Tax-Based Aid Should Be Redirected to Low-Income Students, Report Says

February 20, 2013 | The Chronicle of Higher Education |  Link to article

Many groups participating in the Bill & Melinda Gates Foundation's Reimagining Aid Design and Delivery project have looked to the Pell Grant program and student-loan debt for ways to improve the federal financial-aid system. But a new paper released on Wednesday says policy makers have overlooked two important areas: tax-based student aid and performance measures used in student-aid policies.

The Center on Postsecondary and Economic Success, part of the Center for Law and Social Policy, argues in its Gates-backed paper that the federal government could save billions of dollars by changing tax-based student aid, which now accounts for nearly half of nonloan federal aid.

The center's paper, "Reforming Student Aid: How to Simplify Tax Aid and Use Performance Metrics to Improve College Choices and Completion," focuses on making tax-based student aid more beneficial to low- and middle-income students, who often take longer to complete their degrees due to a lack of financial support.

Tax-based aid currently provides little benefit to low- and middle-income students because the associated tax breaks depend on a family's marginal tax rate, which increases as income rises. A $100 tax deduction, for example, is worth nearly $40 to a high-income household but only $10 to a lower-earning family.

Additionally, nonrefundable tax credits are of no value to households that pay no income tax. The center suggests increasing the refundable portion of the American Opportunity Tax Credit, which would benefit low-income families that tend to pay less income tax. The group also suggests eliminating nonrefundable tax credits, such as the Lifetime Learning Credit.

"Tax-based student aid is going to be how we deliver half of all federal financial aid outside of student loans, and we need to make it work better," said Julie Strawn, a senior fellow at the center and an author of the paper.

Reports on Performance

The authors outline 12 options to simplify tax-based student aid, make it more beneficial to low-income students, and help increase college access and completion. The authors then package different combinations of the options into three alternative proposals that could serve as a framework for reform.

All of the proposed frameworks rely on increasing the maximum value of the refundable portion of the American Opportunity Tax Credit, adjusting it for inflation, and eliminating other tax credits to simplify the process for students and families.

The first of the frameworks would result in a revenue loss to the federal government of $800-million over the next 10 years because it would take many steps to better direct tax-based aid to low-income students.

The two other frameworks attempt to deal with those shortcomings by proposing a slightly lower refundable portion of the tax credit and preserving some credits that the first framework would eliminate. Over the next 10 years, the two latter frameworks could generate, respectively, $3.6-billion and $4.8-billion in revenue, which the authors suggest redistributing to the Pell Grant and other federal aid programs.

The authors also suggest that performance gauges can be used to improve the financial-aid system by expanding federal reporting on measures of affordability and completion; expanding states' public reporting of program-level outcomes, employment, and earnings; and creating a national grant program to encourage students to complete their degrees.

One proposal suggests modifying the Higher Education Act to require colleges to report data on the graduation rates of Pell Grant recipients, their transfer policies, and costs. Another proposal would ask the U.S. Departments of Education and Labor to work with state governments to develop a collection of data on certificate and degree attainment, subsequent employment, and earnings by major.

"We want policy makers to understand," Ms. Strawn said, "that it's possible to make tax-based student aid simpler, and more effective, and that it's possible to do all that in a fiscally responsible way."

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