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Most discussions of federal subsidies for higher education focus on student aid programs such as Pell Grants and student loans. Another category of subsidies costs the federal government over $40 billion per year, but receives much less attention. The federal tax code is riddled with many credits, deductions, and exclusions that benefit the education industry. However, these tax expenditures generally aren’t counted as normal government spending.
However, since carveouts in the tax code represent foregone revenue for the federal government, they have the same effect on the deficit as a traditional spending program of the same size. The Committee for a Responsible Federal Budget notes that if tax expenditures were counted as normal spending, they would consume 28% of the federal budget.
New estimates from the Joint Committee on Taxation show that tax expenditures for education cost a combined $47 billion in 2017. The estimates also reveal how last year’s Republican-backed tax reform bill, the Tax Cuts and Jobs Act, influenced these indirect subsidies for education. Most education-related tax expenditures were relatively unaffected by the law, though there are notable exceptions.
Tuition tax credits represent the largest single tax break for education. These reimburse households for college tuition costs of up to $2,500 per year. The federal government spent $19 billion on these credits in 2017, accounting for 45% of all education-related tax expenditures. For comparison, the federal government spends $27 billion annually on Pell Grants, the main student aid grant program.
The deduction for charitable contributions to educational institutions amounts to the second-largest tax expenditure for education. The “charitable deduction” was also the largest education-related expenditure affected by the Tax Cuts and Jobs Act. While the deduction itself remained mostly untouched after tax reform, other statutory changes will cause the cost of this tax break for schools and colleges to drop from $10.5 billion in 2027 to $8.7 billion in 2021.
Specifically, Congress cut marginal tax rates, which reduces the value of itemized deductions. Additionally, the tax law nearly doubled the standard deduction, to $12,000 for single filers and $24,000 for joint filers. This was a major tax cut for low- and middle-income households, as claiming the standard deduction is more common among these groups.
However, in order to claim the break for charitable contributions, tax filers must forego the standard deduction and instead itemize their deductions. With a larger, more enticing standard deduction, fewer taxpayers will opt to itemize, and so fewer will claim the charitable deduction. Many of these people will still donate to their favorite colleges and universities; they’ll simply no longer get to claim a tax break for it.
Early drafts of the tax law proposed stripping away specialized tax expenditures and using the money to lower tax rates for everyone. Proponents of reform argued that a tax code with lower marginal rates and fewer carveouts would spur faster economic growth than a code with higher rates but more carveouts. Lower marginal rates drive individuals and businesses to invest in projects with high economic dividends, but tax expenditures divert resources to politically popular arenas that may deliver less of a boost to growth.
Under those guiding principles, the tax bill’s authors originally proposed eliminating many education-related tax breaks. These included one of the tuition tax credits, the student loan interest deduction, and tax-exempt bonds for private educational institutions. Yielding to political expediency, however, the final draft of the bill retained most of those tax expenditures while also lowering marginal rates. As a result, under tax reform these carveouts will stay roughly as expensive as they were beforehand. (Meanwhile, the federal budget deficit approaches $1 trillion.)
Two other major tax expenditures—the exclusion of scholarships and fellowships from taxable income and tax preferences for 529 college savings plans—will become more expensive over the next several years. However, the costs of these provisions were already slated to rise before Congress passed tax reform.
Most tax breaks for higher education made it through the Tax Cuts and Jobs Act unscathed. But as Congress grapples with higher deficits over the next several years, it will become more difficult to ignore $40 billion in hidden subsidies for the education industry. Politicians who are serious about reining in government spending should keep tax expenditures on the table.
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