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.
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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 postsecondary education, as well as education-related credits and a deduction. The major credits and the deduction in effect in 2018 are the following:
- The American Opportunity Tax Credit (AOTC) covers qualifying educational expenses for up to four years of postsecondary education. In 2018, 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—that is, families whose income tax liability (before the credit is applied) is less than the total amount of the credit may receive a portion of the credit as a payment. The amount of the AOTC gradually declines with income for higher-income tax filers. In 2018, 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. (Adjusted gross income comprises income from all sources not specifically excluded by the tax code, minus certain deductions. To determine eligibility for education-related tax credits, it is modified by adding certain foreign income and foreign housing allowances that are excluded from taxable income.) Neither the credit amount nor the income thresholds are adjusted, or indexed, to include the effects of inflation.
- 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 beyond the first four years of postsecondary education and by students taking less than half of a full-time course load. Taxpayers may not claim the Lifetime Learning credit and the AOTC for the same student in the same year. In 2018, the Lifetime Learning tax credit gradually declines with MAGI for joint filers whose MAGI is between $114,000 and $134,000 and for single filers whose MAGI is between $57,000 and $67,000. The income thresholds for those ranges are indexed.
- Tax filers may deduct from their taxable income up to $2,500 per year for interest payments on student loans. That deduction is available regardless of whether a tax filer itemizes deductions. In 2018, the interest deduction for student loans gradually declines with MAGI for joint filers with MAGI between $135,000 and $165,000 and for single filers with MAGI between $65,000 and $80,000. Although the maximum deduction is not indexed to include the effects of inflation, the income thresholds for those ranges are indexed.
Over 10 million taxpayers claimed a total of $18 billion in AOTC and Lifetime Learning tax credits on their 2016 tax returns. About 12 million taxpayers deducted a combined $13 billion of student loan interest. The projected effects of the tax preferences depend on taxpayers' incomes and expenditures on higher education.
This option would eliminate the AOTC and the Lifetime Learning tax credit beginning in 2019. The option would also gradually eliminate the deductibility of interest expenses for student loans. Because students have 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.
Effects on the Budget
If implemented, the option would raise revenues by $188 billion from 2019 through 2028, the staff of the Joint Committee on Taxation estimates. Its effect on revenues would be greater after 2026 than in earlier years, following a scheduled increase in individual income tax rates and a reduction in the amounts of the standard deduction. Under current law, because the Lifetime Learning tax credit is not refundable and the AOTC is only partially so, the value of those credits will increase in 2026 for taxpayers who previously had no tax liability against which to apply the credits. In addition, the value of the deduction for student loan interest will increase because deductions are more valuable to taxpayers facing higher tax rates.
The estimate for this option is uncertain because the underlying projection of individual income tax revenues is uncertain. That projection relies on the Congressional Budget Office's projections of the economy and the distribution of income over the next decade under current law. Those projections are inherently uncertain, but they are particularly uncertain because they reflect recently enacted changes to the tax system by the 2017 tax act. In addition, the estimate relies on the number of students pursuing higher education and the costs of those programs in the future, which might differ from CBO's estimates in unexpected ways.
An argument in favor of the option is that current education-related 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 those 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 argument in favor of the option is that providing education benefits through the income tax system results in benefits that are poorly timed and adds complexity to the process. Families must pay tuition and fees before they can claim the education benefits on their tax returns. By contrast, federal spending programs such as the Federal 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, might make it difficult for families to determine which tax preferences would be the most advantageous for their particular economic circumstances.
A drawback of this option is that it would reduce some households' 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. Students might respond by attending lower-cost schools, adjusting the amount they borrow through student loans, or reducing the amount of schooling they pursue. Another drawback is that despite the current system's complexity—which creates overlapping tax benefits—some families might 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.