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The comprehensive tax reform plan recently released by House Ways & Means Committee Chair Dave Camp (R-MI) contains a noteworthy proposal to reform tax benefits for higher education. The plan would consolidate three separate tax benefits for postsecondary students into a single credit that targets low- and middle-income families with students enrolled at least half-time in undergraduate degree or certificate programs. The idea is similar to recent proposals by Rep. Diane Black (R-TN) and Rep. Danny Davis (D-IL) and higher education analysts such as RADD Consortium for Higher Education Tax Reform and HCM Strategists.
Our current tax-based assistance for higher education is highly complex. In 2013, families with college students could benefit from the American Opportunity Credit (AOTC), Lifetime Learning Credit (LLC), or tuition and fees deduction. Eligibility for the three education benefits overlaps and families have to decide which incentive to claim for each student.
This complexity may make it difficult for many families to take full advantage of tax benefits for higher education. According to the Government Accountability Office, 14 percent of tax filers eligible for the LLC or tuition and fees deduction in 2009 failed to claim benefits and 40 percent of filers taking the tuition and fees deduction would have been better off taking the LLC.
Camp would simplify tax-based assistance for higher education by making the AOTC permanent. At the same time he’d repeal the AOTC‘s less generous predecessor, the Hope Credit, which is currently scheduled to replace the AOTC in 2018. He’d also repeal the LLC, and allow the tuition and fees deduction, which expired at the end of 2013, to die. Consolidating the incentives into a single credit would reduce confusion among taxpayers and could increase their use of education benefits.
The Camp plan would also simplify education tax subsidies by eliminating a number of other education-related exclusions and deductions, the largest of which are the deduction for interest on education loans and the exclusion for employer-provided education assistance. The proposal would also eliminate Coverdell education savings accounts which serve a similar purpose to tax-preferred 529 college savings plans, the exclusion for discharge of student loan indebtedness, the exclusion for tuition reductions by educational institutions to their employees, and the education expense exception to the penalty for early withdrawals from retirement accounts. In addition to raising revenues, eliminating these exclusions and deductions makes the tax code more progressive since many of the benefits go to higher income families.
Under current law, the AOTC allows a 100 percent credit against the first $2,000 of educational expenses and 25 percent of the next $2,000 for a maximum credit of $2,500. Forty percent of the credit up to $1,000 is refundable. The plan would modify the AOTC to shift benefits from high-income to low- and middle-income families in several ways. It would make the first $1,500 of tax credits refundable and lower the income level at which the credit starts to phase out from $160,000 to $86,000 for married filers and from $80,000 to $43,000 for non-married filers. It would also index the credit for inflation starting in 2018.
The Tax Policy Center estimates that 23 percent of tax benefits for higher education in 2013 went to households with adjusted gross income exceeding $100,000 while only 17 percent went to taxpayers with income below $25,000. If the Camp provisions had been in place, just 5 percent of benefits would have gone to taxpayers above $100,000 and 32 percent to families below $25,000. While is it not clear how much tax incentives increase college attendance, research suggests that the cost of attendance has a larger impact on enrollment decisions among low-income families.
Higher income families with students would not be the only losers. Since the AOTC is only available to undergraduate students enrolled at least half-time in degree programs, graduate students and non-traditional learners would also lose tax benefits. Excluding graduate students from tax benefits may make sense given scarce resources and their higher expected incomes. However, it may be more problematic to slash benefits for low-wage workers developing new skills by attending school less than half-time and/or taking courses outside of degree programs.
JCT estimates consolidating the three main subsidy programs into a revised AOTC would reduce tax revenue by $9 billion over ten years, relative to current law. But compared to permanently extending the current higher education provisions, the proposal is probably a tax hike. When combined with other education provisions in the Camp proposal, the education package would raise $18 billion over ten years.
The Camp plan contains other non-education provisions that would affect families with postsecondary students, including eliminating personal exemptions and defining qualifying children as under age 18 for the Earned Income Tax Credit (EITC). A new $500 credit for non-child dependents would partially offset the loss of the exemptions and EITC eligibility for dependent college students.
While scrapping benefits for non-traditional learners may raise concerns, the proposal would significantly reduce complexity and improve the targeting of tax subsidies for higher education. It would be a good starting point for discussion of how to rationalize the current hodge podge of higher education tax incentives.
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