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Who Benefits from College Education Tax Credits?

3 min readBy: Gerald Prante

A new study released by the Department of Education shows that those who benefit most from tuition taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. credits, specifically the Hope Learning Credit and the Lifetime Learning Credit, tend to be higher income taxpayers relative to lower income taxpayers. From Bloomberg News via the Boston Globe:

College tuition tax credits are benefiting wealthier U S taxpayers more than the poorest, a federal study concluded , based on tax records, in the first analysis of the nine-year-old program.

The federal credits are saving an average of $700 in taxes for families earning $92,000 or more, and $600 for families earning less than $32,000, the Education Department’s National Center for Education Statistics said in a report.

The findings confirm warnings about the program when it was enacted in 1997, said Kenneth Redd, director of research and policy analysis at the Council of Graduate Schools, which represents about 470 colleges in the United States and Canada.

“The critics of these kinds of credits have said, `Is it right to use scarce resources on people who may not have the most need for it?’ ” Redd said. “But at the same time, higher income families have financial need, because the cost of college is very high.”

The report, based on 2003-04 figures, found that low-income families do better overall with federal college assistance. Counting tax breaks and a variety of federal grants, families earning less than $32,000 get an average benefit of $3,300, while those earning more than $92,000 get $800. (Full Story)

There are a few major reasons why we see that most of the benefits of tuition credits flow to upper-income taxpayers. First, these credits are non-refundable. Therefore, as the article points out, those who have low incomes to begin with have lower tax liabilities. Therefore, if these individuals would be paying little, if any income tax without the credit, and since these credits are non-refundable, these tuition credits can only push their already low tax liabilites down to the lower bound of zero. (See a recent Tax Foundation piece showing how over 43 million tax returns had zero or negative tax liability.)

Another reason that these benefits would tend to flow to the upper-income tax returns is that they are likely to have a larger tuition bill than the lower-income tax returns. There are two reasons for this: (1) higher income families are more likely to send their children to more expensive schools, and (2) colleges heavily practice price discrimination with their student body. Price discrimination is where a firm can charge different prices for the same good to two different individuals. Colleges do this through financial aid based upon financial need by obtaining loads of information regarding the financial status of the student. (Remember how many forms you had to fill out?) Thereby, the colleges charge a lower final tuition price to those students with less financial backing, resulting in lower tuition bills for these students, and less of a tuition credit.

Finally, a problem with looking at tax returns as the unit of analysis is that you are comparing single returns with joint returns, and as the article points out, the single returns have a phaseout range that begins at $43,000, while the joint returns have a phaseout range that begins at $87,000. If you are going to say that a $45,000 single return has lower income than an $80,000 joint return, then this phaseout difference is another obvious reason why the “wealthy returns” would benefit more than the “poor returns.”