Higher Education Tax Credits and Deductions

February, 2013

Washington -- Several new think-tank papers on higher education finance, funded by the Gates Foundation, suggest that existing tax credits and deductions to help students and families pay for college should be changed or eliminated entirely. I agree, if done as part of a comprehensive overhaul of higher education finance.

It's not so long ago that these "tax expenditures" were established. Many people still working in higher education were present at their creation; I was one and here is my recollection.

When President Clinton and Senator Dole contested the 1996 presidential election, Dole advocated across-the-board tax cuts for all; Clinton favored smaller "targeted tax cuts" that would spur certain segments of the economy and would not increase the federal deficit as much as Dole's proposals. Among Clinton's favorite examples were targeted tax cuts aimed at higher education.

After Clinton won the election, many of us at the U.S. Department of Education thought we would hear no more of these targeted tax cuts; we figured they were a part of election year rhetoric. We were taken aback when Clinton proposed his "Hope Scholarships", which were not scholarships at all, but tax credits. The idea was worked up after the election by the White House and the Treasury Department without much if any input from the Education Department. Lawrence Summers gave the Administration's pitch to Capitol Hill.

I was skeptical on many grounds but saw one possible advantage for tax expenditures. Funds would not be handled by colleges but go directly as benefits to students and families. I had just written and published an article in Publius, The Journal of Federalism, showing how colleges captured certain kinds of financial aid for themselves, rather than benefiting students and families as intended.

The Clinton initiatives were soon passed into law. The cost to the federal treasury was not so great as to preclude adoption of the first balanced federal budget in decades. I and a few of my colleagues from the Department of Education got invitations to the White House to mark the signing of the Balanced Budget Act of 1997.

The very first year the Hope Scholarships were in effect, one college (Bowdoin) proudly announced a plan to treat this new program just as it had other student aid programs: students and families were now better able to pay higher net tuition in their financial aid packages. Bowdoin justified its action by saying it would use the proceeds to help the truly needy.

This created a dust-up in Washington. The Bowdoin president quickly said his financial aid officer had spoken out of turn; Bowdoin had no such plan. I proposed (and drafted) a letter from Secretary of Education Riley to all college presidents asking them not to defeat the purpose of the tax expenditures by manipulating financial need calculations in the packaging process.

The letter was sent to all presidents. It had little effect; the enrollment management industry already was marketing to colleges ways they could determine, or estimate, how much families were benefiting from the new tax expenditure programs and how to take advantage of them.

In 2010, Nicholas Turner studied the effect of such tax expenditures and concluded that they were essentially offset "dollar for dollar" by net tuition increases in the aid packaging process. (Ironically, Turner now works at the Treasury Department.)

The higher education tax credits of the 1990s, now in revised iterations, should be ended in favor of federal deficit reduction and appropriated programs that help states and colleges work toward common goals with (not against) federal efforts. None of the savings should be directed toward programs that can and will be exploited in financial aid packaging.