Why Tax Credits Don’t Do Much for Low-Income Students

Today President Barack Obama highlights the benefits of a tax credit program called the American Opportunity Tax Credit, which gives families a $2,500 tax credit for education-related expenses. The program, which replaced the old HOPE tax credit program, would allow individuals making up to $90,000 as individuals or $180,000 as joint tax filers to deduct tuition, fees, and related education expenses at the end of the tax year. The program is currently set to expire at the end of 2011, but Obama is pushing to extend the program.

While the program is a $700 tax credit boost over the HOPE program, it's important to remember that while tax credits are often politically popular, they actually do little to incentivize low-income individuals to attend institutions of higher education. The lowest-income individuals, who often qualify for Pell grants and other student aid, often don’t pay federal income taxes anyway. Furthermore, such tax credits are only applicable after federal and institutional aid is deducted from the bill. As Higher Ed Watch once wrote when it was analyzing the HOPE program:

Every dollar received in the form of a Pell Grant or institutional grant aid leads to a decrease in the maximum possible tax credit a student can claim. Why? Because the Internal Revenue Service deducts Pell Grants and "any tax-free educational assistance," such as institutional aid, from its assessment of "qualified expenses" for college when determining the size of an individual's tax credit.

In other words, a low-income student with $10,000 in tuition expenses would normally be eligible for a $2,000 Lifetime Learning credit. But if that same student receives a $4,050 Pell Grant, he or she would only have $5,950 in "qualified expenses." For that not untypical low-income student, the maximum Lifetime Learning credit he or she could claim would be $1,190 a loss of $810 in benefits. And that's assuming he or she isn't receiving institutional aid as well, which is pretty unlikely and thus means an even lower tax credit.

Tax credits on education expenses also do little to offer instant relief to student debt. By offering a tax credit, the government essentially asks students (or their parents) to front the money for tuition, fees, and other higher education spending and then take that money off the tax bill at the end of the year. While that's a great incentive for someone on the higher end of that $90,000 ($180,000 for joint filings) income bracket, it is less likely to help low-income students. Additionally, the Congressional Budget Office estimates that revenue will drop by $10 billion as a result of this credit and cost the government an additional $3 billion in other administrative costs.

That's not to say that AOTC won't provide a little extra cash to some middle-class families in what is still a very tough economic climate, but if the objective is to help low-income students achieve better access to affordable higher education, let's not pretend that this program will help achieve that goal.

Cross posted.