifetime Learning credit and the AOTC for the same student in the same year. In 2013, the Lifetime Learning tax credit is gradually reduced for joint filers whose MAGI is between $107,000 and $127,000 and for single filers whose MAGI is between $53,000 and $63,000. Those income thresholds are adjusted for inflation over time.
  • Tax filers may deduct from their taxable income up to $2,500 per year for interest payments on student loans. This deduction is available regardless of whether a tax filer itemizes deductions. In 2013, the interest deduction for student loans phases out for joint filers with MAGI between $125,000 and $155,000 and for single filers with MAGI between $60,000 and $75,000. Although the maximum deduction amount is not indexed for inflation, the income thresholds for the phaseout ranges are adjusted for inflation.
  • Taxpayers (regardless of whether they claim the standard deduction or itemize their deductions) can deduct up to $4,000 from their taxable income for qualifying tuition and fees instead of taking a credit. That deduction is scheduled to expire at the end of 2013.
  • Although not currently available, the Hope tax credit is scheduled to be reinstated in 2018 when the AOTC expires. The Hope credit is nonrefundable (the credit may not exceed the filer’s income tax liability) and can be claimed only for expenses incurred in the first two years of a postsecondary degree or certificate program; during that period, the student must be enrolled at least half-time. Fewer types of expenses qualify for the Hope credit than for the AOTC. In 2008, the last year it was available, the Hope credit was equal to 100 percent of the first $1,200 of qualifying tuition and fees and 50 percent of the next $1,200 for a maximum credit of $1,800 per year. As was the case before the Hope credit expired, the parameters used to calculate the credit amount will be indexed for inflation when the credit is reinstated. On the basis of that adjustment for inflation, CBO estimates that in 2018, the maximum credit will be $2,100. As was previously the case, the reinstated Hope credit will decline for high-income tax filers. In 2018, CBO estimates, the credit will be reduced for joint filers with MAGI between $118,000 and $138,000 and for single filers with MAGI between $59,000 and $69,000.

This option would eliminate the AOTC and the Lifetime Learning tax credit beginning in 2014 and cancel the reinstatement of the Hope tax credit in 2018. (The $4,000 deduction for qualifying tuition and fees described above would have already expired by 2014.) 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, the option would raise revenues by $155 billion over the 2014–2023 period, the staff of the Joint Committee on Taxation estimates.

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 increased. 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.