How Governments Support Higher Education Through the Tax Code
Federal and state income tax provisions aim to reduce costs for students and families
To maximize the impact of higher education investments and achieve desired policy goals, policymakers should have knowledge of the full range of assistance provided to institutions and students. This means having an understanding of the billions of dollars made available through spending programs and the tax code. However, too frequently these two types of support are not considered in tandem, and most states lack the cost estimates they would need to determine how tax provisions for higher education compare in size to other postsecondary investments.
The federal government and the states each invested more than $70 billion in higher education-related spending programs, excluding loans, in academic year 2014, the latest year for which data are available. But that figure, as substantial as it is, does not paint a full picture of federal and state investments in higher education. It excludes the billions of dollars that the federal government and the 41 states plus the District of Columbia that levy personal income taxes provide to students and their families through tax expenditures—such as credits for tuition and college savings incentives—to help offset postsecondary costs.
These tax provisions—special deductions, credits, exclusions, and exemptions—allow people to reduce their income tax liability and result in lower federal and state government revenue. They are called tax expenditures because they are similar to direct spending both in their budgetary impacts and in the way they can benefit recipients. The tax code contains many such provisions that support specific policy priorities, of which higher education is just one.
Tax expenditures targeted toward higher education can have substantial costs for governments, but those costs are frequently excluded from federal or state debates about the scale and nature of higher education spending for three main reasons. First, tax expenditures are generally not subject to the same recurring budget procedures as are most spending programs for higher education, which are debated regularly during the appropriations process. Instead, they typically are permanent provisions that are rarely revisited once enacted.1 Second, spending programs and tax expenditures fall under the jurisdiction of different committees at the federal level—and sometimes in state legislatures as well. As a result, the evaluation and oversight of—and legislative debates about—these programs are generally not coordinated. Third, states rarely compile comprehensive information about the cost of their higher education tax expenditures, making it even less likely that provisions at the state level will be part of budget and policy debates about higher education spending programs.
Tax expenditures targeted toward higher education can have substantial costs for governments, but those costs are frequently excluded from federal or state debates about the scale and nature of higher education spending.
To help integrate these tax expenditures into broader discussions of higher education finances and policy, The Pew Charitable Trusts catalogued federal and state higher education income tax provisions and examined their extensive linkages across the levels of government. Other tax expenditures benefit higher education institutions, but this study is limited to tax expenditures that are intended to help students and families. The analysis, which is part of a larger series exploring the full range of federal and state support for higher education, found that:
- Personal income tax expenditures for higher education have substantial costs at the federal level and are comparable to major spending programs. The value of federal tax provisions for students and their families totaled nearly $35 billion in fiscal year 2014, 14 percent more than the cost of Pell Grants, a need-based financial aid program and the largest federal higher education spending program.
- Every state that levies a personal income tax has higher education tax expenditures, and although few states comprehensively estimate the costs, in most that do, the provisions make up a sizable part of the support targeted to students and families. Forty-one states—plus the District of Columbia—have a broad-based income tax, and all of them provide some tax provisions for higher education. However, Pew was able to obtain cost estimates that include forgone revenue for at least two-thirds of relevant tax expenditures from only nine states and the District. In eight of those nine states plus the District, forgone revenue was equal to more than 25 percent of the financial aid grant portion of state higher education spending.
- Federal and state provisions generally target the three phases of postsecondary education financing: saving for the future, offsetting expenses while enrolled, and paying previously incurred costs. For example, tax advantaged savings plans, commonly known as 529 plans, facilitate saving for future college expenses; the American opportunity tax credit (AOTC) offsets current-year course-related expenses; and the student loan interest deduction helps pay off loans for past costs.
- States have implemented most of their higher education tax provisions through two key linkages to the federal tax code. First, when calculating their state taxes, filers in most states must use one of the federal definitions of income, which already capture the effects of as many as eight federal higher education tax expenditures. Second, many states adopt the federal definition of eligible dependent, which allows parents to claim a personal exemption for each child age 19 to 23—above the standard age cap—who is enrolled in school full time for at least five months of the year. Because of the prevalence of such linkages to federal law, provisions for higher education are fairly common and tend to have similar structures across the states.
- Several states also have less common higher education tax expenditures. In many cases, these provisions are unique to one or a handful of states and are independent of federal law. They also sometimes carry substantial costs. New York, for example, allows students and families to choose either a tax credit or deduction for tuition and fees; neither option is based on a linkage to the federal tax code. Together, these credits and deductions resulted in a revenue loss of $240 million in 2013 for the state, accounting for more than half of the revenue loss from the seven provisions for which the state estimated costs that year.
This report explores these findings in greater depth to provide the fullest picture to date of the characteristics and costs of federal and state higher education personal income tax expenditures for students and families. It examines the size of these tax expenditures and their prevalence at the state level, outlines their features, and explains the linkages between state and federal tax codes that generate most of the state-level provisions.
- Michael Leachman, Dylan Grundman, and Nicholas Johnson, “Promoting State Budget Accountability Through Tax Expenditure Reporting,” Center on Budget and Policy Priorities (May 2011), http://www.cbpp.org/research/state-budget-and-tax/promoting-state-budget-accountability-through-tax-expenditure; and U.S. Government Accountability Office, “Tax Expenditures: Opportunities Exist to Use Budgeting and Agency Performance Processes to Increase Oversight,” GAO-16-622 (July 2016), http://www.gao.gov/products/GAO-16-622.