How Federal Tax Policy Interacts With Higher Education Spending

How Federal Tax Policy Interacts With Higher Education Spending
Federal tax policy

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Two significant things happen every April: Income taxes are due and high school seniors, bound for college, decide where they want to continue their education.

These events are not unrelated. The federal government and the states — in addition to the aid they supply through grants and other spending initiatives — provide a range of income tax benefits intended to help students and their families pay for higher education.

Members of Congress are contemplating policy changes that could affect both types of programs: a major tax reform effort and reauthorizing the Higher Education Act.

As legislators engage in debates over changes to tax and spending programs for higher education, such discussions should not happen in silos. Policymakers should consider these two types of support to determine how federal resources can most efficiently and effectively contribute to achieving policy goals.

The federal government provided nearly $80 billion, excluding loans, to support students pursuing higher education in 2014, according to an analysis of federal data by The Pew Charitable Trusts.

Of that, just over half — $45 billion — came from spending programs primarily governed by the Higher Education Act. The rest — $34.5 billion — was in the form of tax benefits for students and families such as deductions, credits, and exclusions.

For budgeting purposes these tax expenditures have the same effect as spending programs: They reduce the amount of revenue available for other national priorities.

The cost of these tax expenditures has increased dramatically in just over two decades, from $2.4 billion in 1990 to $34.5 billion in 2014.

In addition to having similar impacts on the budget, spending and tax programs for higher education often have overlapping goals.

For example, the federal Pell Grant program — a spending initiative — and the American Opportunity Tax Credit — a provision in the federal tax code — are both meant to help individuals and families afford higher education, although the tax credit typically benefits households across a wider range of income levels than Pell Grants do.

Yet, despite their similar goals, the tax programs and the spending programs are considered by separate legislative committees, giving policymakers on each only a partial view of the government’s support for higher education.

This limited outlook is compounded by the fact that tax expenditures are typically permanent programs that are rarely revisited once enacted. In comparison, the Pell Grant and other key federal spending programs for higher education are reconsidered every year through the appropriations process and periodically through the Higher Education Act reauthorization process.

The policy implications of tax expenditures for higher education extend beyond the federal government. All 41 states with a personal income tax and the District of Columbia provide some form of tax benefit for higher education. For example, California estimates that in fiscal year 2012, the state’s various tax provisions for higher education cost the state $443 million in lost revenue, which is equivalent to 30 percent of what it spent that year on financial aid grants.

New York state estimates that $457 million was provided in the form of higher education tax benefits in fiscal 2013, comparable to 47 percent of what it spends on financial aid grants.

And most of these state tax provisions for higher education result from linkages to the federal tax code. That means that changes to federal higher education tax provisions could affect state budgets or force states to decide whether to decouple from the federal tax code.

In addition to considering consequences for states, members of Congress focused on tax policy and those working on higher education legislation should collaborate where tax and spending policies intersect. It is important for policymakers to understand the role of both in supporting higher education.

Ingrid Schroeder directs fiscal federalism initiatives for The Pew Charitable Trusts.

This piece was originally published in The Hill.