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In the run-up to the State of the Union, President Barack Obama proposed a slew of new tax reform ideas designed to benefit low- and middle-income families. One of his proposed reforms is to consolidate and simplify higher education tax breaks to make the credits more accessible.
Right now a handful of overlapping education benefits often cause confusion for those applying. Roughly 14 percent of those who could have filed for education benefits did not, resulting in a loss of about $466 per filer. Obama’s proposals would simplify this process by consolidating the Lifetime Learning Credit into the American Opportunity Tax Credit (AOTC), while adding new and more generous provisions to the credit.
The AOTC, first enacted in 2009 as a part of the stimulus bill, is an expansion of the Hope tax credit but is set to expire in 2017, which means that these breaks will revert to the less generous tax credit. The President proposes to make the AOTC permanent and adjust it annually to keep pace with inflation. Currently the AOTC provides tax credits to offset up to $2,500 of college expenses per year for up to four years. New modifications to the AOTC would increase the maximum refund from the current $1,000 to the proposed $1,500 and increase accessibility by mandating that higher education institutions provide students with the proper information necessary to claim credits.
The essence of Obama’s proposal is shifting from high-income deductions to middle-income credits. Some of the funding for the expansion of the AOTC would come from phasing out student loan interest deductions so that they would only apply to those who started their education receiving them, but it would not apply to new enrollees. According to the White House, eliminating student loan interest deductions would cost the average student or graduate roughly $100 a year, but this would be mitigated by the relief from the AOTC. In general deductions tend to benefit those who have higher tax liability (i.e. the wealthy), so the reallocated money would be better targeted toward low-income and middle-income families.
As Obama originally proposed it, part of the funding for the expansion of the AOTC would have come from ending 529 savings plans benefits. Though 529 savings plans encourage investment in future higher education, the deductions associated with them tend to benefit wealthier families. Less than 3% of families even participate in 529 saving plans and those that do have a median income of $142,400.
Unfortunately, the misguided backlash against Obama’s proposal to cut 529 savings benefits in the name of defending “middle-class” families, led by House Speaker John Boehner (R-OH) but also supported by House Minority Leader Nancy Pelosi (D-CA) and House Budget Committee member Chris Van Hollen (D-MD), has culminated in the White House nixing the 529 proposal to focus on the larger issue of education tax relief. Even without this additional funding, the White House notes that the tax changes to capital gains and inherited wealth would provide more than enough funding for the AOTC expansion.
As lauded as tax breaks for higher education are, the reality is that this money still is not going to those most in need – low-income students and families – and even Obama’s proposals would still benefit those that have the money to begin. The most effective way to financially assist low-income students is to invest more money in Pell Grants, which are substantially better targeted toward low- and middle- income families than any of the current higher education tax breaks. The President’s 2009 budget proposal increased Pell Grant funding from $16 billion for the 2008-2009 school year to $25 billion for the 2009-2010 school year and steadily increases funding over the next ten years. The President’s newest proposal would increase the value of Pell Grants by allowing them to be exempted from the income tax.
While expanding Pell Grants would be the best approach to expanding access to higher education, Obama’s proposal to consolidate and simplify our education credits is still a significant step in the right direction compared to the absolute mess of poorly targeted education tax breaks we have now.