Higher Education Tax Credits

Education tax credits were introduced as a new subsidy for higher education in 1997 and have cost, on average, $4.6 billion a year in lost tax revenue since their enactment. The introduction of the Hope Credit and the Lifetime Learning Credit marked a dramatic increase in education spending through tax expenditures. Prior to 1997, tax incentives for higher education expenses totalled less than $2 billion in estimated lost revenue. The education tax credit program expanded the number of federal agencies involved in education policy making and increased the complexity and cost of administering the income tax system. This book provides analysis of the education tax credit program in the context of issues facing Congress in regard to higher education. This report begins with a review of the economic rationale for subsidising education, then describes federal subsidies for education in general and the education tax credits in particular. An analysis of the education credits follows and the report concludes with a discussion of education tax credit policy options. The Taxpayer Relief Act of 1997 established two permanent federal income tax credits, effective since tax year 1998, for qualified post secondary education expenses -- the Hope Scholarship credit and the Lifetime Learning credit. The Economic Growth and Tax Relief Reconciliation Act of 2001 created a temporary higher education tax deduction beginning in 2002. The Hope credit was introduced to help ensure that students have access to the first two years of undergraduate education. The Lifetime Learning credit and tuition and fees deduction provide support for students in any year of undergraduate and graduate study; they are unique in that they are available to individuals taking occasional courses. Only one of the three tax benefits may be taken in the same tax year for the same eligible student's qualified expenses. Key features of the credits and deduction dictate who the provisions benefit and the value of assistance they confer. Among these are the non-refundable nature of the credits (i.e., persons must have income tax liabilities and the liabilities must exceed the maximum amount of the credits in order to claim their full value), the deduction's availability whether or not taxpayers take itemised deductions, and the statutory limits on benefit amounts and on taxpayers' income. Accordingly, middle-and upper middle-income individuals are the targeted beneficiaries of these tax incentives. All three benefits apply to the tuition and fees required for enrolment that are not offset by grant aid (e.g. qualified scholarships) and other tax benefits (e.g. Coverdell Education Savings Accounts and Section 529 Plans). The Hope credit has had a maximum value of $1,500 per student since its inception; the Lifetime Learning credit, $2,000 per return since 2003.