Tax credits for higher education don’t help

financial aid

“There are many ways a society can finance college, and over time the US has tried almost all of them.”  Thus begins a new paper, “Tax Benefits for College Attendance,” by Susan Dynarski and Judith Scott-Clayton.

American governments currently subsidize higher education in three ways.  First, state and federal governments directly fund a variety of higher education institutions, including community colleges and state universities.  Second, students obtain grants and loans at both the state and federal level.  Third, state and federal tax codes contain a range of deductions and credits designed to reduce the cost of attending college.

Dynarski and Scott-Clayton focus on subsidies built into the federal tax code.  They provide a nice summary of the programs in Table 2 of their paper:

Tax credits for education

Their estimate of the total cost of these programs is $42 billion in 2015 and $44.6 billion in 2016, about 18 percent of federal aid to students in higher education.

Dynarski and Scott-Clayton’s analysis of these programs makes three key points:

  1. Middle- and upper-income families receive almost all of the benefits from tax credits for education.
  2. Tax-sheltered savings for education don’t help low- and middle-income families. “The benefits of education savings accounts rise sharply with income, since those with the highest marginal tax rates benefit the most from sheltering capital income from taxation. These additional deductions have little to no value for low-income families, who often take the standard deduction rather than itemize and who face relatively low marginal tax rates (p. 15).”
  3. “The tax credits and tuition tax deduction apparently have no effect on human capital accumulation.” That is, “The tax credits and tax deduction, which account for most of the tax expenditures for postsecondary education, do not affect schooling decisions (p. 24, both quotes).”

In other words, taxpayers are spending $40 billion to subsidize middle- and upper-income students who would go to college anyway.  The programs are a pure redistribution of resources to these families and do nothing to help students attend college who otherwise would not do so.

 What particularly impressed me is that Dynarski and Scott-Clayton use these results to propose a complete overhaul of the federal financial aid system:

Consolidate the [tax] credits with the Pell Grant program, creating a single grant program that subsidizes, at the time that tuition is due, the postsecondary expenses of low- and middle-income families. Eligibility for this program could automatically be determined using tax data, with funds delivered by the Department of Education (pp. 24-25).

The authors note that “At a minimum, a simpler system of education tax benefits would decrease the administrative and time costs of transferring funds to households with postsecondary expenses. At best, simplification would clarify incentives and increase investments in human capital (p. 26).”

If this sounds radical, so be it. We need to think boldly about the economics of colleges and universities so that higher education institutions meet the needs of our current students and those to come.

Update, 8:30 CDT: Take a look at Susan Dynarski’s TED Talk on reforming financial aid: