BACKGROUND PAPER

Federal Aid

to Postsecondary Students:

Tax Allowances and

Alternative Subsidies

January 1978

»:::

Congress of the United States

Congressional Budget Office

Washington, O.C.

FEDERAL AID TO POSTSECONDARY STUDENTS:

TAX ALLOWANCES AND ALTERNATIVE SUBSIDIES

The Congress of the United States

Congressional Budget Office

PREFACE

For nearly twenty years, tax allowances for the expenses of

higher education have been proposed in the Congress, but none has

been enacted into law. In light of Congressional concern about

the ability of middle-income families to afford a higher education

for their children, Congressional interest in education tax allowances is likely to persist. As it continues to deliberate about

how to provide more aid to students, the Congress may want to

consider alternatives to education tax allowances.

Federal Aid to Postsecondary Students is intended to assist

in deliberations of this subject by analyzing various aspects

of tax allowances for education and alternative subsidies.

The study was prepared in response to a May 1977, request from

Chairman William D. Ford of the House Committee on Education

and Labor. In accordance with the Congressional Budget Office's

mandate to provide nonpartisan analysis of issues before the

Congress, the study offers no recommendations.

Frank S. Russek, Jr., of CBO's Tax Analysis Division prepared the report with assistance from Richard Wabnick of the

Human Resources Division. A number of other people within

CBO gave valuable comments and suggestions, including Charles

Davenport, David S. Mundel, and James Verdier. In addition,

many people outside of CBO helped in the preparation of the

report, including Harry Boissevain, David W. Breneman, Rosalind

Bruno, Anthony P. Carnevale, Jean Frohlicher, William Goggin,

Thomas R. Jolly, John Karr, Donald W. Kiefer, John K. McNulty, Dan

Morrissey, Darla Schecter, Eugene Steuerle, Stanley S. Surrey, Ira

Tannenbaum, and Peter K. Voigt. The paper was prepared for

publication under the supervision of Johanna Zacharias, Martha B.

Roberts edited the manuscript, and Alda Seubert and Shirley

Hornbuckle typed it.

Alice M. Rivlin

Director

January 1978

iii

CONTENTS

Page

PREFACE ill

SUMMARY xi

CHAPTER I. INTRODUCTION 1

CHAPTER II. THE BURDEN OF COLLEGE COSTS ON STUDENTS

AND THEIR FAMILIES 3

The Distribution of Federal

Student Aid 4

Enrollment Changes During the

1967-1976 Decade 8

Growth of College Costs, Family

Income and Student Aid 11

CHAPTER III. EDUCATION TAX ALLOWANCES 15

Forms of Education Tax Allowances ... 15

Further Design Consideations of

Education Tax Allowances 17

Brief Legislative History of

Education Tax Allowances 20

CHAPTER IV. CRITERIA FOR COMPARING ALTERNATIVE

SUBSIDY PROGRAMS 24

Cost 24

Distributional Efficiency 25

Fairness and Equity 26

Maintaining Institutional Diversity . • 27

Ease of Administration 29

Budget Visibility and

Controllability 30

v

CHAPTER V.

APPENDIX A.

ALTERNATIVE PROGRAMS OF AID FOR

MIDDLE-INCOME STUDENTS ....

Tax Credit or Credit/Deduction

Options

Basic Educational Opportunity Grants

Student Loans

Loans to Parents

Tax Deferrals for Education Expenses

BRIEF DESCRIPTION OF TAX

EXPENDITURES AND OTHE STUDENT

AID PROGRAMS ,

Page

32

32

38

43

48

51

59

APPENDIX B. EDUCATION TAX ALLOWANCES

AND TAX EQUITY . . . . , 65

vii

TABLES

TABLE i. DISTRIBUTION OF AID TO STUDENTS BY

INCOME CLASS, FISCAL YEAR 1977

TABLE 2. PERCENTAGE DISTRIBUTION (j)F STUDENT AID

BY INCOME CLASS, FISCAL ^EAR 1977 ...... 6

TABLE 3. PERCENTAGE OF is- TO 24-tEAR-OLD DEPENDENT

FAMILY MEMBERS ENROLLED FULL TIME IN

COLLEGE ........ ........... 9

TABLE 4. COLLEGE COSTS, FAMILY INCOME, STUDENT

AID, AND THE GENERAL PRI(pE LEVEL ....... 12

TABLE 5. SIZE AND DISTRIBUTION OF j BENEFITS UNDER

A NONREFUNDABLE TAX CREDIT OF $250 COSTING

APPROXIMATELY $1.7 BILLIpN IN FISCAL YEAR 1978 34

TABLE 6. SIZE AND DISTRIBUTION OF I BENEFITS UNDER

A $200-CREDIT/$1,000 DEDUCTION COSTING

APPROXIMATELY $1.9 BILLION IN FISCAL

YEAR 1978 ....... : ........... 35

TABLE 7. DISTRIBUTION OF ADDITIONAL BENEFITS FROM

RAISING THE MAXIMUM BEOGi AWARD TO $2,100

AND LOWERING THE FAMILY CONTRIBUTION RATE

FROM 30 TO 20 PERCENT ON I DISCRETIONARY

INCOME ABOVE $5,000 . . ........... 40

TABLE 8. DISTRIBUTION OF BENEFITS! OF A TAX DEFERRAL

PLAN PERMITTING POSTPONEMENT OF $1,500

OF TAXES ANNUALLY PER STJJDENT ........ 53

TABLE A-l. MAJOR STUDENT AID IN THE I FORM OF TAX

EXPENDITURES AND FEDERAL; OUTLAYS ....... 60

TABLE B-l. COMPARATIVE EFFECTS OF TAX CREDITS AND

TAX DEDUCTIONS ON TAXPAYER EQUITY ...... 68

ix

21-200 O - 78 - 2

SUMMARY

Tax allowances for the expenses of higher education have

been considered in the Congress since the 1950s, but no proposal

has ever passed both Housses. Proponents of tax allowances for

education argue in particular that more assistance than middleincome families now get is needed. The Congress' interest in such

allowances reflects a continuing concern about these families'

ability to finance higher education without more aid from the

federal government.

In fiscal year 1977, the federal government provided $8.5

billion in student aid in the form of direct outlays and tax

expenditures. Students from families with incomes between $10,000

and $20,000 (accounting for 33 percent of all students) received

36 percent of this sum although they received a smaller share—21

percent—of the $2.3 billion disbursed under programs based on

need.

The enrollment rate of dependents between ages 18 and 24

from middle-income families has declined somewhat since 1967. In

recent years, however, the rate has begun to go back up. How much

rising college costs account for lower enrollment rates among

middle-income students in the past decade is unclear since median

family incme has risen faster than average college costs. Between

1967 and 1976, charges for college tuition and other fees, plus

room and board, rose about 75 percent. In comparison, median

family income increased almost 89 percent. The incomes of those

families whose incomes were in the top 20 percent rose 95 percent.

Perhaps certain factors other than cost help explain enrollment

rate declines. Such factors may include reduced requirements for

military manpower, families' preferences to spend money on items

other than education, the choice of whether to work or study,

or the diminishing rate of return on the investment in higher

education.

A tax allowance for education is one way to give more financial relief to middle-income families. It could take the form of

a credit, a deduction, or a deferral. Any of these three tax

allowances would aid middle-income families although none would be

especially effective in concentrating aid on this group. A number

xl
of nontax alternatives could also aid middle-income families.

Some of these may be more consistent with present tax and education policy. In addition, these might lower budgetary cost.

Five alternatives are analyzed in this report:

o Tax credit or credit/deduction options,

o Basic Educational Opportunity Grants,

o Student loans,

o Loans to parents, and

o Tax deferrals.

CRITERIA FOR EVALUATION OF STUDENT AID PROGRAMS

Five criteria are used to evaluate the options considered

in this report:

o Cost and distributional efficiency—How much does a

program cost? What fraction of total benefits accrues to

middle-income students or their families?

o Fairness and equity—Do all recipients get the same amount

of benefits, or are benefits related to the income of

recipients?

o Maintaining institutional diversity—How does the subsidy

affect the absolute and relative cost differences between

public and private institutions?

o Ease of administration—Does a subsidy program have few

or many eligibility restrictions? Is the agency that

administers the program experienced at making the required

evaluations?

o Budget visibility and controllability—Is the subsidy

program subject to annual review in the budgetary process?

Are its outlays subject to control?

xtt
COST, DISTRIBUTIONAL EFFICIENCY, AND EQUITY OF ALTERNATIVE

PROGRAMS OF AID FOR MIDDLE-INCOME STUDENTS

If the Congress decides to concentrate more aid on middleincome families, major consideration should be given to how best

to channel adequate and equitable assistance to the target group.

In assessing the options with respect to their costs, distributional efficiency, and fairness, this report draws the conclusions

discussed below.

Tax Credit or a Credit/Deduction Option

Two possible tax allowances for higher education expenses are

a nonrefundable tax credit of $250 per student (prorated for

part-time students) and an option for taxpayers to choose between

a nonrefundable $200 credit or a $1,000 deduction for tuition,

books, fees, supplies, and equipment.

A tax credit plan of this sort would cost the U.S. Treasury

about $1.7 billion in the first year, while the credit/deduction

option would cost roughly $1.9 billion. The tax credit plan would

be more efficient than the credit/deduction option in focusing aid

on middle-income families. About 49 percent of the benefits from

the credit-only plan would go to families with incomes between

$10,000 and $25,000, while only 42 percent of the benefits from

the credit/deduction option would go to this income group. The

distribuiton of these benefits could be concentrated in low- and

middle-income groups by reducing or eliminating the subsidy on

income levels above $25,000. The subsidy could also be reduced for

the first student a family has enrolled in school.

The credit/deduction option would extend larger benefits to

those with higher marginal tax rates. The credit-only plan would

offer the same amount of benefits to all qualified students with

family tax liabilities of at least $250 and thus might be considered more equitable.

Basic Educational Opportunity Grants

Additional federal aid could be provided to middle-income

students by liberalizing the Basic Educational Opportunity Grants

(BEOG) program. The benefits of the program—now aimed mostly at

xiii
low- and moderate-income students—could be extended to those in

somewhat higher income groups hy raising the maximum award to

$2,100 and by reducing from 30 percent to 20 percent the fraction

of discretionary income above $5,000 that a family is expected

to contribute toward higher education financing. (The Education

Amendments of 1976 raised the maximum award from $1,400 to $1,800,

but appropriations for fiscal year 1978 effectively imposed a

ceiling of $1,600.)

Such changes in the BEOG program, costing about $800 million,

would benefit approximately 490,000 more students in the middleincome class ($10,000 to $25,000). This plan would provide about

72 percent of the additional benefits to middle-income students

and thus would rank much higher in terms of distributional efficiency than the tax credit and credit/deduction plans, which focus

less than half of total benefits on fmailies with incomes between

$10,000 and $25,000.

The average additional award for those brought into the

program as a result of the described program changes would vary

with the family income of the recipient; it would be larger for

middle-income families than for low—income families. In this

respect, the distribution of benefits resembles that of the

credit/deduction option. Those who maintain that education

subsidies should be distributed equally among all recipients

might therefore view this option as somewhat less equitable than

the tax credit, which provides about the same benefit for all

students with family tax liabilities of at least $250.

Guaranteed Student Loans

Before 1976, eligibility for some federal interest subsidies

on guaranteed student loans was lost when adjusted family income

reached $15,000. The Education Amendments of 1976 raised this

ceiling to $25,000 (equal to about $31,000 of adjusted gross

income), thus expanding eligibility to about 85 percent of all

students; the amendments also increased from $10,000 to $15,000

the total amount that a student can borrow for undergraduate and

graduate training.

The additional benefit to middle-income families resulting

from the 1976 amendments probably could be enhanced most by

providing larger incentives for banks to include more guaranteed

xiv
student loans in their loan portfolios. Banks might be willing to

provide more funds if their net rate of return were improved by

reducing the costs of complying with administrative procedures and

by increasing the federally subsidized interest payments to

banks.

The federal cost of an expanded Guaranteed Student Loan

Program (GSLP) is difficult to estimate since it depends on

the additional volume of student loans as well as on the federal

interest and default payments per dollar of loans. Also the

distributional efficiency of this way of aiding middle-income

families is difficult to quantify. Banks not only have wide

discretion in determining the amount of GSLs they will make but

also select the individuals to whom such loans will be made.

Middle-income families, however, might benefit disproportionately,

especially if banks think middle-income borrowers are good risks.

Since all qualified students are eligible for the same

amount of loan, an expanded GSLP probably would be considered

equitable by those who maintain that education subsidies should be

distributed equally among all recipients.

Loans to Parents

Another possible way to ease the liquidity problems of

middle-income families would be to establish a guaranteed loansto-parents program. Such a program might not share the deficiencies of the GSLP—high default rate for example—and therefore

might prove more attractive to private lenders.

The terms of a guaranteed loans-to-parents program might

include a loan limit of as much as $5,000 per student per year, a

repayment period of between 5 and 10 years, and an interest rate

of between 8 percent and 10 percent (perhaps varying with the

length of the repayment period).

The cost to the Treasury of a guaranteed loans—to-parents

program would depend upon the volume of loans made, the default

rate on these loans, and the size of any necessary federal supplemental interest payments to banks. The federal costs per dollar

of loans made to parents are likely to be lower than that of the

GSLP because of smaller federal interest subsidies and a lower

default rate. The percentage of loans to parents that would go to

xv
middle-income families would depend upon which families apply for

loans and to whom banks decide to lend.

The equity of this program-—with same loan amounts available

to all families—would likely rank high among those who believe

that education subsidies should be distributed equally among

recipients.

Tax Deferrals

Higher education loans can be provided through the tax

system by allowing taxpayers to postpone a portion of their tax

payments. For example, a tax deferral equal to education expenses

not exceeding $1,500 annually might be permitted each year a

student is in school. Repayments could be made in 10 equal annual

installments, beginning one year after graduation. An interest

rate of 7 percent (equal to that on guaranteed student loans)

could be charged to cover the Treasury's borrowing costs, or a

lower interest rate could be charged to provide.a larger subsidy.

A tax deferral plan of this sort would have an initial cost

of about $8.8 billion, but the annual net cost to the Treasury

would decline substantially as taxpayers begin to repay their

deferred taxes. The program would be less efficient than an

expanded Basic Educational Opportunity Grants program in distributing aid to middle-income families since only 53 percent of the

benefits would go to families earning between $10,000 and $25,000.

Only those with tax liabilities as large as the highest

permitted deferral would benefit fully from this program. Large

tax deferrals would therefore benefit those in high tax brackets

more than those in low tax brackets. This distributional outcome

might not be satisfactory to those who maintain that education

subsidies should be distributed equally among all taxpayers or

be distributed on the basis of need.

OTHER CRITERIA APPLIED TO STUDENT AID PROGRAMS

Applying the remaining tests to the alternative programs

shows a number of common threads (and a few anomolies) running

through the tax alternatives—credits, deductions, deferrals—and

through the nontax options—guaranteed loans to either students or

parents and an expanded BEOG program.

xvi
Maintaining Institutional Diversity

Tax Options. Students would generally get the same amount of

aid whether they attend a public institution or a private one (in

the case of tax deferrals this applies if the college costs at

least equal the deferral). The absolute cost difference between

public and private schools, therefore, would not be changed for

most students. Tax programs, however, would generally represent a

greater percentage reduction of costs at public institutions and

thus would magnify the relative cost difference between public and

private schools. The increase in the relative price of private

institutions might put them at a disadvantage.

Nontax Options. For loan programs, the short-run impact on

the competitive balance between public and private institutions

depends upon the share of costs parents or students borrow;

excepts for interest payments, loan programs would not change the

long—run cost differences between public and private schools.

Changes in the BEOG program genereilly would lower the cost of

attending public instituitons by a greater proportion than the

cost of attending private ones, possibly putting private institutions at a disadvantage.

Ease of Administration

Tax Options. Both the credit-only and the credit/deduction

options would be fairly easy to administer because few eligibility

restrictions are imposed on tax programs and only a small fraction

of tax returns are audited. Tax deferrals with long payback

periods would not be as easily administered because records and

accounts would have to be maintained for about 15 years.

Nontax Options. The administrative burden of BEOGs includes

verifying a high share of claims to detect fraud and abuse.

Student loan programs have been beset by high default rates and

delinquency. A loan program for parents could prove easier to

administer than the student program because of the likelihood of

fewer defaults and greater ease in collecting overdue payments.

Budget Visibility and Controllability

Tax Options. These would rank low in visibility and controllability. Like other tax expenditures, these tax allowances would

xvil

21-200 O - 78 - i
SUMMARY OF ANALYSIS OF ALTERNATIVE WAYS TO PROVIDE ASSISTANCE

TO MIDDLE-INCOME STUDENTS

Criteria

Program

Percent

of Benefits

Going to $10-

25,000 Income

Group

Distribution

of Average

Benefits

Nonrefundable

$250 tax credit

($1.7 billion) a/

49 Equal for fulltime students with

sufficient family

tax liability

Liberalized Basic

Educational Opportunity Grants

Program ($800

million) a/

72 Increase goes

largely to middleincome students

Expanded

Guaranteed Student

Loan Program b/

Uncertain Potentially

equal for all

eligible

students

Loans-to-Parents

Program cj

Uncertain Potentially

equal for all

families with

students

$1,500 Tax

Deferral ($8.8

billion) a/

53 Equal for fulltime students

with sufficient

family tax

liability

aj Initial first-year cost to the Treasury.

b/ Cost estimate not available; federal cost for fiscal year 1977

was $447.6 million (volume of loans was $1.47 billion.

cj Cost estimate not available, but federal cost would likely be

lower than costs for Guaranteed Student Loan Program.
(Summary Table Continued)

Criteria

Budget

Impact on Public & Ease of Visibility and

Private Colleges Administration d_/ Controllability

Absolute cost difference Medium—High Lew

unchanged; relative cost of

private schools increased

Absolute cost difference Medium High

generally unchanged:

relative cost of private

schools generally increased.

Variable Medium Medium

Variable Medium-High Medium

Absolute cost difference Low-Medium Low

generally unchanged; relative cost of private schools

generally increased in

short run

d/ In general, programs with few eligibility limitations are easier

to administer.
not be subject to the same amount of review and scrutiny that is

given most direct outlay programs. Moreover, they are entitlement

programs that provide benefits to all who qualify and therefore

are not subject to fixed ceilings on appropriations. The magnitude of tax deferrals tends to be less visible as repayments

offset new deferrals.

Nontax Options. Loans are moderately visible in the budgetary process but are not very controllable. Unlike tax expenditures, federal outlays for such programs are subject to annual

review. But because they are entitlements, loan programs are less

controllable than other direct spending programs whose costs can

be limited by the budgetary process. The BEOG program, in addition

to being fairly visible, is also controllable through the appropriations process. Generally, however, when a reduction in the

average individual award would have been required to stay within

the initial appropriation ceiling, supplemental appropriations

have been granted.

xx
CHAPTER I. INTRODUCTION

The issue of tax allowances for the personal costs of higher

education deserves analysis for at least three reasons. First,

the matter has been considered in the Congress for many years, and

interest in it remains high. Second, proposals for education tax

allowances are gaining more support as Congressional concern about

the ability of some families—particularly middle-income families--^ finance their children's higher education expenses

grows. Third, the issue is representative of many others in which

the Congress must decide whether the tax structure is an appropriate mechanism for providing a subsidy.

Education tax allowances have not yet been put to a vote in

the House of Representatives. _!/ In 1967 the Senate passed an

amendment that would have provided a tax credit for certain higher

education expenses. Similar action was taken by the Senate in

1969, 1971, twice in 1976, and again in 1977. At no time, however, have these amendments gone beyond conference committees. 2j

Concern about the ability of middle-income families to

provide a higher education for their children has driven much of

the effort to enact an education tax allowance. From time to

^7 In the Second Concurrent Resolution on the Budget for Fiscal

Year 1978, however, the budgetary targets adopted allowed $175

million for possible passage of an education tax allowance.

See Congressional Record, daily ed., September 8, 1977, pp.

H9028-30, and September 9, 1977, pp. S14510-16. Also,

hearings on college tuition tax credits were held by the House

Budget Committee's Task Force on Tax Expenditures, Government

Organization and Regulation (April 28 and May 12, 1977). See

Report on Hearings before the Task Force on Tax Expenditures , Government Organization and Regulation on College

Tuition Tax Credits, House Committee on the Budget, 95 Cong.

1 sess. (Committee Print 95-12, November 1977).

2f For a brief description of these amendments, see Chapter

~ 3.
time, this concern has been heightened by reports that the college

enrollment rate for children from middle-income families is

declining and that inflation-induced increases in college costs

may become so large that the average family will not be able to

afford the expenses of colleg;e. Reports of this sort stimulate

interest in providing more student aid for those who benefit

relatively little from existing federal subsidies for higher

education that are based on need. Such interest appears to

be on the rise.

If the Congress decides to provide more student aid for

middle-income families, it may be useful to consider alternatives

to education tax allowances. Some other form of subsidy may be

more consistent with tax policy and education policy and more

effective in providing assistance to students and their families

at lower budgetary costs.

The analysis that follows is designed to help in the evaluation of education tax allowances as a form of aid for middle-incme

families. It does not address the more fundamental issues of

whether additional federal funds should be spent on higher education _3_/ and, if so, whether education policy objectives are best

served by focusing more aid on middle-income families. To provide

a better understanding of the problems facing middle-income

families, Chapter II briefly discusses the current distribution of

student aid among income groups and examines data on college

enrollment rates, family incomes, and college charges. Chapter

III presents a general discussion of education tax allowances,

including consideration of the various forms such allowances can

take and a brief legislative history of Senate-approved measures.

In Chapter IV a set of criteria or standards is suggested for

comparing different student aid subsidies. Then in Chapter V

these criteria are used to evaluate alternative approaches to

providing student aid for middle-income families.

3/ For a discussion bearing on this issue, see John K. McNulty,

"Tax Policy and Tuition Credit Legislation: Federal Income Tax

Allowances for Personal Costs of Higher Education," California

Law Review, vol. 61 (January 1973), pp. 1-80.
CHAPTER II. THE BURDEN OF COLLEGE COSTS FOR STUDENTS

AND THEIR FAMILIES

The basic goal of most proposals for education tax allowances

is to provide financial relief to middle-income families, although

education subsidies may serve broader objectives, such as insuring

equal access to higher education and maintaining the financial

viability of higher education institutions. _!_/ Although all

families are affected by rising college fees, middle-income

families seem especially burdened since they receive relatively

little assistance from the needs-tested higher-education aid

programs focused on low- and moderate-income groups and since they

lack the financial resources available to high-income families.

Data from the Bureau of the Census suggest that the college

enrollment rate for 18- to 24-year-old dependents of middle-income families has fallen somewhat over the past decade. 2] This

decline is often attributed to the financial pressures imposed by

soaring college costs, although other factors, such as reduced

\J For a discussion of various goals that may be served by

education subsidies, see Congressional Budget Office, Postsecondary Education: The Current Federal Role and Alternative

Approaches (February 1977), and John K. McNulty, "Tax Policy

and Tuition Credit Legislation: Federal Income Tax Allowances

for Higher Education," California Law Review, vol. 61 (January

1973), pp. 1-80.

2J U.S. Bureau of the Census, Current Population Reports,

Series P-60, "School Enrollments—Social and Economic Characteristics of Students, October 1976" (forthcoming).
military manpower requirements, declining rates of return from a

college education, _3_/ family preferences for noneducation purchases, and simply the decision by some to work rather than study,

also may have contributed. The extent to which enrollment rates

have dropped as a result of rising college costs is unclear since

family incomes in general have risen faster than college charges.

THE DISTRIBUTION OF FEDERAL STUDENT AID

In fiscal year 1977 the federal government provided about

$8.5 billion of student aid in the form of direct spending

programs and tax expenditures. Fifty-two percent of this aid

benefited self-supporting students 4_/ and students from families

earning less than $10,000 annually, groups that accounted for 29.3

percent of total student enrollment. Students from families

earning between $10,000 and $20,000 received about 36 percent of

the aid and represented 32.5 percent of all students. The remaining funds went to families earning more than $20.000.

Tables 1 and 2 show the distribution of federal aid provided through various existing tax expenditures, direct grants

(including payments for specified work), loans, and loan guarantees. Federal direct student aid programs, for the most part,

have been designed to expand access to higher education for those

with lower incomes. _5_/ In contrast, most tax expenditures that

provide student aid have not been designed specifically to do so;

3/ Changes in the rates of return from a college education are

examined in Richard B. Freeman, "The Decline in the Economic

Rewards to College Education," The Review of Economics and

Statistics, vol. 59 (February 1977) pp. 18-29.

kj Most self-supporting students have annual incomes below

$10,000.

_5_/ For a discussion of current education policy goals, see

Congressional Budget Office, Postsecondary Education; The

Current Federal Role and Alternative Approaches, Budget Issue

Papet, February 1977.
TABLE 1. DISTRIBUTION OF AID TO STUDENTS BY INCOME CLASS, FISCAL YEAR 1977, IN MILLIONS

OF DOLLARS

(Dollars in Thousands)

Amount to Family

Supported Students

(Grouped by Adjusted

Gross Family income)

Program 0-10 10-20 20+

Self-supporting

Students

Distribution of All Students W f/ 3,370

(Students in Thousands)

3,738 4,392 &/

Total

Tax Expenditures

Exemption for student

dependence

Exclusion of fellowships and scholarships

Exclusion of G.I. Bill

education benefits

Exclusion of student

social security benefits

114

134

143

64

372

70

32

23

229

16

15

13

zJ

Zl

Zl

Zl

715 a/

220 a] W

190 a/ b/

100 a/

Outlays for Major Student

Aid Programs

Basic Educational

Opportunity Grants

Supplemental Educational

Opportunity Grants

Work/study programs

National Direct Student

Loans

Guaranteed student

loans

G.I. Bill education

benefits

Social security student

benefits

Total

777

140

168

106

188

1,304

694

3,832

230

52

97

109

238

1,463

398

3,084

£/

2

21

30

22

413

193

954

432

54

72

50

z/

zl

-Zl

608

1,439 d/

248 d/

358 d/

295 d/

448 b/ d/ e/

3,180 fj

1.285 fj

8,478

11,500

a./ Emil Sunley, "Federal and State Tax Policies," paper prepared for the Brookings Institution Conference on "Public and Private Higher Education," November 11-12, 1977.

_b/ Includes self-supporting students,

j:/ Amount insignificant.

A_l Budget Office, U.S. Office of Education.

_§_/ Includes interest payments of $305 million and default payments of $142.6 million.

fj CBO estimate.

£/ Incorporated under other headings.

21-200 O - 78 - 4
TABLE 2. PERCENTAGE DISTRIBUTION OF STUDENT AID BY INCOME CLASS, FISCAL

YEAR 1977 a/

(Dollars in Thousands)

Adjusted Gross

Program

Tax Expenditures a./ b/

Exemption for student

dependence

Exclusion of fellowships and scholarships

Exclusion of G.I. Bill

education benefits

Exclusion of Student

social security benefits

Outlays for Major Student

Aid Programs b/

Basic Educational

Opportunity Grants

Supplemental Educational

Opportunity Grants

Work/study programs

National Direct Student

Loans

Guaranteed student

loans aj

G.I. Bill education

benefits aj

Social security student

benefits

Total

Distribution of All Students aj b/

Family Income

0-10 10-20

16

61

75

64

54

56

47

36

42

41

54

45.2

29.3

52

32

17

23

16

21

27

37

53

46

31

36.4

32.5

20+

32

7

8

13

I/

1

6

10

5

13

15

11.2

38.2

Selfsupporting

Students

£/

£/

sJ

sJ

30

22

20

17

£/

£/

sJ

7.2

c/

aj Includes self-supporting students,

b/ CBO estimate.

cj Incorporated under other heading.

&_/ Amount insignificant.
they have resulted instead from legislation and rulings concerned

primarily with issues of tax policy. 6_/

Tax expenditures provide direct assistance to students and

their families in two ways. First, the tax law allows a student

to be claimed as a dependent even if the student has an adjusted gross income greater than the $750 ceiling for nonstudents. Second, no taxes are imposed on income received in the

form of scholarships, fellowships, student social security

benefits, or education benefits under the G.I. Bill. These

exemptions and exclusions lower taxable income to which progressive tax rates are applied. Thus they are worth more to

taxpayers with high marginal tax rates than to those with low

marginal tax rates. _7_/

Other tax expenditures (not shown in Tables 1 and 2)

assist students indirectly by providing aid to institutions.

These include: the charitable deduction for contributions to

schools, the exclusion of unrealized capital gains on these

gifts and bequests, the deduction of state and local taxes used

for higher education, and the exemption of interest on state

and local borrowing for education purposes. The U.S. Department of the Treasury has cited figures showing that these tax

expenditures totaled $2.6 billion iri fiscal year 1977. _8/

As shown in Tables 1 and 2, except for guaranteed student

loans and G.I. Bill education benefits, direct federal student

aid programs concentrate funds on students in low- and moderate6/ See John C. Chommie, The Law of Federal Income Taxation

(Second Edition) (West Publishing Company, 1973), pp. 52,

62-66, 220.

]_/ In the case of the exemption for student dependents, a $35

personal tax credit is also granted. This tax saving is the

same for all taxpayers in terms of after-tax income but is

worth more to high-income taxpayers in terms of before-tax

income. For more discussion of this point, see Chapter

III, footnote 3.

8_/ Emil Sunley, "Federal and State Tax Policies," paper prepared

for the Brookings Institution Conference on "Public and Private Higher Education," November 11-12, 1976, incorporated in
income groups. (Appendix A outlines the major student aid programs.) This distribution results because all of these other

programs, except for social security, are needs—tested with the

definition of financial need taking into account college costs as

well as family income. Although student social security benefits

are not needs-tested, benefits are reduced if the parents of

recipients or recipients who are surviving dependents earn more

than specified maximums. Because the Guaranteed Student Loan

Program and G.I. Bill education benefits are not needs-tested, a

greater proportion of benefits from these programs accrue to

middle-income students.

ENROLLMENT CHANGES DURING.THE 1967-1976 DECADE

While the overall college enrollment rate for dependent

18- to 24-year-olds has not changed much between 1967 and 1976,

the enrollment rate for students from middle-income and highincome families has declined, especially when compared to the

somewhat increased enrollment rate for low-income students. 9j

Enrollment rates for all income groups, however, have risen

recently from the 1973-1974 low point, particularly for those in

the middle-income classes.

Table 3 and the Figure show that the overall enrollment

rate for dependent family members rose during the late 1960s,

reflecting in part the decision by some males to enroll in

college rather than to join the military. Between 1969 and

1974 the overall enrollment rate declined somewhat, reflecting

mainly a drop in the enrollment rate for men, with that of

women remaining fairly stable. Afte r 1974, however, the enrollment rate for 18- to 24-year-olds rose again, largely reflecting substantial increases in the enrollment of women. 1Q/

testimony of Assistant Secretary of the Treasury for Tax

Policy, Laurence N. Woodworth, in College Tuition Tax

Credits, Hearings before the House Budget Committee Task

Force on Tax Expenditures, Government Organization and

Regulation, 95: 1, p. 14.

_9_/ Bureau of the Census, "School Enrollments."

1Q/ For a male-female breakdown of individual student enroll

ment rates, see Bureau of the Census, "School Enrollments."
TABLE 3. PERCENT OF 18- TO 24-YEAR-OLD DEPENDENT FAMILY MEMBERS a/ ENROLLED IN COLLEGE, BY

FAMILY INCOME, b/ OCTOBER 1967 TO OCTOBER 1876

Percent Enrolled

Family Income

$

$ 8

$17

$25

All

0-$ 8,525

,525-$17,050

,050-$25,575

,575+

income groups

1967 1968

20.0 22

37.9 38

51.9 50

68.3 63

39.1 39

.5

.5

.7

.0

.7

1969

24.8

38.8

50.6

65.2

41.3

1970

20.8

36.6

48.4

61.7

39.1

1971

22.8

35.4

46.4

61.8

38.9

1972 1973 1974

22.6 20.1 20.3

34.2 31.2 31.7

44.2 42.7 41.4

56.9 56.6 57.5

37.8 36.6 36.2

1975 1976

23.5 22

35.1 36

45.4 47

59.6 58

38.7 38

.4

.3

.5

.2

.8

SOURCE: CBO calculations based on data supplied by the Census Bureau.

aj A dependent family member is a relative of the primary family head other than the wife.

_b_/ Family income in 1976 dollars, civilian noninstitutional population.
Figure

Percent of 18-24-Year-Old Dependent Family

Members^ Enrolled in College, by Family

Income^/ October 1967 to October 1976

Percent

80

__>

70

60

50

40

30

20

10

0

Oct. 67 Oct. 68 Oct. 69 Oct. 70 Oct. 71 Oct. 72 Oct. 73 Oct. 74 Oct. 75 Oct. 76

Calendar Years

a] A dependent family member is a relative of the primary family head other than the wife,

b/ Family income in 1976 dollars for civilian noninstitutional population.

$25J575

and up

$17,050-

25,575

Ail Income

I I I I I

Table 3 and the Figure also indicate how the pattern of

enrollment rates has varied by income class (adjusted for inflation) ll/ in recent years. The lowest and'highest income groups

ll/ Failure to adjust enrollment data for the effect of inflation on family income can produce misleading conclusions.

Enrollment decisions are based in part on what a family can

afford, and this in turn is affected by inflation. Families

earning $10,000 or $20,000 today are less well-to-do than

families

10
($0-$8,525 and $ 25,575-plus) showed declines of roughly 10

percent between 1969 (the peak year) and 1976, while the enrollment rates for the two middle-income groups fell somewhat less—6

percent. Since 1974 the percentage increase in the enrollment

rate for the two middle-income classes ($8,525-$17,050 and

$17,050-$25,575) has been more than twice as large as the growth

of enrollment rates for 18- to 24-year-olds in general.

GROWTH OF COLLEGE CHARGES, FAMILY INCOME, AND STUDENT AID

Increases in college costs can influence the decision

whether to attend college or not. It is unclear, though, to what

extent enrollment rates have been affected by increases in

college tuition and other fees. One set of empirical findings

suggests that a $100 increase in tuition not offset by additional

student aid is likely to result in enrollment declines varying

from negligible to almost 2 percentage points, depending among

other things on the family income of the student and the type of

institution attended. 12/ Increases in family income, however,

can offset the adverse effect of higher college charges. As

shown in Table 4, family incomes and (to a greater extent)

student aid have generally kept pace with college fees.

As indicated in the lower peinel of Table 4, costs at both

public and private institutions rose by roughly 75 percent during

the period 1967-1976. The consumer price index (a measure of the

general price level) rose by somewhat less—70.5 percent. As a

result, real college costs (that is, costs adjusted for inflation) rose by only 2.2 percent at public institutions and 3.7

percent at private institutions.

earning $10,000 or $20,000 five or ten years ago. Because

such families have a smaller "real income" today, their

enrollment rate is likely to be lower. In order to focus on

enrollment changes for families with the same real income,

therefore, family incomes must be adjusted for inflation.

12/ Gregory A. Jackson and George B. Weathersby, "individual

Demand for Higher Education: A Review and Analysis of

Recent Empirical Studies," Journal of Higher Education, vol.

46 (November/ December 1975), pp. 623-52.

11
TABLE 4. COLLEGE COSTS, FAMILY INCOME, STUDENT AID, AND THE GENERAL PRICE LEVEL

Students costs a/

Year Public Private

Family Income b/ Federal

80th Top Appropriations

Median Percentile 5 Percent Per Student c/

Consumer

Price Index d/

(Amounts in Dollars)

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1968

1969

1970

1971

1972

1973

1974

1975

1876

1,063

1,117

1,024

1,288

1,357

1,458

1,517

1,617

1,748

1,854

5.1

13.3

27.2

27.5

37.2

42.7

52.1

64.4

74.2

a/ Includes charges

for

2,205

2,321

2,531

2,739

2,917

3,038

3,164

3,386

3,667

3,896

5.3

14.9

24.2

32.3

37.8

43.5

53.6

66.3

76.7

7,933 12,270

8,632 13,400

9,433 14,751

9,867 15,531

10,285 16,218

11,116 17,760

12,836 19,253

12,902 20,690 e/

13,719 22,037 e/

14,958 23,923 e/

CUMULATIVE PERCENTAGE

8.8 9.2

18.9 20.3

24.4 26.6

29.6 32.2

40.1 44.7

61.8 56.9

62.6 68.6

72.9 79.6

88.6 95.0

for tuition fees, room, and board

Education Statistics, Projections of Education

estimates (year

b/ U.S.

1967 equals

Bureau of the Census,

academic year 1967-68,

Statistical Abstract of

19,025

20,590

22,703

24,250

25,325

27,836

30,015

32,199 e/

34,144 e/

37,047 e/

CHANGE FROM 1967

8.2

19.3

27.5

33.1

46.3

57.8

69.2

79.5

94.7

as found in U.S. Office

Statistics, table 41, p

etc.)

the U.S., 1976 and U.S.

87

92

82

97

107

165

160

210

248

315

5.7

-1.1

11.5

23.0

89.7

83.9

141.4

185.1

262.1

of Education,

100.0

104.2

109.8

116.3

121.3

125.3

133 . 1

147.7

161.2

170.5

4.2

9.8

16.3

21.3

25.3

33.1

47.7

61.2

70.5

National Center

. 86. Costs for 1976 are NCES

Bureau of the Census , Current

Population Report, Series P-60, no. 105, table 10 (June 1977), p. 45, and table 13, p. 58, and no. 107

(September 1977), table 1, p. 6, and Table 4, p. 11.

cj CBO estimates based on data from the following sources: U.S. Office of Education, Bureau of Higher

Education, Factbook (1976); U.S. Office of Education, Office of Guaranteed Student Loans, Monthly Report

(December 1976); and U.S. Office of Education, National Center for Education Statistics, Fall Enrollment

in Higher Education (Selected Years).

d/ Economic Report of the President, January 1977, p. 241; and U.S. Department of Commerce, Survey of

Current Business (November 1977), table S-8.

e/ Not strictly comparable to earlier years due to revised procedure.
This increase in college costs, however, has been offset by

a rise in family incomes, both in real and current dollar terms.

From 1967 to 1976 median family income increased by 88.6 percent

(10.6 percent in real terms), compared to the increase in

college charges of roughly 75 percent. 13/ Because of the

relatively faster growth in family income, student costs at

public institutions decreased from 13.4 percent to 12.4 percent

of median family income, and student costs at private institutions fell from 27.8 percent of median family income to 26.1

percent during the 1967-1976 period,.

Families with incomes well above the median have experienced an even faster growth in income. For those in the 80th

percentile (that is, just below the richest 20 percent) and those

in the top 5 percent, the growth in current dollar income has

been about 95 percent. As a result, college costs for those

families with incomes of approximately $25,000 or more in 1976

comprised a smaller portion of income than for comparable

families in 1967.

Growth in federal student aid has also helped to offset

increases in college costs for middle-income families. During

the period 1967-1976, appropriations for the major student aid

programs grew 262 percent per full-time-student equivalent.

While most of the appropriations were for programs primarily

aiding lower-income students, the Guaranteed Student Loan Program

(GSLP)—the primary source of assistance for middle-income

families also grew substantially. From 1967 to 1976 appropriations for the GSLP (which primarily represent the subsidy element

of the program) rose by 433 percent on a full-time-student

equivalent basis while the volume of loans increased by 121

percent on a full-time-student euivalent basis. 14/ During

13/ Using a different measure, U.S. per capita disposable

income increased 101 percent during the 1967-1976 period.

See Economic Report of the President, January 1977, Tables

B-22 and B-26, and U.S. Department of Commerce Survey of

Current Business (October 1977) Table S-2.

14/ CBO estimates based on data from the following sources:

U.S. Office of Education, Bureau of Higher Education, Factbook (1976); U.S. Office of Education, Office of Guaranteed

Student Loans, Monthly Report (December 1976); and U.S. Office of Education, National Center for Education Statistics,

Fall Enrollment in Higher Education (Selected Years).

13

21-200 O - 78 - 5
this period, students with adjusted family incomes of $15,000 or

less (approximately $19,000 of adjusted gross income) were eligible for federal payment of interest charges on their loans while

they were in school 15/ Thus, even for families not covered

by the student aid programs focused on low- and moderate-income

groups, federal support has risen faster than college costs.

These data on family income, college fees and student aid

do not support the claim that the financial burden of college

expenses has increased for middle- and upper middle-income

families in general. Factors other than cost increases may be

more important in explaining changes in enrollment patterns.

Such factors may include reduced military manpower requirements, the declining rate of return from a college education,

family preferences for consumer expenditures, and simply the

decision of some to work rather than to study.

15/ In 1976, the ceiling for this subsidy was raised to $25,000

of adjusted family income (roughly $31,000 of adjusted gross

income). The difference between these two income concepts

is that adjusted family income reflects adjustments for

personal tax exemptions and other deductions while adjusted

gross income does not.

14
CHAPTER III. EDUCATION TAX ALLOWANCES

Adopting an education tax allowance is one way to provide

financial relief to middle-income families for higher education

costs if the Congress decides that additional federal funds

should be spent for this purpose. An education tax allowance can

take various forms, each of which would have different budgetary

costs, distributional outcomes, and policy implications. The

major forms of education tax allowances are discussed in this

chapter. The legislative history of proposals for education tax

allowances is then briefly reviewed to show how these various

proposals have varied over time.

FORMS OF EDUCATION TAX ALLOWANCES

Education tax allowances can take three basic forms: a

deduction against adjusted gross (or gross) income; a credit

against tax liability; and a deferral (or postponement) of tax

payments.

Tax Deductions

Tax deductions for education expenses provide benefits by

reducing the taxable income base. Usually the designated base is

adjusted gross income, although gross income may be chosen to

extend the benefits to those who do not itemize. \J Because a

deduction reduces the tax base to which progressive tax rates are

applied, a deduction is worth more to high-income taxpayers than

to those with low incomes. For example, a $100 deduction is

worth $70 to someone with a top 70 percent marginal tax rate but

only $30 to a taxpayer with a 30 percent marginal tax rate.

I/ Adjusted gross income is reached by subtracting from gross

income all deductions which are not "itemized deductions" or

personal exemptions. Taxable income is adjusted gross income

minus the total of personal exemptions and either an amount

now called the "zero bracket amount"—formerly called the

standard deduction—or, if greater, itemized deductions.

15
Tax Credits

In contrast to a tax deduction which reduces the tax base,

a tax credit reduces the taxpayer's liability directly and thus

is worth more than a deduction of '-he same amount. For example,

a $100 tax credit provides a tax benefit of $100 (unless the

taxpayer does not have $100 of tax liability to be offset by the

credit), 2j while a $100 deduction provides a tax benefit ranging

from $14 to $70. A tax credit provides the same tax reduction to

those in high and low income brackets because, in contrast to a

deduction, the tax saving does not depend on the taxpayer's

marginal tax rate. 3j

Tax Deferrals

Tax deferrals for education expenses can be viewed as a

form of higher education loan by which a taxpayer is granted

relief in the form of postponement of part of his tax payments.

The repayment of deferred taxes can be spread over several years

and may begin after the student leaves school to provide greater

relief while the student is attending school. Interest can be

charged on the tax loan to reduce the cost to the Treasury, or

the tax loan can be made interest-free to provide more of a

subsidy.

Thus, if a deduction for education expenses were allowed as

an offse t to gross income for arriving at adjusted gross

income, it would always filter through to reduce the tax

base even for those who do not itemize. If, however, it were

allowed only as an itemized deduction, it would not benefit

those whose itemized deductions do not exceed the standard

deduction or zero bracket amount.

2_/ If a tax credit is made "refundable," those whose tax liability is less than the credit would receive a cash payment

equal to the difference.

37 If a tax credit is used to provide an explicit subsidy,

however, and the amount of the credit itself is not subject

to tax, the benefit of the subsidy will vary with the recipient's marginal tax rate. A $100 tax-free credit is worth

$200 of taxable income to someone with a 50 percent tax rate

rate but is worth only $125 to someone with a 20 percent tax

16
The value of a tax deferral depends on the length of the

payback period and on the interest rate charged. Tax loans with

long payback periods and low interest charges are worth more than

those with short payback periods arid high interet charges. The

value also depends on the taxpayer's marginal tax rate and on

what rate of return the taxpayer can earn on savings. Individuals who can earn high after-tax rates of return on their

savings are apt to place a higher value on their tax loans than

are those who would not forego as much interest income by spending their own funds for higher education.

FURTHER DESIGN CONSIDERATIONS OF EDUCATION TAX ALLOWANCES

Tax deductions, credits, and deferrals can be related in

various ways to family income, education expenses, and other

factors to achieve preferred distributional or budgetary objectives.

Relating Tax Allowances to Education Expenses

The design of an education tax allowance must specify the

type and the amount of education expenses to be offset by the

allowance. A major distinction it, often made between expenses

that are required for instruction and those associated with

day-to-day living. For the most part, proponents of education

tax allowances have restricted coverage of expenses to those

associated with instruction—tuition, fees, books, supplies, and

equipment. 4_/ Items such as room and board generally have been

excluded from coverage, perhaps because of budgetary cost considerations. This type of restriction avoids bias against those

students who live at home for financial or other reasons. Most

direct education subsidies, however, do not impose this restriction on qualified expenses. These programs avoid the bias noted

above by "covering" at-home living costs.

rate. Most federal direct grant subsidies to businesses are

treated as taxable income, thereby avoiding this problem.

See Stanley S. Surrey and others, Federal Income Taxation:

Cases and Materials, 1 (Foundation Press, 1972), pp. 214-15.

4/ Some proposals would cover tuition charges only and would

reduce qualified expenses by amounts received as scholarships, fellowships, and veterans' benefits.

17
The amount of qualified expense which is offset by an

education tax allowance depends on the amount of the qualified

expenses and the fraction of them which may be offset. An

allowance can be designed to apply to expenses between, for

example, $500 (a floor) and $2,000 (a ceiling). An allowance

with a high floor on qualified expenses will direct relatively

more aid to those attending high-priced private institutions. _5_/

A low ceiling on qualified expenses will reduce federal revenue

losses.

Allowances that offset less than 100 percent of qualified

expenses may reduce the extent to which institutions would be

able to capture the subsidy (by raising tuitions or by reducing

their student financial aid) without losing some students who

would have to bear a portion of the cost increase, bj The

fraction of each dollar of qualified expenses that is offse t

by an allowance can be constant or can vary with the level of

education expenses. For example, an allowance can offset 50

percent of all qualified expenses or may offset 75 percent of the

first $500, 50 percent of the next $500, and 5 percent of expenses above $1,000.

Relating Tax Allowances to Income

A tax allowance can be related to the taxpayer's income in

order to produce a desired distribution of benefits or to reduce

total costs. For example, if considerations of budgetary costs

and family need suggest that benefits should not be extended to

high-income families, the allowance can be reduced by some

percentage of income above a specified level. The allowance could

be reduced, for example, by 2 cents for each dollar of adjusted

gross income above $25,000. This would completely phase out a

$400 tax credit at $45,000 of adjusted gross income. ]_/ If a

_5_/ For a discussion of this point, see Chapter IV.

6j This point is discussed more fully in Chapter IV.

T_l If a family had two children in school at the same time,

and if a $400 credit were allowed for each student, then the

total ($800) credit would not be phased.out completely until

$65,000 of adjusted gross income was reached, unless the

phase-down was calculated on a per-student basis.

18
faster phaseout is desired, the rate of reduction could increase

with income. In the above example, a $400 credit would completely phase out at $40,000 if benefits were reduced by 2 cents for

each dollar of income between $25,000 and $35,000 and by 4 cents

for each dollar of income above $35,000.

At the low end of the income scale are many families with

little or no taxable income or tax liability. These families

would not benefit from education allowances that operate through

a reduction of income taxes. If a tax credit is used, however,

full benefits can be extended to those with little or no tax

liability by making the credit "refundable"—that is, providing a

direct cash payment to recipients if the credit exceeds their tax

liability. &_/ In principle, the same outcome can be achieved

when the mechanism is a tax deferral. In this case, the Treasury

would make loans to low-income taxpayers even though no taxes

were due. In the case of a deduction where benefits vary

with marginal tax rates, cash benefit payments to nontaxpayers

could be based on the lowest marginal tax rate; that is, the

payment could be equal to 14 percent of qualified expenses.

If benefits are to be focused on middle-income families

only, an appropriate allowance is one which incorporates a

phaseout of benefits for taxpayers located at the upper end of

the target income group. For example, the allowance could be

reduced by 2 percent of adjusted gross income above $25,000.

Also a nonrefundable allowance would seem appropriate when

there is no intent to extend benefits to those with little or no

tax liability. (Those in this group are generally eligible for

direct federal aid.)

Relating Tax Allowances to the Number of Children Attending

School

Another factor that can be introduced in the formulation of

an education tax allowance is the number of students a family

has attending school at the same time. Although almost all

proposals that have been made would grant equal tax allowances

for each child, the instances of families with two or more

children attending school simultaneously are frequently cited

8/ The earned income credit is an example of a refundable tax

credit. See Internal Revenue Code of 1954, Section 43.

19
as the ones in which financial hardships are likely to be the

greatest. Such families constitute roughly 15 percent of the

families with 18- to 24-year-olds attending school full time and

about 1 percent of all families. 9/ Concentrating aid on those

families could reduce the costs of any program substantially

and/or permit larger benefits for multiple-student families.

BRIEF LEGISLATIVE HISTORY OF EDUCATION TAX ALLOWANCES

A brief review of the history of proposals for education

tax allowances shows how the different approaches have evolved.

1Q/ In the 1950s most of the proposals for education tax allowances offered a tax deduction against adjusted gross income for

some portion of college expenses or, in some cases, provided an

additional personal exemption for each student. In the 1960s a

credit against tax liability became the popular form of tax

allowance proposals, perhaps because of the recognition that

deductions favor those with high tax rates over those with low

tax rates. During the period from 1967 to 1977, six proposals

for education tax credits passed the Senate, but none was ever

approved by the House of Representatives.

Senator Abraham Ribicoff (D.-Conn.) was the chief sponsor

of the first Senate-approved education tax credit measure, ll/

His 1967 amendment would have provided taxpayers a nonrefundable

credit t for college expenses equal to 75 percent of the first

$200, 25 percent of the next $300, and 10 percent of expenses

between $500 and $1,500. Thi,s credit was to be reduced by 1

9_/ U.S. Bureau of the Census, Current Population Reports,

Series P-20, no. 303 (December 1976), p. 38.

1Q/ A fuller discussion of the legislative history of education

tax allowances is presented in John K. McNulty, "Tax Policy

and Tuition Credit Legislation: Federal Income Tax Allowances for Personal Costs of Higher Eduation," California

Law Review, vol. 61 (January 1973), pp. 4-14.

ll/ Congressional Record, vol. 113, 90:1 (1967) pp. S9665-76

(debate on Ribicoff amendment) and p. S9688 (Ribicoff

amendment passed).

20
percent of the taxpayer's adjusted gross income above $25,000.

The Ribicoff amendment was attached, to H.R. 6950, a bill restoring the investment tax credit. The amendment, however, was

deleted from the bill in conference with the House.

In 1969 the Senate again passed a Ribicoff-sponsored tax

credit amendment. 12/ The provisions of this measure were

similar to those which passed the Senate in 1967 except that

high-income tapayers would have benefited somewhat less. It

offered a nonrefundable tax credit equal to 100 percent of the

first $200 of expenses, 25 percent of the next $300, and 5

percent of expenses between $500 and $1,500. The credit was to

be reduced by 2 percent of adjusted gross income above $15,000.

In the conference with the House, the 1969 Ribicoff amendment was

dropped from H.R. 13270, the bill which became the Tax Reform Act

of 1969.

In 1971 the Senate passed its third education tax credit

amendment. 13/ The measure was introduced by Senator Ernest F.

Rollings (D.-S.C.) and was identical to the 1967 Ribicoff proposal except that the Rollings amendment was the first Senate-passed education tax credit measure that provided a refundable

credit. The Rollings tax credit amendment, however, was dropped

in conference on H.R. 10947, the Revenue Act of 1971.

In 1976 Senator William V. Roth, Jr. (R.-Del.) sponsored an

education tax credit amendment that would have provided a nonrefundable tax credit of up to $250 per student when fully phased

in. 14/ Unlike the Ribicoff and Rollings amendments, the Roth

credit was not limited to a percentage of expenses (although the

credit could not exceed tuition expenses) and was not phased out

for high-income taxpayers.

Initially the Roth amendment was attached to H.R. 10612,

the Tax Reform Act of 1976, but the conference committee con12/ Congressional Record, vol. 115, 91:1 (1969), pp. S37289-305.

13/ Congressional Record, vol. 117, 92:1 (1971), pp. S18606-12.

147 Tax Reform Act of 1976, S. Rept. 938. 94 Cong. 2nd sess.

(1976), pp. 33-35.

21

21-200 O - 78 - 6
sidered the revenue loss excessive and deleted the Roth amendment

prior to final passage of the bill. Subsequently the Senate

passed the Roth proposal as an amendment to H.R. 1386, a bill

which would have allowed Smith College a tariff exemption on the

purchase of a set of imported carillon bells. 15/ A unanimous

consent request for a conference on the bill was objected to in

the House, and the legislation died as the 94th Congress ended.

In 1977 the Senate again approved an education tax credit,

which was offered by Senator Roth as an amendment to S. 9346, the

Social Security Financing Amendments of 1977. 16/ The amendment

would have provide a $250 tax credit for students. In contrast

to Senator Roth's previous proposals, however, a floor amendment

was added to make the credit refundable during its first year so

that direct payments would be made to those whose tax liability

was less than the credit. The Roth amendment was dropped from

the social security bill in the House-Senate conference.

In 1977 the House Budget Committee's Task Force on Tax

Expenditures, Government Organization, and Regulation held

hearings on the subject of college tuition tax credits. 17/

Later in the year, during debate on the Second Concurrent Resolution on the Budget for Fiscal Year 1978, proponents of education

tax allowances successfully managed to provide $175 million

in the budget for possible passage of an education tax allowance. 18/

15/ Congressional Record, vol. 122, 94:2 (1976), pp. S16002-5.

16/ Congressional Record, daily ed. , November 4, 1977, pp.

S18792-802.

17/ See Report on Hearings before the Task Force on Tax Expenditures, Government Organization, and Regulation on College

Tuition Tax Credits, House Committee on the Budget, 95 Cong.

1 sess. (Committee Print 95-12, November 1977).

18/ Congressional Record, daily ed., September 8, 1977, pp.

H9028-30 and September 9, 1977, pp. S14510-16.

22
Also the Senate Finance Committee scheduled three days

of hearings on the issue of education tax allowances in January

1978. 19/

19/ "Finance Subcommittee on Taxation and Debt Management Sets

Hearings on Tuition Tax Relief Bills," Press Release, U.S.

Senate Committee on Finance, Subcommittee on Taxation and

Debt Management Generally, December 19, 1977.

23
CHAPTER IV CRITERIA FOR COMPARING ALTERNATIVE SUBSIDY PROGRAMS

If the Congress considers additional student aid for middleincome families, it may want to compare tax subsidies and nontax

alternative forms of aid. This chapter discusses one set of

criteria for making that comparison. In the next chapter these

criteria are applied to various tax subsidies and other forms of

student aid. I/

COST

An important factor in evaluating any government subsidy

program is its cost to the Treasury. More costly progams result

in larger deficits or, alternatively, require additional tax

revenue to be raised 2_l or require reductions to be made in

other types of government spending. More costly programs also

leave relatively less room to introduce other new spending

programs or to enact tax reforms that cut taxes.

Cost estimates for alternative subsidy programs are given

in the next chapter. It should be noted, however, that in general

tax deferrals and other types of loans are, by their nature, less

costly in the long run than are tax credits, deductions, or other

types of grants of the same magnitude. 3/ Loans assist families

jY The criteria developed here do not exhaust all possibilities, but they do provide a basis for budgetary decisionmaking. Different readers may find some of the criteria more

important than others and thus can place more weight on them

when deciding among alternatives..

2_f If taxes are raised to finance an education subsidy program

for middle-income families, those receiving the subsidy may

find that they must pay higher taxes for a long time in

exchange for relatively short-term relief.

_3/ If the government's discount rate were equal to the interest

rate charged on loans, the present value of the government's

cost for loan programs would be zero (except for administrative and default costs).

24
by providing them with liquidity and allowing them to spread their

financial burdens over an extended period of time. Grants, in

contrast, provide relief with no payback requirement, kj Grant

and loan programs having the same long-term budget cost will,

therefore, differ in the amount of short-term relief provided.

Loans can provide greater short-term relief than grants having the

same long—term cost since loans are repaid.

The cost of a particular loan or grant program will depend on

its characteristics. By changing subsidy amounts and eligibility

restrictions,program costs can be set at whatever level desired.

This point will be illustrated by considering cost-reducing

variations in some of the programs described in Chapter V.

DISTRIBUTIONAL EFFICIENCY

A government subsidy program is efficient wheih it serves the

intended purpose at minimum cost. Alternatively, an efficient

subsidy is one which provides maximum desired benefits for a given

cost. As indicated in Chapter II, the main objective of most

proposals for education tax allowances apparently is to distribute

additional educational aid to students from middle-income families.

Thus, in measuring the distributional efficiency of alternative

student aid programs in the next chapter, attention will be given

to the portion of total benefits that accrues to middle-income

students rather than to those in other income groups. Although

the definition of "middle-income families" is not rigid, a review

of recent Congressional proposals for education tax allowances

suggests that the $10,000 to $25,000 income group is a reasonable

approximation of the target group of many proposals.

This narrowly defined measure of efficiency ignores the question of whether additional federal funds should be spent for

higher education subsidies and, if so, whether the benefits should

be focused on middle-income families. It also does not measure

the efficiency of these subsidies in meeting other possible

education policy goals, such as increasing higher education

opportunities for those who could not otherwise attend college.

47 Under tax deferrals or other types of loan programs, the

recipient is the one who bears the burden of repayment. Under

tax credits, deductions, or other grant-like programs, the

general public bears the burden of payments.

25
Nevertheless, it is an important criterion when one is simply

concerned with deciding on an appropriate way to assist middleincome students.

The distributional efficiency of a student subsidy for

education expenses is reduced to the extent that institutions

capture the benefits either by raising fees or by altering their

financial aid policies. When the subsidy is generally available

to most students and can be used to offset costs on a dollar-fordollar basis, institutions could raise student fees without

losing many students since most students would not experience a

net increase in college costs. Even when the subsidy is focused

on a narrowly defined group of students or when less than a dollar

of costs can be offset by each dollar of subsidy, institutions

nevertheless could capture the subsidy without losing students

by simultaneously raising fees and providing additional aid to

selected students. Finally, in those cases in which students who

are receiving financial aid from an institution also qualify for

the subsidy, the institution could capture the subsidy by reducing

its financial aid to those students.

Although these strategies would capture the student subsidy,

it is not clear whether schools or state legislatures that often

mandate fees at public institutions would fully exploit the

opportunity. Certainly institutions have significant pressures

to raise fees since the costs of supplying education services have

increased substantially in recent years. In addition, with the

last of the postwar baby boom generation now largely through

college, this source of enrollment growth can no longer be

counted upon to defray rising institutional costs. At the same

time, those institutions faced with declining enrollments may want

to obtain an advantage in the competition for students. They

therefore might not raise student fees or reduce their financial

aid to students even though other institutions were doing so in

response to student subsidies.

FAIRNESS AND EQUITY

Issues of fairness and equity are also appropriate considerations when evaluating alternative education subsidy programs.

People may differ in their judgment as to what constitutes a fair

distribution of subsidy payments (whether or not the payments are

distributed through the tax system). In general, however, most

people probably believe that subsidies should be distributed

26
either (a) equally among all recipients regardless of income or

(b) progressively, with those with more income receiving smaller

subsidies than those with less income.

For example, the distribution of welfare payments may be

considered equitable because the benefits are based on financial

need—those with less income but similar in other respects get

larger benefit checks than those with more income. In contrast,

G.I. Bill education benefits and the insulation tax credit proposed in President Carter's energy program provide benefits

without regard to income. Although G.I. Bill education benefits

vary depending on whether the veteran attends school on a fulltime or part—time basis and on the number of dependents the

veteran is supporting, those veterans in similar circumstances in

these respects receive the same amount of monthly benefits regardless of their other income. The insulation tax credit would be

varied in accordance with insulation costs to the taxpayer, not

with respect to his income. 5j

When subsidies are distributed through the tax system, they

may also be judged also on the basis of how they affect equity

among taxpayers who are similarly situated (horizontal equity) and

among taxpayers with different incomes (vertical equity). This

issue, however, has not played an important role in shaping most

education tax allowance proposals, and tax policy has not been

used as a criterion for evaluating education tax subsidies in the

next chapter. Appendix B provides a discussion of tax equity,

including consideration of when tax subsides for education may be

appropriate and how such subsidies may be evaluated in terms of

tax equity.

MAINTAINING INSTITUTIONAL DIVERSITY

A relevant criterion for evaluating alternative student aid

progrms is whether they are likely to have a neutral or nonneutral

effect on the competitive balance between private (independent)

5/ Strictly speaking, the benefits of an insulation tax credit

would be distributed equally regardless of income only if the

credit is refundable. The Administration-proposed insulation

tax credit is not refundable.

27
and public institutions. 6/ Although its effect is difficult to

forecast, a subsidy could affect the proportion of students at

public and private institutions in two ways.

First, a subsidy to students will lower the net price of

higher education—assuming that institutions do not capture it

through higher fees or other policies. ]_/ Little can be said with

confidence, though, about the net change in enrollments at public

and private institutions resulting from a general lowering of the

price of higher education.

Second, changes in the cost difference between public and

private institutions brought about by the subsidy can be measured

either in absolute or relative terms. If it costs $4,000 to

attend a private college and $2,000 to attend a public institution, the absolute cost difference is $2,000; in relative terms,

the private school costs twice as much. A $1,000 student subsidy

would reduce the net price of attending these schools to $3,000

and $1,000, respectively. Although this subsidy would not change

the absolute cost difference, it would raise the relative price of

attending the private institution to three times the price of

attending the public institution ($3,000/$1,000 = 3). This

increase in the relative price of the private institution may

induce some students to attend the public institution whose

relative price has fallen.

jj/ Congressman Barber Conable, Jr,, (R.-N.Y.), for example, has

expressed concern about the financial viability of private

institutions. See Tuition Tax Credits, Hearings before the

House Budget Committee's Task Force on Tax Expenditures,

Government Organization and Regulation, 95:1 (1977), pp.

19-25. In their recent study, Bowen and Minter conclude that

private institutions are holding their own relative to public

institutions. See W. John Minter and Howard R Bowen, Private

Higher Education; Third Annual Report on Financial and Educational Trends in the Private Sector of American Higher

Education (Association of American Colleges), 1977, p. 61.

T_l When institutions raise tuitions or reduce student aid, they

benefit at the expense of students. If institutions do not

change their tuition or financial aid policies, students

retain the subsidy and institutions may benefit from increased

enrollments.

28
On the other hand, if the subsidy is a percentage of cost,

the relative costs would remain the same as they were before the

subsidy, but the absolute cost difference would change. If, in

the above example, a subsidy were provided for 25 percent of

education expenses, the net cost of attending the private school

would fall to $3,000 while the net cost of the public school would

decline to $1,500. The relative price difference is unchanged

(the private school still costs twice as much as the public), but

the absolute cost difference is reduced from $2,000 to $1,500. In

general, subsidies which reduce the absolute cost difference (the

"tuition gap") are likely to favor institutions with higher

costs.

In short, flat amount subsidies increase the relative cost

difference and tend to favor public institutions while percentageof-cost subsidies reduce the absolute cost difference and tend to

favor private institutions. The next chapter will analyze student

subsidies in terms of their impact on the absolute and relative

price difference of these institutions.

EASE OF ADMINISTRATION

A desirable feature of an education subsidy program is ease

of administration. An easily administered program will generally

involve fewer administrative costs and shorter delays in the

distribution of benefits

A number of factors bear on the ease of administration. If

eligibility must be certified before payment of benefits, an

agency must make the determination. Generally, direct spending

programs have required such agency certification. In contrast,

tax programs give benefits to anyone who claims them; "certification" is achieved subsequently by auditing a small percentage of

claims.

Programs that impose several restrictions on the eligibility

of applicants and on the type of benefits claimed will require

more diligent monitoring of the distribution of benefits. This

monitoring will generally be more difficult to perform when the

agency responsible for administering the program is not the

agency most familiar with making the type of evaluations required

by the restrictions of the program.

The tax system may be as efficient as other mechanisms for

distributing subsidy payments when the subsidies are generally

29
available to most taxpayers, when certification of eligibility

is not required, and when unfamiliar or unusual evaluations

by the Internal Revenue Service are not necessary. Under these

conditions, administration of the program may be similar to such

routine functions as the distribution of refund checks. When the

subsidy does not have these features, however, the tax system

loses its ability to operate as an easily administered distribution mechanism.

The alternative subsidies discussed in the next chapter will

be evaluated in light of their potential for administrative

complexity. Where possible, differences in administrative difficulties will be indicated.

BUDGET VISIBILITY AND CONTROLLABILITY

The final standard that will be used to compare alternative

student aid subsidies is how visible and controllable a program is

in the federal budgetary process. Programs that are more visible

than others are more likely to be subject to annual review and

thus have a greater potential for better control.

Despite a growing recognition and understanding of tax

expenditures, they are not highly visible in the federal budget

process, _8_/ and no procedure for regular review of tax subsidies

has been developed. Unlike most direct spending programs, tax

expenditures are entitlements, which generally do not require

annual budget authorization and appropriations and thus are not

8/ The first tax expenditure budget was published in 1968.

See U.S. Department of the Treasury, Annual Report of the

Secretary of the Treasury for Fiscal Year 1968, pp. 326-40.

The Congressional Budget Act of 1974, P.L. 93-344 (July 12,

1974) requires that the President's budget include a list of

tax expenditures (Sec. 601). The most recent tax expenditure

budget presented by the Administration appears in Special

Analyses, Budget of the U.S. Government, Fiscal Year 1978,

pp. 128-30, Table F-l. The House and Senate Budget Committees also present tax expenditure estimates. See, First

Concurrent Resolution on the Budget for Fiscal Year 1978, H.

Rept. 189, 95:1 (1977), pp. 109-20 and First Concurrent

Resolution on the Budget for Fiscal Year 1978, S. Rept. 90,

95:1 (1977), pp. 19-25.

30
subject to the discipline of the budgetary process imposed on

most other programs.

Advocates of student aid subsidies may not desire high

budgetary visibility and controllability—these features might

increase the likelihood that the subsidy will compete with other

education programs for Congressional support and limited federal

funds. This group therefore would probably prefer tax allowances

(which also may be attractive because some people may believe that

tax subsidies really do not involve the spending of federal

funds). On the other hand, those who would not benefit from

education tax allowances and those whose main concern is maintaining control over the budget may prefer direct grants or other

subsidy forms that are relatively more visible and controllable

than tax allowances.

31
CHAPTER V. ALTERNATIVE PROGRAMS OF AID FOR MIDDLE-INCOME

STUDENTS

This chapter analyzes five alternative mechanisms for distributing additional federal aid to students or their families,

especially those in middle-income classes. JY These mechanisms

include tax and nontax programs in the form of both grants and

loans. (A tabular overview of this analysis is provided in the

Summary.)

TAX CREDIT OR CREDIT/DEDUCTION OPTIONS

Several different types of benefit formulas and eligibility

criteria can be combined to produce alternative tax credit and

credit/deduction plans for the expenses of higher education. One

option would be simply to provide a nonrefundable $250 tax credit

for every student, applicable to expenses for tuition, fees,

books, supplies, and equipment. 2j Another possibility would be

to grant an option to choose between a nonrefundable $200 tax

credit or a $1,000 deduction. Each of these two plans could be

modified to reduce revenue losses and/or focus benefits more

precisely on middle-income families,. The specific modifications

considered here are (1) reducing the size of each tax credit

by 1 percent and the size of each deduction by 5 percent of

adjusted gross income above $25,000 and (2) limiting the size of

JY As indicated earlier, the analysis does not address the

fundamental issues of whether additional federal funds should

be spent for higher education and, if so, whether education

policy is best served by focusing the aid on students in the

middle-income group.

2_/ For this and other tax options considered in this chapter,

it is assumed that the subsidy will be prorated for part-time

students. Eligible students are defined to include taxpayers,

spouses, or dependents who maintain at least half of a

full-time course load at postsecondary institutions of higher

education or vocational schools.

32
the allowance for one-student families to one-half the amount that

can be taken for second and subsequent students in a family

with two or more students €>nrolled in school simultaneously.

Cost and Distributional Efficiency

Table 5 shows that slightly less than half (49.4 percent) of

the tax savings from a nonrefundable $250 credit costing about

$1.7 billion would go to taxpayers with incomes between $10,000

and $25,000, and 37.3 percent would go to families whose incomes

exceed $25,000. Table 6 shows that, under a nonrefundable

$200-tax-credit/$l,000-deduction option costing about $1.9 billion, middle-income families would receive a smaller proportion

(41.7 percent) than under the $250 credit plan, but those having

at least $25,000 of income would receive more—48.2 percent. This

shift in the proportion of benefits from low- and middle-income

families to upper-income families occurs because tax deductions

are worth more than tax credits to those in higher income tax

brackets and are worth less than credits to those in lower tax

rate brackets.

If a general $250-per-student tax credit were reduced by 1

percent of the taxpayer's adjusted gross income above $25,000, the

cost of the program would be lowered to $1.4 billion. Middleincome families would get 59.6 percent. No taxpayer earning more

than $50,000 would benefit. 3/

The cost of a nonrefundable $200-tax-credit/$l,000-deduction

program of the same sort but with the credit phased down by 1

percent and the deduction phased down by 5 percent for each dollar

of adjusted gross income above $25,000 would be $1.3 billion.

Those earning between $10,000 and $25,000 would get 58.4 percent

of the tax savings. Families earning more than $45,000 would not

benefit from this option.

Instead of phasing down the allowances for incomes above

$25,000, the size of the credit or deduction could be reduced

37 A family earning nore than $50,000 would benefit from a

credit if the credit were not phased out on a per-student

basis and if the family had more than one member in school at

the same time. See Chapter III, footnote 7.

33
TABLE 5. SIZE AND DISTRIBUTION OF BENEFITS UNDER A NONREFUNDABLE

TAX CREDIT OF $250 COSTING APPROXIMATELY $1.7 BILLION IN

FISCAL YEAR 1978 a/

Adjusted Gross Income Class

(Dollars in Thousands)

0-K) 10-25 25+ All Groups

Aggregate Benefits

(Dollars in Millions) 223 831 628 1,682

Percentage of Total

Benefits 13.3 49.4 37.3 100

Average Benefit

Per Eligible

Student (Dollars) b/ 143 160 213 174

a/ CBO estimate based on data from the U.S. Bureau of the

Census; data from the U.S . Offic e of Education, National

Center for Education Statistics; data supplied by Joseph

Froomkin, Inc.; and tax data published by the U.S. Department

of the Treasury, Internal Revenue Service.

b/ The average benefit for students with family incomes above

$25,000 is greater than that for students in the $10,000-

$25,000 income class because those in the higher income group

are more likely to attend school on a full-time basis. The

average benefit for full-time students in both of these income

classes would be $250. Many full-time students with family

incomes below $10,000 would not get the full credit because

the family's tax liability is less than $250.

34
TABLE 6. SIZE AND DISTRIBUTION OF BENEFITS UNDER A $200-CREDIT/

$1,000-DEDUCTION OPTION COSTING APPROXIMATELY $1.9 BILLION

BILLION IN FISCAL YEAR 1978 a/

Adjusted Gross Income Class

(Dollars in Thousands)

O-lo 10-25 25+ All Groups

Aggregate Benefits

(Dollars in Millions)

Percentage of Total

Benefits

Average Benefit

Per Eligible

Student (Dollars)

188 777 899

10.1 41.7 48.2

120 150 305

1,864

100

192

aj CBO estimate based on data from the U.S. Bureau of the

Census; data from the U.S. Office of Education, National

Center for Education Statistics; data supplied by Joseph

Froomkin, Inc.; and tax data published by the U.S. Department

of the Treasury, Internal Revenue Service.

35
by half for the first student a family has enrolled in school,

with the higher level retained for second and subsequent students

enrolled in school at the same time. This would reduce the total

cost of the plan substantially since only about one family out of

seven with students in school has more than one student in school

at the same time, kj (To take care of families who have students

attending school back-to-back rather than simultaneously, eligibility for the higher subsequent-student benefit might be extended

for a period of time after the first student graduates.)

This restriction on benefits would lower the total cost of

the tax credit plan to $1.1 billion. It would also change the

distribution of benefits somewhat. Families earning between

$10,000 and $25,000 would get a slightly smaller share (47.2

percent) than under the unrestricted credit plan, and those

earning more than $25,000 would get a slightly larger share

(40.8 percent). This change in distribution occurs because

high-income families are more likely to have more than one student

in school at the same time. _5_/

If the tax credit/deduction option were modified in the same

way, the total cost of the plan would be lowered to $1.2 billion,

with 39.1 percent going to middle—income families and 52.0 percent

to upper-income families.

Fairness and Equity

The tax credit option is more appropriate than the credit/

deduction option for those who believe that subsidies should not

4_/ U.S. Bureau of the Census, Survey of Income and Education

(Spring 1976).

_5_/ Ibid. If this form of tax allowance were adopted, low-income

families who currently cannot afford to send more than one

student to school at the same time might become able to do so.

To the extent that such behavior is induced by the allowance,

low-income families would get somewhat more than 12.0 percent

of the benefits.

36
be larger for those with higher incomes. 6j If, because of income

distribution considerations, one prefers a more progressive

distribution of subsidies than that provided by a simple tax

credit, then the tax credit that is phased down for families

with adjusted gross incomes above $25,000 is more appropriate than

the one which is not. Reducing the size of the allowance for a

family's first student produces a less progressive distribution of

benefits than that realized under the simple tax credit since

those in higher income groups are more likely to have more than

one student in school at the same time.

Maintaining Institutional Diversity

The tax credit and credit/deduction options presented above

may have an adverse impact on the competitive position of the more

expensive private schools because they do not reduce the absolute

cost difference of attending these schools but do raise the

relative price of attending private institutions (see Chapter

IV) . The reason is that they provide fixed dollar benefits

rather than benefits determined as a percentage of qualified

expenses. ]_/

The modified plans that reduce the size of the tax allowance

for the family's first student or phase down the allowance for

6J As indicated in footnote _b/ of Table 5, the $250 tax credit

plan would provide the same average benefit ($250) for fulltime students in both the middle- and upper-income groups.

Many full-time students with family incomes below $10,000,

however, would not get the full $250 credit because the

family's tax liability is too low and the credit is not

refundable.

Tj As indicated in Chapter IV, an example of an allowance that

would reduce the absolute cost difference between high- and

low-cost schools but would not change the relative price

difference is a tax credit (or credit/deduction option) equal

to 25 percent of qualified expenses. An allowance which would

generally reduce the relative cost of attending a high-cost

institution is one which applies only to expenses above some

level, say $500.

37
those earning more than $25,000 would have less of an impact on

the competitive balance between public and private schools simply

because, with many students eligible only for reduced allowances,

fewer students would experience as much change in relative prices.

Ease of Administration

The ease of administering an education tax credit or credit/

deduction program depends mainly on the extent to which restrictions are imposed. Therefore, the relatively unrestricted tax

credit and credit/deduction plans presented above rank somewhat

higher in terms of administrative ease than do the modified plans

that depend on the family's income or on the number of students a

family has in school. The difference, however, is probably not

great. The effective monitoring of any of these tax allowances,

of course, would require the IRS to verify that students for whom

allowances have been claimed are in fact attending school on

at least a half-time basis.

Budget Visibility and Controllability

Even with the annual reporting of tax expenditures, an

education tax credit or credit/deduction plan would rank low in

terms of budgetary visibility and controllability. The tax

expenditure concept is still relatively new, and tax subsidies in

general tend not to receive as much review and scrutiny as direct

subsidies. More importantly, however, an education tax allowance

is an entitlement program that provides benefits for all students

who qualify. Once subsidy amounts and eligibility requirements

have been established, program costs cannot be controlled because

they are not subject to fixed appropriation ceilings.

BASIC EDUCATIONAL OPPORTUNITY GRANTS

Another way to provide more student aid for the middle-income

group would be to expand the Basic Educational Opportunity Grants

(BEOG) program that is currently designed to assist low- and

moderate-income students. _8/ One option would be to increase the

Q /

—' Other needs-tested student assistance—such as Supplemental

Educational Opportunity Grants and the Work/Study Program—also

38
size of the maximum award to $2,100, 9_/ and to reduce from

30 percent to 20 percent the share of "discretionary income" above

$5,000 that a family is expected to contribute toward the financing of higher education costs. 10/ Although these program

changes would increase the amount of aid going to those already

receiving BEOGs, the changes would also extend benefits to 490,000

middle—income students who now do no't qualify because their family

income is too high.

Cost and Distributional Efficiency

Table 7 shows that the above-described changes in the BEOG

program would cost $812 million. Approximately 72 percent of these

additional funds would go to families earning between $10,000 and

$25,000, while families earning more than $25,000 would receive an

insignificant share. This option ranks higher, in terms of distributional efficiency, than the tax allowances discussed earlier

since middle-income students would get a larger share of total

additional benefits, ll/ It should be noted, however, that fewer

students (including those from middle-income families) would

benefit from these changes in the BEOG program than from the

could be changed to include a greater number of middle-income

students. A broad approach of this sort might give a more

complete coverage to needy middle-income students.

_9_/ The Education Amendments of 1976 raised the ceiling on the

maximum award from $1,400 to $1,800. Fiscal year 1978 appropriations for the BEOG program, however, will effectively

limit the maximum award to $1,600 for this year.

1Q/ Discretionary income is basically adjusted gross income plus

transfer payments minus both federal taxes and the amount of

income needed to sustain a family at the poverty level.

ll/ A change in the BEOG program that lowers to 20 percent

the expected contribution rate on discretionary income but

does not raise the BEOG ceiling would cost $155 million.

Approximately 87 percent of these additional funds would go

to middle-income students. In contrast, a change that raises

the BEOG ceiling from $1,600 to $2,100 but that does not

lower the contribution rate would cost $698 million, of which

only 65 percent would go to middle-income students.

39
TABLE 7. DISTRIBUTION OF ADDITIONAL BENEFITS FROM RAISING THE

MAXIMUM BEOG AWARD TO $2,100 AND LOWERING THE FAMILY

CONTRIBUTION RATE FROM 30 TO 20 PERCENT ON DISCRETIONARY

INCOME ABOVE $5,000 a/

Adjusted Gross Income Class

(Dollars in Thousands)

0-10 10-25 25+ All Groups

Distribution of

Additional Benefits

(Dollars in Millions) 22:4 588 — 812

Percentage of

Additional Benefits 27.6 72.4 — 100

Average Additional

Benefit Per

Recipient (Dollars) b/ 163 383 — 279

aj CBO estimates based on simulations with the U.S. Office of

Education's BEOGs estimation model, updated December 1977.

b/ To estimate how the incremental $812 million would be distributed among recipients on average, it was assumed that the

average award for new beneficiaries would be the same as the

increase in award size for those already in the program.

40
tax allowances discussed above since the eligibility limitations

in the BEOG program are more restrictive. 12_/ The tax allowances

would provide benefits to all students attending college on at

least a half-time basis. In contrast, the BEOG program restricts

benefits to students who can demonstrate financial need on the

basis of college costs and expected family contribution.

The average additional award associated with these changes

in the BEOG program would be larger for those in the middle-income

class than for those with low family incomes, although low-income

students would continue to receive larger overall awards than

those going to middle-income students. 13/ Two reasons account

for this outcome. First, very few students with family income

below $10,000 will benefit from the reduced contribution rate

on discretionary income above $5,000 since the discretionary

income of most families in this group is less than $5,000.

Second, many low-income students now eligible for BEOGs attend

relatively low-cost schools and would not benefit fully from an

increase in the maximum award from $1,600 to $2,100 because of a

program restriction that limits the award to one-half the cost of

college attendance.

Middle-income students would benefit from both program

changes to a much greater extent. More of these students would

benefit fully from the maximum award increase to $2,100 because

their attendance at high-cost institutions makes the half-cost of

attendance limitation on BEOG awards less likely to be binding.

Middle—income students also would benefit more than low-income

students from the reduction from 30 to 20 percent in the fraction

of discretionary income above $5,000 that a family is expected to

contribute.

Fairness and Equity

These changes in the maximum BEOG award and the expected

family contribution would not result in a uniform distribution of

12/ Eligibility requirements of the BEOG program are outlined

in Appendix A.

13/ Under a BEOG program with a $2,100 maximum award and a 20

percent family contribution rate on income above $5,000, the

average awards would be $1,135 for those with incomes below

41
additional funds among recipients. Students in the middle-income

group would get relatively larger additional average benefits than

those in the low-income group. In this respect, the distribution of benefits resembles that resulting from the tax allowances

discussed earlier. 14 / If a somewhat more equal distribution of

subsidies than that resulting from these BEOG program changes is

considered more equitable, the share of discretionary income above

$5,000 that a family is expected to contribute could be left

unchanged at 30 percent when the maximum BEOG award is raised to

$2,100.

Maintaining Institutional Diversity

For all students whose BEOG awards would not be limited by

the half-cost-of-attendance restriction, the program changes would

provide the same amount of funds regardless of the type of school

attended and thus would raise the relative cost of attending a

high-cost institution, although the absolute cost difference would

remain unchanged. For students whose awards are restricted by the

half-cost-of-attendance limitation, the program changes generally

would lower the absolute cost difference of attending a highpriced private institution. In this case, the relative price of

attending a private institution could go up or down, depending on

how much the half-cost-of-attendance limitation restricted the

size of grants for those attending public institutions.

Ease of Administration

An expansion of the BEOG program of the sort described here

could be accommodated by the existing system without substantially

changing the nature of program operations. This mode of distributing more student aid to middle-income families necessarily would

share the administrative problems associated with the current BEOG

$10,000 and $784 for those with incomes between $10,000

and $25,000.

14/ As indicated in footnote b/ of Table 5, full-time students

in the middle-income group would receive an average benefit

of $250 under the tax credit plan. Many full-time students

with family incomes below $10,000, however, would not qualify

for the full credit because the family's tax liability

is less than $250 and the tax credit is not refundable.

42
program, including the detection of fraud and other abuses. 15/

It would involve a greater administrative burden than the tax

allowances discussed above since more benefit claims are verified

under the BEOG program than under the tax system, where only a

very small percentage of returns is audited.

Budget Visibility and Controllability

Changes in the- BEOG program would rank high in terms of

visibility and controllability. Since the BEOG program is a

direct spending program, its authorizations, appropriations, and

outlays are reviewed annually in the course of the budget process.

According to the BEOG legislation, the annual cost of the program

can be kept within appropriation limits by reducing the average

award size. In practice, however, when total grants have exceeded

appropriations, the policy generally adopted has been to request

supplemental appropriations rather than to reduce subsidy amounts.

This course of action has resulted in less hardship for students

and institution administrators.

STUDENT LOANS

If the Congress decides that loans rather than grants should

be used to provide more assistance to students from middle—income

15/ The extent of fraud and other abuses in the BEOG program is

not known. A study conducted for the Office of Education

concludes that "the degree of income misreporting [fraud] is

small and the impact of misreporting is minor." Applied

Management Sciences for the U.S. Office of Education, Validation of Student and Parent Report Data on the Basic Grant

Application Form, vol. 6 (November 23, 1976), p. 6,. Other

abuses in the program include students' enrolling in college, receiving basic grants, then dropping out of college.

See Karen J. Winkler,"How Much Fraud in Basic Grants for

Students," Chronicle of Higher Education (April 4, 1977), p.

11. Program administrators indicate that when fraud and

abuses have been discovered in the BEOG program, steps have

been taken to curb them (telephone conversation with Peter K.

Voigt, former Director of the BEOG program, January 4,

1978).

43
families, an expansion of the current federal loan programs

might be considered. Direct federal loans are now made through

the National Direct Student Loan Program (NDSLP); most nonfederal

loans are guaranteed under the Guaranteed Student Loan Program

(GSLP), which was established in 1965 specifically to aid middleincome families who face liquidity problems. If it is considered

desirable to minimize the structural changes in the existing loan

programs, then the GSLP is probably better suited to direct

additional assistance to middle-income and upper middle-income

students. Because of its needs test, the NDSLP focuses relatively

more assistance on low-income families than does the GSLP, which

has no strict needs test. 16/

The Education Amendments of 1976 made more middle-income and

upper middle-income families eligible for GSLP benefits by raising

from $15,000 to $25,000 the ceiling on adjusted family incomes

that qualify a student for federal payment of interest charges

while the student is in school. _!?_/ Also the total amount of

loans a student can borrow for undergraduate training was increased from $7,500 to $10,000, while the total available for

undergraduate and graduate training combined was raised from

$10,000 to $15,000. 18/ These changes will not only provide an

"in—school" interest subsidy to mo>re middle-income families and

allow each student to borrow more but are also expected to result

in a greater number of loans made to this group.

Theoretically, any student can obtain a 7 percent loan

under the GSLP even if the student's family income makes the

student ineligible for the in-school interest subsidy. In practice, however, only about 4 penrcent of all loans have gone to such

16/ Under the GSLP, however, an applicant is required to verify

that the funds will be used to finance education expenses.

_T7/ Justification of Appropriations Estimates for Committee on

Appropriations, Fiscal Year 1978, revised vol. 2, p. 185. An

adjusted family income of $25,000 corresponds to an adjusted

gross income of approximately $31,000. The higher-income

ceiling will extend eligibility for GSLP benefits to about 85

percent of all students (CBO estimate).

18/ Justification of Appropriations Estimates, p. 185.

44
students. 19 / The apparent reason is that banks refrain from

making many loans to students who do not qualify for the in-school

interest subsidy because it is more costly and difficult to

obtain interest payments from many individual students while they

are in school than it is to collect interest payments from one

source--the government. If this is the case, extending the

in-school interest subsidy to those with family incomes ranging

from $15,000 to $25,000 should result in more student loans going

to these families.

The benefits to middle—income and upper middle-income families resulting from the 1976 amendments probably could be enhanced

most by encouraging banks to increase the amount of guaranteed

student loans (GSLs) in their loan portfolios. 20/ A scarcity of

GSLs is now a major shortcoming of the GSLP. More GSLs might be

provided by lenders if their net rate of return on GSLs were

increased.

In addition to the 7 percent rate now charged on GSLs,

lenders receive a "special allowance" from the government when

market interest rates are high. The special allowance (2 7/8

percent for the fourth quarter of 19-77) 21/ is related to the rate

on three-month Treasury securities and can be as large as 5

percent. The net rate of return on GSLs, however, is reduced by

the high cost of complying with administrative procedures.

19/ U.S. Office of Education, Analysis of Student Borrower and

Loan Characteristics; Guaranteed Student Loan Programs, Draft

(January 1974).

2Q/ Somewhat higher benefits for middle-income students could

also be realized through federal payment of some of the

interest costs now borne by students and by further raising

(or eliminating) the limit on the amount of funds that a

student can borrow. For those who believe that student aid

should be extended to families with adjusted gross incomes

above $31,000, raising the ceiling on the amount of family

income that qualifies a student for the in-school interest

subsidy might be an attractive alternative.

21/ Source: U.S. Office of Education.

45
The net rate of return to banks could be improved by increasing the rate charged to students (although this would reduce the

student's subsidy), by raising the special allowance, or by

reducing the bank's administrative costs. Increases in the basic

rate and the special allowance have been considered by the Congress. The Office of Education has implemented some procedures to

reduce administrative costs, such as centralization and automation

of recordkeeping and report filing. Greater efforts in these

areas might induce banks to provide more student loans.

Cost and Distributional Efficiency

Fiscal year 1977 federal outlays for interest and default

payments on GSLs amounted to $447.6 million. 22/ The volume of

loans made in fiscal year 1977 was $1.47 billion. Since data on

the effect of the 1976 amendments on the volume and distribution

of GSLs among income groups is not available, quantitative statements cannot be made about the benefits accruing to middle-income

families. Banks have wide discretion in determining the volume

of loans they will provide and to whom the loans will be made.

Quantitative estimates of their response (and that of student

borrowers) would necessarily involve arbitrary assumptions.

As noted above, though,, it seems reasonable to expect that

middle-income and upper middle-income students will receive a

substantially larger portion of GSLs than before. This outcome

would result from the extension of subsidy eligibility to these

families and from a tendency for banks to favor students in the

middle-income group if such students are thought to have a lower

default rate than those in low-income groups. The effect of these

two factors on the amount of aid going to middle-income families

would be magnified if the willingness of lenders to provide a

larger volume of GSLs were increased.

Fairness and Equity

Since all qualified students are potentially eligible for

loans of the same size and at the same interest rate, this GSLP

22/ Of the total, $305 million was spent for interest payments,

and $142.6 million was spent on default payments. Source:

46
option would be considered equitable by those who maintain that

education subsidies should be distributed equally among all

recipients. For those who believe that a progressive distribution

of benefits is more equitable, a loan program which charges lower

interest rates to those with less income might be preferred. (The

NDSLP currently extends loans to low- and moderate-income students

at an interest rate of 3 percent.)

Maintaining Institutional Diversity

Guaranteed student loans make available the same maximum

amount of funds to students attending private and public institutions although the amount borrowed will generally depend on the

amount of expenses incurred. Students who do borrow the maximum

amount in either case will not experience an absolute dollar

change in the current cost difference between high- and low-priced

schools, but the relative out-of-pocket cost of attending a more

expensive private school will generally rise. If students could

borrow as much as they want rather than the fixed dollar limit now

allowed, this option would not necessarily affect relative prices

since students could borrow enough to cover the same percentage of

costs at either type of institution. In this case, the absolute

difference in current costs would be reduced—a result that would

probably favor private institutions. Of course, except for

interest payments, GSLs do not—and would not even if the program

were expanded— alter the long-run cost difference between public

and private institutions.

Ease of Administration

Changes in the GSLP that provide more benefits to middleincome and upper middle—income students are not likely to increase

the administrative problems of the program, foremost of which is a

high default rate on GSLs (12.5 percent in fiscal year 1977). 23/

In fact, if these students prove to have lower default rates,

administering the GSLP could become easier.

U.S. Office of Education. Data on administrative costs were

not available when this report was completed.

—' This 12.5 percent default rate on GSLs excludes defaults

resulting from deaths and disablements. Source: U.S.

Office of Education.

47
Budget Visibility and Controllability

Guaranteed student loans are moderately visible in the

budgetary process, but are not very controllable. Unlike tax

expenditures, outlays for the GSLP (interest and default payments

and administrative costs) 24 / are reported under the education

function in the budget and are subject to the review and scrutiny

given to other direct outlays. The federal government, however,

is obligated to make interest and default payments for whatever

volume of GSLs that lenders supply. In this respect, they are

like education tax allowances. But since federal outlays for GSLs

are only a fraction of the liquidity benefits provided by loans,

each dollar of federal funds supports more than a dollar of

student benefits. In contrast, each dollar of tax allowances and

other types of grants costs the government more than a dollar when

administrative costs are taken into account.

LOANS TO PARENTS

If the 1976 changes in the GSLP and increased incentives for

banks to expand their volume of guaranteed student loans fail to

promote enough student loans to satisfy the liquidity needs of

middle-income families, another course of action might be to

establish a loan program for parents. A loans-to-parents program

would assist those families now unable to obtain a GSL. Such

families may find it difficult to get GSLs because their incomes

are too high for them to qualify for the federal in—school interest subsidy. Another reason is that banks may be reluctant to

lend to students whose default rates are high and who are often

difficult to locate when repayment is overdue. Loans to parents

would also help families who need more liquidity than the annual

maximum of $2,500 per student now offered under the GSLP.

A loans-to-parents program might offer loans of as much as

$5,000 per year for each student the family has enrolled in a

postsecondary institution if education expenses required this much

borrowing. The repayment period could be set somewhere between 5

and 10 years, with monthly payments of interest and principal

beginning immediately after the loan is made. Alternatively,

24/ The Budget of the United States Government, Fiscal Year

1978, app., pt. I, p. 341.

48
if more relief while the student is in school is desired, repayment of principal could be postponed until some time after the

student finishes college. An interest rate of between 8 percent

and 10 percent could be charged, perhaps varying with the length

of the repayment period. If no collateral were required, a

federal guarantee would undoubtedly be needed to induce most

private lenders to participate, and during periods of high interest rates, a supplemental federal interest payment to lenders

might be necessary to insure an adequate supply of capital.

Generally, though, private lenders might be more attracted to a

guaranteed loans-to-parents program than to the current GSLP since

loans to parents are likely to incur fewer administrative costs

and a lower default rate than loans to students.

Although many middle—income and upper middle—income families

have liquidity problems that make it difficult for them to pay

large, lump-sum education costs, 25/ these families generally have

sufficient incomes to make monthly payments on long—term education

loans. In contrast, recently graduated students are less likely

to have sufficient income to repay their GSLs.

Currently 17 colleges and universities participate in a

coordinated system of "Parent Loan Plans." 26/ Under this program, nonguaranteed, nonsecured loans expected to average $4,000 a

year are provided by the institutions to families with incomes

generally between $20,000 and $60,000. Interest rate charges

range between 8 and 8 1/4 percent. The repayment period is

generally between six and eight years, with repayment of both

interest and principal made in monthly installments beginning soon

after the loan is made.

Cost and Distributional Efficiency

The federal cost of a loans-to»parents program would depend

mainly on the size of supplemental interest payments to banks (if

25/ The largest asset for most families is their house, and many

homeowners are reluctant, to apply for second mortgages.

26 / See Karen J. Winkler, "Private Colleges Weigh Loans To

Parents Earning $20,000 to $60,000," Chronicle of Higher

Education, March 21, 1977, p. 3. The Office of Education

staff also provided information about this program.

49
the program's success required such payments) and on the number of

defaults. If the interest rate charged to parents were significantly higher than the 7 percent rate now charged on GSLs, smaller

supplemental interest payments would be needed during periods of

very high interest rates. Federal interest payments for each

dollar of loans to parents would also be less than under the

current GSLP since under the program outlined above the government

would not be assuming responsibility for the payment of interest

charges while the student is in school.

The federal cost per dollar of loans to parents also might be

expected to be lower than the $.24 per dollar of loans disbursed

under the GSLP thus far, 27/ since default rates would probably be

lower when parents rather than students are liable for loans.

The share of loans that would go to middle-income families

under a loans-to-parents program is difficult to estimate. As in

the case of the GSLP, the outcome would depend on which families

decide to apply for the loans and on the decisions by banks

regarding the amount of loans to make and to whom they will go.

As indicated above, though, a loans-to-parents program could prove

successful in satisfying the liquidity needs of those middleincome families who now qualify for GSLs but who cannot obtain

these loans because of reluctance of banks to lend to students.

Fairness and Equity

Since all families in the target group would be eligible for

the same amount of loan, a guaranteed loans-to-parents option

would be considered fair by those who believe that education

subsidies should be distributed equally among recipients. Those

who maintain that subsidies should be distributed progressively

might prefer a loans-to-parents program that reduced the amount of

guaranteed loan that those with relatively high incomes could

get.

Maintaining Institutional Diversity

As in the case of the GSLP, the effect of a loans-to-parents

program on the cost differences between public .and private institutions depends on the amount that a family borrows. A program

27/ Source: U.S. Office of Education.

50
that offers annual per-student loans of as much as $5,000 would

provide families with enough liquidity to completely finance costs

at either type of institution in all but a few cases. If parents

borrowed enough to cover the same percentage of costs at public

and private institutions, the dollar difference in current costs

would be reduced--a result that would probably favor private

institutions. Of course, except for interest payments, a loansto-parents program would not alter the long-run cost difference

between public and private institutions.

Ease of Administration

A guaranteed loans-to-parents program is likely to be easier

to administer than the GSLP. The default rate on loans to parents

is likely to be less than the default rate on GSLs, and in the

case of delinquent payments, parents are likely to be more easily

located and contacted than are recently graduated students.

Budget Visibility and Controllability

A guaranteed loans-to-parents program would have about the

same ranking as the GSLP in terms of budget visibility and controllability. Like the GSLP, federal interest payments, default

payments, and administrative costs would be reported under the

education function in the budget. The federal outlays for the

program, therefore, would be more visible than the federal revenue

losses resulting from a tax expenditure program. Like the GSLP,

however, a loans-to-parents program would be an entitlement and

thus less controllable than direct spending programs that can be

subjected to a firm ceiling through the appropriations process.

TAX DEFERRALS FOR EDUCATION EXPENSES

Another way to provide additional aid to middle-income

students and their families is to allow taxpayers to defer (or

postpone) a portion of their tax payments to finance education

expenses, including room and board as well as tuition costs. This

type of tax allowance is essentially a loan which is made available through the tax system.

An example of one possible tax deferral plan is to allow the

taxpayer to postpone the payment of as much as $1,500 of taxes per

student each year while the student is in school, with a lifetime

51
maximum of perhaps $10,000. Repayments could be made in 10

equal installments, beginning a full year after graduation, and an

interest rate of 7 percent could be charged. (This interest rate

is the same as that charged to students under the GSLP.)

Cost and Distributional Efficiency

Table 8 shows that the start-up costs of this tax deferral

program would be about $8.8 billion—substantially greater than

that of the other options discussed above. 28/ The net annual

cost, however, would become minimal after 10 or 15 years, when the

program was in operation long enough for repayments to be in full

swing. Thereafter, the Treasury's outflow would exceed its

inflow (adjusted for interest payments) only to the extent of

growth in the number of borrowers and delinquent payments. Since

the 7 percent interest charge approximates the rate on long-term

Treasury securities, the Treasury would have little or no net

interest cost unless its borrowing costs rise.

Table 8 also shows the distribution of tax deferrals resulting from this plan. Approximately 53 percent of the deferred taxes

would benefit families earning between $10,000 and $25,000. This

program, thus, distributes funds to middle-income families somewhat more efficiently than do the unmodified tax credit or credit/

deduction options but less efficiently than the expanded BEOG

program. Like the other loan programs, though, the much larger

average benefit (in the form of liquidity) provides more meaningful relief than that realized under these other programs.

Fairness and Equity

If one views tax deferrals simply as a means of distributing

a subsidy, then tax deferrals may be considered equitable to the

extent that they allow some people to obtain loans that otherwise

might not be available to them. Large tax deferrals, however,

provide larger loans to high-income taxpayers who have a sufficient tax liability to take full advantage of the deferral. Thus

those who believe that subsidized loans for education purposes

28/ If it is decided that start-up costs should be lower, the

size of the deferral could be reduced.

52
TABLE 8. DISTRIBUTION OF BENEFITS OF A TAX DEFERRAL PLAN

PERMITTING POSTPONEMENT OF $1,500 OF TAXES ANNUALLY

PER STUDENT a/

Adjusted Gross Income Class

(Dollars in Thousands)

0-10 10-25 25+ All Groups

Aggregate Benefits

(Dollars in Millions)

Percentage of Total

Benefits

417 4,648 3,767 8,832

4.7 52.6 42.7 100

Average Tax Deferral

Per Eligible

Student (Dollars) 286 897 1,278 911

aj CBO estimate based on data from the U.S. Bureau of the Census;

data from the U.S. Office of Education, National Center for

Education Statistics; data supplied by Joseph Froomkin,

Inc.; and tax data published by the U.S. Department of the

Treasury, Internal Revenue Service.

53
should be distributed equally among all recipients might consider

tax deferrals less equitable than subsidized loans that do not

depend on the individual's tax liability.

Maintaining Institutional Diversity

This tax deferral plan would provide the same amount of

liquidity to students attending private and public institutions

whose charges for tuition, room, and board total at least $1,500;

in this case the plan would not change the absolute difference in

the current costs of attending these two types of schools. A

$1,500 tax deferral, however, would produce greater percentage

reductions in the current costs of attending public institutions

that charge less than private ones and therefore would result in a

relative increase in the current costs of attending most private

institutions. (At some public institutions, the tax deferral might

finance education costs completely.) Of course, except for

interest payments, a tax deferral does not alter the long-run cost

differential of high- and low-cost schools because the tax loan

eventually must be repaid.

Ease of Administration

A tax deferral for education expenses would be more difficult

to administer than a general education tax credit or credit/deduction plan with similar eligibility limitations since a tax deferral plan would involve more recordkeeping. For example, the

specific option described above would require records to be kept

by the IRS for 15 years or so to insure that the entire tax

loan is repaid. If the payback period were shortened to avoid

this shortcoming, the benefit to taxpayers would be reduced

accordingly.

At present, records are generally kept in the IRS computer

system for only three years. (Records going back more than three

years generally are not maintained in the system but are sent to

Federal Record Centers, which are less accessible.) For the IRS

effectively to monitor a tax deferral program with a long payback

period, the Service would need ready access to records for a

period much longer than three years. Substantially increasing the

recordkeeping capabilities of the IRS computer system would be

54
costly. The recordkeeping chore would be further complicated by

the fact that taxpayers change residences frequently. 29/

Budget Visibility and Controllability

A tax deferral for higher education expenses ranks low in

terms of budget visibility and controllability. In this respect it

is like a tax credit, a credit/deduction option, and other tax

expenditures that have not yet become subject to as much review

and scrutiny as direct outlays and which, because they are entitlement programs that provide subsidies to all who qualify, are

not subject to fixed ceilings on appropriations.

In addition, as in the case of other loan programs, the

actual magnitude of tax deferrals tends to be less visible once

the program has been in effect for some time and repayments begin

to offset new deferrals.

29/ During the 1970-1975 period, 41.3 percent of the population

four years and older changed residences within the United

States. Source: U.S. Bureau of the Census, Current Population Reports, Series P-20, no. 285.

55

APPENDIXES

APPENDIX A. BRIEF DESCRIPTION OF TAX: EXPENDITURES AND

OTHER STUDENT AID PROGRAMS I/

Federal aid to students is provided in the form of tax

expenditures, grants, direct loans, and loan guarantees. Table

A-l lists the major programs.

The Exemption for Student Dependents allows a student to be

claimed as a dependent for tax purposes even if he would otherwise

be ineligible because he is over 19 years of age or has an adjusted gross income greater than $750. This tax provision benefits families who have tax liabilities and children with earnings. The value of each $750 personal exemption is $525 for

families with a top marginal tax rate of 70 percent and $150 for

families taxed at the median marginal rate of 20 percent. In

addition to a $750 exemption, a $35 personal tax credit can be

claimed for each student.

The Exclusion of Fellowships and Scholarships benefits

those students who have taxable income or whose spouses have

taxable income. The value of this exclusion varies with the size

of the award and with the marginal tax rate of the taxpaying

unit.

The Exclusion of G.I. Bill Education Benefits aid those

veterans who choose to attend school. The benefits of this

JL/ Tax expenditures for higher education are discussed more

fully in Committee on the Budget, U.S. Senate, Tax Expenditures; A Compendium of Background Material on Individual

Provisions, 94:2 (1976). Federal programs of direct assistance for higher education are described in House Committee on

Education and Labor and the Senate Committee on Human Resources, A Compilation of Feder;il Education Laws; As Amended

Through June 30, 1977, 95:1 (1977). See, also, Congressional

Budget Office, Postsecondary Education; The Current Federal

Role and Alternative Approaches (February 1977); Veterans'

Administration, Federal Benefits for Veterans and Dependents

(January 1977); and Congressional Budget Office, Social

Security Benefits for Students (May 1977).

59
TABLE A-l. MAJOR STUDENT AID IN THE FORM OF

TAX EXPENDITURES AND FEDERAL OUTLAYS a/

Tax Expenditures Direct Outlays

Exemption for Student Basic Educational

Dependents Opportunity Grants

Exclusion of Fellowships Supplemental Education

and Scholarships Opportunity Grants

Exclusion of G.I. Bill Work/Study Programs

Education Benefits

National Direct Student

Exclusion of Student Loans

Social Security Benefits

Guaranteed Student

Loans

G.I. Bill Education

Benefits

Student Social Security

Benefits

aj The budgetary costs of these programs and their distribution

among income groups are presented in Tables 1 and 2 of the

text.

60
exclusion are distributed among income groups in approximately the

way actual payments are distributed except that the value of the

exclusion will vary with the marginal tax rate of the recipient.

The Exclusion of Student Social Security Benefits assists

those families in which the head of household is disabled, retired, or deceased, and in which there is a student 18 to 21 years

old. The benefits of this tax exclusion are distributed among

income groups in approximately the way student social security

payments are distributed except that those in somewhat higher

income groups will benefit somewhat more because of their higher

marginal tax rates.

Other Tax Expenditures than those discussed above assist

students indirectly by providing aid to educational institutions.

These include the deductibility of gifts and bequests to educational institutions, the exclusion of unrealized capital gains

on these charitable contributions, the deductibility of state and

local taxes used for higher education, and the exemption of

interest on state and local higher-education borrowing. Aside

from tuition charges, charitable contributions and nonfederal

government support are the primary sources of finance for institutions. To the extent that tax expenditures promote charitable

contributions or make it easier for states and local governments to raise revenues, they assist students by allowing institutions to rely more on these sources of finance than on increases

in tuition and other charges.

Basic Educational Opportunity Grants were established in 1972

to provide aid to students who are carrying at least half of a

normal full-time load at colleges, postsecondary vocational

schools, and technical/trade institutions. Student eligibility is

based on need as determined by an annually reviewed formula that

takes into account such factors as family income, assets, taxes,

number of wage earners, and family size. The amount of each

qualified student's grant is equal to the lesser of (1) $1,800

minus the family's expected contribution 2j or (2) one-half the

cost of attendance. Eligible students may receive basic grant

2/ Appropriations for fiscal year 1978 effectively reduce the

maximum award from $1,800 to $1,600. A family is expected to

contribute 20 percent of its discretionary income up to $5,000

and 30 percent of discretionary income above $5,000.

61
awards for four academic years although eligibility is sometimes

extended to five years.

Supplemental Educational Opportunity Grants (formerly called

Educational Opportunity Grants) were established in 1965. These

funds flow through institutions to students of exceptional financial need as determined by the institutions under national criteria. The size of the grant is based on the student's financial need and ranges from $200 to the lesser of (1) $1,500 per

academic year or (2) one-half the total financial aid provided to

the student by the institution.

The College Work/Study program was started in 1965 to assist

financially needy students through part-time employment. Together

with Supplemental Educational Opportunity Grants and National

Direct Student Loans (discussed below), they form "packages" of

aid by which institutions assist students. Grants to institutions

are authorized for partial reimbursement of wages paid to students

participating in a work/study program in public or private nonprofit organizations. Currently federal funds pay 80 percent of

the student's wages, with the remainder being paid by the institution, the employer, or some other donor.

National Direct Student Loans were established in 1958 and

provide long-term, low-interest funds to needy students at eligible postsecondary institutions. For this purpose, a revolving

loan fund is created at each institution with 90 percent of the

capital provided by the federal government and 10 percent by the

institution. Loans bear 3 percent interest generally beginning

nine months after the student ceases at least part-time attendance.

The Guaranteed Student Loan program was established in 1965

to help students borrow from private lenders to apply for training

at colleges, universities, and vocational schools. Loans carry a

7 percent interest charge to the student and are either guaranteed

by a state or private nonprofit agency or insured by the federal

government. A maximum of $2,500 per academic year ($5,000 for

graduate training) may be applied for in most states if the

education costs warrant borrowing this amount. Total loans

outstanding may not exceed $10,000 for undergraduates and vocational students or $15,000 for students who extend their borrowing

for graduate study. The federal government pays the interest for

eligible students while they are in school and during a 12-month

grace period following completion or withdrawal from school. Any

62
student whose adjusted family income is less than $25,000 (this

corresponds to an adjusted gross income of about $31,000) is

automatically eligible for the "in-school" subsidy. Over 95

percent of all borrowers receive this subsidy.

The G.I. Bill that currently provides virtually all of the

veterans' education benefits was enacted in 1966 and covers those

who served during the period February 1955 through December 1976.

It grants up to 45 months of benefits for veterans enrolled in

approved courses of instruction. Under this program, the veteran

receives a monthly education assistance allowance that is intended

to meet in part living expenses as well as education costs. The

amount of the allowance depends on the number of dependents the

veteran has and on whether school attendance is full time or part

time. Currently those with no dependents who attend school full

time receive $310 per month. Eligibility for these benefits

extends for a period of 10 years after separation from service.

The most recent education program assisting military personnel was enacted in October 1976 and covers those entering the

service after December 1976. The new program differs from the

previous ones in that those wishing to participate must make

contributions while they are in the service. The federal government matches each dollar of a participant's contribution with

$2 of government funds.

Social Security Student Benefits were begun in 1965 and are

paid to 18-to-21-year-old, unmarried, full-time student dependents

of dead, disabled, or retired workers,. Currently about one-eighth

of all full-time enrolled 18-to-21-year-old students draw such

benefits, averaging over $1,900 a year. Social security student

benefits are not needs tested; rather the benefit is simply

calculated as half that paid to a retired (or disabled) worker and

three-fourths of the amount that a deceased worker would have

received as retirement benefits. But 43 percent of the student

beneficiaries receive less than the formula amount because

of the family maximum rule that, in general, restricts total

family benefits to no more than 175 percent of the worker's

benefit.

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APPENDIX B. EDUCATION TAX ALLOWANCES AND TAX EQUITY

Education tax allowances raise issues about the tax equity

among individuals similarly situated (horizontal equity) and among

taxpayers with different incomes (vertical equity). Education

expenses do reduce the amount of income that can be used for other

purposes, but it is not clear that such expenses represent the

kind of reduction in ability to pay taxes that is normally taken

into account in the tax code. The implications of education tax

allowances for tax equity depend on what view of this issue is

adopted.

In theory, involuntary and unexpected personal expenses that

are extraordinarily large relative to income have a greater impact

on ability to pay taxes and thus may have more claim to be treated

as legitimate allowances against taxes. Casualty losses and

extraordinary medical expenses are good examples. A person

generally has little control over these outlays; I/ they usually

are unforeseen and sometimes are catastrophically large. Because

of the nature of these expenses, the tax allowances provided for

them receive fairly wide support as measures that improve tax

equity. They help to relieve hardships that would arise from the

strict application of a tax on economic income.

It is not clear that education expenses resemble casualty

losses and medical expenses closely enough to warrant special tax

allowances for tax equity purposes.. Like an expenditure for

medical care, an expenditure for tuition may be viewed by many

taxpayers as a duty, a high-priority expense to be borne for the

benefit of one's children or other dependents. As such, they may

be considered semi-involuntary in nature and deserving of a tax

allowance on the grounds that, to some extent, they represent a

nonvoluntary reduction in ability to pay taxes. But they also

resemble other semi-involuntary expenses, such as those for food

and shelter, for which no deduction is provided. Moreover,

education expenses differ from medical expenses and casualty

losses in that the need to finance an education can almost always

be anticipated far in advance. Finally, it may be argued that

—' Some medical expenses, such as those incurred for face-lifting

and hair transplants, may be viewed as voluntary, however.

65
education expenses are inherently a more personal type of consumption than are medical expenses and thus should not be given any

tax allowance. 2j

If education expenses are not considered to be a legitimate

offset to taxes, then the adoption of an education tax allowance

will worsen both horizontal and vertical equity. Horizontal

equity will be adversely affected since two families with the same

income, wealth, and number of children will be subject to different tax liabilities if one has children in college while the other

does not. _3_/ Vertical equity (fair treatment among taxpayers who

differ only in income) will also suffer since the progressivity of

the tax structure will depend in part on the number of students in

a family. On average, taxpayers with children in college are

wealthier than most other taxpayers; thus the adoption of an

education tax credit will also make the tax structure less progressive overall. Some may view reduced progressivity as a

desirable reform, but it could be provided in a more straightforward way by altering the tax rate schedule rather than by providing allowances for education expenses.

If, however, one adopts the opposing view that some tax

allowance for education expenses is necessary to achieve equity

among taxpayers based on their ability to pay taxes, the only

question left is the form that the allowance should take. A tax

deduction seems more consistent with this view than a credit.

In our tax system, expenses that reduce the ability to pay,

such as casualty losses or unusually high medical expenses,

usually take the form of deductions. In this way, the relationships among taxpayers with different incomes but the same ability

to pay taxes are not modified. A credit, by contrast, could leave

a low-income taxpayer with modest education expenses better off

2j For a discussion of the relation between education tax allowances and taxpayer equity, see John K. McNulty, "Tax Policy

and Tuition Credit Legislation: Federal Income Tax Allowances

for Personal Costs of Higher Education," California Law

Review, vol. 61 (January 1973), pp. 36-42.

3J If education tax allowances are focused on middle-income

families with children in school and are financed by higher

taxes on middle-income families, the result is a transfer of

income from one group of middle-income families to another.

66
than someone with higher income and more education expenses even

though it is stipulated that the education expenses have left them

both with the same ability to pay taxes.

If, for example, Taxpayer A has income of $22,000 and education expenses of $2,000 while Taxpayer B has income of $25,000 and

education expenses of $5,000, both have $20,000 left after these

expenses with which to pay taxes. If education expenses are

deductible for tax purposes, both A arid B would pay the same tax.

But if instead a credit is given for some portion of the education

expenses, Taxpayer A would end up paying less than Taxpayer B even

though it is assumed that both have the same ability to pay. This

example is elaborated in Table B-l.

Some tax theoreticians have advocated education tax allowances not on the basis of ability to pay taxes but rather to

perfect the definition of taxable income. 4_/ The tax law now

allows businesses to deduct certain expenses incurred in the

production of income. These include depreciation costs on capital

investment. It may be argued, that the expenses of obtaining a

college education, at least in part, can also be viewed as costs

associated with the production of future income—an investment in

human capital—and that the current definition of taxable income

should be changed to allow deductions over time of the portion of

college expenses considered to be a form of investment.

If this view is adopted, then tax allowances to students—who

will earn the income resulting from the investment— would seem

appropriate while tax credits, deductions, or deferrals for

parents would not. 5_/ Deductions seem preferable because they

reduce the tax base to which the progressive tax rates are applied. Thus, deductions do not affect the progressivity of the tax

structure. In contrast, credits and deferrals of equal amounts

reduce taxes otherwise due. This reduction is not proportional to

the progressive tax structure and thus changes its progressivity.

A_/ For example, see Richard Goode, The Individual Income Tax

(Brookings Institution, 1976), pp. 80-92.

5j Education expenditures by parents, relatives, or friends may

be considered gifts, the value of which could be recovered

free of income tax just as the cost of a depreciable asset

acquired as a gift can now be written off against the recipient's income.

67
TABLE B-l. COMPARATIVE EFFECTS OF TAX CREDITS AND TAX DEDUCTIONS

ON TAXPAYER EQUITY!IN DOLLARS

Deduction

Income

Education

Expenses

Deduction

Taxable Income

Tax before

Credit

Credit (25%)

Net Tax

Taxpayer

A

22,000

2,000

-2,000

20,000

4,380

*

4,380

Taxpayer

B

25,000

5,000

-5,000

20,000

4,380

*

4,380

Credit

Taxpayer

A

22,000

2,000

*

22,000

5,020

-500

4,520

Taxpayer

B

25,000

5,000

*

25,000

6,020

-1,250

4,770

^J Not applicable.

68