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The Ladder

A Blog from New America's Asset Building Program

Extending the American Opportunity Tax Credit Shouldn’t be a Slam Dunk

Published:  November 3, 2010

This guest post from Jason Delisle, Director of the Federal Education Budget Project at the New America Foundation originally appeared on the Higher Ed Watch blog on October 22, 2010.

Last week the U.S. Treasury Department issued a report on the American Opportunity Tax Credit, a $2,500 income tax credit for college students’ higher education expenses that was included in the American Recovery and Reinvestment Act of 2009. The credit expires at the end of this tax year and the Obama Administration has proposed a permanent extension. The report includes a lot of information on the benefits families are getting from the credit, yet there is no mention of the inherent problems in delivering student aid through the tax code.

First and foremost, delivering federal aid through the tax code is fraught with complications, especially when compared to grant programs or student loans. To get a tax credit students and families first have to know that they are eligible for it and then they must carefully calculate all 29 lines on the IRS form 8863 and then crosswalk the resulting figure to their form 1040 each tax season. To be sure, students must fill out a separate set of paperwork each year to get Pell Grants and Stafford loans (the Free Application for Federal Student Aid). However, Congress, the Bush and Obama Administrations, and advocacy groups have worked tirelessly in recent years to simplify the FAFSA -- and they’ve made some significant improvements. But one wonders why the complexity of the FAFSA is such an important issue to lawmakers and advocates, yet sending students and families through the tax code and its mind-numbing forms to claim another set of assistance is never questioned as good policy.

Consider Lines 14 and 15 on the IRS form 8863 which alone make the entire FAFSA a breeze by comparison:

14. If line 12 is: Equal to or more than line 13, enter 1.000 on line 14 ... Less than line 13, divide line 12 by line 13. Enter the result as a decimal (rounded to at least three places)...

15. Multiply line 9 by line 14. Caution: If you were under age 24 at the end of the year and meet the conditions on page 5 of the instructions, you cannot take the refundable American opportunity credit. Skip line 16, enter the amount from line 15 on line 17, and check this box ...

It’s important for policymakers to keep in mind that college financial aid offices are set up to help students get federal grant aid and student loans, but not tax benefits. That’s why, despite the complexity of the FAFSA, most students eligible for Pell Grants end up getting the benefit. The same is true for federal student loans. But there is evidence that a significant share of eligible students and families never claim federal tax credits for higher education, or they don’t claim the full benefits for which they are eligible. In 2008, the Government Accountability Office issued a report that concluded almost 20 percent of eligible students or families never filed for their benefits.

The U.S. Treasury report released last week never mentions how many students were eligible for the America Opportunity Tax Credit but didn’t claim it; it only discusses those who did claim it. Yet this flaw in federal tax credits for higher education is an important point Congress must weigh when it considers how the federal government will deliver student assistance.

If tax credits are more difficult to deliver than grant aid or loan subsidies, why does Congress continue to create them for higher education expenses? There are two main reasons. First, grant aid and loan programs, unlike tax benefits, show up in the budget as spending. As such, they are highly visible, subject to intense scrutiny, and must compete with other priorities in the budget process. This isn’t the case for tax benefits. That makes it easier – in the political sense – for lawmakers to deliver assistance through the tax code rather than direct grant aid. In other words, tax benefits don’t look like spending and therefore win more support from lawmakers. But from a true budget perspective, tax benefits and grants have the same effect.

That leads to the second reason why Congress and the president like to enact tax credits instead of “spending programs”. Tax benefits can be doled out to more affluent families with surprisingly little opposition, but a grant program targeting the same income groups with the same amount of aid would never fly. Consider that the AOTC provides tax credits to families with annual incomes up to $180,000, and it provided nearly $5 billion in aid to families with incomes over $75,000 in 2009. That’s more than the Student Aid and Fiscal Responsibility Act (SAFRA) provides for the Pell Grant program each year.

Imagine if the Pell Grant, which is restricted to the lowest income families, was expanded to families earning $180,000 a year. There would be outrage. Yet there’s certainly no outrage over the AOTC. What’s more, there’s no difference in cost to the federal government between a $1,000 tax credit and a $1,000 Pell Grant for families earning $180,000  –  and there’s no difference for taxpayers since they have to fund either by paying higher taxes.

When Congress returns after the November 2nd election for a lame duck session, they will consider an extension of a host of expiring tax provisions, including the American Opportunity Tax Credit. They should bear in mind that tax benefits are no different than spending programs—with the exception that they are more complicated and don’t reach all eligible students like grant aid and loan programs. That’s why we believe it would ultimately make far more sense to fold the American Opportunity Tax Credit into the Pell Grant program than to make it a permanent fixture of the tax code.

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