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No Cliff for Tax-Based Student Aid

Jan 04, 2013

By Patrick Reimherr, Elizabeth Lower-Basch, and Julie Strawn

Several major tax incentives for higher education were scheduled to expire at the end of 2012.  These incentives benefit college students — or their parents, in the case of dependent students. Thanks to the bill averting the “fiscal cliff,” the American Taxpayer Relief Act of 2012 (ATRA), these tax-based student aid provisions have all been extended. While over the next few months Congress and the President may still make substantial changes to tax-based student aid, in its first act, policymakers chose the status quo.

  • First, ATRA extended the American Opportunity Tax Credit (AOTC) through 2017. The AOTC, created under the American Recovery and Reinvestment Act of 2009 to replace the former Hope Credit, is partially refundable (40 percent), provides up to $2,500 in value, and is available for the first four years of postsecondary education to students attending at least half time.  The credit phase out starts at $80,000 and ends at $90,000 for single and head of household filers ($160,000-$180,000 for joint filers).
  • Second, the above-the-line deduction for tuition and fees was extended for another year. Above-the-line refers to a deduction that can be taken by any household regardless of whether they itemize deductions or claim the standard deduction.  The deduction is capped at $4,000 for households with incomes of $65,000 or less ($130,000 for joint returns) or $2,000 for households with incomes of $80,000 or less ($160,000 for joint returns).
  • Third, ATRA also permanently extended the expansions made to the student loan interest deduction under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).  Individuals who have paid interest on education loans may claim an above-the-line deduction up to $2,500. EGTRRA also eliminated the time restriction on the benefit (the benefit was only allowed for 60 months) and increased the income phase-out range to $55,000-$70,000 ($110,000-$140,000 for joint filers). 

Taken as a whole, these changes represent a significant step toward enshrining the current policy of providing substantial student aid through the tax code.

Tax-based student aid has grown significantly over the last decade, and now reduce federal revenues by $34.2 billion per year (FY2012), compared to $35.6 billion for Pell grants (FY2012), the largest financial aid grant program. The postsecondary education provisions in ATRA alone will reduce federal revenues by $106 billion dollars over ten years (2013-2022). As federal tax-based student aid has increased, so too has criticism of it. The three primary concerns about tax-based student aid are that: it provides little benefit to the lowest-income students, it does not increase college access or completion, and it is too complex and difficult to use.

These criticisms are well-founded. Tax-based student aid does provide substantial support to individuals who are already highly likely to attend college. In 2009, 20 percent of AOTC and the Lifetime Learning Credit (LLC) benefits went to households with incomes over $100,000 per year; and more than half of the benefits of the tuition and fees deduction went to such households.  This is both because the AOTC is only partially refundable (and the other credits and deductions are not refundable) and because low-income students are more likely to attend community colleges and other low-cost institutions.

Moreover, student aid provisions in the tax code are numerous and include multiple tax credits, a variety of deductions, and numerous exclusions. These benefits are not independent of one another, can be confusing, and often lead to households making choices that do not garner the best tax benefits. For example, the GAO recently found that, in 2009, 40 percent of those who claimed the tuition deduction would have increased their tax benefit by clmaiming the Lifetime Learning Credit instead.

Fortunately, there are ways to improve this public investment and address the major criticisms of tax-based student aid policy in a fiscally responsible way. By better targeting, simplifying, and improving the overall delivery of tax-based student aid, this aid can expand access for those students most sensitive to the price of education. (CLASP will release detailed recommendations on these reforms in early 2013).


Notes: Figure based on FY12 data from the Department of Education.


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