Higher Education Denied

Tuition tax credits help students pay for the costs of college, but they are of little or no help for lower-income households who donít owe any income tax.

Question 8. Ask the Candidate:

Would you make all tax credits for college tuition fully refundable, so that they would be equally available to households who donít owe income taxes but often need the assistance most?

Tuition tax credits have the same effect as tax-free grants of money from Congress. For example, whether you save $1,000 of taxes through a tuition tax credit or pay that amount in taxes but get it back in a tax-free grant from the Department of Education, you have $1,000 more to spend on college. But if the $1,000 came from the Department of Education, we could never imagine that DOE would give low-income students less or none of the money because they have too little income to pay taxes. But Congress has created just such a policy by not making tuition tax credits fully refundable. That’s bad social policy. And bad economics.

The Costs and Payoff for a College Education

We all know that the long-term financial rewards of higher education can be enormous. Consider these figures from the College Board: 

Within each demographic group, median annual earnings for year-round, full-time workers with bachelor’s degrees are about 60% higher than earnings for those with only a high school diploma.... Over a lifetime, the gap in earnings between those with a high school diploma and those with a B.A. or higher exceeds $1,000,000.[1]

Unfortunately, the percentage of Americans with only a high school degree is likely to grow if our nation continues on its current course. Whether you look at community colleges or snazzy Ivy League schools, the costs are growing more formidable, even for middle-income families.

Most troublesome are the costs at two-year and four-year public institutions, which educate 75% of our college students. According to the College Board, the average tuition and fees over the decade from 2001-02 to 2011-12 for two-year public colleges rose at an average rate of 3.8% per year, after adjusting for inflation; the rate for four-year colleges was 5.6% per year after inflation.[2] Yet, over this same period, average inflation-adjusted wages (assuming you had a job) grew a meager 1% per year, increasing the likelihood that students from ordinary households cannot afford higher education, at least without incurring a frightening level of debt.

The tax which will be paid for education is not more than the thousandth part of what will be paid if we leave the people in ignorance.” —Thomas Jefferson

Consider this: The average budget for an in-state student at a four-year public institution for the 2011-12 academic year--tuition and fees, room and board (or rent), books, supplies, transportation, and other expenses-- was about $21,500. And that’s just for one year! For a two-year institution, it was about $15,300, assuming the student lived away from home.[3] Average need-based grants from the educational institutions themselves plus federal and state grants, while helpful, leave  the vast majority of the costs to the students themselves.[4]

Tuition and fees alone for in-state students, for the 2011 – 2012 academic year, averaged about $8,000 at public four-year colleges and universities and about $3,000 for two-year institutions.  

An Idea Not Good Enough: Hope Scholarship and Lifetime Learning Credits

In 1997, Congress responded to widespread concerns about escalating costs of higher education by enacting two income tax credits-- the Lifetime Learning Credit and the Hope Scholarship Credit--to help with post-high school education expenses. This time, by enacting credits rather than deductions, Congress got it right: Each $1 of credit, unlike each $1 of deduction, offsets $1 of tax, The credit thus has equal value for each person who owes at least $1 of tax, regardless of her top tax bracket. This makes credits equivalent to a direct government grant: Whether it’s a $1,000 tax credit for college or a $1,000 college grant from the Department of Education, you have $1,000 more to spend on college.

By not making the credits “refundable,” however, Congress got it wrong: No one who doesn’t owe an income tax can benefit, yet these are the very people who usually need the assistance most. As explained in Question 3 with respect to child care credits, if the credits were refundable, the IRS would treat each student (or their parents) as if they had paid taxes equal to at least the amount of the credit. If the credit exceeds any income tax they owe, the IRS would send them a refund check, up to the maximum credit.

To determine your credit, you count all tuition and mandatory fee expenses up to $10,000, and multiply by 20%. If you have only $1,000 of expenses, your credit is $200.

The Lifetime Learning Credit. This credit, unchanged since 1997, provides a maximum credit of $2,000 for tuition and mandatory fee expenses for any higher-education expenses.  The Lifetime Learning Credit is available only for one family member each year, although it may be a different member in subsequent years. Students may claim the credit if they do not qualify as “dependents” of their parents; otherwise, only parents may claim the credit. But again: The credit is not refundable: No one is entitled to it if they don’t owe income taxes.

A partial credit is allowed for single people with income between $52,000 and $62,000, and for married couples with income between $104,000 and $122,000.

Congress also sets upper income limits to be eligible for the credit. In 2012, the credit can’t be claimed by single people if their income exceeds $62,000 or by married couples if their income exceeds $122,000. But let’s think about these limits. If you’re married with one student in college and have $100,000 of income, Congress will give you up to $2,000 toward your college expenses; if your income is far less and you don’t owe any income tax, you’re out of luck.

The Hope Scholarship Credit (now the American Opportunity Tax Credit). The Hope Scholarship Credit initially allowed a household to reduce its income tax bill by up to $1,500 for each member attending the first two years of college; this made the credit particularly useful for students at community colleges or for families with several members attending college at the same time. But the credit was nonrefundable.

Eligibility for the AOTC is governed by the same rules as the Lifetime Credit.

In 2009, however, Congress renamed the credit the American Opportunity Tax Credit (AOTC), made it available for tuition and mandatory fees for the first four years of college, and raised the maximum credit to $2,500.[5]  Moreover, in a concession to low-income households, Congress made 40% of the credit, up to a maximum of $1,000, refundable.

A student may claim either the full AOTC or Lifetime Credit for the year, but not both.

For example, Judy, who is not a dependent of her parents and who, working part-time, earns $10,000 this year, will not owe any income tax because of her personal exemption, her standard deduction, and a small Earned Income Credit. So she can receive, at most, a $1,000 AOTC. But Priscilla, who receives $50,000 of income from a trust fund, can get the full $2,500.

These credits have helped millions of students over the years. But by denying them entirely or in part to lower-income students, while granting the full amounts to students from households with considerably greater means, Congress has expanded an already unacceptable and growing gap between haves and have-nots. Moreover, these eligibility rules do not make economic sense: Our economy needs more, not less, well-educated workers.

Who Got the Credits

The two credits saved certain students and families about $8.7 billion in 2010. Of that amount, more than 70% went to taxpayers with over $50,000 of income. About 15% went to taxpayers with under $30,000 of income.[6]

The Double Loser Problem

The problem is even worse than it looks. Basic economics teaches us that the tax credits are likely to produce higher tuitions and fees because (a) they increase demand for higher education among beneficiaries, and (b) institutions realize that the government will cover part of the costs. This means that students who don’t benefit fully or at all from these credits actually may be worse off than they would be if the credits didn’t exist in the first place.

What Congress Should Do: Make the Credits Fully Refundable

The simplest, and most efficient way, to help students with costs for higher education would be through the direct budget process. Then, Congress would eliminate tax credits and substantially increase Pell Grants, favorable loans, and other subsidies. If, for example, that $8.7 billion of tax credits in 2010 had instead been doled out by the Department of Education as tax-free subsidies for higher education, we should expect that a much higher portion would have been provided for students in low- and moderate-income households. Until that happens, the credits should be made fully refundable to make sure that those with the greatest need are fairly treated.  

“By nature all men are alike, but by education widely different.” —Chinese Proverb

By focusing the subsidy on such households, and reducing it for higher-income households, Congress could adopt revenue-neutral reforms and make the subsidies right-side up rather than upside-down. That way, Congress would improve opportunities for students of limited means to become better educated[7] and obtain jobs that pay a liveable wage. Congress also would increase employers opportunities to hire educated workers able to learn and adapt on the job.

In short, making college more accessible for lower-income Americans is one investment that pays off for everyone. How often have we heard politicians say that a better-educated workforce would make our businesses more profitable and more competitive in this global economy? Yes, we all realize this is the right and smart thing to do. Now let’s hear it from the candidates.     



[1] The College Board, Trends in College Pricing, 2003, www.collegeboard.com..

[2] Analysis Brief, Trends in Higher Education Series, College Board Advocacy and Policy Center, May 2012.

[3]  Ibid.

[4]  See “Distribution of Grant Aid by Income Level and Institution Type,” Trends in Higher Education Series, College Board Advocacy and Policy Center,2009.

[5] The AOTC equals 100% of the first $2,000 of expenses, plus 25% of the next $2,000.

[6] Joint Committee on Taxation. Estimates of Federal Tax Expenditures for Fiscal Years 2011–2015. JCS-1-12. Washington, D.C.: GPO, 2012, 52.

[7] Counting all costs, including tuition, fees, room and board, books and supplies, transportation and miscellaneous expenses, “grants and federal tax savings covered about 20% of expenses for public four-year college students in 2007 – 2008.” “Net Price—Public Institutions,” Trends in Higher Education Series, College Board Advocacy and Policy Center, 2011.

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