Federal Tax Incentives for Higher Education

As I gear up for the April 15 tax-filing deadline, I have become acutely aware of some of the tax benefits that may be available due to my status as a full time student. There are a couple of different income tax credits that are available to students: The American Opportunity and Lifetime Learning Credits. If an individual qualifies, these credits directly reduce income tax liability. These are much more powerful incentive than a tax exemption or deduction because it is a one for one dollar amount reduction in the taxes that an individual pays (rather than reducing taxable income, to which a tax rate is applied). In addition, taxpayers who qualify for neither of the credits may be eligible to deduct some of their education expenses. Although there is some debate on the need for higher education funding and incentives, these tax benefits may be justified on at least two important grounds: increased equity and the provision of public goods.

The American Opportunity Credit qualifies eligible taxpayers for an annual $2,500 credit per student for the 2011-2012 tax years. This credit applies to undergraduate students in their first four years of college. Parents who claim such students as dependents may also qualify for the tax credit. Interestingly, students may still qualify for the American Opportunity Credit even if they are not liable for any taxes because 40% of the credit is considered refundable. This may allow eligible students to collect up to $1000 if they qualify, even if they pay no taxes. The Lifetime Learning Credit Tax Credit is available to students or parents of dependent students who are admitted to an undergraduate or graduate degree, or other recognized educational program. This credit, of up to $2000 per person per year, may be of particular interest to students who do not qualify for the American Opportunity Credit. While both of these tax credits are income restricted (at different levels), students who qualify for neither may be able to deduct up to $4,000 in education expenses on their federal tax returns. However, this tax credit is also phased out for high-income earners, allowing eligibility only for taxpayers with incomes slightly higher than the eligibility level for the Lifetime Learning Tax Credit.

Because of the income limitations on the various education tax credits and deductions referenced above, these incentives constitute progressive tax policies because they increase vertical equity. Those who may not be able to easily afford to send their children to school or pay for their own education are given substantial tax breaks to facilitate tuition and education expenses. In the case of the American Opportunity Credit, which is partially refundable, the credit could actually contribute to the annual income of very low-income students or their parents. Some scoff at the idea of subsidizing higher education on equity grounds because the children of high and low income earners alike have access to free or reduced cost public education. Because the dollar amount of tuition is essentially the same for both high-income and low-income students at public institutions, the argument is that public education costs less as a percentage of the income of high-income earners than low-income earners. Tax credits and deductions such as the ones discussed in this blog post are important in reducing the effect of the inequities inherent in extending low public education tuition to all levels of income earners. These types of policies may increase vertical equity in our tax structure and within markets for higher education by both reducing tax bills for low-income earners and providing additional incentives for low-income individuals to pursue higher education.

Tax credits for education spending is a powerful incentive for encouraging the pursuit of higher education. It is important to be critical of incentives that our government provides, especially when taxpayer money is involved. Analyzing the extent to which education is a pure public good may make more clear the reasons for government provision or subsidy of higher education. If education were to be classified as a pure public good, then it would have to be (1) non-excludable such that it is not possible to exclude non-payers from benefitting from education, and (2) non-rivalrous such that when more people consume education the benefit to others is not reduced. In recent years, advocates of education spending have noted a shift in society’s perception of education from a public good to a private good. Higher education cannot be classified as a pure public good because it is possible to include only those people who pay for education, at least in terms of the private benefits that accrue to individuals from education. However, education cannot be classified as a pure private good because of the positive externalities that accrue to society as a whole when people become more educated. Although there is lively debate over whether or not our current educational system adequately provides the type of education that will most benefit society, it seems relatively clear that education provides benefits that accrue to individuals and further provides some benefits that spill over to accrue to society as a whole.

Tax incentives for education can help us achieve the dual purpose of creating a more vertically equitable society. Furthermore, because education is not a pure public good, such progressive policies can help balance the need for individuals to pay for the educational benefits that accrue to themselves and the need for society to subsidize the positive externalities that arise from having an educated population.

Sources:

http://20somethingfinance.com/education-tax-credits-deductions-2012/

http://econlog.econlib.org/archives/2012/11/higher_educatio_3.html

http://chronicle.com/blogs/innovations/is-education-a-public-good-or-a-private-good/28329

http://www.irs.gov/uac/Tax-Benefits-for-Education:-Information-Center