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EDUCATION TAX INCENTIVES AND TAX REFORM 

HEARING 

BEFORE THE

COMMITTEE ON FINANCE 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

JULY 25, 2012 

( 

Printed for the use of the Committee on Finance 

COMMITTEE ON FINANCE 

MAX BAUCUS, Montana, Chairman 

JOHN D. ROCKEFELLER IV, West Virginia 

KENT CONRAD, North Dakota 

JEFF BINGAMAN, New Mexico 

JOHN F. KERRY, Massachusetts 

RON WYDEN, Oregon 

CHARLES E. SCHUMER, New York 

DEBBIE STABENOW, Michigan 

MARIA CANTWELL, Washington 

BILL NELSON, Florida 

ROBERT MENENDEZ, New Jersey 

THOMAS R. CARPER, Delaware 

BENJAMIN L. CARDIN, Maryland 

ORRIN G. HATCH, Utah 

CHUCK GRASSLEY, Iowa 

OLYMPIA J. SNOWE, Maine 

JON KYL, Arizona 

MIKE CRAPO, Idaho 

PAT ROBERTS, Kansas 

MICHAEL B. ENZI, Wyoming 

JOHN CORNYN, Texas 

TOM COBURN, Oklahoma 

JOHN THUNE, South Dakota 

RICHARD BURR, North Carolina 

RUSSELL SULLIVAN, Staff Director 

CHRIS CAMPBELL, Republican Staff Director 

(II) 

(III) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee 

on Finance ............................................................................................................ 1 

Hatch, Hon. Orrin G., a U.S. Senator from Utah ................................................. 3 

WITNESSES 

Cruzado, Dr. Waded, president, Montana State University, Bozeman, MT ....... 5 

Munson, Lynne, president and executive director, Common Core, Washington, 

DC .......................................................................................................................... 8 

Dynarski, Dr. Susan, professor of public policy and education, University 

of Michigan, Ann Arbor, MI ................................................................................ 10 

Hodge, Scott, president, Tax Foundation, Washington, DC ................................. 11 

White, James, Director, Tax Issues, Government Accountability Office, Washington, DC ............................................................................................................. 13 

ALPHABETICAL LISTING AND APPENDIX MATERIAL 

Baucus, Hon. Max: 

Opening statement ........................................................................................... 1 

Prepared statement .......................................................................................... 33 

Cruzado, Dr. Waded: 

Testimony .......................................................................................................... 5 

Prepared statement .......................................................................................... 35 

Dynarski, Dr. Susan: 

Testimony .......................................................................................................... 10 

Prepared statement .......................................................................................... 39 

Grassley, Hon. Chuck: 

‘‘Who Benefits from Student Aid? The Economic Incidence of Tax-Based 

Federal Student Aid,’’ by Nicholas Turner, University of California, 

San Diego, October 20, 2010 ........................................................................ 51 

‘‘Administrators Ate My Tuition,’’ by Benjamin Ginsberg, Washington 

Monthly, September/October 2011 .............................................................. 100 

‘‘Tax Arbitrage by Colleges and Universities,’’ CBO Study, April 2010 ....... 110 

Hatch, Hon. Orrin G.: 

Opening statement ........................................................................................... 3 

Prepared statement .......................................................................................... 131 

Hodge, Scott: 

Testimony .......................................................................................................... 11 

Prepared statement .......................................................................................... 133 

Munson, Lynne: 

Testimony .......................................................................................................... 8 

Prepared statement .......................................................................................... 144 

White, James: 

Testimony .......................................................................................................... 13 

Prepared statement .......................................................................................... 152 

COMMUNICATIONS

American Council on Education (ACE) .................................................................. 161 

American Institute of Certified Public Accountants (AICPA) .............................. 168 

Center for Fiscal Equity .......................................................................................... 175 

Coalition to Preserve Employer Provided Education Assistance ......................... 177 

College Savings Foundation .................................................................................... 181 

Page

IV 

College Savings Plans Network (CSPN) ................................................................ 185 

National Association of Home Builders ................................................................. 195 

National Education Association (NEA) .................................................................. 203 

Rebuild America’s Schools ...................................................................................... 206 

United Technologies Corporation ........................................................................... 207 

(1) 

EDUCATION TAX INCENTIVES 

AND TAX REFORM 

WEDNESDAY, JULY 25, 2012 

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC. 

The hearing was convened, pursuant to notice, at 10:10 a.m., in 

room SD–215, Dirksen Senate Office Building, Hon. Max Baucus 

(chairman of the committee) presiding. 

Present: Senators Bingaman, Wyden, Hatch, Grassley, Snowe, 

and Thune. 

Also present: Democratic Staff: Russ Sullivan, Staff Director; Tiffany Smith, Tax Counsel; and Lily Batchelder, Chief Tax Counsel. 

Republican Staff: Chris Campbell, Staff Director; Jim Lyons, Tax 

Counsel; and Chris Hanna, Senior Tax Policy Advisor. 

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR 

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE 

The CHAIRMAN. The hearing will come to order. 

Benjamin Franklin once said, ‘‘An investment in knowledge always pays the best interest.’’ 

For more than a century, America has invested in education, and 

this investment has paid ample dividends. For older generations, 

up to age 64, the United States ranks second in the world in college graduation rates. But for younger generations, the United 

States is slipping. For those ages 24 to 35, the United States has 

fallen to 16th in the world. And in today’s global economy, an education is even more important than ever. 

In these tough economic times, as job markets get even more 

competitive, this is even more apparent. And yet, American families face skyrocketing college costs. In the last 2 decades, the price 

of higher education has grown at 19 percent a year, 4 times faster 

than inflation. College costs are growing at twice the pace of medical care. 

These rising costs hit low-income families especially hard. A lowincome family has to spend the equivalent of 72 percent of its income to send a child to college. Compare that to 14 percent for a 

higher-income family. 

This debt burden often deters young people from going to college 

at all and has harmful ripple effects throughout our economy. Differences exist even for students with similar high test scores. Students from high-income backgrounds were about 32 percent more 

likely than those with the same test scores but from low-income 

backgrounds to enroll in college. 

2 

That means some of our best and brightest students never have 

the opportunity to develop their talents. This leads to fewer scientific breakthroughs, fewer innovative companies, and a weaker 

overall economy. 

Since 1954, Congress has provided tax cuts for families with children pursuing a college education. These provisions help families 

cover past, present, and future expenses. The student loan interest 

deduction provides students a tax deduction for interest paid on a 

student loan. 

The tax code also encourages families to save for future education expenses by providing tax-free savings vehicles. Five-twentynine programs and Coverdell accounts allow families to save for 

college without paying taxes on the earnings. Distributions from 

these accounts can be used to pay education expenses. 

The tax system provides the most tax benefits for current expenses. Under our current tax system, there are helpful provisions 

that exclude certain financial assistance from income. For example, 

scholarships and fellowships that cover qualifying education expenses are excluded from income of the student. The tax code also 

contains credits and deductions to help students pay for current expenses. 

The code cannot solve our educational challenges on its own, but 

it plays an important role. In 2009, taxpayers claimed almost $30 

billion in education tax cuts, making college more affordable. This 

equates to about 22 percent of the assistance received through Federal grants and loan assistance. 

That same year, 2009, we expanded these education tax benefits 

by passing the American Opportunity Tax Credit. As a result, 4.8 

million more lower-income students and families had access to college subsidies. 

These expansions are critical to ensuring that American families 

can afford college. This is particularly true in my home State of 

Montana. Montana has a higher proportion of lower-income students than other States. As a result, many Montanans only benefit 

from tax benefits that are partially refundable, like the American 

Opportunity Tax Credit. In 2010, Montanans claimed nearly $105 

million in education tax credits and deductions to help offset the 

cost of college. 

But the multitude of education tax benefits can result in complexity and confusion for American families. Under current law, 

there are eight separate tax expenditures—that is, deductions and 

credits and so forth—eight separate tax expenditures related to 

higher education, and these benefits use five different definitions of 

‘‘eligible expenses.’’ 

The chart to my right, behind me, gives an example of the complexity and the questions asked of taxpayers when they are trying 

to calculate what provisions qualify. And I might say, at this point, 

this is IRS Publication 970. It is entitled Tax Benefits for Education for Use in Preparing 2011 Returns. This is just with respect 

to tax provisions. I do not think anybody—very few people read it. 

Taxpayers must calculate their taxes using each tax cut to determine which one works best. It is a little bit like the AMT—you 

have to figure which one works best here. 

3 

*For more information, see also, ‘‘Background and Present Law Relating to Tax Benefits for 

Education,’’ Joint Committee on Taxation staff report, July 23, 2012 (JCX–62–12), https:// 

www.jct.gov/publications.html?func=startdown&id=4474. 

Behind me on this chart is an actual IRS questionnaire—I just 

referred to it—that families need to fill out to determine if they are 

eligible for an education tax credit. This is just one page from an 

87-page IRS guide for obtaining education tax credits. 

Based on the complexity of this guide, one would think the IRS 

expected all of America’s future students to want to major in accounting. The Government Accountability Office will tell us today 

how this complexity affects families. They have found that many 

families often pick the wrong benefit and leave money on the table. 

Kelly McInerney is a CPA in Fairfield, MT. Kelly is the mother 

of four college-aged kids and knows firsthand how complicated 

these tax benefits can be. Kelly says many families she works with 

do not realize that they can claim credits for tuition paid for with 

student loans. As a result, they get less help than they are eligible 

for. This can make the difference between being able to send a kid 

to college or not. 

We obviously need to make the system simpler for families. We 

should improve these benefits for the students. Through tax reform, we need to look at how we can achieve the greatest bang for 

our buck. Our system has to work a lot better to make sure we do 

not lose our competitive edge. Let us listen to Ben Franklin’s advice that investment in knowledge will pay the best interest.* 

[The prepared statement of Chairman Baucus appears in the appendix.] 

Senator Hatch? 

OPENING STATEMENT OF HON. ORRIN G. HATCH, 

A U.S. SENATOR FROM UTAH 

Senator HATCH. Thank you, Mr. Chairman. 

The focus of today’s hearing is narrow, but it is a very important 

one: the role of education incentives in our tax code. Traditionally, 

the Federal Government has supported millions of individuals 

seeking higher education through grants and loans. Over the last 

15 years, however, Federal support for higher education has increasingly relied on incentives in the tax code. These education tax 

incentives can generally be classified into one of three categories. 

The first category includes tax incentives for current expenditures for higher education. These incentives include the Hope, 

American Opportunity, and Lifetime Learning credits; a deduction 

for higher education expenses; and the exclusion for scholarships 

and fellowships. 

The second category includes tax incentives for student loans. 

These incentives include the deduction for interest paid on student 

loans and the exclusion from income for certain student loans that 

have been forgiven. 

The third category includes tax incentives for savings for college. 

These incentives include qualified tuition plans, generally referred 

to as 529 plans; Coverdell plans; education savings bonds; and IRA 

withdrawals to pay for college expenses without penalty. 

Generally, two reasons have been given for the various education 

tax incentives. First, college education costs are increasing and are 

4 

a barrier to entry for those who cannot afford the costs. Second, college education is a good investment that produces external benefits, sometimes referred to as positive externalities. 

According to the National Center for Education Statistics, the 

cost of college education for the 2009–2010 academic year—annual 

prices for undergraduate tuition, room, and board—were estimated 

to be $12,804 at public institutions and $32,184 at private institutions. 

Between 1999–2000 and 2009–2010, costs for undergraduate tuition, room, and board at public institutions rose 37 percent, and 

costs at private institutions rose 25 percent, after adjustment for 

inflation. 

The high cost of a college education does create a barrier to 

entry. However, some portion of the barrier is alleviated by the 

U.S. Department of Education’s direct loan programs, such as 

Stafford loans, Federal Perkins loans, Federal Work Study, Federal 

Supplemental Educational Opportunity Grants, and the Federal 

grant programs, such as Pell Grants, for lower-income students. 

In fact, according to the John William Pope Center for Higher 

Education Policy, of the 16.4 million undergraduate students enrolled in college in the United States in 2010, approximately 58 

percent, or 9.6 million students, received Pell Grants. 

As to the external benefits of a college education, some benefits 

from higher education may benefit not just the individual student 

in the form of higher wages, but also, society as a whole. Since 

these external benefits may not be considered by individual students when considering higher education, individuals may invest 

less in higher education than is optimal for society. Providing educational tax incentives may induce potential students to enroll in 

higher education, increasing investments in education and thereby 

creating external benefits. 

A frank conversation about these incentives must also consider 

whether Congress is encouraging a higher-education bubble. Are 

these incentives encouraging students to take on more debt and degrees than is warranted by the economic and professional gain 

these students are likely to realize from their educational achievements? 

In evaluating the education tax incentives, we use the same 

three factors that are used in evaluating all tax incentives—equity, 

efficiency, and simplicity. Some crucial questions in evaluating education tax incentives are whether Federal subsidization of higher 

education is good policy and whether a tax subsidy would be provided more efficiently by direct spending. 

In 1987, then Secretary of Education William Bennett stated 

that, in the long run, Federal financial aid programs lead to higher 

tuition as colleges capture some of the Federal aid to students. 

Some studies have shown some evidence of the Bennett hypothesis. 

I would be interested to hear from our witnesses if they believe the 

Bennett hypothesis applies to Federal student aid in the form of 

education incentives in the tax code. In other words, do colleges 

and universities capture the financial benefits of education tax incentives at the expense of eligible students and families? One recent economic paper indicates that this is the case. 

5 

As to simplicity, one noted tax scholar, Michael Graetz, has said, 

‘‘The education tax incentives represent the greatest increase in 

Federal funding for higher education since the GI Bill. But no one 

can tell you what they are, how they work, or how they interact. 

Planning to pay for college around these tax breaks is essentially 

impossible for middle-income families.’’ 

I think there is a lot of agreement that the education tax incentives are very complex and, at a minimum, should be consolidated 

and reformed. 

Now, we have a very distinguished panel with us today, and I 

look forward to hearing what they have to say. 

I want to congratulate you, Mr. Chairman, for this hearing and 

looking at this matter. 

[The prepared statement of Senator Hatch appears in the appendix.] 

The CHAIRMAN. Thank you, Senator. 

I would like to introduce the panel. The first witness is Dr. 

Waded Cruzado. Dr. Cruzado is the president of Montana State 

University in Bozeman, MT. Welcome, Doctor. 

Next, Ms. Munson. Ms. Lynne Munson is president and executive 

director of Common Core. 

The third witness is Dr. Susan Dynarski. Dr. Dynarski is a professor of public policy and education at the University of Michigan. 

Our fourth witness is Mr. Scott Hodge. Mr. Hodge is the president of the Tax Foundation. 

And the last witness is Mr. Jim White. Mr. White is the Director 

of Tax Issues at the Government Accountability Office. 

Thank you all for coming. I would ask each of you to speak about 

5 minutes and submit your statement for the record. 

Dr. Cruzado, welcome. Good to have you here. Why don’t you go 

ahead? 

STATEMENT OF DR. WADED CRUZADO, PRESIDENT, 

MONTANA STATE UNIVERSITY, BOZEMAN, MT 

Dr. CRUZADO. Thank you very much. Good morning, Mr. Chairman and Ranking Member Hatch and members of the committee. 

I am Waded Cruzado, president of Montana State University. 

Thank you for the opportunity to appear before you to discuss 

tax policy as it relates to higher education, a topic that affects millions of students and their families. 

Montana State University is one of more than 100 land grant 

universities created by the Morrill Act of 1862, a brave piece of legislation that opened the doors of higher education to the sons and 

daughters of the working families of America. 

The Morrill Act, proposed by a former chairman of this committee, I should add, was approved by Congress in the midst of the 

Civil War. This month, we celebrated the courage of those elected 

officials who, 150 years ago, envisioned a better and brighter future 

by focusing on education as the key to social mobility and the 

strengthening of American democracy. 

More than 48,000 students attend the Montana State University 

system, with almost half of them enrolled in the four campuses of 

MSU. Even in this day, many of our students are the first in their 

family to attend college. Unfortunately, we see that it is becoming 

6 

increasingly difficult for students and their families to pay for their 

education. At MSU, faculty, students, staff, and alumni are committed to improving the situation by working together to maximize 

efficiency in administration without sacrificing access or excellence 

in academics. 

I want to propose how, by reforming the tax code, you too can 

make a difference. Federal financial aid and tax credits related to 

higher education are crucial to students and their families as they 

confront serious challenges. According to the Department of Education, between 2006 and 2011, the percentage of first-time fulltime undergraduates receiving financial aid increased from 75 to 

85 percent at all 4-year colleges. There is evidence students are assuming more costs and borrowing more. 

According to a recent Sallie Mae report, parents reduced their 

spending on college, both in terms of current income and savings. 

The report also notes that scholarship awards were down. To compensate, students assume more costs on their own and borrow 

more. 

For a student from a low-income family or with a limited family 

contribution, a package of aid is usually required to finance a college education. But complex paperwork accompanies applications 

for Federal financial aid. Furthermore, how students stack aid may 

affect the amount they ultimately qualify for or, in some sad, but 

not all together infrequent choice of fate, make a student ineligible 

outright. 

A first-time student in his or her family must understand the tax 

code and master the 1098–T form and another form known as a 

FAFSA, which stands for Free—not simple—Application for Federal Student Aid. 

Based on national data, we know that thousands of Montana 

State students and their families are utilizing at least some of the 

tax deductions and exemptions available. But we also know that 

not all of them take full advantage of the tax code provisions. Even 

tax accountants find the tax credits and deductions for higher education confusing. 

For students confronting such a steep learning curve, especially 

for the first time, this complexity translates into insurmountable 

obstacles, and many of them simply will give up. To describe the 

situation at MSU, a school with one of the lowest student loan default rates in the Nation, let me start with two data points— 

FAFSA applications and Pell Grant awards. 

The number of FAFSA forms received by MSU has grown 43 percent in just the last 3 years, and that tremendous growth rate 

shows no signs of slowing down. The number of students receiving 

Pell Grants has jumped by 66 percent in the same period. Currently, a third of our entire undergraduate student body is deemed 

by Federal standards to have the greatest financial need. 

This aid is particularly important for our Native American, 

adult, and Hispanic students, with about 67 percent of these 

groups receiving Pell Grants. That is twice the utilization of the 

student body as a whole. 

Another disturbing trend is the amount of debt students have 

when they graduate. Up until 2007, the average amount of debt 

MSU students graduated with remained relatively flat at $17,000. 

7 

Once we entered the recession, that debt grew by almost 36 percent, so that now, 66 percent of our graduates are living with an 

average debt of about $26,000. 

Anecdotally, I am meeting more parents who are sending their 

children to college while they are still trying to pay off their own 

college debts. Recent data from the New York Federal Reserve indicates this is a real national trend. 

And I know about a family who, confronting a difficult financial 

situation, had to sit at the kitchen table to decide which of their 

twins was sent off to college and which would stay behind, knowingly impacting their lives forever. 

American families deserve better than this. And here are some 

recommendations. One, commit to protect Federal financial aid. 

There is no way a large portion of our students could afford to attend college without it. There is a compelling national interest in 

providing assistance for students to attend college. Studies suggest 

that the U.S. is projected to produce 3 million fewer college graduates than needed in the next decade. This will happen while other 

nations are making significant investments in higher education as 

a strategic element of their economic development and advantage. 

Two, simplify the tax code as it relates to higher education expenses. The tax code can play a vital role in assisting students and 

their families with the cost of higher education, but its complexity 

discourages many from even considering its use. Simplifying it and 

following up with an intrusive, almost fanatical communications 

campaign would alert students and their families to take advantage of these provisions. 

Third, clarify and coordinate the various Federal aid programs so 

that students and their families fully understand their options and 

utilize the available resources. The current collection of Federal aid 

programs, while well-meaning, is difficult to understand and navigate. You will not be surprised to learn that this derives from the 

split jurisdiction between the Department of Education and the Department of the Treasury, and the individuality of the programs 

themselves. 

And finally, number four, continue support for deductions for college savings plans. Such deductions offer an important incentive 

for students and families to plan ahead, save for college, and, importantly, help students avoid indebtedness. 

In closing, I would like to emphasize that, just like it was 150 

years ago, a college degree results in benefits to the individual and 

to the Nation as a whole. The Morrill Act had it right. Providing 

the opportunity for our Nation’s citizens to attend and succeed in 

college is crucial to the future economic prosperity of our Nation 

and the strength of our democracy. 

Thanks for your leadership. 

[The prepared statement of Dr. Cruzado appears in the appendix.] 

The CHAIRMAN. Thank you very much, Doctor. 

Ms. Munson? 

8 

STATEMENT OF LYNNE MUNSON, PRESIDENT AND EXECUTIVE 

DIRECTOR, COMMON CORE, WASHINGTON, DC 

Ms. MUNSON. Chairman Baucus, Ranking Member Hatch, thank 

you for inviting me back to testify on the issue of college affordability. 

For the record, I want to point out that I am actually not here 

in my capacity as president of Common Core, which is a nonprofit 

that I run that looks out for the quality of K–12 public education. 

Rather, I am here as a former Deputy Chairman of the National 

Endowment for the Humanities, as an independent scholar who 

has researched and published on college affordability since 2007, 

and as a mother of two precocious toddlers whose college education 

is going to cost $1 million if current trends continue. 

When you asked me here 5 years ago, I shared some tuition cost 

analyses that many found surprising. I took the prices of milk and 

of gas in 1980, and I told you how much those goods would cost 

at that time—this was in 2007—if their prices had gone up as rapidly as had in-State tuition at 4-year public institutions. 

I have now updated those prices. Back in 2007, the tuition- adjusted price of a gallon of gasoline was $9.15. Today, it stands 

at $13, just 5 years later. The tuition-adjusted price of milk is up 

from $15 for a gallon 5 years ago to $22 today. 

For decades, we have been accommodating the problem of runaway tuition instead of holding schools accountable for the price 

that they put on American education. As former committee staffer 

Dean Zerbe has written, ‘‘Colleges and universities have been raising tuition faster than a monkey can shell nuts. And of course, 

Washington’s response has been to throw a lot more peanuts their 

way.’’ 

The most popular accommodation is to increase the number and 

size of Federal student loans and grants, but, as Senator Hatch 

asked about, Bill Bennett’s hypothesis has indeed held true. This 

only incentivizes colleges to deliver students bigger bills. And 

please, do not for a moment entertain the illusion that education 

tax credits end up in the bank accounts of families. Every subsidy 

simply ups the footing upon which tuition continues to grow. 

Let us remember that higher education’s take on the public 

purse is not limited to these subsidies. There are the billions in research dollars the government provides and the fact that schools 

pay no taxes on bonds, donations, real estate, sports revenues, and 

on their endowments. 

Further, remember that our colleges and universities are sitting 

on more wealth than had been amassed by any nonprofit institution in the history of our Nation, including private foundations. 

Now, I should not say they are sitting on these billions, because 

they are actually very busy investing them in some of the most 

complicated and illiquid, long-term, experimental investments that 

man has ever created. My point is that the focus is on amassing 

this wealth, not on spending it. 

Today, 143 colleges and universities have endowments larger than $500 million; 74 have endowments over $1 billion. One-third 

of those schools with $1 billion-plus endowments are public institutions, including the Universities of Michigan, Texas, Oklahoma, 

Nebraska, Minnesota, and Florida. 

9 

Keeping in mind this wealth and these subsidies and the tax 

freedom our colleges and universities enjoy, tuition accountability 

is long overdue. Here are a couple of ideas to get the ball rolling. 

First, require colleges and universities to do what private foundations must: spend a certain percentage of the value of their endowments every year. Foundations must spend 5 percent, which is an 

old number that likely needs to be revised upwards. Even a very 

conservative minimum payout requirement would let loose more 

than $1 billion, which could be spent on decreasing the cost of college. 

Second, make colleges and universities publicly disclose the 

amount and purpose of every endowment expenditure, as private 

foundations must do in annual reports. You want higher education 

endowment spending to bring down tuition, not to fuel more opulent fundraisers or more climbing walls in the gymnasium. 

When this committee focused its attention on the issue of college 

affordability 5 years ago, there were some very good effects. Unfortunately, they were short-lived. A few schools instituted ‘‘no loan’’ 

policies, allowing students from low-income families to attend college without taking out any loans. But most of these programs, including at Williams and Dartmouth Colleges, were cancelled just 2 

years after they were created. No one who had enrolled under the 

program even had a chance to graduate. 

Some schools also increased scholarship and grant expenditures 

5 years ago. But according to Sallie Mae, college and university 

grants and scholarships fell 15 percent during the last academic 

year. That is more than $1,000 per student. 

Also, in 2008, the IRS sent 400 colleges and universities questionnaires to inform work on a new schedule to the 990 on endowments. The schedule never appeared. 

I suggest, Chairman Baucus and Ranking Member Hatch, that 

you write to the IRS and ask them what happened. 

Our colleges and universities have been given every opportunity 

for decades to do the right thing with regard to controlling the cost 

of college. They have not done it, and there is abundant proof that 

they will never deliver American families a fair and honest tuition 

bill unless our Nation’s political leaders join the public and insist 

on it. 

Thank you very much. 

[The prepared statement of Ms. Munson appears in the appendix.] 

The CHAIRMAN. Thank you very much. I appreciate that. 

Senator HATCH. Mr. Chairman, before you go to the next witness, 

I am going to have to go to the floor. So I want to apologize to all 

of you. This has been extremely interesting to me, and I will read 

the transcripts, and we will see what we can do. Forgive me for 

that. 

The CHAIRMAN. Thank you, Senator. 

Dr. Dynarski, you are next. 

10 

STATEMENT OF DR. SUSAN DYNARSKI, PROFESSOR OF PUBLIC POLICY AND EDUCATION, UNIVERSITY OF MICHIGAN, 

ANN ARBOR, MI 

Dr. DYNARSKI. Chairman Baucus, Senator Hatch, members of the 

committee, I am honored to testify before you today. 

The goal of student aid and the education tax incentives is to 

open the doors of college to those who have the ability, but not the 

means to attend. 

Through some simple reforms, the government can serve this 

goal more effectively and efficiently. The current education tax benefits do little to get more people into college. We should simplify 

and focus the tax incentives and coordinate them with the student 

aid programs. 

A college education is one of the best investments a young person 

can make. Even with record-high tuition prices, a bachelor’s degree 

pays for itself several times over. Everyone has been hammered by 

the recession, but college graduates have been buffered from the 

worst of it. Those without a degree are twice as likely to be unemployed and earn much, much less. 

As college has grown more valuable, it has grown more unequal. 

Only 9 percent of children born in the poorest quarter of families 

earn a BA. The figure is 54 percent, 6 times larger, for those with 

the highest incomes. This gap is much larger than it was 20 years 

ago. 

Education has long been a vehicle for opportunity in our country, 

a path to prosperity for every class. Growing education gaps between the children of the rich and the poor threaten this vision of 

economic mobility. We are in danger of devolving into a rigid caste 

society in which the children of the poor are destined to low levels 

of education and menial jobs. 

There is a role for post-secondary policy in shrinking these disturbing gaps. These gaps can be eliminated only with improvements at every level of education. Inequality builds along the entire 

educational pipeline. Half the gap between the rich and poor and 

college attendance is explained by the gap in high school graduation. 

The Pell Grants and the American Opportunity Tax Credit are 

the flagships of the student aid and tax incentive programs. The 

Pell is squarely focused on low-income students. Just 15 percent of 

Pell recipients have household incomes above $40,000 a year, and 

just 3 percent of them have $60,000. The AOTC, by contrast, is less 

focused, extending to families with incomes as high as $180,000 a 

year. 

The AOTC, while not as well-targeted as the Pell, does a better 

job getting money to poor families than did its predecessor of Hope 

Credit. This is because the AOTC is partly refundable and covers 

some non-tuition costs. 

Both of these programs have doubled in size in the past few 

years. We now have two full-scale systems of aid for college in this 

country, one run by the Department of Education and one run by 

the Department of the Treasury. This is double the trouble, because both of these well-meaning bureaucracies generate complexity, paperwork, and administrative headaches that burden families, colleges, and taxpayers. 

11 

Complexity in these programs is undermining their effectiveness. 

How? It is very simple. Families cannot respond to a price subsidy 

if they do not know about it. Information about both the Pell Grant 

and the tax incentives is hidden behind a thicket of paperwork. 

Students do not find out about how much help they can get until 

a few months before college entry. This is simply too late to affect 

the decision to prepare for, apply to, and attend college. 

Here are some concrete suggestions for focusing, simplifying, and 

coordinating the tax credits and aid to make them more effective. 

First, deliver the tax credits at the time of college enrollment. 

Families need the credit when the tuition bill arrives, not months 

or years later. The refundable portion of the AOTC could be delivered to students through the aid system along with the Pell. 

Second, create a single simple application for aid and for the tax 

credits. Families currently have to wade through two long duplicative forms, the 1040 and the FAFSA. The FAFSA alone has 100 

questions. Research shows that most of these questions could be 

eliminated and still target aid in the same way as we do now. 

The data already collected on the 1040, in fact, could be used to 

define financial aid eligibility. We have moved a step towards this 

goal by allowing some aid applicants to automatically transfer their 

IRS data into their FAFSA application. 

A single simple application would reduce fraud and error and 

save citizens millions of hours spent filling out duplicative forms. 

Best of all, it would boost college enrollment. A recent experiment 

showed that college attendance rose significantly when low-income 

families were allowed to use a vastly simplified aid application 

process. 

You asked that I address whether aid for college students drives 

up college prices. The best economic evidence indicates no, at least 

for the 91 percent of students who attend public and nonprofit institutions. We do have evidence that prices at the for-profit schools 

do increase when the Pell does. While these schools teach only 9 

percent of students, they account for 24 percent of Pell expenditures. 

I stress that this problem is limited to the for-profit sector, and 

any remedies should, therefore, be focused on this sector. 

The Federal Government can do better with its aid and tax incentives for college. Simplifying, focusing, and coordinating the tax 

and aid programs will allow them to serve their goal: opening the 

doors of college to those who have the ability, but not the means 

to further their education. 

Thank you. 

[The prepared statement of Dr. Dynarski appears in the appendix.] 

The CHAIRMAN. Thank you very much, Dr. Dynarski. 

Mr. Hodge? 

STATEMENT OF SCOTT HODGE, PRESIDENT, 

TAX FOUNDATION, WASHINGTON, DC 

Mr. HODGE. Thank you, Mr. Chairman and members of the committee. I appreciate the opportunity to talk about this important 

issue. 

12 

As you all know, inequality is in the news these days, and it is 

commonly thought that tax policies, in particular low tax rates, are 

the principal cause of inequality. But the reality is very different. 

One of the biggest contributors to inequality in America is the 

growing earnings gulf between workers with college degrees and 

those without. Indeed, median income for a worker with a college 

degree is $76,000 a year, while the median income for a worker 

with a high school diploma is about half as much. And there is 

even greater income disparity between those with a high school diploma and those with advanced degrees. 

America’s income gap is really an education gap. At the bottom 

end of the income scale, about 70 percent of low-income Americans 

have a high school degree or less, whereas at the other end of the 

extreme, 80 percent of those earning over $250,000 a year have a 

college education or better. 

And there has been a clear shift in recent years in education policy away from traditional loan programs and direct subsidy programs toward the use of various tax credits and deductions. So 

really, the question here before the Finance Committee today is, is 

the tax code the proper tool to increase access to higher education 

and make education more affordable? And generally speaking, the 

answer should be ‘‘no.’’ At the highest level, these education credits 

and deductions violate the principles of sound tax policy by greatly 

increasing the complexity and distortions in the tax code. 

But there are serious practical reasons we should be very wary 

of using such policies. The first is that tax credits and subsidies undermine the market forces that deliver quality goods at low prices 

for everything from toasters to automobiles. It should be no surprise that the sectors suffering the biggest financial crises today— 

health care, housing, and, now, higher education—all receive the 

most government intervention through the tax code and other 

mechanisms, such as subsidized loans. This intervention is actually 

causing the price inflation for the very things that they are intended to make more affordable. 

Subsidized student loans and education credits are helping to 

fuel higher education costs by disconnecting student consumers 

from the true cost of higher education, and, in turn, the benefits 

of these programs get capitalized into the price of tuition because 

universities can boost tuition costs without suffering the normal 

backlash that you see in the marketplace. 

Another reason to avoid using the tax code in this way is that 

the extensive use of tax credits has already knocked 58 million 

Americans off the tax rolls. Today, some 41 percent of all tax filers 

have no income tax liability because of the generosity of credits and 

deductions in the tax code. And many of these people, about half 

of them, actually receive refundable tax credits because of the expansion of these types of programs. We have not had such a large 

share of Americans off the tax rolls since 1940, when the income 

tax system became a mass tax. 

In addition to the lost revenues from having so may Americans 

off the tax rolls and the social cost of having so many Americans 

with no skin in the game, our research suggests that the 20-year 

growth in the non-payers is associated with more than $215 billion 

in higher transfer spending this year. And there is also a very 

13 

strong statistical correlation between the growth in non-payers and 

increases in the national debt. And as we heard, on the distributional level, education credits and deductions tend to benefit highincome families, not low-income families. They are simply becoming 

middle-class entitlements. 

But lastly, the overuse of tax credits has turned the IRS into an 

extension of and, in some cases, a substitute for other government 

agencies, and the IRS is simply not equipped to be a social welfare 

agency. And as a result, these credits tend to be abused, and fraud 

rates are very high. 

Treasury’s Inspector General has raised many red flags about 

taxpayers improperly claiming the Hope Credit and billions of dollars in improper payments of the American Opportunity Tax Credits. And we should not be surprised by these kinds of abuses. In 

fact, we are simply asking the IRS to do more than just be a tax 

collection agency. 

And let me just conclude, Mr. Chairman, that, while we all understand the value and financial benefit of getting a college degree, 

using the tax code to make college more affordable not only violates 

the principles of sound tax policy, but also produces unintended 

consequences. And these education tax programs, for lack of a better term, are likely contributing to the rising cost of higher education, while helping to knock millions of people off the tax rolls. 

And this, in turn, is disconnecting millions of people from the basic 

costs of government and transforming the IRS into an extension of 

the Department of Education and the welfare system. 

These are not the kind of consequences that can be cured by a 

simple reform of tax credits, but by a wholesale reform of the entire 

tax code. 

Thank you very much for the opportunity to address you today, 

and I appreciate any questions that you may have. 

[The prepared statement of Mr. Hodge appears in the appendix.] 

The CHAIRMAN. Well, you gave us a lot to think about. Thank 

you, Mr. Hodge. We appreciate that. 

Mr. White? 

STATEMENT OF JAMES WHITE, DIRECTOR, TAX ISSUES, 

GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, DC 

Mr. WHITE. Chairman Baucus, Ranking Member Hatch, and 

members of the committee, on behalf of my colleague, George Scott, 

and myself, I am pleased to be here to discuss Federal assistance 

for higher education provided through a variety of tax and spending programs. 

By way of background, figure 1 on page 2 of my statement shows 

large title IV grants, loans, and work-study programs run by the 

Department of Education. It also shows the large tax deductions, 

credits, and exemptions administered by IRS. 

Several things are noteworthy about the programs in figure 1: 

first, the number of students and families getting assistance. In 

2009, almost 13 million students received title IV aid; 18 million 

tax filers claimed one of the higher education tax benefits. 

Second, the cost of the programs. In 2010, the Department of 

Education provided $38 billion in grants and billions more in interVerDate Nov 24 2008 21:01 Sep 06, 2013 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 R:\DOCS\82271.000 TIMD
14 

est subsidies on student loans. For the tax programs, the foregone 

revenue was an estimated $25 billion. 

Third, the programs provide assistance through a student’s entire life. Before a student attends college, the qualified tuition and 

Coverdell savings programs allow for tax-free buildup in savings 

accounts. While in college, a variety of grant, loan, and work-study 

tax credit and deduction programs help pay tuition and other expenses. After college, interest on student loans may be tax deductible. 

Now, I want to summarize the results of our analysis regarding 

the distribution of these benefits across families, the extent to 

which eligible families are using the benefits, and what is known 

about the effects of these programs on college attendance. 

The various programs tend to benefit different types of families. 

Title IV grants tend to benefit families below the national median 

income of about $52,000. Loan and work-study programs benefit a 

broader income range, as do most of the tax credits. The tuition 

and fees deduction and parental exemption for students generally 

went to families with incomes above the median. 

When we looked at whether families are claiming benefits for 

which they are eligible, we found they were not always doing so. 

We had data to analyze tax filers who were eligible for either the 

Lifetime Learning Credit or the tuition and fees deduction. They 

could claim one or the other, but not both. We estimated that 1.5 

million tax filers, 14 percent of those eligible, failed to claim either 

one, giving up an average of almost $500 in benefits. Furthermore, 

we found another quarter of a million filers who made the wrong 

choice. They claimed one benefit, but would have gained an average of $300 by claiming the other one instead. 

Why did so many taxpayers make wrong choices? The answer, at 

least in part, may be due to the complexity of the provisions. For 

example, the IRS lists 12 separate higher education assistance provisions in its guidance. What constitutes academic eligibility can be 

difficult to figure out for students who do not follow the traditional 

path of 4 years of college. Some of the provisions are similar, making it hard to figure out which one is best. For example, there are 

four different tax breaks for educational savings, each with different requirements and benefits to the taxpayer. What counts as 

a qualified expense varies across the provisions. 

Although educational institutions must send the form 1098–T to 

taxpayers about their qualifying educational expenses, the different 

program rules mean that what is reported on the form may not 

match what taxpayers are allowed to claim on a tax return. 

In addition, the number of education-related tax provisions has 

led to so-called ‘‘anti-double-dipping rules.’’ While important protections, these rules add yet more complexity for families trying to figure out their best option. 

IRS and the Department of Education have taken steps to inform 

students and their families about tax benefits, but further actions, 

such as more research on the characteristics of non-claimants, 

could help develop a coordinated and comprehensive strategy. An 

example of this is the new financial aid shopping sheet just developed by the Department of Education and others. We have not 

evaluated this sheet, which is voluntary, but it appears to provide 

15 

information that could help students plan for college costs. However, I would also note that it does not mention any tax benefits. 

My final point is that we do not know as much as we should 

about the effectiveness of the many tens of billions of dollars we 

invest annually in higher education assistance. Has Federal spending increased college attendance? Has it improved graduation 

rates? Some good research has been done on these questions, but 

it is incomplete. 

Education’s efforts to sponsor and conduct research are an important step, but we still lack evaluative information on the effects of 

Federal assistance. Tax information that might be useful for research is not readily available to most researchers. Evaluative research can help policymakers build on successful programs and 

make changes to less effective programs. This is especially important in today’s tight budget environment. 

Mr. Chairman, this concludes my statement. I would be happy 

to answer any questions. 

[The prepared statement of Mr. White appears in the appendix.] 

The CHAIRMAN. Thank you very much, Mr. White. I appreciate 

that. 

Dr. Cruzado, I would like to ask you your thoughts on the remarks of a couple panelists that a lot of these increases, whether 

it is direct aid, Pell Grants, for example, or increases in tax benefits, are just absorbed by the institution, and the benefits are not 

passed on to the students. I think Ms. Munson makes the point 

that colleges and universities in America are getting bigger. There 

is no requirement that they pay out any percent of their endowment. Tuition rates have gone up pretty rapidly. Costs are going 

up, and so forth. 

You are the only president here of a university. So why don’t you 

tell us what you think about all of that? 

Dr. CRUZADO. At Montana State University, we pay special attention, and we really make it almost a philosophy that dollars will 

follow students and their needs. 

But start with the realization that running a university nowadays is a far more complex business than what it was 20 years 

ago. Twenty years ago, we did not have the complexities of information technology nor the requirements of compliance, not accreditation requirements, but the whole host of student services that 

our students need and deserve, particularly mentoring and counseling for those with additional learning disabilities whom we encounter. 

Having said that, though, as I said in my testimony, we at Montana State University are paying close attention to reducing the 

cost of administration. I started that 21⁄2 years ago when I reduced 

the number of vice presidents from eight to five, and that established a tone. 

We are now taking a look at all our administrative efforts and 

trying to reduce the cost of payroll and human resources and finance and accounting so that those dollars can be freed up and redirected back to the students. 

And finally, we are encouraging our students to finish their degree as soon as possible. That is the best way in which we can reduce cost at the university. 

16 

One of the best examples has to do with some courses that students need to take over and over again. How can we make sure 

that, without diluting course content, we give students the tools to 

be successful so that they only need to take those courses once and 

accelerate the time to graduation, which results in a gain for families, for the students, and for the institution as well? 

The CHAIRMAN. A legitimate question could be asked of, why are 

college expenses rising at such a rapid rate, much more rapidly 

than health care costs? I assume my statistic of 19 percent annual 

is not too far off the mark. But whether it is a little bit off or not, 

still, college costs are going up at a very rapid rate. 

Why is that? What is the cause of all that? 

Dr. CRUZADO. That is a fair question, Mr. Chairman and members of the committee. And again, at Montana State University, 

what we have observed is just that the cost of operations has increased rapidly. 

For example, information technology, as you know, is a huge investment in colleges and universities, and it is a necessary one. We 

need to provide for students and the faculty members the information technology that they need, and those are additional costs that 

were not with us 20 years ago. 

As I mentioned also, the cost of student services has skyrocketed 

in colleges and universities. For example, we are observing a great 

need for additional counseling services in all our colleges and universities. Student disabilities, learning disabilities, put an additional burden on colleges and universities, and we want to make 

sure that students have the resources that they need in order to 

be successful in the classroom. 

New, additional compliance efforts that have added—for example, institutional data that we need to provide for some Federal 

agencies—those are costs that were not with us 20 years ago and 

have resulted in additional tuition expenses. 

Having said that, though, I need to say, in the State of Montana, 

we were able to keep tuition flat for almost a decade. We have not 

increased tuition since 2007, and we only did that last year, but 

only after the State further reduced the State appropriation that 

will support students. 

So it is a combination, also, of the erosion of the State support 

that has affected almost every State. Let me just give you this example. When you and I went to school, and almost until 20 years 

ago, the State would subsidize our studies by almost 80 percent. 

Today, that is a complete reversal. The State provides between 20 

and 30 percent of the cost of education and asks students and their 

families to shoulder the remaining 80 percent. 

That is the biggest cost, and that is why tuition has increased 

so rapidly in America. 

The CHAIRMAN. My time is up, but very briefly, would that apply 

to private schools as well? 

Dr. CRUZADO. I am sorry? 

The CHAIRMAN. That would not apply to private schools. Why has 

private school tuition gone up so rapidly? Maybe they have State 

aid. 

Dr. CRUZADO. Well, Mr. Chairman, I cannot speak for private institutions. They have additional resources and a different set of priVerDate Nov 24 2008 21:01 Sep 06, 2013 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 R:\DOCS\82271.000 TIMD
17 

orities than public institutions. I can speak for public institutions 

who are not part of some of the goals of private universities. 

The CHAIRMAN. Thank you very much. I appreciate that. 

Dr. CRUZADO. Thank you. 

The CHAIRMAN. Senator Bingaman, you are next. 

Senator BINGAMAN. All right. Thank you very much. Thank you 

all for being here. 

Let me ask Mr. White to comment on some of the recommendations that Dr. Dynarski has made in her comments. She recommended that we merge the AOTC and the Lifetime Learning 

Credit into a single credit. Is that something that makes sense? 

Mr. WHITE. Senator, we have developed a framework for thinking about questions like that. And one issue is thinking about the 

purpose of the provisions. And you have some provisions, such as 

the grant programs, the tax credits, and some of the deductions, 

that have a very similar purpose of providing a lump of money to 

students or families to pay for current education costs. 

So that raises the question of whether we need so many different 

programs. Part of the answer to that question depends on whether 

the differences in these programs allow you to target different 

groups differently, more effectively, than you would otherwise. 

But I think it is a combination of thinking about the purpose of 

the program and whether you can do something different. If you 

cannot do something different with it, that does suggest some consolidation. 

Consolidating would allow you to save on administrative costs 

and provide the same amount of aid to families and students. 

Senator BINGAMAN. I am going to take that as a qualified ‘‘yes.’’ 

Mr. WHITE. It is a qualified ‘‘yes.’’ 

Senator BINGAMAN. Let me ask about—she also suggests we deliver the credit at the time of college enrollment rather than wait, 

having people wait to file tax returns and all of that. Does that 

make sense, from your perspective? 

Mr. WHITE. That is one of the disadvantages of providing assistance through the tax code, that the money does not come in to families or students until the following year when they file their tax 

return. 

Senator BINGAMAN. So you think going ahead and providing that 

credit at the time of college enrollment makes good sense? 

Mr. WHITE. Well, if you try to provide the credit up front, that 

creates more challenges for IRS, because then you are providing 

the money to taxpayers before they file the tax return. So it is 

harder—you are not determining eligibility then. 

There might be alternative ways to provide the money up front, 

not through a tax credit, but through an up-front grant. 

Senator BINGAMAN. Right. And is that what you are recommending, Dr. Dynarski? 

Dr. DYNARSKI. Yes, it is. An additional option is to use income 

data from an earlier year to establish eligibility for the tax credit. 

So, we could simply use a previous year’s income to indicate somebody’s need and use that to determine their eligibility for a tax 

credit, which could then be delivered to the institutions through 

the same mechanism that the Department of Education uses to deliver the Pell Grants. 

18 

Senator BINGAMAN. Let me ask any of the witnesses, but maybe, 

Mr. White, you would particularly know the answer to this. 

Has there been a proposal developed, an actual legislative proposal, to accomplish some of this simplification of these educationrelated tax provisions, or is this something that we just have hearings about? 

Has anybody put a piece of legislation on the table and said, 

‘‘Here is a way to do it’’? Has the tax advocate done that, for example, or anybody else in the administration or in the Congress, as 

far as you are aware? 

Mr. WHITE. I am not sure the extent to which actual legislation 

has been drafted to do this. 

Senator BINGAMAN. Do any of the rest of you know about that? 

Dr. DYNARSKI. There is legislation that has been crafted to simplify the aid programs in such a way that potentially we could establish eligibility for both the aid programs and the tax incentives 

using the same information. 

Essentially, if you were able to whittle down the aid application 

to include the same questions that are used to determine eligibility 

for the tax incentives, we could have a unified application. 

Senator BINGAMAN. Mr. Hodge, your basic point was that the tax 

code is not the right vehicle to be assisting people with the costs— 

covering the costs of their education. Is that an accurate statement? 

Mr. HODGE. That is accurate, yes. 

Senator BINGAMAN. You are not advocating that the Federal Government back off of supporting people in covering the costs of their 

education, you are just saying it should not be done in the tax code; 

is that right? 

Mr. HODGE. That is correct. I would rather see that assistance 

on the spending side of the budget rather than on the tax side. Perhaps even, rather than having duplicate programs, we could simply 

fold in any of the moneys dedicated to tax programs into, say, Pell 

Grants and what have you. 

Rather than having the IRS run this program, it should be run 

exactly where it is, at the Department of Education. 

Senator BINGAMAN. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you very much. 

Next, Senator Wyden? 

Senator WYDEN. Thank you very much, Mr. Chairman. I know 

it has been a hectic morning trying to get in and out. I thank you 

for doing it. 

I would like to ask you all about the nature of Federal education 

policy and whether, particularly in the context of tax reform, there 

is an opportunity to make a break. 

What we historically have done in terms of Federal education 

policy is to focus on access to education. That is the magical word: 

access. And so we make available grants and loans and, through 

the tax code, interest subsidies and things of that nature. But it 

is all designed to make sure that people have access to education. 

I continue to think that that is hugely important, and I want to 

keep that focus. I think what I would like to ask you, Ms. Munson, 

and you, Dr. Dynarski, is whether there ought to be an effort to 

build on top of that focus on access a new emphasis on value—on 

19 

value of various kinds of education offerings and whether we ought 

to start looking at that, as well, as part of the tax debate. 

Mr. Hodge knows that Senator Coats and I have the first bipartisan tax reform bill in a quarter-century. So we have provisions 

that relate to the tax code, trying, again, to reform it and look to 

the future. 

But apropos of this question of value, for you, Ms. Munson, and 

you, Dr. Dynarski, Senator Rubio and I—he is the Republican Senator from Florida—have introduced a bill called the Student Right 

to Know Before You Go Act. And this legislation would, for the first 

time, make it possible in one place to get information about graduation rates and debt levels and a lot of the essential information 

that students and parents need. But it would also make it possible 

for a student, for the first time, to get a sense of how much they 

would earn if they got a degree in a particular field from a particular school. 

So my question is, what are your thoughts on that, again, recognizing that I do not want to tamper at all with this historic focus 

on access? I have supported Pell Grants and Stafford Loans and all 

of the efforts that have provided assistance to students. 

The question is, can we go further and put a new focus on value 

as part of the tax reform debate? I also love the fact I was getting 

some nods there from our wonderful witness from Montana. 

So maybe we will start with you three and get your reaction, if 

time allows. 

Mr. Hodge, as you know, we always enjoy working with you, and 

your input would be welcomed. 

Doctor? 

Dr. DYNARSKI. More information is better. Families need good information if they are going to make smart choices about which institution to send their kids to. Prices vary wildly across schools, 

both sticker prices and prices net of scholarships. Success rates, 

graduation rates vary wildly across schools that are quite similar 

in the same missions. 

So I think it would be a great step forward to have uniform information about graduation rates, about prices, and about employment rates and earnings of graduates from institutions. The State 

of Florida has been doing this on its own using its own data systems, but seeing a more uniform set of information across the country would be a great step. 

We have been moving in this direction a bit with the gainful employment rules, which require that we gather this information for 

schools and programs that are focused on career preparation. These 

standards are pretty weak ones, and they do not apply across the 

board. So getting that information published for all schools, I think, 

would be a wonderful step forward. 

Senator WYDEN. Great. Ms. Munson? 

Ms. MUNSON. I appreciate your dedication to the important agenda of maintaining access, and, as I said, I have two young toddlers. 

I look forward to—— 

Senator WYDEN. Me too. 

Ms. MUNSON. You do too. 

Senator WYDEN. Another one on the way. 

Ms. MUNSON. Congratulations. 

20 

Senator WYDEN. Pictures available on my iPhone later. [Laughter.] 

Ms. MUNSON. I think though, when we think about tax policy, in 

particular with regard to education, we are often torn between our 

desire to help in the current day provide access now, but trying to 

do it in a way that maybe is not contributing to a larger problem 

of feeding this tuition machine. 

I think that part of the equation, the second part, is where our 

focus needs to be, and that is why I talk a lot about tuition honesty 

and full disclosure. I agree entirely with Professor Dynarski that 

more information is always better. 

One piece of valuable information: we have talked about graduation rates, but you realize that it actually, on average, takes students 6.2 years now to graduate from so-called 4-year public institutions of education. Only 27 percent of entrants to 4-year public 

institutions these days are actually graduating within 4 years. 

This is, obviously, contributing to the debt problem, to the tax 

burden, to the bankruptcies, and all of this. 

Senator WYDEN. Dr. Cruzado? 

Dr. CRUZADO. I could not agree more. I would welcome an opportunity to build on the layer of value. At Montana State University, 

perhaps because of our culture of being very prudent and very conservative in how we approach finances, we would be more than 

happy to show parents and families what are the programs that 

will result in higher wages or in additional opportunities for our 

students. 

And I think that, with the proper instruments, we can show the 

taxpayers exactly where is the money that they are investing in 

our university. 

Senator WYDEN. I thank you. It is striking, Dr. Cruzado, your 

answer is very similar to what the president of Oregon State University, Ed Ray, said when I asked him about this. He said, ‘‘We 

have an important story to tell. We like what you are talking 

about, Ron, with Senator Rubio, because we think disclosing this 

information at a school like ours’’—and, obviously, a school like 

Montana State—‘‘if anything, allows you to showcase the important 

work that you are doing.’’ 

So I am going to put you and Ed Ray from Oregon State down 

now as people whom we are going to call on. 

I think the other point I would mention—I know my time is up, 

and Chairman Baucus has been very gracious to give me the time. 

One of the things that has come up in discussion about this, Mr. 

Hodge, because you and I have talked a lot about markets over the 

years, and, as you know, I am a Democrat who believes strongly 

in trying to find a role for marketplace forces. Part of what I think 

this legislation can do, the Student Right to Know Before You Go 

Act, is, if you have a school over here and they are charging a lot 

more than the school over there, and the school over here is not 

producing as impressive a record in terms of graduation and employment prospects and the like, the school over here is going to 

say to themselves, apropos of Dr. Cruzado’s comments, this is going 

to be out in the real world. This is going to be on line. It is going 

to be part of a market that families look at for purposes of education. And the school over here had better say to themselves, ‘‘We 

21 

better clean up our act in terms of graduation rates, prospects for 

careers,’’ or the school over here is going to have problems. 

So I am going to want to talk to you some more about it, because 

I think what you and I have talked about in the past—and you 

have been very helpful to us in the discussions with respect to tax 

reform—always comes back to, can you, under the tax code, find 

new ways to unleash marketplace forces and do it fairly so that 

there is opportunity for everybody, not just the people born on 

third base, but opportunity for everybody. And I am going to want 

to follow up with you. 

Thanks for the extra time, Mr. Chairman. 

The CHAIRMAN. You bet, Senator. You are very welcome. 

Senator Grassley? 

Senator GRASSLEY. I would prefer to make a statement instead 

of asking questions, and I am going to refer to a Turner endowment study, a Ginsberg article, and a CBO report. And I would ask 

unanimous consent that those be put in the record. 

The CHAIRMAN. Without objection. 

[The publications referred to appear in the appendix beginning 

on p. 51] 

Senator GRASSLEY. As we consider how tax incentives help students and families pay for college, we should consider whether and 

how these incentives also increase cost. This is something that 

Chairman Baucus referred to in his last question. 

We have a 2010 study by Nicholas Turner, University of California-San Diego, suggesting that schools are reducing financial aid 

awards by the amount of tax benefits a student or family may receive. 

In addition, a 2011 article in Washington Monthly by Benjamin 

Ginsberg exposes the explosion in spending on administrators and 

support staff who are not directly involved in instruction or research. Such spending includes hefty increases in executive compensation and benefits. 

Aside from getting a handle on the rising costs and tax incentives for students and families, it is also important to consider the 

tax benefits that tax-exempt colleges and universities receive. Just 

like tax-exempt hospitals, tax-exempt colleges and universities are 

exempt from income taxes. They also have the ability to raise capital through tax-deductible charitable contributions and the issuance of tax-exempt bonds. 

The Joint Committee on Taxation, in a document prepared for today’s hearing, indicates that the most expensive Federal tax expenditure for education is the charitable deduction, at more than 

$32 billion. The tax exemption for bonds is third most expensive at 

$18 billion. 

The charitable deduction for sure fuels the growth of multibillion-dollar college and university endowment funds. According to 

the most recent annual endowment study, endowments with more 

than $1 billion in assets had a 1-year rate of return of more than 

20 percent and a 10-year rate of almost 7 percent. 

So, even though they had a couple of rough years, like 2007 and 

2008, they are also still doing well. Yet, despite their success and 

skyrocketing tuition, their payout rate hovers around 5 percent. 

22 

Part of their success results from their investment strategies. 

The same endowment study tells us that these endowments with 

more than $1 billion are 60 percent invested in what is termed ‘‘alternative strategies.’’ Such investments include private equity; 

international private equity; mergers; acquisition funds; hedge 

funds; derivatives; and energy and natural resources, including oil, 

gas, timber, and commodities. 

Aside from their lack of spending on students, it is unclear 

whether such investments may also be contributing to the erosion 

of the tax base by sheltering otherwise taxable commercial activity 

in tax-exempt entities. Commodity speculation is another issue 

that I have been working on that concerns both me and Senator 

Wyden of this committee. When it comes to tax-exempt bonds, it 

seems that the ease of borrowing is causing a race to spend without 

considering whether such spending adds to student learning. 

In a May 1, 2012 CNBC report, the dean of admissions of Po- mona College suggests a $53-million investment in student housing 

is very important because students are not making choices based 

on whether they are going to get a good education. The same report 

highlights other California colleges offering perks such as dorm 

rooms with oceanfront views and cafeterias with gourmet food. 

In addition, an April 30, 2010 Congressional Budget Office study 

suggests that colleges and universities may benefit from indirect 

tax arbitrage by using tax-exempt bonds to fund buildings and 

equipment while hoarding money to invest in assets such as I just 

mentioned that provide a higher rate of return. 

So I get to the bottom line. The incentives for students and families are not the only ones that should be reviewed in the context 

of tax reform. All education-related tax expenditures should be examined to ensure that students and families, in addition to taxpayers, are getting the most bang for their buck. 

Thank you. 

The CHAIRMAN. Thank you, Senator. 

I would just like to focus a little bit on what works here. I also 

tend to think—this is from my perspective—there is still not a sufficient sense of urgency about what needs to be done to address 

America’s education needs. 

Let me start this way. A few years ago, I took several Montana 

business people to Asia, China, India, and other countries. Near 

the end of the trip, we were in Bangalore, India, one of General 

Electric’s major research facilities. They have a big one there in 

Bangalore. It is called the Jack Welch Research Facility. 

We went through it, spent half a day there, all the ‘‘gee whiz’’ 

stuff. And at the end of the day, I walked up to the manager, Dr. 

Guillermo Willie is his name. He is not Indian. He is half German 

and Portuguese. But most everybody else working there are all Indians. They are from Bangalore. 

And I said to him, ‘‘Why are you located here in Bangalore? Why 

is your facility here?’’ He said, without batting an eyelash, without 

skipping a beat, ‘‘Greatest talent pool.’’ So I asked, ‘‘What country 

has the next greatest talent pool?’’ ‘‘China,’’ he said. ‘‘Where are 

we?’’ I asked. ‘‘What about our talent pool?’’ ‘‘Well, you’re kind of 

down there pretty far.’’ I asked, ‘‘What do we have to do to get up 

there?’’ Again, without skipping a beat, this is just his view, he 

23 

looked straight at me and said, ‘‘Two things. One, health care. Second is education.’’ He said, ‘‘You’ve got to educate your people better, and, second, your health care system tends to discriminate 

against—makes it more difficult for your companies to compete 

compared with other companies in other countries.’’ 

Now, I am not going to say this fellow had all the answers, but 

I do think he had a kernel of truth in what he was talking about, 

both, including education. And I believe strongly, because we see 

all the data, how competitive this world is becoming, that we have 

to focus a lot more on how we get better bang for our buck in education. 

It is all levels. It is elementary, it is K–12, it is community colleges, it is votech schools, it is higher ed, and so forth. 

But the hearing today is focused a little more on higher ed. Community colleges and other similar forms of education would qualify 

here. But I am just trying to get a sense here of, what do we do 

to cut through all this stuff? 

So what works? Let us just take, for the sake of discussion right 

now, only the tax provisions. And there are a lot of them, and they 

are complex, and they are very difficult for people to understand. 

So I would just like you, whoever wants to take a crack at this, 

to tell us which ones work the best, which ones do we pare back 

and perhaps even eliminate. We have 529 plans, Coverdells, the 

American Opportunity Tax Credit, a couple others. 

What works for students, and what really does not work that 

much, just candidly? And, if you want to change some of these, tell 

us how they should be changed. It sort of begs the question, 

though. Should there be any tax provisions? 

Mr. Hodge is basically saying, no, we do not need any. Let this 

all be handled on the spending side, Pell Grants, et cetera. Well, 

there are some people who do not qualify for a Pell. And education 

costs are different in different parts of the country. It is a pretty 

big country we have here. 

So let us just say, first, which tax provisions work? How should 

they be modified? And should we even think about tax provisions 

or just forget them and say, ‘‘Department of Ed, it’s up to you. You 

take care of students. The Finance Committee, we are just going 

to wash our hands of it, from a tax perspective.’’ 

Who wants to tell us what works? 

Dr. DYNARSKI. I would say that if the tax credits could be made 

refundable, delivered up front, if they are targeted, made simpler 

to understand, then families are going to find them indistinguishable from a grant. If we cannot get to that goal, then they are not 

useful. 

The CHAIRMAN. You say refundable and up-front. 

Dr. DYNARSKI. Delivered up front when people pay a tuition. 

The CHAIRMAN. Advanced refundability. 

Dr. DYNARSKI. Indeed. So, if people need the money to go to 

school, they need it when they need to pay the tuition bill. They 

do not need it 18 months later. If we could achieve those goals with 

the tax provisions, then as far as the families are concerned, they 

are going to be a grant. So, if we can make the tax credits look like 

a grant, great. If we cannot get to that goal, then we are probably 

24 

better off just running things through the traditional systems and 

with one program in particular. 

No matter how we are delivering them, whether it is through the 

tax system, through the Ed system, I think we need a unified system so that we have a single application for families, so they can 

understand clearly what their eligibility is, and so we—so you, as 

policymakers, can understand clearly who is getting how much 

money. 

The CHAIRMAN. What is the importance of incentives to save, like 

529 plans? We have several options—incentives for saving. Second 

is assistance while you are in college. Third is paying off loans. 

Maybe it is a combination. What do you think? 

Dr. DYNARSKI. The low-income families that we are trying to get 

into college, whose attendance rates are low, they are not using the 

529 and the Coverdell. 

The CHAIRMAN. Sorry. Say again. 

Dr. DYNARSKI. They are not using the 529 and Coverdell. 

The CHAIRMAN. Who is not? I am sorry. 

Dr. DYNARSKI. Low-income families. So the people who save the 

most and who benefit most from the savings protections are going 

to be upper-income families. They are the ones who save more. 

So I would say we do not have any evidence at all that the savings incentives increase college attendance. 

The CHAIRMAN. Who else? Ms. Munson? 

Ms. MUNSON. I think you are chasing a runaway train. I think 

that tuition—unless you can find a way to disconnect the relationship between tuition increase and providing more subsidies, you 

are going to be in the business of just continually providing more 

subsidies. 

The CHAIRMAN. All right. Now, give me one or two ways you 

would do that. 

Ms. MUNSON. I am not sure. One idea would be to make universities and colleges get some skin in the game and worry about 

themselves being taxed, for example, if they are not spending from 

their endowment. 

The only way you can start getting to some evaluative information about the use of endowments and their potential to truly bring 

down the cost of college is to shine really some very bright sunshine on them. 

The CHAIRMAN. You gave us two proposals. 

Dr. Cruzado, what do you think of those two ideas that Ms. Munson has? Number one, you have to spend a certain percent of your 

endowment. Number two, you have to disclose your expenditures, 

as, apparently, private foundations do, and I am not that knowledgeable about private foundations. 

Dr. CRUZADO. I am always in favor of more transparency rather 

than less. So in that sense, I would not be opposed. 

I have been thinking about whether there can be some type of 

provision where we say, the tax code benefits will be available for 

a fixed number of years, because whatever incentive we put out 

there, we will incentivize a particular type of behavior. 

And what we really want to do is to reduce that. The best way 

is to make sure that students get in school, get in school full-time, 

if possible, and graduate as soon as possible. 

25 

The CHAIRMAN. On the requirement about a certain percent of 

endowment being paid, what is your thought about that? 

Dr. CRUZADO. Well, again, let us talk about which percentage, 

and I think that we would be open to have a conversation. For example, at Montana State University, the endowment of the ASMSU 

Foundation is about $125 million, of which only 79 percent is permanently restricted. 

Yet, every year—last year, for example, our students received 

more than $2.5 million in scholarships. Those are dollars that 

would not have been there had it not been for those donors and 

benefactors who decided to invest in Montana State students. 

The CHAIRMAN. Dr. Dynarski, you gave me an answer to my 

question of what works. 

Does anybody else have an idea of what works? We are going to 

put runaway train aside for a moment. What works? 

Mr. HODGE. I think, Senator, that we need to get the government 

as much out of this as possible, because we do not have an efficient 

marketplace in higher education. 

This is the only market that I know of in which the seller of a 

good has complete financial information about the buyer. If I go 

into a store to buy a pair of shoes, the seller has no idea of what 

my income is or what my assets are. If I go to buy an airline ticket, 

the seller has no idea what my assets are or what my income is. 

And yet, in this marketplace, the seller of the good has complete 

information about my finances and can cherry-pick and design a financial package or a price that I can pay based on all of that. 

That is not an efficient market. That is a backwards market. 

The CHAIRMAN. That is going to occur, also, with respect to 

spending only; the seller is going to have more information. 

Mr. HODGE. The problem here is that we have all of these dollars 

which are forcing up cost. This is exactly the kind of bubble that 

was created in the housing market, where all of that cheap lending 

caused a bubble in the housing market. 

This is exactly what we are seeing in health care, where such 

things as the exclusion for employer-provided health insurance creates a third-party payer problem in which the actual consumer of 

the good has no real market power, because the seller of the good, 

the doctors and hospitals, are dealing with the insurers and the 

employers. 

And the more that we can try to make this a functioning market, 

that is the only way to get these costs under control and put the 

consumers back in the driver’s seat. Right now, they are not. They 

are simply victims or pawns in this whole system. 

The CHAIRMAN. How do we get there from here? 

Mr. White, go ahead. What works? 

Mr. WHITE. Mr. Chairman, the fact that you have to ask that 

question is part of the problem here. 

The CHAIRMAN. Yes. 

Mr. WHITE. We do not know the answer. There is a debate 

among the panelists here about the effect of Federal assistance on 

tuition. Well, the flipside of that is the effect of Federal assistance 

on the quantity of students attending college. Price and quantity 

are just flipsides of the same thing in a market. 

26 

And we do not know the effect on price, nor do we understand 

very well the effect on students’ access to education, the extent to 

which these programs affect that. 

So what is needed here is some—part of what is needed to get 

you to the answer to the questions you are asking about is some 

better research by the Department of Education about the effects 

of these different programs on students’ access to education, their 

persistence, the extent to which they follow through and graduate, 

what the ultimate outcome is from the billions of dollars that are 

being spent on these programs right now. 

The CHAIRMAN. You have somewhat answered the question. But 

what are some of the questions you want to have answered? 

Mr. WHITE. What is the increase—what is the effect of all of the 

tens of billions of dollars that are being spent, at the margin, on 

the number of students attending college and finishing college? 

The CHAIRMAN. Does the Department have that data? 

Mr. WHITE. Right now, the answer to that question is not very 

well understood. Part of the job of the Department ought to be to 

figure out what data is needed to answer that question and work 

with, for example, the IRS to obtain the data to answer that question. 

The CHAIRMAN. I did not realize Senator Thune was here. I am 

sorry, John. 

Senator THUNE. Thank you, Mr. Chairman. I just kind of blend 

in down here. 

I am interested in that data as well. If there is a way—I think 

that would be really important information to have in order to 

make informed judgments about what works and what does not 

work and what is cost-effective. 

I think we all understand the critical role that education plays 

in our modern society and how important it is that we continue to 

expand the opportunity for more Americans. I think the tax code 

can and has played a role in that. 

I think the question is if the tax system is the appropriate place 

from which to expand access to education, and if these subsidies 

are really truly benefitting students or are they just structured primarily to benefit the educational institutions. It seems, to me at 

least, given the critical importance of education, that these are 

questions that really need to be explored, certainly, as part of fundamental tax reform, if we ever get there. 

I am interested in asking the question the chairman was asking 

maybe a slightly different way. But, between these various incentives that exist in the tax code today to help Americans afford higher education, you have provisions to help Americans save for college, provisions to help Americans deal with the debt associated 

with a college education, and some incentives to help Americans afford higher education. 

I am interested in drilling down a little bit more on the question 

of which of these categories of tax benefits are most cost-effective 

to the Federal Government. And again, that gets maybe back to the 

previous question that really needs more of an analysis of the data 

to come to that conclusion. 

But, if we could only choose one of these incentives, which is the 

one that you think would be the one that we would want to put 

27 

our resources and our effort behind, and why? I just throw that 

question open. 

Mr. White? 

Mr. WHITE. I will start. And I think part of the problem here is 

that we are spending tens of billions of dollars on these programs 

and we do not know the answer to the question you are asking. 

Some of these programs do serve different purposes. Some are effectively grants. The credits and deductions are providing money 

right now to pay for current expenses. Other programs are assisting with paying off loans, which is a different sort of assistance. 

But we do not know what the effect of these different kinds of programs is. We do not adequately understand—there is some research that has been done, but it is limited. We do not understand 

how effective those programs are at things that we want to accomplish, such as increasing college attendance by students who would 

not otherwise have gone to college. 

Senator THUNE. Mr. Chairman, is that something that we could 

ask the GAO to do? 

The CHAIRMAN. We can ask them to do whatever we want. 

[Laughter.] 

Senator THUNE. Good. 

Dr. DYNARSKI. I would like to point out, actually, that the Department of Education is right now fielding two experiments that 

will answer some of these questions. They are about to start some 

experiments that would look at the effect of the Pell Grant, as well 

as the education savings incentives. 

So at least we are moving in the direction of getting answers to 

some of these questions. 

Senator THUNE. Let me ask Mr. Hodge. There are a number of 

us on this committee, I think, who have been surprised to learn 

that roughly half of all Americans do not pay Federal income tax 

at all, because they do not have an income tax liability. 

What are your thoughts and your opinion as to what extent the 

tax benefits in the code for education contribute to that? 

Mr. HODGE. Well, it has not been the driving force. Obviously, 

the child credit, the Earned Income Tax Credit, Making Work Pay, 

all these others are the bigger factors, but this is certainly a factor. 

And certainly, the American Opportunity Tax Credit has been a big 

part of that. 

I was troubled to read the Inspector General report which found 

as much as $3.2 billion in erroneous payments under the American 

Opportunity Tax Credit in the last year. So these programs are 

ripe for fraud, in addition to the fact that they are knocking people 

off the tax rolls. 

But to answer your previous question, I would say the only provisions that we are talking about here that are consistent with fundamental tax reform are the savings provisions, the 529 plans and 

the IRAs, because, even under fundamental tax reform, we would 

want to encourage savings. 

I would not try to pigeonhole savings into various buckets that 

we choose, such as health insurance or housing or so forth, but to 

encourage savings for whatever a family’s needs may be, but certainly, education would be a big part of that. 

28 

And so all of these other credits do violate the basic principles 

of fundamental tax reform and the basic principles of tax policy. 

But on the other hand, the savings provisions are fully consistent 

with that and are things that we would want to encourage. 

It is better to encourage people to save for college rather than to 

mortgage their future with all of these loans, which too many 

Americans now—I think the outstanding loan debt in America is 

now over $1 trillion, which is greater than all of the consumer debt 

that is out there. 

We are facing the same kind of bubble in student loans that we 

have seen in housing, and that is a very troubling turn of events. 

Dr. DYNARSKI. I would just like to add to that that I agree it is 

important to encourage savings, but I think we should be clear 

about that savings policy and not call it education policy. We basically do not have any evidence that these programs increase 

college-going. 

The people who take up the 529 plan, the Coverdell, are very 

high-income families. Their children go to college at rates well 

north of 90 percent. And providing tax savings incentives for them 

is not going to increase education levels. 

Senator THUNE. Final question, and I guess maybe this was addressed earlier. But did we sort of establish, in response to some 

of the questions that were raised earlier, that some of these subsidies for education are contributing to the higher cost of college 

education? Was that a sort of agreed-upon point? 

Dr. DYNARSKI. No. 

The CHAIRMAN. It was discussed. 

Senator THUNE. Good. Well, I will go back and read the transcript and figure out who agreed and who disagreed. 

But anyway, this is—if we get to fundamental tax reform—obviously something that will be hopefully included, an element of that, 

and, hopefully, by then we will have some of the information that 

will give greater clarity at least to what works, what does not 

work, what is a good return for the taxpayer. And so I look forward 

to that. 

Thank you, Mr. Chairman. Thank you all. 

The CHAIRMAN. Thank you, Senator. 

Don’t financial aid directors have some sense of what works and 

what does not work? Surely, we need some data, but we can be 

chasing data until the cows come home, and I am guessing that 

some financial aid directors have some sense—they are going 

through the applications—what works and what does not work and 

so forth. 

Dr. DYNARSKI. We actually do have evidence that simple, welldesigned, easy-to-communicate aid programs increase college attendance quite a bit. This evidence comes from State programs that 

have those characteristics. 

We also have evidence that simplifying the Federal programs 

would have a large impact on college-going. There was a recent experiment run by economists at the National Bureau of Economic 

Research where they randomly assigned families to get a vastly 

simplified aid application process, and it boosted college enrollment 

rates substantially. 

29 

So we have very strong evidence that if we were able to streamline and simplify the process for applying for aid, we would get a 

large boost to college attendance right away. 

The CHAIRMAN. Given the number of potential grants and the 

number of potential tax provisions, is it possible to design a simple 

form, or do we just have so many different alternatives here that 

it is pretty hard to design one? 

Dr. DYNARSKI. It can be complicated on the back end, but simple 

on the front end for the student who is applying. So, if we want 

to have aid coming from lots of different funding streams, that is 

fine. But as long as the student who is applying sees a transparent 

and simple answer to how much does college cost and how much 

does the government help me, then that can have a real impact. 

The CHAIRMAN. I think we are going to have both spending and 

tax provisions. That is just reality here. So it seems to me we have 

to simplify and streamline both the law and, second, the forms. 

And I am trying to figure out how we make that happen. 

You have two departments here. You have IRS and you have the 

Department of Education, and it is a problem. 

But while I am thinking about that, you raised your hand, Mr. 

White. 

Mr. WHITE. Well, we have been discussing the merits of grants 

versus tax programs. One of the advantages of tax programs that 

gets at your point is that IRS has information off of tax returns 

suitable for making decisions about means-tested programs. If you 

are going to target people based on income, IRS has that information off of tax returns. So that information is already there. 

The CHAIRMAN. That is a good point. 

Mr. Hodge? 

Mr. HODGE. Senator, I should point out that 73 percent of people 

who get the Earned Income Tax Credit have to pay a professional 

preparer in order to get that credit. So even something like that, 

which is well-intended to try to assist low-income working Americans, people are then stuck with this highly complicated tax credit 

in which they have to pay someone else in order to fill out the 

form. 

The CHAIRMAN. That may be, but I would guess that the benefit 

outweighs the cost. I do not know. 

Mr. WHITE. Well, it also has led to a lot of unscrupulous preparers. And so the fraud rates are between 23 and 28 percent of 

EITC. 

The CHAIRMAN. Are you suggesting we repeal the EITC? 

Mr. WHITE. We have to consider whether or not—we have two 

programs. We have TANF and we have EITC. They are awfully 

similar. And which ones are most effective? 

The CHAIRMAN. No, they are not. They are very different. They 

are very different. One is work-related, the other is not. They are 

very different. 

Anyway, final thoughts. Has anybody said anything that needs 

to be addressed? Did somebody say something so outrageous that 

it has to be addressed? 

Ms. MUNSON. I simply think that you are not going to get to the 

honest truth about why tuition is going up so much unless colleges 

and universities are forced to have some skin in the game with reVerDate Nov 24 2008 21:01 Sep 06, 2013 Jkt 000000 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 R:\DOCS\82271.000 TIMD
30 

gard to controlling those tuition costs and being honest with the 

public about how they are using their resources. 

I do not think that you are ever going to catch up with the runaway train unless universities really are forced to put themselves 

on the tracks. So just looking at the student side of the equation 

or, as Mr. Hodge would say, the buyer part of the equation, and 

providing all the information from the buyer and none from the 

seller, is never going to get us anywhere. 

The CHAIRMAN. Yes. Dr. Cruzado? 

Dr. CRUZADO. Yes. Mr. Chairman, I could not agree more in 

terms of the need for transparency, but also with the need for 

building a platform of urgency here and in the end asking ourselves, so what type of a Nation do we want to build; what type 

of a Nation do we aspire to continue being or to be in the future? 

And the answer to that is in higher education. 

I need to say that many universities are doing the right thing, 

and perhaps sufficient credit has not been given, perhaps because 

the information is not there. But for example, at Montana State 

University, I discovered that our graduation rate, our 6-year graduation rate, was 42 percent, and I thought that was unacceptable. 

And we started to do some work, and 2 years later it is 52 percent, 

a 10-percent increase in just 2 years. Still, a lot needs to be done. 

One of the findings that I have made is that—why is it that it 

is taking so long for students to complete their degrees? And there 

are some exceptions in which students are head of household and 

have other obligations. The reality is, students across the Nation 

are taking far less credits than what we used to take when we 

went to college. Perhaps we enrolled in 15 or 18 credits. 

At Montana State University, we have a provision that we call 

the flat spot. That is, students will pay exactly the same tuition 

whether they enroll in 12 credits or 15 credits, up to 18 credits. 

And what did I find? That 50 percent of our students are enrolled 

in 14 credits or less. 

So starting this year, we are doing things differently. We are 

starting financial literacy sessions with students and their families, 

and we are urging the new class of freshman to enroll in more 

credits. We call it Freshman 15. It is a new take at augmenting 

their academic workload. 

And in order to make it visual, at a meeting with the parents of 

all the freshman, I show them a voucher, and I say, ‘‘How many 

of you would like to have a voucher for $800 if you are an in-State 

student or for $2,400 if you are an out-of-State student?’’ And of 

course, all of the hands go up. 

And I say, ‘‘Well, that is the equivalent of a 3-credit course over 

12 credits if you were to enroll now. If you were to enroll in up to 

18 credits, that is twice as much.’’ And I finish up by telling them 

to not leave money on the table. 

So there are sound opportunities that colleges and universities 

are already improving and implementing today in order to make 

sure that families and students get to their objectives but, collectively, we build that Nation that we want to build. 

The CHAIRMAN. Thank you. That is a very good point to end on, 

a platform of urgency. 

31 

Thanks, everybody, very, very much for attending. I know you 

have come great distances at great expense to come here, and we 

thank you very much for the hearing. 

[Whereupon, at 11:52 a.m., the hearing was concluded.] 

(33) 

A P P E N D I X 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD


82271001.eps
34 


82271.002

The tax code cannot solve our educational challenges on its own. But it plays an important role. In 

2009, taxpayers claimed almost $30 billion in education tax cuts, making college education more 

affordable. This equates to about 22 percent of the assistance received through Federal grants and 

loan assistance. 

That same year, we expanded these education tax benefits by passing the American Opportunity Tax 

Credit. As a result, 4.8 million more lower-income students and families had access to college 

subsidies. These expansions are critical to ensuring American families can afford college. This is 

particularly true in my home state of Montana. 

Montana has a higher proportion of low-income students than other states. As a result, many 

Montanans only benefit from tax benefits that are partially refundable, like the American Opportunity 

Tax Credit. In 2010, Montanans claimed nearly $105 million in education tax credits and deductions to 

help offset the cost of college. 

But the multitude of education tax benefits can result in complexity and confusion for American 

families. Under current law, there are eight separate tax expenditures related to higher education. And 

these benefits use five different definitions of "eligible expenses." Taxpayers must calculate their taxes 

using each tax cut to determine which one works best. 

Behind me on this chart is an actual IRS questionnaire that families need to fill out to determine if they 

are eligible for an education tax credit. This is just one page from an 87 page IRS gUide for obtaining 

education tax credits. Based on the complexity of this guide, one would think the IRS expected all of 

America's future students to want to major in accounting. 

The Government Accountability Office will tell us today how this complexity affects families. They have 

found that many families often pick the wrong benefit and leave money on the table. 

Kelly Mcinerney is a CPA in Fairfield, Montana. Kelly is a mother of four college-age kids and knows 

firsthand how complicated these tax benefits can be. Kelly says many families she works with do not 

realize they can claim tax credits for tuition paid for with student loans. As a result, they get less help 

than they are eligible for. This can make the difference between being able to send their kids to college 

or not. 

We need to make the system simpler for families. And we should improve these benefits for 

students. Through tax reform, we need to look at how we can achieve the greatest bang for our 

buck. Our entire system should work to help, not hinder, the pursuit of an education. 

America is losing its competitive edge, but it is not too late. 50 let us heed the warnings. Let us listen to 

Benjamin Franklin's advice that investing in knowledge will pay the best interest. Let us find ways to 

continue to close the education gaps. Let us ensure this next generation - our children and our 

grandchildren - have a fair shot at making their futures brighter. 

### 
35 


82271.003

Testimony of Dr. Waded Cruzado before the Senate Finance Committee, July 25, 2012 

Mr. Chairman and Members ofthe Committee, I am Waded Cruzado, President of Montana State 

University. Thank you for the opportunity to appear before the committee today to discuss federal 

financial aid and tax policy as it relates to higher education, a topic that affects millions of students and 

their families. 

Montana State University is one of more than 100 land-grant colleges and universities created by the 

Morrill Act of 1862, a brave piece of legislation that promised the average American an opportunity at a 

higher education that would help him or her prosper and become a more engaged member of our 

society. 

The Morrill Act was signed by President Abraham Lincoln in the midst ofthis nation's greatest trial, the 

Civil War. This year is the act's 150th anniversary. In those years, more than 20 million Americans have 

earned degrees and given America one of the most highly educated workforces in the world, helping to 

ensure our prosperity and the strength of our democracy. 

More than 14,000 students attend Montana State University's flagship campus in Bozeman. Many of 

our students are the first in their family to attend college. These students pursue a wide range of studies 

from agriculture and natural resources, to arts and humanities, to education, to engineering and the 

sciences. 

Our most cherished asset and strength are the students who choose to attend MSU. Unfortunately, we 

see that it is becoming increasingly difficult for students and their families to pay for college. In my 

remarks today, I want to emphasize two points: 

1) Students are taking on far more debt. 

2) The tax code can playa vital role in aSSisting students and their families with the cost of higher 

education. 

Current challenges/Scope of problem: 

Federal financial aid and tax codes related to higher education are vital to students and their families: 

In 2009, 12.8 million students received Title IV aid and approximately 18 million tax filers 

claimed a higher education tax benefit for current expenses, according to the GAO report, 

"Improved Tax Information Could Help Families Pay for College." 

• Between 2006-7 and 2010-11, the percentage of first-time, full-time undergraduates receiving 

financial aid increased from 75% to 85% at all four-year colleges, according to the Department 

of Education report, "Condition of Education, 2012," released in May. 

• Based on national data, we can assume that thousands of Montana State students and their 

families are utilizing at least some of the tax deductions and exemptions available. 

There is evidence students are assuming more cost and borrowing more: 

Parents reduced their spending on college, both in terms of current income (4%) and savings 

(22%), according to the recent Sallie Mae and Ipsos report, "How America Pays for College 

2012." 

This is a change from two years ago when parents reached "deeply" into their pocketbooks. The 

report surmises that such a level of commitment was unsustainable. 
36 


82271.004

The report also notes that scholarship awards were down and attributes this to the economy, 

constraints on endowments and tighter budgets. 

To compensate, students assumed more costs on their own and borrowed more. 

Financial aid for higher education comes in packages: 

• Students and their families rely on several types of aid, including: federal grants, federal loans, 

work-study, and some type of institutional aid. 

The best known form of federal aid is the Pell Grant, which is based on need. Federal loans are 

widely available and must be repaid, but offer interest rates dramatically lower than the private 

market. 

• Additionally, there are federal "campus-based" aid programs, as well as state programs, private 

and institutional awards. 

• For a student from a low-income family or family with a limited family contribution, a package of 

aid is usually required to finance a college education. 

Complex - if not bewildering - paperwork accompanies applications for federal financial aid: 

A first-time student - and his or her parents - must master a form known as FAFSA, which can 

be intimidating, as well as the tax code and the 1098T form. 

Some students or their parents will have to understand something of the tax code even when 

they have no tax liability if they want to access a program such as the American Opportunity 

Credit (AOe) which has a "refundability" provision. 

• Even tax accountants find the tax credits and deductions for higher education confusing. 

The situation is further complicated by the fact that these different programs were passed at 

various times, are somewhat "stove piped" in their implementation and operation, and carry 

assorted terms and conditions. 

• For example, some may cover tuition and fees, while others may allow for housing or other 

expenses. Furthermore, how a student "stacks" aid may affect the amount they ultimately 

qualify for. 

• For a student confronting all the options, especially for the first time, the situation can be 

challenging, if not bewildering. 

Montana students taking on more debt, more reliant on federal aid: 

To describe the situation at Montana State University, let me start with two data points: FAFSA 

applications and Pell Grant awards. FAFSA stands for Free Application for Federal Student Aid and is the 

key form students and their families use to access federal student aid. The number of FAFSA forms 

received by MSU has grown 43 percent in just three years (from 2008-2009 to 2011-2012) and that 

tremendous growth rate shows no signs of slowing down. 

When students and their families use the FAFSA form, those students with the greatest financial need 

qualify for Pell Grants. As such, Pell Grants are a good indicator of the financial stress students and their 

families face. The number of students receiving Pell Grants has jumped 65.6 percent in just three years 

(from 2008-09 to 2011-2012). Currently, 33 percent of all our undergrads are receiving Pell Grants, 

which means 33 percent of our entire undergrad student body was deemed to have the greatest 
37 


82271.005

financial need under the FAFSA form. These grants are particularly important for our Native American, 

non-traditional (25+ and older) and Hispanic students, with 66 to 67 percent of these groups receiving 

Pell Grants - that's twice the utilization of the student body as a whole. 

Another trend corresponding to the recession is the amount of debt students have when they graduate. 

From 1999-2007 the average amount of debt Montana State University students graduated with 

remained relatively flat at between $17,000 and $18,000. 

Once we entered the recession, that debt grew dramatically - by 35.7 percent - so that now 66 percent 

of our graduates are leaving with an average debt of $25,682. 

Anecdotally, I am meeting more parents who are sending their children to college while still trying to 

payoff their own college debts. Recent data from the New York Federal Reserve indicates this is a real, 

national trend. 

Overall, a dramatic decline in the finances of students and their families has forced them to borrow 

more. 

Recommendations: 

Continue, or increase, federal financial aid: 

There is no way a large portion of our students could afford to attend college without federal financial 

aid. Additionally, there is a compelling national interest in providing assistance for students to attend 

college: Studies suggest that the U.S. is projected to produce 3 million fewer college graduates than 

needed in the next decade. 

Simplify the taK code as it relates to higher education eKpenses: 

The tax code can playa vital role in assisting students and their families with the cost of higher 

education, but its complexity discourages many from using it to full advantage. Even tax accountants 

find it difficult to navigate all the rules. For example, the tax code currently assists students across a 

broad range of incomes - from the "refundability" component of the American Opportunity Credit 

(AOe); through the Lifetime Learning Credit; deductions for tuition and fees; exclusion of scholarships, 

grants and tuition reductions from income; exclusion of employer-provided educational assistance; and 

student loan interest deductions. 

Clarify and coordinate the various federal aid programs so that students and their parents fully 

understand their options and utilize the available resources to their best advantage: 

The current collection of federal aid programs - while well-meaning - is difficult to understand and 

navigate. This derives from the split jurisdiction between the Department of Education and Department 

of Treasury and the individuality of the programs themselves. 

Continue support for deductions for college savings plans: 

Such deductions offer an important incentive for students and families to plan ahead and save for 

college. Saving for college gives students and families more financial flexibility and helps them avoid 

indebtedness. 
38 


82271.006

In closing, I would like to emphasize - again - that students and their families are struggling more than 

ever with the cost of education and that the tax code can play an important role in assisting them. The 

number one obstacle to students and their families taking full advantage of federal financial aid and tax 

benefits is the complexity in understanding and applying for these programs and tax advantages. 

Thank you for your work on the tax code as it applies to higher education. Please know I am committed 

to assisting you in any way I can. Providing the opportunity for our nation's citizens to attend and 

succeed in college is important to the future economic prosperity of our nation and the strength of our 

democracy. 
39 


82271.007

Testimony of Dr. Susan Dynarski 

Professor, University of Michigan 

Gerald R. Ford School of Public Policy, 

School of Education & 

Department of Economics 

Faculty Research Associate, National Bureau of Economic Research 

Research Associate, Center for Analysis of Postsecondary Education and Employment 

before the 

Committee on Finance 

United States Senate 

July 25, 2012 
40 


82271.008

Chairman Baucus, Senator Hatch, Members of the Committee, I am honored to testify before 

you today. 

Summary 

The goal of federal aid and the education tax incentives is to open the doors of college to those 

who have the ability but not the means to attend. Through some simple reforms, the government 

can serve this goal more effectively and efficiently. The current education tax benefits provide 

relief for middle- and high-income families with children in college but do little to get more 

people into college.' We should simplify and focus the tax incentives, and coordinate them with 

Title IV programs. 

College is a Smart Investment 

A college education is one of the best investments a young person can make. Even with recordhigh tuition prices, a bachelor's degree pays for itself several times over, in the form of higher 

income, lower unemployment, better health and enhanced civic engagement? Within ten years of 

college graduation, the typical BA will already have recouped the cost of her investment.3 It's 

true that during the current economic downturn college graduates have suffered - but much less 

so than those without a degree, who are twice as likely to be unemployed and who earn 

substantially less. 

Growing Gaps in Educational Attainment 

As a college education has grown more valuable, it has also grown more unequally distributed. 

Children born in the poorest quarter of the income distribution are unlikely to earn a BA - just 

9% manage to do so. In the richest quarter of the income distribution, 54% of children go on to 

earn a BA. Troublingly, this gap has increased substantially over the past twenty years.4 

This gap in educational attainment is enormous, and translates into a yawning gap in economic 

opportunity. Disparities of this magnitude in the educational outcomes of rich and poor children 

bode ill for our democratic society. Education has long been a vehicle for opportunity in our 

country, a path to prosperity for every class. Growing gaps between rich and poor in educational 

attainment threaten this vision of economic mobility. We are in danger of devolving into a rigid, 

caste society, in which the children of the poor are destined to low education and menial work. 
41 


82271.009

What Role for Federal Postsecondary Policy? 

I give you these statistics to focus our thinking about postsecondary policy. Getting more lowincome kids into and through college is, in my judgment, the defining goal of federal student aid. 

We may also have other goals, such as easing the pinch of college costs for upper-income 

families who would send their kids to college even in the absence of federal assistance. In 

families in the top quarter of the income distribution, eighty percent of children go on to college.5 

Handing money to these families will make their lives more comfortable, and perhaps reduce 

their borrowing, but it is unlikely to boost their educational attainment. 

It is important to understand the limits of postsecondary policy. Gaps in educational attainment 

and achievement start early. Inequality builds along the entire educational pipeline.6 Half the 

gap between the rich and poor in college attendance can be explained by the lower rate of high 

school graduation among poor children. Postsecondary aid and tax policy can play an important 

role in shrinking gaps in educational attainment, but these gaps will only be eliminated with 

improvements at every level of education.' 

Student Aid and the Education Tax Incentives Have Grown Rapidly 

The past few years have seen substantial growth in both traditional student aid (the Title IV 

programs) and education tax incentives. 

Pell spending doubled from $18.3 billion in 2008 to $36.5 billion in 2010.8 Part of this 

growth was driven by the recession, which decreased family incomes (thereby increasing 

Pell eligibility of current students) and weakened the labor market (thereby driving 

people into college). However, most of the rise in spending is explained by changes in the 

Pell formula that made the program more generous. 9 

With the introduction of the American Opportunity Tax Credit in 2009, the value of the 

education tax credits doubled, from $9 billion in 2008 to $18 billion in 2009.10 Most of 

this increase went to high-income families who were not eligible for the Hope Credit. 

These two programs - the AOTC and the Pell - are the largest of a broad array of federal 

programs that aim to reduce the cost of college. 

The Department of Education (ED) administers the Pell Grant as well as Direct Loans 

and a number of smaller programs that totaled $145 billion in 2010. Loans are by far the 

largest program in the Title IV portfolio. 

The IRS administers the American Opportunity Tax Credit and the Lifetime Learning 

Credit plus a variety of smaller programs (e.g., deductibility of student loan interest, 

exclusion of earnings from 529 and Coverdell plans) for a total of $28.6 billion in 

education-related tax expenditures." Besides the tax credits, the dependent exemption for 

students between 18 and 23 is the largest tax expenditure for education. 
42 


82271.010

Pell is Better Targeted Than The American Opportunity Tax Credit 

The Pel! Grant is squarely focused on low-income students. The incomes of those receiving the 

tax credits are comparatively high. 

Only 15% of Pel! recipients have household incomes above $40,000, and just 3% above 

$60,000.12 

27% of AOTC recipients have incomes over $75,000 while 16% have incomes over 

$]00,000. 13 

The lowest-income families get the largest Pell grants. The opposite is true of the AOTC. 

The 58% of Pell recipients with incomes under $20,000 account for 62% of Pell 

expenditures, while the 26% of recipients with income over $30,000 account for only 

20% of spending." 

The 28% of AOTC recipients with income under $20,000 account for only 15% of 

spending, while the 17% of AOTC recipients with incomes over $100,000 account for 

22% of AOTC expenditures." 

While the AOTC is not as well targeted as the Pell, it does deliver more money to low-income 

families than its predecessor, the Hope Credit. This is because, unlike the Hope Credit, the 

AOTC is partially refundable and covers some non-tuition costs. On the other hand, the income 

ceiling is much higher on the AOTC than Hope ($180,000 vs. $120,000 for a married couple) 

and families in this newly eligible group send their children to college at very high rates. As a 

result, the AOTC flows to many more high-income families than did the Hope Credit. 

Complexity in Student Aid and Tax Incentives Undermines Effectiveness 

Families can't respond to a price subsidy if they do not understand it. Two parallel bureaucracies 

and application processes now lie between families and the funds that can help them pay for 

college. 

The education tax incentives are far too complicated to do their job. The IRS publication 

devoted to explaining them is 87 pages long. The consequences of this complexity extend 

beyond mere annoyance and frustration. Many families do not choose the credit that 

benefits them the most, in part because they are confused about which expenses are 

eligible for which tax benefit.16 

A recent experiment showed that complexity in the aid process discourages many 

students from attending college. College attendance rose 7 percentage points among those 

allowed to use a vastly simplified process for applying for aid. 17 
43 


82271.011

Simplify, Focus and Coordinate Title IV and the Education Tax Incentives 

The goals ofrefonn should be t%cus the incentives on those who are on the margin of 

attending college, to simplify the incentives so that families can understand and respond to them 

and to coordinate the programs. 

1) Create a single, refundable benefit for tuition, fees, room, and board. 

Merge the AOTC and Lifetime Learning Credits into a single credit. A single credit 

would significantly reduce complexity, enabling families to estimate their likely credit 

well in advance. 

Make the credit fully refundable so families in lower tax brackets are eligible for the 

maximum benefits. 

2) Deliver the credit at the time of college enrollment. 

Families need the credit when tuition is due, not a year or more later when taxes are filed. 

If delivered at the time of enrollment the tax credit will pay for college, as Congress 

intended. 

IRS can use previous year's income to define eligibility for the education tax credit, so 

that eligibility is known early. 

3) Coordinate eligibility, application and administration for the tax credits and Title IV 

programs. 

A unified program can be easily communicated to families. Families can't respond to an 

incentive they do not know about. 

A unified program cuts back on duplicative paperwork for families. Complexity in the 

application process undennines program effectiveness." 

A unified program eliminates perverse and confusing interactions between the tax code 

and Title IV. Example: Title IV provides a Pell Grant, IRS reduces its value by taxing it, 

IRS then provides an education tax credit. 19 

A unified program can be a well-targeted program. Social Security is an example of a 

program with universal eligibility that still targets assistance to the most needy.'o 

A unified program cuts down on administrative costs for colleges. Colleges currently 

have to report on student spending and attendance to both IRS and ED. 

A unified program cuts down on administrative costs for goverrunent. The Treasury 

Inspector General has proposed that IRS substantially expand its oversight of the 

education tax credits in order to reduce errors and fraud. The infrastructure for such 

oversight already exists in ED. Duplicative bureaucracies will be costly for taxpayers." 
44 


82271.012

How Can We Get from Here to There? Some Examples 

There are several paths to this more effective system of tax credits and aid. Each of the following 

would, separately or in combination, move us closer to these goals. 

Reform 1: Simplify the aidformula and create a single application 

The best approach would be to determine eligibility for the aid and tax credit programs 

with a single, simple application. While the aid application contains over 100 questions, 

just a handful of data items (e.g., income) affect aid eligibility.22 By eliminating the 

superfluous questions (including those about assets) we would allow eligibility for aid 

and tax credits to be determined in a single application. This would reduce opportunities 

for fraud and error, as well as save citizens millions of hours now spent filling out 

duplicative forms."' 

Reform 2: Deliver the AOTC through the Aid System 

The refundable portion of the AOTe could be delivered to students through the aid 

system, along with the Pell. This would allow students to receive the AOTe when they 

need it to pay for college, instead of months later. This early deli very would allow the 

AOTe to affect college decisions, not just reward students who have decided to go to 

college. 

Reform 3: Provide Estimates of AOTC Eligibility to Aid Applicants 

The tax credits can affect college attendance only if students know about them before 

they go to college. When students apply for aid, they learn about their Pell eligibility. ED 

could inform students about AOTe eligibility at the same time. 

Does Aid for College Drive Up Prices? 

You requested that I discuss whether aid for college students (in the form of Title IV or tax 

credits) drives up college prices. The best evidence indicates "No" - at least for the public and 

non-profit institutions attended by 91 % of college students. We do have evidence, however, that 

prices at for-profit schools increase when the Pell does.24 While these schools teach only 9% of 

students, they account for 24% of Pell expenditures. 

I stress that the problem is limited to the for-profit sector. Any remedies should therefore be 

focused on this sector. There are other problems in this sector, which tripled in size from 1999 to 

2009. Students at for-profit schools drop out, borrow and default at unusually high rates. We are 

slowly moving in the right direction by tightening federal oversight of the sector in the form of 

the new gainful employment standards. These standards are painfully weak, and will have to be 

strengthened considerably if they are to root out the bad apples in this sector.25 Failure to do so 

will result in an upward spiral in Pell costs, loan debt and loan defaults. 
45 


82271.013

Conclusion 

The federal government could do better with its aid and tax incentives for college. Although the 

education tax benefits provide relief for middle- and high-income families with children in 

college, they do little to get more people into college. Simplifying and focusing the tax 

incentives, and coordinating them with the Title IV programs, will allow them to serve their 

goal: opening the doors of college to those who have the ability but not the means to further their 

education. 
46 


82271.014

Figures: Growing Gaps in College Attendance and BA Completion 

These figures are from Bailey & Dynarski (2011) 

Calculations are based on datafrom the National Longitudinal Surveys o/Youth, 1979 & 1997. 

1.00 1%1-1964 birth <!)hem 

.47 

... -_ .. .... _--- 38 

.32 

.58 

0.00 1...---.-----------------------

2ndQnmil. lrdQuartile Top Quartile 

Figure 3: F roctlon of StwkllU C ompJtriDg C"Uege, by InroIM Quartllt olld Y tar ofBirtb 

0.75 

0.00 

- .... l%l-l964birthrohem 

..... 1979-1982 birth cohorts 

Top Quartile 
47 


82271.015

References 

Ackennan, Deena, Julie-Anne Cronin, Nick Turner, and Andrew Bershadker. 2011. 

"Coordinating the American Opportunity Tax Credit and The Federal Pell Grant." Paper 

presented at National Tax Association Conference. 

Bailey, Martha J. and Susan M. Dynarski. 2011. "Gains and Gaps: A Historical Perspective on 

Inequality in College Entry and Completion," in Greg Duncan and Richard Murnane, 

eds., Whither Opportunity? New York: Russell Sage. 

Barrow, Lisa and Cecilia Rouse. 2005. "Is College Still Worth It?" The Economists' Voice 2:4. 

Bettinger, Eric P., Bridget T. Long, Philip Oreopoulos, and Lisa Sanbonmatsu. Forthcoming. 

"The Role of Simplification and Infonnation in College Decisions: Results from the 

H&R Block FAFSA Experiment." Journal of Labor Economics. 

Cellini, Stephanie Riegg and Claudia Goldin. 2012. "Does Federal Student Aid Raise Tuition? 

New Evidence on For-Profit Colleges." NBER Working Paper No. 17827. 

College Board. 2010. Education Pays 2010. New York: College Board Publications. 

Crandall-Hollick, Margot L. 2012a. "Higher Education Tax Benefits: Brief Overview and 

Budgetary Effects ," Congressional Research Service Report R41967 . 

Crandall-Hollick, Margot L. 2012b. "The American Opportunity Tax Credit: Overview, 

Analysis, and Policy Options," Congressional Research Service Report R42561. 

Deming, David and Susan Dynarski. 2010. "Into College, Out of Poverty? Policies to Increase 

the Postsecondary Attainment of the Poor." In Phil Levine and David Zimmennan, eds. 

Targeting Investments in Children: Fighting Poverty When Resources are Limited, pp. 

283-302. Chicago: University of Chicago Press. 

Duncan, Greg and and Richard Murnane, eds., Whither Opportunity? New York: Russell Sage. 

Dynarski, Susan. 2004. "Tax Policy and Education Policy: Coordination or Collision?" Tax 

Policy and the Economy 18, pp. 81-116.Dynarski, Susan and Judith Scott-Clayton. 2006. 

"The Cost of Complexity in Higher Education: Lessons from Optimal Tax Theory and 

Behavioral Economics." National Tax Journal 59:2, pp. 319-356. 

Dynarski, Susan and Judith Scott-Clayton. 2007. "College Grants on a Postcard: A Proposal for 

Simple and Predictable Federal Student Aid." Hamilton Project Discussion Paper, 2007-

01. 

Dynarski, Susan and Judith Scott-Clayton. 2008. "Complexity and Targeting in Federal Student 

Aid: A Quantitative Analysis." Tax Policy and the Economy 22, pp. 109-150. 

Dynarski, Susan and Mark Wiederspan. 2012. "Student Aid Simplification: Looking Back and 

Looking Ahead." National Tax Journal 65:1 ,pp. 211-234 
48 


82271.016

Government Accountability Office. 2012. "Improved Tax Information Could Help Families Pay 

for College." GAO-12-560, United States Government Accountability Office, 

Washington, DC. 

Long, Bridget Terry. 2004. "The Impact of Federal Tax Credits for Higher Education Expenses," 

in Caroline M. Hoxby, ed., College Choices: The Economics of Where to Go, When to 

Go, and How To Pay for It. Chicago: University of Chicago Press. 

Rethinking Student Aid Study Group (2008). "Fulfilling the Commitment: Recommendations for 

Reforming Federal Student Aid." College Board. 

Skocpol, Theda. 1991. "Targeting within Universalism: Politically Viable Policies to Combat 

Poverty in the United States." In The Urban Underclass, edited by Christopher Jencks 

and Paul Peterson. Washington, DC: Brookings Institution. 

Turner, Nicholas. 20 II. "The Effect of Tax-Based Federal Student Aid on College Enrollment." 

National Tax Journal 64:3, pp. 839-862. 

U.S. Department of Education. 2012. "Student Financial Assistance: FiscalYear 2013 Budget 

Request." 

U.S. Department of the Treasury, Inspector General for Tax Administration. 20 II. "Billions of 

Dollars in Education Credits Appear to be Erroneous." 
49 


82271.017

Endnotes 

I The best evidence on the effect of the tax credits suggests that they increase college attendance 

of young people by zero (Long, 2(04) to 2.2 percentage points (Turner, 2011). Well-designed aid 

programs have been shown to have substantially larger effects (Deming and Dynarski, 2010). 

2 See evidence summarized in College Board (2010). College is not a sure bet (no bet is!), and 

returns vary considerably. For an academically prepared student, however, the odds are quite 

good that college will more than pay for itself. 

3 Barrow and Rouse (2005). 

4 Bailey and Dynarski (2011), based on National Longitudinal Surveys of Youth. The quartiles 

are of households with children in 1979 and 1997. For the later cohort, the bottom quartile has a 

maximum household income of $25,500 (average $14,000), while the top quartile has a 

minimum income of $85,500 (average $140,0(0). The gap in BA completion was 31 percentage 

points twenty years ago, as compared to 45 percentage points today. 

5 Figure on college attendance is from Bailey and Dynarski (2011). 

6 Duncan and Murnane (2011). 

7 Deming and Dynarski (2010) review the evidence on the effect of student aid on educational 

attainment. 

8 Ackerman, Cronin, Turner and Bershadker (2011). 

9 Dynarski and Wiederspan (2012). 

10 Crandall-Hollick (2012b). 

II Ackerman, Cronin, Turner and Bershadker (2011). 

12 Table 2 in 2010-2011 Federal Pell Grant End-of-Year Report. 

13 Figures are for 2009 year and are from Ackerman, Cronin, Turner and Bershadker (2011). 

14 U.S. Department of Education (2012). Figures are for 2010-11 academic year. 

15 Figures are for 2009 year and are from Ackerman, Cronin, Turner and Bershadker (2011). 

16 Government Accountability Office (2012). 

17 Bettinger, Long and Oreopou10s (forthcoming). 

18 Bettinger, Long and Oreopoulos (forthcoming). 
50 


82271.018

19 See Ackerman, Cronin, Turner and Bershadker (2011) for more examples. Dynarski (2004) 

shows similar perverse interactions between Title IV aid and the tax incentives for education 

saving. 

20 See Skocpol (1991) for a discussion of the political viability of targeted, universal, antipoverty programs. Dynarski and Scott-Clayton (2006, 2007,2008) discuss targeted universalism 

in the context of federal student aid. 

21 U.S. Department of Treasury (2011). 

22 See Dynarski and Scott-Clayton (2006, 2007,2008), as well as Rethinking Student Aid Study 

Group (2008). 

23 In a recent conference presentation, economists from Treasury and ED put forth thoughtful 

options to combine, coordinate and simplify the AOTC and the Pell. See Ackerman, Cronin, 

Turner and Bershadker (2011). 

24 Cellini and Goldin (2012). 

25 This sector is highly heterogeneous and the "bad apples" are almost certainly a minority. The 

gainful employment rules are intended to identify these bad apples and remove them from the 

Title IV programs. 
51 


82271.019

SUBMITTED BY SENATOR GRASSLEY 

WHO BENEFITS FROM STUDENT AID? 

THE ECONOMIC INCIDENCE OF TAX-BASED FEDERAL STUDENT AID 

Nicholas Turner'·'·1 

• Department of Economics, University of California, San Diego, La Jolla CA 92037 

October 20,2010 

Abstract: Federal benefit programs are designed to aid targeted popUlations. Behavioral 

responses to these programs may alter the incidence of their benefits, a possibility that receives 

less attention in the literature compared to tax incidence. 1 demonstrate the importance of benefit 

incidence analysis by showing that the intended cost reductions of tax-based federal student aid 

are substantially offset by institutional price increases for a sample of 4-year colleges and 

universities. Contrary to the goal ofpolicymakers, 1 fmd that tax-based aid crowds out 

institutional aid roughly dollar-for-dollar. Unfortunately, it is not clear how institutions utilize 

these captured resources, so that the ultimate incidence of the programs is uncertain. 

JEL Codes: 122, 128, H22 

• Corresponding author. Telephone: (202)-622-1721. Email: Nicholas.Turner@do.treas.gov. 

1 This work was completed as part of my doctoral thesis while at the University of California, San Diego. My 

present affiliation is the Office of Tax Analysis, United States Treasury, Washington D.C. 20220. 
52 


82271.020

1. Introduction 

Behavioral responses to government programs may undermine their intended effects, and as a 

result, alter their designed welfare implications. For this reason, tax incidence, which examines 

where the burdens oftaxation ultimately fall, receives much attention in the literature (Fullerton 

and Metcalf 2002; Gruber 1997; Kubik 2004). The study of benefit incidence of government 

programs is less cornmon. For example, until recently the assumption that the Earned Income 

Tax Credit benefits recipients had never been tested. Leigh (2010) and Rothstein (2010) address 

this omission, and find substantial erosion of benefits for nominal recipients via reduced wages 

in the labor market. These results suggest that the efficacy of benefit programs depends crucially 

on the extent of offsetting price changes. This paper adds to the benefits incidence literature by 

quantifying the institutional price response to tax-based federal student aid. 

Funding for federal student aid, over $660 billion between 1998 and 2006/ is based on 

the assumption that students and families claiming the programs are the economic beneficiaries. 

The existing literature finds that student aid increases enrollment (Dynarski 2000, 2003; Ellwood 

and Kane 2000; Heller 1997; Leslie and Brinkman 1987; Turner 2009), but how effectively these 

programs do so depends on the degree to which there are offsetting price changes. Yet, the 

literature examining the institutional price response to student aid is limited and generally 

focuses on tuition effects at the school level. The use of tuition increases to appropriate the 

benefits of federal student aid is referred to as the Bennett Hypothesis, named after former 

Education Secretary William Bennett. J Long (2006, 2008) and Ikenberry (1997) discuss the 

2 Expenditures are in 2006 dollars and include grants, student loans and tax-based aid (Baum and Steele 2007). 

3 Bennett (1987) made his original argument in the context of federal loan programs. Following Singell and Stone 

(2007) and Hoxby (1998), I use a broad interpretation of the Bennett Hypothesis that includes the appropriation of 

any external student aid program using tuition increases. 

2 
53 


82271.021

existing work on the Bennett Hypothesis and note that there is weak empirical evidence 

supporting its validity.4 

One possible explanation for these inconclusive [mdings is that instead of increasing 

tuition, schools may appropriate the benefits offederal student aid by strategically reducing 

institutional grant aid. I refer to this possibility as the price-discrimination Bennett Hypothesis. 

Unlike tuition increases that affect all students, the reduction of institutional aid allows schools 

to realize financial gains from increases in federal student aid while ensuring that no student is 

made worse off. The strategic use of institutional aid also avoids the highly visible and 

unpopular process of increasing tuition.s Both policymakers and financial aid administrators are 

aware of the possibility that institutional aid will be replaced by tax-based aid. Fonner 

Education Secretary Richard Riley sent a letter to presidents of colleges and universities 

declaring that the goal of tax-based aid is to, ..... provide additional help for families to pay for 

college and not simply substitute for existing sources of financial assistance" (Riley 1998). In 

response, some financial aid administrators pledged that students would receive the full benefits 

of tax-based aid (Burd 1998). However, others argued for the need to incorporate tax-based aid 

awards in the calculation of institutional aid. One such director noted, " ... families that receive 

4 Long (2004) finds limited support for the Bennett Hypothesis in response to two tax-based aid programs. Contrary 

to the Bennett Hypothesis. Long (2003) and Scafidi, Rubenstein, Schwartz and Henry (2007) report price decreases 

in the context of the Georgia Hope Scholarship. McPherson and Shapiro (1991) and Singell and Stone (2007) report 

conflicting patterns of changes in tuition across public and pri vate schools in response to federal grant programs. 

Singell and Stone (2007) and Rizzo and Ehrenberg (2003) report opposite findings on the effect of out-of-state 

tuition at public schools. 

5 This is an especially complicated process for public schools. Only 16 states give schools the authority to raise 

tuition, while the legislature, a state agency or a system board sets tuition in the remaining states (Mumper and 

Freeman 2005). McPherson and Shapiro (1998) note that there is substantial pressure to limit tuition increases at 

private schools, and in earlier work (1991), suggest that the goal of maintaining an economically diverse applicant 

pool moderates tuition increases. 

3 
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82271.022

$1,500 from the federal government are better off than those that don't. And I don't think that I 

can ignore that" (Hurd 1998).6 

Despite the awareness that institutions may decrease aid, rather than increase tuition, in 

response to increases in external aid, Long (2003) and McPherson and Shapiro (1991) are the 

only papers that explicitly raise this possibility. They document student aid incidence at the 

school level and reach different conclusions on whether external aid is a substitute for 

institutional aid.7 Yet, the use of school-level data prevents Long (2003) and McPherson and 

Shapiro (1991) from determining which students are impacted by the institutional response. The 

flexibility of student-level data allows me to add to this work by addressing several related 

questions. First, do colleges and universities selectively lower institutional grant aid/or students 

that benefit from tax-based aid? Second, how do students who experience these aid declines 

cope? Due to a likely time delay in benefit receipt of tax-based aid, a reduction in institutional 

aid may cause students to borrow more in order to offset their short-term unmet need. 

To estimate student-level effects, I exploit policy-induced variation in all three tax-based 

aid programs, the Hope Tax Credit, the Lifetime Learning Tax Credit and the Tuition Deduction, 

using data from the National Center on Education Statistics. The analysis sample includes 

students enrolled at 190 4-year schools during the 1995-96, 1999-2000 and 2003-04 school 

years.S Enrollment at the schools in the sample represents roughly 40 percent of students enrolled 

in 4-year colleges and universities, although schools in the sample are relatively more selective 

and have larger enrollments than comparable 4-year schools nationally. I estimate the intention 

6 $1,500 is the maximum value oflbe Hope Tax Crectit, and was the maximum tax-based aid award when the 

statement was made in 1998. 

7 Long (2003) reports that merit-based aid substitutes for institutional aid at private colleges in Georgia in the 1990s, 

whereas McPherson and Shapiro (1991) find that federal grant aid complements institutional aid for private schools 

in an earlier period for a nationally representative sample. 

S The number of schools is rounded to the nearest 10 to comply with the Department of Education Institute of 

Education Sciences confidentiality statutes. 

4 
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82271.023

to treat effect of tax -based aid using instrumental variables to address the endogeneity of 

education spending and school fixed-effects to control for unobserved heterogeneity in student 

aid practices across institutions. 

Contrary to the goal of policyrnakers, who sought to increase postsecondary access for 

eligible students by lowering the cost of enrollment, I find that the institutional price response 

substantially counteracts the intended cost savings of tax-based aid. Students appear to increase 

loans in response to the reduction of institutional aid, suggesting that tax-based aid falls short of 

an important federal aid goal to reduce student indebtedness (Burgdorf and Kostka 2006). These 

results imply that students eligible for tax-based aid may not be the economic beneficiaries of the 

programs. To determine the ultimate incidence of tax-based aid, I consider two ways in which 

institutions might utilize the captured resources. One, that institutions redirect aid towards 

students who are ineligible for tax-based aid, or two, that institutions channel the resources into 

other expenditures, such as capital improvements or faculty/staff salaries. Unfortunately, these 

results are largely uninformative so that the incidence of tax-based aid is uncertain (see 

Appendix A). However, I offer an important first step in establishing the incidence oftax-based 

aid by demonstrating that eligible students and their families are not directly benefitting from 

tax-based aid in the manner envisioned by policymakers. Similar unintended behaviors are 

found to offset the intention of policies in other contexts, including public health insurance 

(Cutler and Gruber 1996) and intergovernmental grants (Bakker and Gordon 2006; Gordon 

2004; Hines and Thaler 1995). 

The remainder of this paper proceeds as follows. Section 2 provides information on the 

tax-based aid. In Section 3, I discuss the institutional price response to federal student aid. 

Section 4 discusses the empirical specifications and results. Section 5 concludes. 

5 
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82271.024

2. Tax-Based Federal Student Aid 

Tax-based aid programs provide a convenient natural experiment for examining the impact of 

federal aid on college pricing. Program implementation and changes in program generosity 

create discrete changes in aid for eligible students over time. In 1997, the Taxpayers' Relief Act 

introduced the Hope Tax Credit and the Lifetime Learning Tax Credit. In 2001, The Economic 

Growth and Tax Relief Reconciliation Act added a third program, the Tuition Deduction. 

Between 1998 and 2006 these three tax-based aid programs cost over $41 billion and were 

claimed by more than 54 million students and their farnilies (Baum and Steele 2007). 

While there are three tax-based aid programs, only one program may be claimed per 

student per year. The value of each program depends in part on educational spending. The Hope 

Tax Credit is equal to 100 percent ofthe first $1,000 and 50 percent of the next $1,000 of 

qualified expenses and may only be used during the first two years of undergraduate education 

(Internal Revenue Service [IRS] 1998). The Lifetime Learning Tax Credit covers 20 percent of 

qualified expenses for all years of postsecondary study for most students. Between 1998 and 

2002, the qualified spending limit was $5,000, and in 2003, it increased to $10,000 (IRS 1998, 

2003). The Tuition Deduction allows tax filers to deduct 100 percent of the first $3,000 of 

qualified education expenses,9 and has a broader eligibility range compared to the Hope Tax 

Credit and Lifetime Learning Tax Credit (IRS 2002). Maag and Rohaly (2007) report that 

program take up is 63-74 percent, comparable to take up rates for Unemployment Insurance, 

9 The maximum deduction increased to $4,000 and the adjusted gross income eligibility range expanded in 2004. 

Because I USe data from the 2003-04 school year, I calculate the Tuition Deduction based on the 2003 program rules, 

which were in place for the first half of that school year. This is done because the data do not include payment date 

and only expenses paid after January 1,2004 are affected by the program changes. 

6 
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82271.025

Head Start and the Earned Income Tax Credit (Currie 2006).10 Table I describes the programs in 

greater detail. 

In contrast to federal grant aid, such as Pell Grants and Federal Supplemental Education 

Opportunity Grants that target relatively low-income students and families, tax-based aid targets 

middle and upper-middle class families. Figure I highlights several key features of the tax-based 

aid programs that result in middle-class targeting, showing how the maximum value of tax-based 

aid varies by adjusted gross income for a hypothetical joint-filing family of four. Below $20,000 

of income, a family of four claiming only the standard deduction and personal exemptions will 

have no tax liability. Families in this income range will be unable to capitalize on tax-based aid 

because the Hope Tax Credit and the Lifetime Learning Tax Credit are nonrefundable and the 

Tuition Deduction cannot reduce taxable income below zero. As income increases beyond 

$20,000, tax-based aid phases in according to the marginal tax rate until tax liability is no longer 

binding. At higher-income levels, the value of the Hope Tax Credit and the Lifetime Learning 

Tax Credit are reduced due to the phase-out range, which begins around $80,000 for joint 

returns. The value of the Tuition Deduction is a function of the marginal tax rate. As shown in 

Figure 1, the Tuition Deduction increases with income due to the progressive tax rate schedule. 

Figure 1 also shows how the value of tax-based aid changes over time. The top panel reflects the 

introduction of the Hope and Lifetime Learning Tax Credits. The introduction of the Tuition 

Deduction and the increased generosity of the Lifetime Learning Tax Credit are visible in the 

lower panel of Figure 1. 

10 Long (2004) provides evidence that many parents/guardians were unaware of tax-based aid using data from the 

National Household Education Survey. She also reports that take-up was less than expected in the first years of the 

programs using National Postsecondary Student Aid Study data. However, the National Postsecondary Student Aid 

Study may not accurately capture program take up. More than one-third of respondents in the 1999-2000 survey 

replied "don't know" or "not reached/missing" when asked about tax-based aid USe. 

7 
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82271.026

The timing of award receipt also sets tax -based aid apart from traditional forms of student 

aid. Benefits from tax-based aid are likely realized when tax returns are received, generally after 

educational expenses are paid. For example, a family that pays education costs in September and 

receives their tax return in April faces an eight-month delay.11 As a result, if schools substitute 

tax -based aid for their own sources of aid, students wiJI face a temporary increase in unmet 

financial need. 

3. Institutional Pricing Behavior 

While most authors agree that the standard profit maximization model does not fit colleges and 

universities (Clotfelter 1999; Winston 1999) there is not a consensus in the literature on the 

objective function for institutions of higher learning. 12 Despite this uncertainty, it is possible to 

infer the general institutional price response to tax-based aid. Suppose that schools have an 

optimal input allocation in equilibrium that includes student enrollment.13 Other inputs are likely 

to include items such as research support, student services, faculty and staff salaries and physical 

capital. The introduction of tax-based aid distorts the equilibrium allocation by increasing 

education demand among eligible students. In response, colleges and universities will act to 

capture the financial gains from tax-based aid and redistribute it optimally across inputs. 

Competitive pressures of the market determine the extent to which colleges and 

universities may capture the financial benefits of tax-based aid. If there is perfect competition 

then schools will not be able to reduce grant aid. To the extent that institutions exert some 

I! Tax filers could smooth the impact of the credit by adjusting their withholdings in earlier periods. However, this 

requires a high level of sophistication, and it is likely that most returns realize the benefits as a lump sum after 

education costs are paid. 

12 James (1978, 1990) and Long (2003) argue that prestige maximization incorporates many ofthe important goals 

of colleges and universities. 

II Several authors suggest that enrollment is a key input in the objective function (Hoxby 2000; James 1990; 

McPherson and Shapiro 1991; Rothschild and White 1995). 

8 
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82271.027

degree of market power they will be able to realize financial gains by lowering grant aid for 

students that benefit from tax-based aid. There are several potential sources of market power for 

colleges and universities. 14 First, colleges and universities may be considered differentiated 

products. Second, unlike profit maximizing firms, schools select the purchasers of their product 

(Clotfelter 1999; Rothschild and White 1995; Winston 1999). This aspect allows some schools 

to maintain excess enrollment demand in equilibrium. Third, information asymmetry may give 

pricing power to schools. Entering students do not observe the counterfactuallevel of aid that 

would have been offered in the absence of the institutional response. Therefore, colleges and 

universities have the ability to increase the net-price that they receive in a manner that may avoid 

backlash from parents and students. While some continuing students do have a history of aid 

that may serve as a basis for comparison with their current aid offer, institutions may still 

exercise pricing power over continuing students due to the costs associated with transferring 

schools. Transferring students are likely to incur financial costs in addition to academic costs, as 

credit hours may not be entirely transferable. 

In practice, financial aid administrators can determine eligibility and award size for taxbased aid from the Free Application for Federal Student Aid (F AFSA). Given this information, 

administrators can substitute tax-based aid for other sources of aid. Such a response should not 

be driven by a mechanical relationship between the receipt of tax-based aid and an increase the 

expected family contribution. The F AFSA explicitly collects information on tax-based aid in 

order to prevent these programs from being clawed-back via the expected family contribution 

14 The Department of Justice alleged anticompetitive behavior among private colleges in the late 1980s and early 

1990s (Jaschik 1991; Netz 1999). While Hoxby (2000) shows evidence that schools named in the antitrust case 

were not colluding to increase tuition or to decrease the total amount of grant aid awarded, she does find evidence 

that the distribution of institutional grant aid across students changed within these schools following the lawsuit. 

9 
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82271.028

calculation.15 McPherson and Shapiro (1998) speculate that institutional aid may be reduced 

dollar-for-dollar in response to tax-based aid. In contrast, it is unlikely that tax-based aid will 

have a large impact on Pel! Grants and federal campus-based aid, due to limited overlap in 

eligibility with these programs. Maag and Rohaly (2007) estimate that tax returns with income 

of at least $40,000 receive about 65-70 percent of the total expenditures for the tax credit 

programs while Mercer (2005) notes that 90 percent of families claiming Pell Grants have 

income less than $40,000. 

Ultimately, determining the scope of the institutional price response to tax-based aid is an 

empirical question. Figure 2 provides some suggestive evidence that financial aid administrators 

at 4-year colleges and universities responded to tax-based aid by lowering institutional grant aid 

for eligible students. This figure shows changes in tax-based aid and changes in institutional 

grant aid by income between the 1999-2000 and 1995-96 school years (top panel) and the 2003-

04 and 1999-2000 school years (bottom panel). A decrease in grant aid for students realizing an 

increase in tax-based aid is consistent with the price-discrimination Bennett Hypothesis, although 

the changes in aid are unconditional on school or student characteristics and are relatively noisy. 

4. Empirical Strategy and Results 

4.1. Analysis Sample 

To explore the institutional price response to tax-based aid, I use data from the National 

Postsecondary Aid Study (NPSAS) published by the National Center for Education Statistics. 

These data provide student-level information on financial aid, student and parent characteristics, 

and institutional detail. Using samples from the 1995-96, 1999-2000 and 2003-04 school years, I 

include 190 4-year schools with roughly 74,280 undergraduate students aged 18-24 in the 

15 See Worksheet B in the 1999-2000 FAFSA or Worksheet C in the 2003-04 FAFSA. 

10 
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82271.029

primary analysis sample. I6 To construct this sample I limit the data in two ways. First, I drop 

students with invalid grade level responses. I7 The value of tax-based aid depends on grade level 

(the Hope Tax Credit is available only during the first two years of college), so including 

observations with missing grade level information adds measurement error. I also limit the 

sample to the 190 schools that appear in each of the NPSAS files, ensuring that the sample of 

schools is balanced over time. 18 As a robustness check, I also analyze an unbalanced panel of 

350 4-year schools that appear in the 1995-96 school year and at least one ofthe later school 

years (1999-2000, 2003_04).19 

The NPSAS does not include information on the value of tax-based aid, or reliable 

information on program use. To address this shortcoming of the data, I estimate the value of the 

tax-based aid in the following way. First, I use IRS rules (1998, 2002, 2003) to define the 

formulas for the Hope Tax Credit, the Lifetime Learning Tax Credit and the Tuition Deduction, 

which depend on education spending, adjusted gross income and taxes owed. The NPSAS 

contains data on family income and education spending, defined as tuition minus student aid. In 

calculating taxes owed, I assume that only the standard deduction and personal exemptions are 

claimed. Using these values of income, education spending, and taxes owed, I apply the taxbased aid formulas to estimate the value of each of the three programs for a given student. 

16 Both the number of schools and the sample size are rounded to the nearest 10 to comply with the Statistical 

Standards Program of the U.S. Department of Education Institute of Education Sciences restricted use data protocol. 

17 Invalid grade level responses include both observations with missing information and those that skipped the 

~~rvey question. Roughly 5 percent of students have invalid grade level responses. 

In the 1995-96 NPSAS sample there are roughly 440 4-year schools. 

19 The number of schools is rounded to the nearest 10 to comply with the Department of Education Institute of 

Education Sciences confidentiality statutes. 

II 
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82271.030

Students can claim at most one program per year, so for students that are eligible for multiple 

programs, I assign the program with the largest value.2o 

Figure 3 shows the average value of the eligible tax-based aid award by adjusted gross 

income for the 1999-2000 and 2003-04 school years. Cross-sectional variation in the subsidy 

arises from differences in qualified education spending, differences in adjusted gross income, 

differences in tax filing status and from program rules that defme eligibility. These sources of 

variation are evident across the panels in Figure 3. For example, the decrease in value around 

$40,000 corresponds to the phase out range for non-joint returns whereas the decrease in value 

around $80,000 corresponds to the phase out for joint returns. Time-series variation comes from 

the enactment of the tax-credit programs in 1998, and from the increase in the value of the 

Lifetime Learning Tax Credit and introduction ofthe Tuition Deduction between the 1999-2000 

and 2003-04 school years. 

For public (private) schools in the sample, average tax-based aid eligibility is $586 

($634) compared to $480 nationally in the 1999-2000 school year and $682 ($869) compared to 

$540 nationally in the 2003-04 school year.21 Omitting 2-year schools from the sample is likely 

to result in larger tax -based aid relative to the national average.11 Table 2 shows the mean values 

of various measures of student aid, including tax-based aid, and student demographic variables 

by institution type for each of the three school years. (All dollar amounts in Table 2 are in 2003 

dollars.) The value of tax-based aid is comparable across public and private school students in 

the sample because the maximum qualified spending of the tax-based aid programs is relatively 

20 Analyzing individual tax return data from the IRS, Turner (20 I 0) finds that not all taxpayers select the single taxbased aid program that offers the largest value. However, the dollar amount of the loss incurred from these 

selections is small, so the effect on the estimated value of tax-based in this work should be minimal. 

21 National average for tax-based aid from Trends in Student Aid 2004, The College Board, Table 7. 

22 The price response by 2-year schools is likely to be different than that of 4-year schools, as 2-year schools 

generally offer less aid and therefore have less scope for the price-discrimination Bennett Hypothesis. 

Unfortunately, I am unable to consider 2-year schools separately due to sample size considerations. Omitting 2-year 

institutions removes an important component of the national postsecondary education market. 

12 
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82271.031

low, so that additional education spending by private school students does not increase the value 

of the tax-based aid award. 

Enrollment at schools in the analysis sample represents roughly 40 percent of national 4-

year college enrollment during the analysis period. Table 3 shows both aggregate national 

enrollment and total enrollment for schools in the analysis sample. Broken down by school type, 

enrollment at 4-year public schools in the sample is roughly 45 percent of 4-year public 

enrollment nationally and enrollment at 4-year private schools in the sample is about 25 percent 

of national4-year private enrollment. However, schools in the sample are on average larger than 

comparable schools nationally. In the 2003-04 school year, median enrollment in the sample at 

public (private) institutions is about 24,000 (12,500) compared to roughly 10,000 (2,000) 

nationally?3 The sample of schools is also relatively more selective than comparable 4-year 

schools nationally. In the sample, the share of public (private) schools that are most or very 

selective is 27 (60), moderately selective 65 (36), and minimally selective and open admissions 

is 8 (4). Nationally, these shares for public (private) schools were 14 (38), 59 (41) and 27 (21) in 

the 2003-04 school year.24 Baum and Steele (2007) show that more selective schools offer more 

institutional aid, suggesting greater scope for the price-discrimination Bennett Hypothesis. As a 

result, the institutional response for the sample of schools considered here is likely to represent 

an upper bound of the price-discrimination Bennett Hypothesis. 

4.2. Measuring the Price-Discrimination Bennett Hypothesis 

2J I measure avemge school size using enrollment and number ofinstitutions from Tables 168 and 243 from the 

Digest of Education Statistics 2005, National Center for Education Statistics. 

24 National selectivity from the 2003-04 NPSAS and includes 4-year not-for-profit schools. 

13 
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82271.032

The price-discrimination Bennett Hypothesis predicts that institutions reduce institutional aid to 

capture the financial benefits of tax-based aid. To explore this possibility, I exploit policyinduced variation in the value of tax-based aid using Equation (1): 

where i, j, t index individuals, schools and years respectively. The key independent variable is 

tax-based (TBA), which is a function of education spending (S), adjusted gross income (1) and 

taxes('l') as described in Section 4.1. f3, measures the impact of eligibility for one dollar of taxbased aid on institutional aid. An estimate of -1 for f3, implies dollar-for-dollar aid substitution, 

while f3, < 0 is consistent with the price-discrimination Bennett Hypothesis. 

A primary concern with ordinary least squares (OLS) estimation of Equation (1) is the 

possibility that tax-based aid and institutional aid are jointly determined, because tax-based aid is 

a function of education spending. Holding all else equal, if spending is below the programs' 

limits, an increase in education costs, such as a reduction in institutional aid, will increase the 

value of tax-based aid. Figure 4 highlights this program feature, showing the values of the three 

tax-based aid programs as functions of qualified education spending. To address this source of 

bias, I instrument for tax-based aid using two separate approaches. In each case, I generate an 

instrument by calculating the value of the tax-based aid using a plausibly exogenous value of 

education spending in order to isolate policy-induced variation in tax-based aid eligibility.25 

In the first approach, I instrument using the value of tax-based aid calculated at the 

programs' spending limits. As shown in Figure 4, the value of tax-based aid is constant for 

25 Wooldridge (2002) refers to this as a generated instrument, and shows that estimates using generated instruments 

are consistent and reach valid inferences. This approach is similar to Dahl and Lochner (2008) who replace an 

endogenous input in the Earned Income Tax Credit schedule to isolate policy-induced variation. It is also similar to 

Hoxby and Kuziemko (2004) who use pre-period school district characteristics in the contemporaneous school aid 

fonnula to isolate policy-induced variation from a school finance equalization in Texas and refer to their approach as 

simulated instrumental variables following Currie and Gruber (1996). 

14 
65 


82271.033

qualified spending that exceeds these limits, so that this instrument is unaffected by an 

institutional response that increases spending. Equation (2) gives the first-stage equation: 

where Sm"" is the maximum spending limit in year t. 

As a second approach, I use an instrument that includes variation in education spending 

by student characteristics for each school. This instrument relies on a plausibly exogenous level 

of spending that is based on the determinants of spending in the 1995-96 school year. A key 

assumption of this approach is that spending in 1995-96 is unaffected by the endogenous 

response expected after the enactment of tax-based aid. To construct this instrument, I first 

estimate spending in the 1995-96 school year as a function of student income and demographic 

characteristics for each schoolj, using Equation (3). 

Next, I use the parameter estimates from Equation (3) to predict qualified spending for students 

in later periods at the same school (in real terms).26 From this simulation, I calculate the 

instrument as the value of tax-based aid that a given student would have received ifthe pattern of 

qualified spending were held constant from the 1995-96 school year. Equation (4) gives the first 

stage equation. 

TBAi

, (SU,,lil' Til) is the subsidy based on simulated qualified spending S'it defined by Equation 

(3). This instrument contains variation at the individual-year level that results from program 

26 I use the CPI-U to adjust dollar amounts to 2003 dollars. J also used bolh the Higher Education Cost Adjustment 

published by the State Higher Education Executive Officers Association and the Higher Education Price Index 

reported in Lingenfelter, L 'Orange, Winter. and Wright (2004) to adjust qualified spending. and the results were 

similar. 

15 
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82271.034

rules and differences in income, and also includes variation in spending both across schools and 

within schools based on income-demographic groups. 

A key assumption of the estimation strategy is that the tax-based aid variable is not 

simply identified from an underlying relationship between institutional aid and income. To 

guard against this possibility, I flexibly control for income in Xijl using a cubic spline function 

with five knots. Figure 5 shows the relationship between institutional aid and income in the 

1995-96 school year using a similar spline function. For public schools, Figure 5 suggests that 

the preexisting relationship between institutional aid and income is substantively different than 

the relationship between tax-based aid and income shown in Figure 3. For private schools, 

where the underlying relationship between income and institutional aid is non-linear, this 

implication is less clear. However, for both public and private schools, the estimated effect of 

tax-based aid is identified, in part, from the differences in functional forms shown in Figures 3 

and 5. To test the robustness of the estimates, I consider different income controls, including 

alternate spline function specifications and higher-order polynomial functions of income. I also 

control for the key determinants used in calculating tax liability, including the amount of taxes 

owed, family composition, number of family members and dependency status. 

As control variables, I include sources of aid that the financial aid administrator is likely 

to treat as given when making institutional aid decisions. These include Pell Grants, federal 

campus-based aid and state aid. I also include school-year averages ofthese variables to address 

the possibility that changes in these programs for other students at a given school affect the 

institutional response to tax -based aid. Another assumption of the identification strategy is that 

these other sources of aid are relatively constant during the analysis period. Average changes in 

Pell Grants, campus-based aid and state aid for eligible students are small compared to the 

16 
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82271.035

average change in tax-based aid, suggesting that this assumption holds.27 As a robustness check 

of the baseline results, I remove students who may have experienced changes in state aid based 

on the timing of state level policy changes. I discuss these results in Section 4.5. 

To address time effects, I include indicator variables for the 1999-2000 and 2003-04 

school years, and I allow for different time trends based on institutional selectivity by interacting 

year indicator variables with variables for selectivity. I also include controls for student, parent 

and institutional characteristics that may affect the receipt and value of institutional aid such as 

student race, age, gender, parent/guardian education and Census division of residence. To 

control for unobserved heterogeneity in student aid practices across schools, I include school 

fixed effects. I also cluster the standard errors at the school level, to allow for arbitrary 

correlation in the error terms between observations, both across different students and across 

different school years, at a given schoo1.28 

4.3. Baseline Results for the Price-Discrimination Bennett Hypothesis 

The estimates imply that colleges and universities substantially offset the intended cost reduction 

of tax-based aid by reducing institutional grant aid. Panel A of Table 4 presents the baseline 

results. Columns (1)-(3) show the OLS, maximum spending IV and simulated spending IV 

results for public schools, while these results for private schools appear in Columns (4)-(6). For 

public schools, I cannot rule out nearly complete crowd out of institutional aid. The OLS 

estimate of the effect of an additional $1.00 of tax-based aid implies a reduction of $0.83 in 

institutional grant aid, while the maximum spending and simulated spending IV results suggest a 

27 For example, between the 1995-96 and 1999-2000 school years the average changes for eligible students were: 

Pell Grants ($46), campus-based aid (-$81), state aid ($14), tax-based aid ($754). 

" Kezdi (2004) shows that cluster robust standard errors allow for accurate inference when the number of clusters 

exceeds 50. 

17 
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82271.036

reduction of $0.89 and $0.82. The reduction of institutional grant aid is also substantial at 

private schools, and I cannot reject an effect equal to that found for public schools. For private 

institutions, the OLS estimate implies a $1.20 reduction in grant aid per $1.00 of tax-based aid 

while the IV results suggest a reduction of $0.91 using the maximum spending IV and $0.69 

using the simulated spending IV. 

The instruments perform well among both public and private school students in Panel A 

of Table 4. The strength of the instruments is a result of the limited scope for endogeneity, 

occurring only when actual spending is less than the programs' limits (see Figure 4).29 To the 

extent that education spending is endogenous, OLS will overestimate the impact of tax-based aid 

because education spending and institutional grant aid are negatively related and education 

spending and tax-based aid are positively related over the endogenous range of spending. 

Removing this source of bias will decrease the absolute value of the OLS estimates. For private 

schools, the OLS results are larger in magnitude compared to the IV estimates consistent with 

this interpretation, although the OLS estimate is not significantly different from the IV results. 

The results for public schools do not fit this pattern, as the OLS estimate is not larger than the IV 

estimates. However, I cannot reject a cluster robust test of endogeneity (at the 1 percent level) 

for either public schools or private schools in Panel A.30 Therefore, I rely on the IV estimates to 

address the endogeneity of education spending. 

The effect oftax-based aid in Panel A is the average of the institutional response for 

students eligible for tax-based aid and for ineligible students. However, the institutional 

29 For example, using the maximum spending IV the first-stage regression holds as an identity for students with 

qualified spending at or above the programs' limits. Roughly 60 percent of public school students and 80 percent of 

p,rivate school students have spending in this range. 

o I test for endogeneity by calculating the C statistic, defined as the difference in two Sargan statistics. In the case 

of one endogenous regressor and the null hypothesis of exogeneity, this statistic is distributed chi-square (I). 

Hayashi (2000) shows that this statistic is equivalent to the Hausman test under conditional homoskedasticity. 

18 
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82271.037

response is likely to vary across these student types. The price-discrimination Bennett 

Hypothesis predicts that colleges and universities will reduce institutional aid to offset the 

benefits of tax-based aid for eligible students. One possible use for the captured institutional aid 

is to redirect it towards ineligible students. In this case, the results in Panel A represent the 

average of institutional aid decreases for eligible students and institutional aid increases for 

ineligible students. To the extent that this type of aid redistribution occurs, Panel A may 

overstate the institutional response.)! To explore this possibility, I limit the sample to eligible 

students by removing students who would never be eligible for tax-based aid based on the 2003-

04 program rules in Panel B of Table 4. In Panel B, I cannot reject a dollar-for-dollar reduction 

in institutional grant aid for both public and private schools using either of the two instruments. 

Compared to Panel A, the estimated effects in Panel B are larger, which suggests that colleges 

and universities do not substantively redirect the captured aid towards ineligible students. In 

Appendix A, I explore further the possibility that institutions redirect the captured aid to students 

ineligible for tax-based aid, or towards other institutional expenditures. Unfortunately, these 

results are inconclusive. 

4.4. Further Results 

In the baseline results, institutional grant aid includes both non need-based and need-based 

institutional grants. As Table 5 shows, institutions reduce both of these components in response 

to tax-based aid.32 Non need-based aid includes merit-based aid as well as other grant aid 

JI Ifschools redistribute the captured aid towards ineligible students then the estimated effect of tax-based aid will 

be more negative on the entire sample compared to the sample of eligible students. To the extent that substantive 

redistribution occurs, including ineligible students will increase the intercept and will result in a more negative 

relationship between institutional grant aid and tax-based aid. (Eligible students outnumber ineligible students by 

roughly 5:1 so that redistributing a large share of the captured aid implies a large increase for ineligible students.) 

J2 A small number of observations do not distinguish between need-based and non need-based aid and are not 

included in Panels A or B of Table 5. 

19 
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82271.038

awarded for circumstances not related to financial need. Due to data limitations, I cannot 

separately consider merit-based aid.33 The larger reduction in non need-based aid, relative to 

need-based aid, may be the result of greater discretion financial aid administrators have in 

awarding non need-based grant aid. The reduction in need-based aid may reflect the beJiefby 

financial aid administrators that tax-based aid increases student ability to pay (McPherson and 

Shapiro 1998). However, differences in non need-based and need-based aid should be 

interpreted with caution. The definition of what constitutes need-based aid varies across schools 

(Saum and Lapovsky 2006) and may even change over time for a given school. 

Students appear to finance the institutional aid reduction, in part, through increased 

student loans?4 These results appear in Panel C of Table 5. Increased borrowing may result from 

the short-term increase in urnnet need in the period after paying education costs but before 

receipt oftax-based aid. Total loan amounts may also increase if program take up is less than 

complete, as the results here represent the intention-to-treat effect oftax-based aid. Total loan 

amounts, including federal Stafford loans and private loans, are estimated to increase $0.42-

$0.46 per $1.00 of tax-based aid at public schools using the IV estimates. At private schools, the 

IV estimates imply an increase of $0.37-$0.43. Although not reported in Table 5, a breakdown 

ofloan types suggests the majority of increased borrowing is from subsidized Stafford loans, the 

most favorable loan option.J5 

33 Merit-based aid is not included as a separate category for the 1995-96 school year in the NPSAS. 

34 These loan effects may be counteracted if continuing students use their tax-based aid to finance education in 

subsequent years and therefore reduce their borrowing. To test this possibility, I estimated the effect of tax-based 

aid on total loans for first-year students and students in their second year and beyond separately. Equal borrowing 

effects across years could not be ruled out. Instead of reducing loans in subsequent years, students and families may 

use their tax~based aid to finance consumption or pay back loans from previous years. Just under one-third of 

respondents in the Survey of Consumers report that they will "mostly save" their tax refunds from 2008 and 200 I 

(Shapiro and Slemrod 2003, 2009). 

35 In the case of dependent students, institutional aid reductions and increases in student Joan amounts suggest an 

intra-family transfer. The institutional grant in the student's narne is replaced with tax-based aid for the parent and a 

loan in the studenfs name. 

20 
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82271.039

4.5. Robustness Checks of Price-Discrimination Bennett Hypothesis Results 

In Table 6, I demonstrate the robustness of the baseline results in Table 4 in several ways. (To 

simplify the discussion, I report only the IV results in Table 6, although as in Tables 4 and 5 the 

corresponding OLS results are similar in magnitude.) First, I address the possibility that changes 

in state level policies bias the results. Second, I show that the results are not sensitive to the 

omission of student and family controls. Third, I show that the substantive reduction in 

institutional grant aid persists using an unbalanced panel of schools. The results in Table 4 are 

also robust to alternate income controls, including cubic and linear splines with up to 7 knots (the 

baseline specification uses a cubic spline with 5 knots), and to higher-order polynomial functions 

of income (not shown). I also find little evidence that there is substantial heterogeneity in the 

institutional response based on grade level, by institutional selectivity, or by student quality. 

These results appear in Appendix B. 

During the analysis period, several states enacted changes to race-based admission and 

aid policies. Additionally, several states initiated merit-based aid programs during this period. 

Concurrent changes in state-level policies could bias the estimated effect of tax-based aid if 

schools respond to changes in state-based aid programs.36 Although not reported, I find little 

evidence that institutional aid responded to changes in state aid in the analysis sample. One 

reason for this finding may be the difficulty in determining which students experience increases 

in state aid. Changes to state-based programs could still bias the effect of tax-based aid by 

altering the composition of enrolled students. To further explore these possible sources of bias, I 

estimate the effect of tax-based aid after removing states that enacted substantive policy changes. 

,6 The average increase in state aid for eligible students is $1 10 in states enacting merit-based aid compared to $8 for 

students in the remaining states between the 1999-2000 and 1995-96 school years. 

21 
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82271.040

Panel A of Table 6 reports the results after removing three states (CA, MI, TX)37 that 

experienced major changes to race-based policies. The results obtained on this limited sample 

are similar to those reported in Table 4, and suggest that large-scale changes to race-based 

admissions and aid policies in three populous states do not affect the baseline results. Using 

sample splits based on minority status and also on gender, I also find that the effect of tax-based 

aid on institutional aid is similar across these groups of students (not shown). In Panel B of 

Table 6, I remove 10 states (FL, KY, LA, MD, MI, NV, NM, SC, TN, WV) that enacted meritbased aid programs during the analysis period.38 The similarity of the results from this limited 

sample, compared to the baseline results, imply that the introduction of merit-based aid in these 

states does not impact the baseline results. 

If tax-based aid affects the sample of enrolled students, then the estimated effect of taxbased aid may also reflect compositional changes. To the extent that students sort into schools 

based on the lowest net price (into schools that offset their tax-based aid the least), the bias from 

a changing composition of enrolled students works against finding a substantive effect. 

Alternatively, if students select different schools than they would have absent tax-based aid and 

if these schools are less likely to offer less institutional aid, then the bias is towards negative one. 

I do not find evidence that tax -based aid affects the composition of enrolled students using a 

school-year level analysis that estimates the effect of tax-based aid on the share of eligible 

students (not shown). To further explore the possibility that a changing composition of enrolled 

students impacts the estimated effect of tax-based aid, I estimate Equation (I) after omitting the 

37 In 1996 the Fifth Circuit Court of Appeals handed down the Hopwood v. University of Texas decision and 

California passed Proposition 209. Also in 1996, a lawsuit was filed in Michigan challenging race-based 

admissions. In 2003, after several lower court rulings and appeals in this lawsuit, Grutter v. Bollinger, the Supreme 

Court ruled that race could be used as a "plus factor" in the admission decision, but it can't be the only factor schools 

consider. and schools canlt have a quota system for race. 

38 See Dynarski (2004) Table 2.1. I also tried removing an additional three states that enacted merit-based aid 

programs in an earlier period (AR, GA, MS) and the results were similar to those in Panel B. 

22 
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82271.041

following controls: student demographic variables (race, age gender, dependency status); parent 

characteristics (education level, marital status); and family size. If the effect of these control 

variables is changing over time due to compositional effects of tax-based aid, then omitting them 

from the analysis may lead to a different estimated effect of tax-based aid. The similarity of the 

results without the control variables in Panel C of Table 6, compared to the baseline results, 

suggests that the impact of the observable control variables is not changing over time in a way 

that is correlated with tax-based aid. This may be interpreted as evidence that compositional 

effects do not substantively impact the baseline results. 

I also find a substantial reduction in institutional grant aid using an unbalanced panel of 

4-year schools as shown in Panel D of Table 6. The unbalanced panel includes institutions that 

appear in the NPSAS in the 1995-96 school year and at least one of the later school years (1999-

2000,2003-04).39 Enrollment in these schools represents a considerable share ofnational4-year 

enrollment: 57 percent in the 1995-96 school year, 53 percent in the 1999-2000 school year and 

48 percent in the 2003-04 school year. In Panel D, the impact of tax-based aid is identified from 

either the introduction of the programs (schools that appear in 1995-96 and 1999-200 only), the 

total change in the programs (schools that appear in 1995-96 and 2003-04 only), or from the 

introduction and expansion of tax-based aid (schools that appear in all three school years). In 

contrast, for each school in the balanced panel, the institutional response is identified from both 

the introduction and expansion of tax -based aid. 

IV. Conclusion 

I demonstrate the importance of benefit incidence analysis by showing that the intended cost 

reductions of tax-based federal student aid are substantially counteracted by reductions in 

39 The number of public (private) schools in the unbalanced panel (rounded to the nearest 10) is 200 (\50) for 1995-

96, 170 (llO) for 1999-2000 and 140 (100) for 2003-04. 

23 
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82271.042

institutional grant aid for a sample of 4-year colleges and universities. I find that students at 

these schools cope with this reduction of institutional support by increasing student loan 

amounts. Together, these findings imply that students eligible for tax-based aid are not directly 

benefitting from the programs in the sense of realizing a lower cost of postsecondary attendance. 

Rather, they may be evidence that institutions and the student loan industry realize financial 

gains from tax-based aid at the expense of eligible students. Given that schools in the primary 

analysis sample represent about 25 percent of all students enrolled at degree-granting 

postsecondary institutions, the results here imply that a substantial share of total tax-based aid 

expenditures do not reduce costs for students and their families. In aggregate, more than 37 

million students claimed one of the programs during the analysis period for a total tax 

expenditure of$29 billion (Baum and Steele 2007). 

The results here suggest several areas for future work. First, it is unclear how institutions 

utilize the captured resources. The two possibilities considered here, that schools redirect the 

captured aid towards students ineligible for tax-based aid, or into other institutional expenditures 

are inconclusive. Clarifying this aspect of the institutional response is a necessary step for 

determining the ultimate incidence of tax-based aid. Eligible students may partially benefit from 

tax-based aid if institutions devote the captured resources to increasing education quality, 

providing student services, or other expenditures valued by students. 

Second, the results here do not characterize the response of all postsecondary institutions. 

While enrollment at schools in the sample represents roughly 40 percent ofnational4-year 

enrollment, schools in the sample have larger enrollments and are more selective than 4-year 

schools nationally. The sample also excludes students enrolled at 2-year institutions. Less 

selective 4-year schools and 2-year schools generally offer less institutional aid compared to 

24 
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82271.043

more selective 4-year schools, so that the effects found here are likely to be an upper bound of 

the institutional price response. Understanding the pricing behavior of the remaining school 

types is an important avenue for future research. 

Third, the results suggest that institutions may also offset the intended cost reduction of 

other direct student aid programs targeting middle-income students and families, such as the 

recently enacted American Opportunity Tax Credit. Yet, it is not clear if the crowd out of 

institutional aid similarly undermines traditional student aid programs targeting lower-income 

students. To the extent that the reduction of institutional grant aid holds for other forms of 

student aid, previous studies may have underestimated the price sensitivity of postsecondary 

enrollment by presuming greater than achieved cost reductions. More generally, the results 

underscore the need for consideration of benefit incidence in the context of other government 

benefit programs. 

25 
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82271.044

Appendix 

AI. Institutional Aid Redistribution 

Ai.l Measuring institutional Aid Redistribution 

An increase in institutional aid for ineligible students may be evidence that schools redistribute 

institutional aid. I consider this possibility by estimating how much of the total institutional aid 

withheld from eligible students is redistributed to ineligible students using Equation (A 1). 

(AI) 

[

En'OI"""'"' 1 L TBAu(Sij,,lit,f,,) 

InstitutionalAidn == 7r, iEj.. + 7r2XV

' + aj + fijI 

J IneltglbleEnrollmentjl 

Xijl contains similar controls as in Equation (1). The key independent variable is 

[ 

"nmli",,"', 1 L TBA" ( Sift ,Iii' fil ) 

'ej , the total value of tax-based aid, per ineligible student, received at 

IneligibleEnroliment jl 

schoolj in year t. It represents the total amount of institutional aid available for redistribution if 

schools reduce institutional aid dollar-for-dollar with tax-based aid. The parameter 7r, measures 

the share of this total that is redistributed. A positive estimate for 7r, in Equation (A 1) combined 

with a negative estimate of f3, in Equation (I) is consistent with the redistribution of institutional 

aid away from eligible students towards ineligible students. Complete redistribution is implied 

by 7r, == 1 and f3, ==-1. 

Total tax-based aid per ineligible student may be endogenous in Equation (A I) for 

several reasons. First, similar to the case of eligible students, qualified spending may be 

endogenous. School-wide changes in institutional aid could affect both the tax-based aid of 

26 
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82271.045

eligible students, through qualified spending, and the institutional aid of ineligible students. 

Second, enrollment may be affected by institutional aid redistribution, so that the number of 

ineligible students and the total value of tax-based aid at a given school may both be 

endogenous. To address these concerns, I exploit the timing of tax-based aid implementation to 

generate plausibly exogenous instruments. In place of contemporaneous values of spending and 

enrollment, I use values from the 1995-96 school year. This approach isolates the policyinduced variation in the tax-based aid function while holding fixed the composition of students 

from the 1995-96 school year. Spending and enrollment in this year should be free from the 

endogenous responses expected in later periods. Paralleling the approach used in the text, I also 

estimate the total value of tax-based aid based on maximum spending. Equation (A2) gives the 

first-stage regression using the IV based on actual spending in the 1995-96 school year: 

(A2) 

[ 

F.,.ml/ment, 1 [ Enml/menl"" 1 L TBA" ( SUI' IiI' 'ril ) L TBAil ( Sii96' Ii96 , 'ri96 ) 

iEj = y, iEi + Y2Xi'I + a, + 17ft 

IneligibleEnrolimentil IneligibleEnrolimentj96 "J" 

[

Enrol/me,,,,, 1 L TBA" (SU96 ,1'9.' 'ri96 ) 

where 'Ej is the total value of the tax-based aid received at schoolj 

Ine Zig ibleEnroliment;96 

in year t based on the enrollment characteristics in the 1995-96 school year. 

I also explored the possibility that schools translate large total tax-based aid receipt into 

increased expenditures in other categories. Unfortunately, the NPSAS has little information on 

other types of expenditures and changes in accounting practices during the analysis period make 

expenditures from other sources difficult to compare across years (Budack 2000; IPEDS Data 

Center; Wellman, Desrochers and Lenihan 2008). For categories that may be comparable, I 

27 
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82271.046

linked the NPSAS data to expenditure data from the Integrated Postsecondary Education Data 

System (IPEDS) from the National Council of Education Statistics at the school-year level to 

estimate if schools translate large total tax-based aid receipt into increases in other expenditures. 

These estimates are imprecise, and combined with the data quality concerns, offer little insight 

into this possibility. 

Ai.2. institutional Aid Redistribution Results 

The redistributive results for ineligible students are largely inconclusive because the approach 

suffers from weak instruments. As shown in Panel A of Table AI, neither of the instruments 

perform well in the fIrst stage. (F-tests on the restriction that the instrument is zero in the fIrst 

stage range from 2.01 to 6.52.) The weakness of the instrument may be the result of the limited 

sources of variation in total tax-based aid at the school-year level after including both school 

fIxed effects and flexible time controls. In Panel B, I replace the time controls (year indicator 

variables and interactions of year indicators with indicator variables for institutional selectivity) 

with a squared time trend. When this step is taken, the instrument performs better in the fIrst 

stage, although it is still weak for private schools. (Making this replacement has no effect on the 

baseline results reported in Table 4.) At public schools, the estimates in Panel B suggest at most 

a modest amount of redistribution. A necessary condition for complete redistribution, 1r, = I, is 

unlikely in this case. However, as these results are not robust to the flexible time controls in 

Panel A, the redistributive consequences are unclear even for public schools. Results using a 

sample of only low-income ineligible students or only high-income ineligible students are also 

inconclusive. 

28 
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82271.047

BI. Heterogeneity in the Price-Discrimination Bennett Hypothesis hy Grade Level, 

Institutional Selectivity and Student Ahility 

Both entering and continuing students experience nearly complete crowd out of institutional 

grant aid. Table B I reports the results for first year students and students in years two through 

five separately. For both public and private schools, the estimated reduction in grant aid is larger 

for first year students compared to continuing students. Entering students have no history of 

institutional aid offers, and therefore do not observe an aid offer that may represent their 

counterfactuallevel of aid. This information asymmetry may provide schools with increased 

pricing power for entering students relative to continuing students, some of whom have a history 

of institutional aid offers. However, the differences across first year students in Panel A and 

continuing students in Panel B are not substantively large, nor are they statistically significant, so 

that this implication is unclear. One explanation for the similar effects across grade levels is the 

transaction costs associated with transferring schools. As a result of these costs, both academic 

and fmancial, schools may also exert pricing power over continuing students. 

The reduction of institutional grant aid holds for both more selective and less selective 

institutions. Panel A of Table B2 shows the results based on institutional selectivity.40 The point 

estimates suggest that the reduction in institutional aid is larger at more selective institutions, 

compared to less selective ones. This pattern may reflect the market structure for selective 

schools. If more selective institutions have fewer direct competitors and/or larger excess demand 

for enrollment, compared to less selective institutions, then the price response should be 

relatively larger at more selective institutions. Due to sample size considerations, I combine 

40 Institutional selectivity is defined by NPSAS categories. Most selective includes "most" and "very" selective, 

while less selective includes Hmoderately" and Hminimally~' selective as well as "open admissions." There are very 

few "open admissions" schools and the results are the same if these schools are removed. 

29 
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82271.048

public and private schools when considering institutional selectivity." However, because 

relatively more private schools are in the most selective category, the comparison across 

institutional selectivity may also be partially attributable to the differences in public and private 

school types. 

The reduction of institutional grant aid holds for both high and low ability students. 

Using SAT scores to determine student ability, I define above (below) average students as those 

with combined math and verbal SAT scores that are above (below) the average scores at their 

school in a given school year.42 Unfortunately, in the NPSAS many student records do not 

include valid SAT scores. Roughly 55 percent of students in the analysis sample have valid 

scores, and I am forced to condition the sample to these students in order to explore student 

ability implications.43 As shown in Panel B of Table B2, I cannot reject the possibility that taxbased aid is substantively offset for both high ability and low ability students. While the point 

estimates imply a larger effect for higher ability students, the differences across high and low 

ability students are not significant. 

41 Kezdi (2004) shows that cluster robust standard errors allow for accurate inference when the number of clusters 

exceeds 50. Given the distribution of selectivity across school types, I am forced to combine public and private 

schools to create school quality groups that meet this requirement. 

421 also tried different cuts of the data, using the 75'h and 25th percentiles to define three student quality groups. The 

results from this analysis are similar to the results reported in the text. 

43 Using a specification similar to Equation (1) but with an indicator variable for valid SAT scores as the dependent 

variable, I find no evidence of a substantive or significant relationship between having valid SAT scores and taxbased aid, suggesting that tax-based aid does not affect SAT reporting. Missing SAT scores appears to be 

distributed evenly across grade level and public and private school types. 

30 
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82271.049

Acknowledgements 

I am grateful to Julie Cullen, Nora Gordon and Roger Gordon for their helpful comments and 

discussions. I also benefitted from comments received during the NBER Education Program 

Meeting and also at the 102nd Annual Meeting of the National Tax Association. 

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Salience, Tax Evasion and Inertia in Selection of Tax-Based Federal Student Aid. University of 

California San Diego Working Paper No 2010-03. 

Wellman, J., Desrochers, D., Lenihan, c., 2008. The Growing Imbalance, Recent Trends in 

Postsecondary Education Finance. A Report of the Delta Cost Project, Technical Appendix. 

Winston, G., 1999. Subsidies, Hierarchy and Peers, The Awkward Economics of Higher 

Education. The Journal of Economic Perspectives. 13, 13-36. 

Wooldridge, 1., 2002. Econometric Analysis of Cross Section and Panel Data. The MIT Press, 

Massachusetts. 
86 


82271.054

No Tax Liability Phase Out Range 

Adjusted Gross Income 

2003-2004 

Figure 1 

Ma>;imum Tax-Based Aidfor Joint-Filing Married Family of Four with one College Student 

Notes: Tax liability is estimated using only the standard deduction and personal exemptions. 

Sec Section 2 for" description of tax-based aid. 
87 


82271.055

Changes 1999-2000 and 1995-96 School Years 

2.()OO ,-------------------------------------, 

t.5no 

1.000 

10.000 20.DOO JO.IJ'llQ 4(U~){l 50,000 DO,GOO 70J)(K) NO,OOO 90.000 IOO.OOO 1IO.OVO 12lU;U(} 1.10.00U 

Changes 2003-04 and 1999-2000 School Years 

1.000 

1,500 

soo t-------------I,------------~-~-------~------------+'Ir___/:::::,"""---;;,4i=::":=;=-~='\~ 

·500 

~ l,OOO t------------ ----------------------------------------------~-------------------- ---1 

·1500 

Figure 2 

1O.OCH) 20.000 :'iO.Q(}() 40J)00 :50,000 60,000 10.000 !H.UKtO 90.000 100,000 J 10,000 11U.0(}() 130,000 

Adjust-C'd Grnsli- income j 52fl1)]) 

Changes in Tax-Based Aid and Institutional Grant Aid by Adjusted Gross Income 

Notes: The value of tax-based aid is calculated from program rules (IRS 970) and income and education 

spending data from the NPSAS. Institutional aid is from the NPSAS data. Sec Section 4.1 for details. 
88 


82271.056

0 

0 

Vl 

-I""l 

88 

NO --......., 

"0 

;.;: 

as 

!GO 

lXlo 

~Vl 

I0 

0 

0 

II"> 

o 

Figure 3 

0 

o 

1999-2000 

25000 50000 75000 100000 125000 

Adjusted Gross Income ($2003) 

2003-2004 

25000 50000 75000 100000 125000 

Adjusted Gross Income ($2003) 

Average Tax-Based Aid Eligibility by Adjusted Gross Income 

Notes: The value of tax-based aid is calculated from program rules (IRS 970) and income and 

education spending data from the NPSAS, See Section 4,1 for details, 

150000 

150000 
89 


82271.057

1999-2000 School Year 

2000 

Hope Tax Credit 

1500 

~ 

~ 

Lifetime Learning Tax Credit 

§ 1000 .g 

UJ 

500 

0 -tI¥'------.--,--------------r-------.-.-.--.....,-----~-------__,_ 

0 5000 10000 15000 20000 

Qualified Education Spending ($) 

2003-2004 School Year 

2500 

Lifetime L.:aming Tax Credit 

2000 

Hope Tax Credit 

~ 

~ 1500 » 

:s 

1: 

;:l 

UJ 1000 

500 

0 

0 5000 10000 15000 20000 

Qualified Education Spending ($) 

Figure 4 

Value of Tax-Based Aid by Education Spending 

The value of the programs also depend on taxes owcd. The values shown here assume a tax liability as least 

as large as the subsidy. Thc value of the Tuition Deduction also depends on the marginal tax ratc. The value 

shown uses a 28-pereent marginal ratc. 
90 


82271.058

0 

0 Public Schools V> 

-f"") 

80 NO 

~g 

"0 

< 

"0 

IV 

~g IV> 

~ ..... 

0 

0 25000 50000 75000 100000 125000 

Adjusted Gross Income ($2003) 

150000 

1 __ Institutional Aid (mean) Spline (5) I 

Private Schools 

c:> 

0 

15 

-

<"'> 

8 

"'8 

~g ..., 

< 

)8 

~~ ..... 

0 

C> 

0 

"" 0 25000 50000 75000 100000 125000 Adjusted Gross Income ($2003) 150000 

1__ Insti1:utional Aid (mean) Spline (5) I 

Figure 5 

Institutional Aid by Income Group, 1995-96 

Notes: Thesc figures show average institutional aid, and the fitted values using a cubic spline function with 

five knots. This is the same spline function used in Equation (1) that estimates institutional aid effects at the 

student level. Income groups are based on $5,000 increments with the top group including all observations 

with income $150,000 or more. 

82271.059

Table 1 

Tax-Based Aid Program Details, 1998-2003 

Hope Tax Credit Lifetime Learning Tax Credit Tution and Fees Deducti

Expenses Tuition and required fees at an educational instituion eligible for Department of Education student aid programs. 

Covered Expenses covered do not include medical expenses, room and board, transportation, insurance and are net of scholarships, Pell G

or anv other tax free funds used to pay education expenses. 

Adjusted 1998-2001: Full credits for single (joint) returns less than $40,000 ($80,000). Single filers with less than $65,

Gross Credits linearly phased out for single (joint) returns until $50,000 ($100,000). Married couples must file ajoin

Income 2002: Limits changed to $41,000 ($82,000) and $51,000 ($102,000) for single (joint) returns. return less than $130,000. 

Eligibility 2003: Limits changed to $83 000 and $103000 for joint returns. 

Amount 100 percent of first $1,000 plus 1998-2002: 20 percent of first $5,000. 100 percent of first $3,000 of qu

50 percent of the next $1,000 of Max credit $1,000 per return. education spending per return. 

qualified education spending. 2003: 20 percent of first $10,000. Value to student/family depends 

Max credit $1 500 per student. Max credit $2 000 per return. marginal tax rate. 

Recipient Only available for two tax years for students in Undergraduate, graduate, vocational education and job skills programs. 

Eligibility the first two years of postsecondary education. Available for an indefinite number of years. 

Must be enrolled at least half-time, Lack of a felony drug conviction does not apply. 

pursuing a degree or credential and 

student cannot have a felony drug conviction. 

Start Date January I 1998 July 1 1998 Janury I 2002 

Source: IRS Publication 970 "Tax Benefits for Education"Yari()llsyears. ...... ____ 

82271.060

Table 2 

Means of Student Aid and Demographic Data by School Year and Institutional Control 

School Year 1995-1996 1999-2000 2003-2004 

School TYEe Public Private Public Private Public 

Tuition and Student Aid 

Tuition 3,752 16,588 3,998 17,553 5,115 

Institutional Aid 550 5,667 643 6,287 807 

Tax-Based Aid" 0 0 586 634 682 

Federal Grant Aid 1,291 2,171 1,208 2,310 1,884 

Federal Campus-Based Aid 435 1,518 315 1,262 468 

State Aid 409 855 480 845 640 

Student and Family Characteristics 

Family Income 50,892 61,723 57,395 68,108 63,297 

Dependent Student 84.33 90.58 79.61 87.16 85.72 

Age 20.40 20.06 21.46 21.01 20.69 

Black 11.49 9.68 10.94 12.86 11.81 

Hispanic 6.58 9.29 7.75 9.35 7.29 

Female 54.68 53.26 59.12 59.13 56.42 

Student Married 4.45 3.45 4.30 3.47 2.11 

Median School Emollment 23,746 12,707 22,082 11,529 23,755 

Number of Schools 120 70 120 70 120 

Data from the National Postsecondary Student Aid Study (NPSAS) 1995-96, 1999-2000 and 2003-04. 

'Tax-Based Aid is calculated as the value of the eligible award. By definition it is equal to zero for the 1995-96 school year. See Section 4.1 for details. 

The number of schools is rounded to the nearest 10 to comply with the Department of Education confidentiality statutes. 

All dollar amounts are in 2003 dollars. 

Priv

20,1

6,2

86

3,2

1,3

91

75,7

92.

20.

9.5

10.

57.

1.1

12,4

70 
93 


82271.061

Table 3 

National Enrollment and Enrollment in Analysis Sample 

School Year 1995-1996 1999-2000 2003-2004 

National Enrollment 

4-year Public 5,806,036 5,969,950 6,649,441 

4-year Private 2,998,157 3,228,575 3,767,806 

Total4-year 8,804,193 9,198,525 10,417,247 

2-year Public 5,314,463 5,339,449 6,209,257 

2-year Private 248,864 253,250 284,977 

Total 2-year & 4-year 14,367,520 14,791,224 16,911,481 

Enrollment in Institutions in the Analysis Sample 

4-year Public 2,571,280 2,704,230 3,146,390 

4-year Private 784,610 793,810 929,390 

Total4-year 3,355,890 3,498,040 4,075,780 

Ratio of Sample Enrollment to National Enrollment 

SamplelNational4-year 38 38 39 

Public SamplelNational4-year Public 44 45 47 

Private SamplelNational4-year Private 26 25 25 

Total SampleiTotal National 2-year & 4-year 23 24 24 

National enrollment from the Digest of Education Statistics: 2009, Table 190, National Center 

for Education Statistics and includes students enrolled at institutions granting at least an associate's 

degree and whose students are eligible for Title IV federal aid. Sample enrollment calculated from the 

annual enrollment for the schools included in the primary analysis sample from the 

National Postsecondary Student Aid Study and is rounded to the nearest 10 to comply with the 

U.S. Department of Education confidentiality statutes. 

82271.062

Table 4 

Estimated Tax-Based Aid Effect on Institutional Grant Aid 

(I) 

School Type Public 

(2) 

Public 

(3) 

Public 

(4) 

Private 

(5) 

Private 

(

Pri

Maximwn Simulated Maximwn Sim

Estimator 

Tax-Based Aid 

R2 

Sample Size 

Number of Schools 

First Stage Results 

F (instrument) 

Partial R2 

C-statistic 

Tax-Based Aid 

R2 

Sample Size 

Number of Schools 

First Stage Results 

F (instrument) 

Partial R2 

C-statistic 

OLS Spending)\' .. __ .Sllending IV Q.LS IV Spend

Panel A: Entire Sample of Students 

-0.828 -0.894 -0.819 -1.203 -0.905 -0

[0.075] [0.083] [0.0891 [0.2281 [0.2351 [0.

0.081 0.081 0.081 0.188 0.187 0.

51,800 51,800 51,800 22,480 22,480 22

120 120 120 70 70 7

8,343 

0.80 9.23 

2,003 

0.58 

4.35 

Panel B: Eligible Student Sample 

7,847 

0.91 

16.33 

1,

0

10

-1.035 -1.158 -1.081 -1.846 -1.449 -1

[0.091] [0.103) . [0.112] [0.311] [0.317] [0.

0.109 0.108 0.109 0.189 0.188 0.

41,210 41,210 41,210 17,350 17,350 17

120 120 120 70 70 

6,403 

0.75 

16.99 

1,188 

0.52 

1.25 

6,155 

0.87 

16.34 

8

09

Sample sizes and the number of schools are roWlded to the nearest IOta comply with the Department of Education confidentiality statutes. 

Panel A includes the entire sample of students. Panel B limits the sample to students who would be eligible for tax-based aid based on program rules. 

The estimates use tax-based aid based on maximum spending Of all simulated spending as the instrument. See Section 4.2 for details. The F-test is for the restriction that the excluded instrument is zero. The C-statistic is distributed chi-squared (1) under the null hypothesis that all regressors are exogenous. 

Control variables include school ftxed effects, student characteristics age, gendcr, dependency status), family income (cubic spline), 

parent/guardian controls (education and marital status), family controls (size, home Census Division), time (year indicator variables 

and interactions of year indicators with indicators for institutional selectivity). 

Controls are also included for other fonns of aid (Pell Grants, federal campus-based aid. state aid) at both the student level and as the average values. 

Standard errors, clustered at the school level, are reported in brackets. 
95 


82271.063

TableS 

Estimated Tax-Based Aid Effect on Non Need-Based and Need-Based Institutional Grant Aid and Student 

Loan Amounts 

(I) (2) (3) (4) (5) 

School T:iEe Public Public Public Private Private 

Maximum Simulated Maximum 

Estimator OLS SEendingIV SEendingIV OLS S\l.!:ndingIV 

Panel A: Non Need-Based Institutional Grant Aid 

Tax-Based Aid -0.510 -0.551 -0.553 -0.690 -0.512 

[0.059] [0.066] [0.068] [0.177] [0.182] 

R' 0.055 0.055 0.055 0.069 0.069 

Sample Size 51,600 51,600 51,600 22,240 22,240 

Number of Schools 120 120 120 70 70 

First Stage Results 

F (instrument) 8,321 1,997 7,847 

Partial R' 0.80 0.58 0.91 

C-statistic 7.90 4.50 11.32 

Panel B: Need-Based Institutional Grant Aid 

Tax-Based Aid -0.264 -0.286 -0.233 -0.456 -0.339 

[0.045] [0.050] [0.049] [0.180] [0.195] 

R2 0.073 0.073 0.073 0.203 0.202 

Sample Size 51,600 51,600 51,600 22,240 22,240 

Number of Schools 120 120 120 70 70 

First Stage Results 

F (instrument) 8,321 1,997 7,846 

Partial R' 0.80 0.58 0.91 

C-statistic 3.95 3.94 5.45 

Panel C: Student Loan Amounts 

Tax-Based Aid 0.556 0.416 0.464 0.515 0.365 

[0.079] [0.086] [0.114] [0.127] [0.123] 

R' 0.147 0.147 0.147 0.112 0.112 

Sample Size 51,800 51,800 51,800 22,480 22,480 

Number of Schools 120 120 120 70 70 

First Stage Results 

F (instrument) 7,756 1,863 7,934 

Partial R2 0.79 0.57 0.91 

C-statistic 12.07 2.88 11.64 

Sample sizes and the number of schools are rounded to the nearest 10 to comply with the Department of Education 

confidentiality statutes. 

(6) 

Private 

Simulated 

SEending IV 

-0.469 

[0.184] 

0.069 

22,240 

70 

2,017 

0.77 

12.09 

-0.322 

[0.202] 

0.202 

22,240 

70 

2,017 

0.77 

6.71 

0.426 

[0.142] 

0.112 

22,480 

70 

2,050 

0.77 

4.66 

The estimates use tax-based aid based on maximum spending or on simulated spending as the instrument. See Section 4,2 for details. 

The F~test is for the restriction that the excluded instrument is zero. 

The C-statistic is distributed chi-squared (1) under the null hypothesis that all regressors are exogenous. 

Control variables include school fixed effects, student characteristics (race, age, gender, dependency status)~ family income 

(cubic spline), parenUguardian controls (education and marital status), family controls (size, home Census Division), 

time (year indicator variablesand interactions of year indicators with indicators for institutional selectivity). 

Controls are also included for other fonns of aid (Pe11 Grants~ federal campus-based aid, state aid) at both the student level and 

as the school-year average value. Standard errors, clustered at the school level, are reported in brackets. 
96 


82271.064

Table 6 

Robustness Checks a/Tax-Based Aid Effect on Institutional Grant Aid 

School Type 

Instrument 

(1) (2) (3) 

Public 

Maximum 

Spending 

Public 

Simulated Spending 

Private 

Maximum 

Spending 

Panel A: Remove States with Changing Race-Based Aid/Admission Policies 

Tax-Based Aid -0.859 -0.828 -0.909 

R2 

Sample Size 

Number of Schools 

F (instrument) 

Tax-Based Aid 

R' 

Sample Size 

Number of Schools 

F (instrument) 

Tax-Based Aid 

Sample Size 

Number of Schools 

F (instrument) 

Tax-Based Aid 

Sample Size 

Number of Schools 

F (instrument) 

[0.095] [0.100] [0.260] 

0.081 0.082 0.186 

43,370 43,370 19,060 

110 110 70 

6,537 1,969 8,249 

Panel B: Remove States Introducing Merit-Based Aid 

-0.924 -0.832 -0.866 

[0.095) [0.103] [0.229] 

0.089 0.089 0.188 

43,030 43,030 19,130 

120 120 70 

7,864 1,630 6,131 

Panel C: Remove Parent/Family Controls 

-0.869 -0.811 -1.022 

[0.081] [0.086] [0.243] 

0.063 0.063 0.155 

51,780 51,780 22,480 

120 120 70 

8,471 2,380 9,367 

Panel D: Unbalanced Panel of Schools 

-0.801 -0.728 -0.766 

[0.071] [O.073J [0.203J 

0.081 0.081 0.172 

71,860 71,860 37,960 

200 200 150 

8,526 3,002 7,070 

(4) 

Private 

Simulated 

Spending 

-0.768 

[0.288] 

0.185 

19,060 

70 

2,033 

-0.646 

[O.275J 

0.187 

19,130 

70 

1,883 

-0.846 

[0.293) 

0.154 

22,480 

70 

2,053 

-0.510 

[0.248J 

0.132 

37,960 

150 

3,230 

Sample sizes and the nwnber of schools are rounded to the nearest 10 to comply with the Department of Education 

confidentiality statutes. 

Panel A removes students from three states (CA, MI and TX). 

Panel B removes students from 10 states (FL, KY, LA, MD, MI, NY, NM, SC, TN, WV), 

Panel C removes student demographic varaibles and parenVfamily controls from the primary (balanced panel) sample. 

Panel D uses an unbalanced panel of schools that appear in the 1995-96 school year and one of the later 

(1999-2000, 2003-04) school yea". 

The F-test is for the restriction that the excluded instrument is zero. 

Control variables include school fixed effects, student characteristics (race, age! gender, dependency status), 

family income (cubic spline), parent/guardian controls (education and marital status), family controls 

(size) home Census Division), time (year indicator variables and interactions of year indicators 

with indicators for institutional selectivity). Controls are also included for other fonns of aid 

(Pell Grants, federal campus-based aid, state aid) at both the student level and as the school-year average value. 

Standard errors, clustered at the school level, are reported in brackets. 

82271.065

Table Al 

Institutional Aid Redistribution/or Ineligible Students 

(1) (2) (3) (4) 

School Type Public Public Private Private 

Instrument Maximum Spending Simulated Spending Maximum Spending Simulated Spe

Panel A: Flexible Time Controls 

Total Tax-Based Aid 0.147 0.141 1.963 1.751 

per Ineligible Student [0.119] [0.102] [1.608] [1.329] 

R2 0.038 0.033 0.217 0.211 

F (instrument) 3.85 6.52 2.03 2.01 

Sample Size 10,590 10,590 5,130 5,130 

Number of Schools 120 120 70 70 

Panel B: Time Trend Controls 

TotalTax-Based Aid 0.066 0.056 0.737 0.647 

per Ineligible Student [0.067] [0.044] [0.415] 

R2 0.031 0.033 0.115 0.137 

F (instrument) 11.29 24.61 5.88 5.05 

Sample Size 10,590 10,590 5,130 5,130 

Number of Schools 120 120 70 70 

Sample sizes and the number of schools are rounded to the nearest \0 to comply with the Department of Education confidentiality statutes. 

The sample is limited to students who would be ineligible for tax-based aid based on 2003-04 program rules. 

Panel A includes year indicator variables and interactions of year indicators with indicator variables tor institutional selectivity. 

Panel B uses a squared time trend. 

The instrument uses enrollment from the 1995-96 school year and spending from either the 1995-96 school year (simulated spending), 

or from program limits (maximum spending). See Appcndix for details. The F-test is for the restriction that the excluded instrument is zero. 

Control variables include school fixed effects, student characteristics (race, age, gender, dependency status), family income (cubic spline), 

parent/guardian controls (education and marital status), family controls (size, home Census Division), time (year indicator variables 

and interactions of year indicators with indicators for institutional selectivity). 

Controls are also included for other forms of aid (Pell Grants, federal campus-based aid, state aid) at both the student level and as the school-year average va

Standard errors, clustered at the school level, are reported in brackets. 

82271.066

Table HI 

Estimated Tax-Based Aid Effect on Institutional Grant Aid by Grade Level 

School Type 

Estimator 

Tax-Based Aid 

R' 

Sample Size 

Number of Schools 

First Stage Results 

F (instrument) 

Partial R2 

C-statistic 

Tax-Based Aid 

R2 

Sample Size 

Number of Schools 

First Stage Results 

F (instrument) Partial R2 

C-statistic 

(1) (2) (3) (4) (5) (

Public Public Public Private Private Pri

Maximum Simulated Maximum Sim

OLS Spendingry IV OLS Spending IV Spend

Panel A: Entering Students (Istyear) 

-0.935 -0.976 -0.934 -1.597 -1.039 -1

[0.129] [0.1391 . -----.l0.159] [0.254] [0.288] [0.

0.092 0.092 0.092 0.188 0.187 0.

11,180 11,180 11,180 5,440 5,440 5,

120 120 120 70 70 

4,890 

0.81 

12.49 

1,750 

0.63 9.77 

Panel B: Continuing Students (2nd-5th years) 

3,514 

0.90 

16.97 

7

0

6

-0.798 -0.866 -0.789 -1.147 -0.918 -0

[0.0761 [0.0831 [0.0891 [0.2711 [0.2771 [0.

0.083 0.083 0.083 0.191 0.191 0.

40,620 40,620 40,620 17,040 17,040 17

120 120 120 70 70 

7,108 

0.79 

7.29 

1,628 

0.56 

3.88 

7,708 

0.91 9.18 

2,

0

1

Sample sizes and the number of schools are rounded to the nearest 10 to comply with the Department of Education confidentiality statutes. 

Panel A includes only 1st year (entering) students. Panel B includes students enrolled in 2nd-5th years (continuing students). 

The estimates use tax-based aid based on maximum spending or on simulated spending as the instrument. Sec Section 4.2 for details. 

The F-test is for the restriction that the excluded instrument is zero. 

The C-statistic is distributed chi-squared (I) under the null hypothesis that all regressors are exogenous. 

Control variables include school fixed effects, student characteristics (race, age, gender, dependency status), family income (cubic spline), 

parent/guardian controls (education and marital status), family controls (size, home Census Division), time (year indicator variables 

and interactions of year indicators with indicators for institutional selectivity). 

Controls are also included for other fonns of aid (Pell Grants, federal campus-based aid, state aid) at both the student level and as the school-year averag

Standard errors, clustered at the school level, are reported in brackets. 

82271.067

Table B2 

Estimated Tax-Based Aid Effect on Institutional GranL;Jid by Institutional Selectivity and Stucleflt Ability 

School Type 

Estimator 

Tax-Based Aid 

R' 

Sample Size 

Number of Schools 

First Stage Results 

F (instrument) Partial R' 

C-statistic 

Tax-Based Aid 

R' 

Sample Size 

Number of Schools 

First Stage Results 

F (instrument) 

Partial R' 

C-statistic 

(I) (2) (3) (4) (5) (

Public & Private Public & Private Public & Private Public & Private Public & Private Public & 

Maximum Simulated Maximum Spending Simu

OLS Spending IV IV QI"S IV Spend

Panel A: Effects by Institutional Selectivity 

More Selective More Selective More Selective Less Selective Less Selective Less S

-1.205 -1.149 -0.825 -0.591 -0.613 -0

[0.170] [0.173] [0.216] [0.094] 19.104] ... 10.

0.164 0.164 0.060 0.060 

27,040 27,040 27,040 47,240 47,240 

70 70 70 120 120 

2,730 

0.87 

2.26 

2,499 

0.72 

8.05 

Panel B: Effects by Student Ability 

6,785 

0.80 

3.44 

47

1

1,

0

5

Above Average Above Average Above Average Bcl()\V1\verageBel()},\, Average. Below 

-1.064 -1.108 -0.871 -0.809 -0.809 -0

[0.1651 [0.166] [0.200] [0.139]_10.140].10.17

0.060 0.060 0.107 0.107 

20,710 20,710 20,710 20,340 20,340 

180 180 180 180 180 

5,980 

0/86 

1.16 

2,246 

0.72 

6.56 

4,535 

0.84 0.66 

20

1

1,

0

4

Sample sizes and the number of schools are rounded to the nearest 10 to comply with the Department of Education conftdentiality statutes. 

In Panel Aj institutional selectivity is defined by NPSAS categories. In Panel B, student quality is detennined by SAT scores. See Appendix B 1 for details. 

The F-test is for the restriction that the excluded instrument is zero. Standard errors. clustered at the school level, are reported in brackets. 

The C-statistic is distributed chi-squared (1) under the null hypothesis that all regressors are exogenous. 

Control variables include school fIxed effects, student characteristics (race, age, gender, dependency status), family income (cubic spline), parent/guardian controls 

(education and marital status), family controls (size, home Census Division), time (year indicator variables and interactions of year indicators willi indicators for 

public and other fonns <lid, average value. 
100 


82271.068

From Washington Monthly magazine 

September/October 2011 

Administrators Ate My Tuition 

Want to get college costs in line? Start by cutting the overgrown management ranks. 

By Benjamin Ginsberg 

No statistic about higher education commands more attention-and anxiety-among members of 

the public than the rising price of admission. Since 1980, inflation-adjusted tuition at public 

universities has tripled; at private universities it has more than doubled. Compared to all other 

goods and services in the American economy, including medical care, only "cigarettes and other 

tobacco products" have seen prices rise faster than the cost of going to college. And for all that, 

parents who sign away ever-larger tuition checks can be forgiven for doubting whether 

universities are spending those additional funds in ways that make their kids' educations betterto say nothing of three times better. 

Between 1975 and 2005, total spending by American higher educational institutions, stated in 

constant dollars, tripled, to more than $325 billion per year. Over the same period, the faculty-tostudent ratio has remained fairly constant, at approximately fifteen or sixteen students per 

instructor. One thing that has changed, dramatically, is the administrator-per-student ratio. In 

1975, colleges employed one administrator for every eighty-four students and one professional 

staffer-admissions officers, information technology specialists, and the like-for every fifty 

students. By 2005, the administrator-to-student ratio had dropped to one administrator for every 

sixty-eight students while the ratio of professional staffers had dropped to one for every twentyone students. 

Apparently, as colleges and universities have had more money to spend, they have not chosen to 

spend it on expanding their instructional resources-that is, on paying faculty. They have 

chosen, instead, to enhance their administrative and staff resources. A comprehensive study 

published by the Delta Cost Project in 2010 reported that between 1998 and 2008, America's 

private colleges increased spending on instruction by 22 percent while increasing spending on 

administration and staff support by 36 percent. Parents who wonder why college tuition is so 

high and why it increases so much each year may be less than pleased to learn that their sons and 

daughters will have an opportunity to interact with more administrators and staffers-but not 

more professors. Well, you can't have everything. 

Of course, universities have always employed administrators. When I was a graduate student in 

the 1960s and a young professor in the 1970s, however, top administrators were generally drawn 

from the faculty, and even midlevel managerial tasks were directed by faculty members. These 

moonlighting academics typically occupied administrative slots on a part-time or temporary 

basis and planned in due course to return to full-time teaching and research. Whatever their 

individual faults and gifts, faculty administrators seldom had to be reminded that the purpose of a 
101 


82271.069

university was the promotion of education and research, and their own short-term managerial 

endeavors tended not to distract them from their long-term academic commitments. 

Alas, today's full-time professional administrators tend to view management as an end in and of 

itself. Most have no faculty experience, and even those who have spent time in a classroom or 

laboratory often hope to make administration their life's work and have no plan to return to 

teaching. For many of these career managers, promoting teaching and research is less important 

than expanding their own administrative domains. Under their supervision, the means have 

become the end. 

Every year, hosts of administrators and staffers are added to college and university payrolls, even 

as schools claim to be battling budget crises that are forcing them to reduce the size of their fulltime faculties. As a result, universities are now filled with armies of functionaries-vice 

presidents, associate vice presidents, assistant vice presidents, provosts, associate provosts, vice 

provosts, assistant provosts, deans, deanlets, and deanlings, all of whom command staffers and 

assistants-who, more and more, direct the operations of every school. If there is any hope of 

getting higher education costs in line, and improving its quality-and I think there is, though the 

hour is late-it begins with taking a pair of shears to the overgrown administrative bureaucracy. 

Forty years ago, America's colleges employed more professors than administrators. The efforts 

of 446,830 professors were supported by 268,952 administrators and staffers. Over the past four 

decades, though, the number of full-time professors or "full-time equivalents"-that is, slots 

filled by two or more part-time faculty members whose combined hours equal those of a fulltimer-increased slightly more than 50 percent. That percentage is comparable to the growth in 

student enrollments during the same time period. But the number of administrators and 

administrative staffers employed by those schools increased by an astonishing 85 percent and 

240 percent, respectively. 

Today, administrators and staffers safely outnumber full-time faculty members on campus. In 

2005, colleges and universities employed more than 675,000 full-time faculty members or fulltime equivalents. In the same year, America's colleges and universities employed more than 

190,000 individuals classified by the federal government as "executive, administrative and 

managerial employees." Another 566,405 college and university employees were classified as 

"other professional." This category includes IT specialists, counselors, auditors, accountants, 

admissions officers, development officers, alumni relations officials, human resources staffers, 

editors and writers for school publications, attorneys, and a slew of others. These "other 

professionals" are not administrators, but they work for the administration and serve as its arms, 

legs, eyes, ears, and mouthpieces. 

Before they employed an army of professional staffers, administrators were forced to rely on the 

cooperation of the faculty to carry out tasks ranging from admissions to planning. An 

administration that lost the confidence of the faculty might find itself unable to function. Today, 

ranks of staffers form a bulwark of administrative power in the contemporary university. These 

administrative staffers do not work for or, in many cases, even share information with the 

faculty. They help make the administration, in the language of political science, "relatively 

autonomous," marginalizing the faculty. 
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While some administrative posts continue to be held by senior professors on a part-time basis, 

their ranks are gradually dwindling as their jobs are taken over by full-time managers. College 

administrations frequently tout the fiscal advantages of using part-time, "adjunct" faculty to 

teach courses. They fail, however, to apply the same logic to their own ranks. Over the past thirty 

years, the percentage offaculty members who are hired on a part-time basis has increased so 

dramatically that today almost half of the nation's professors work only part-time. And yet the 

percentage of administrators who are part-time employees has fallen during the same time 

period. 

Administrators are not only well staffed, they are also well paid. Vice presidents at the 

University of Maryland, for example, earn well over $200,000, and deans earn nearly as much. 

Both groups saw their salaries increase as much as 50 percent between 1998 and 2003, a period 

of financial retrenchment and sharp tuition increases at the university. The University of 

Maryland at College Park-which employs six vice presidents, six associate vice presidents, five 

assistant vice presidents, six assistants to the president, and six assistants to the vice presidentshas long been noted for its bloated and extortionate bureaucracy, but it actually does not seem to 

be much of an exception. Administrative salaries are on the rise everywhere in the nation. By 

2007, the median salary paid to the president of a doctoral degree-granting institution was 

$325,000. Eighty-one presidents earned more than $500,000, and twelve earned over $1 million. 

Presidents, at least, might perform important services for their schools. Somewhat more difficult 

to explain is the fact that by 20 I 0 even some of the ubiquitous and largely interchangeable 

deanlets and deanlings earned six-figure salaries. 

If you have any remaining doubt about where colleges and universities have been spending their 

increasing tuition and other revenues, consider this: between 1947 and 1995 (the last year for 

which the relevant data was published), administrative costs increased from barely 9 percent to 

nearly 15 percent of college and university budgets. More recent data, though not strictly 

comparable, follows a similar pattern. During this same time period, stated in constant dollars, 

overall university spending increased 148 percent. Instructional spending increased only 128 

percent, 20 points less than the overall rate of spending increase. Administrative spending, 

though, increased by a whopping 235 percent. 

Three main explanations are often adduced for the sharp growth in the number of university 

administrators over the past thirty years. One is that there have been new sorts of demands for 

administrative services that require more managers per student or faculty member than was true 

in the past. Universities today have an elaborate IT infrastructure, enhanced student services, a 

more extensive fund-raising and lobbying apparatus, and so on, than was common thirty years 

ago. Of course, it might also be said that during this same time period, whole new fields of 

teaching and research opened in such areas as computer science, genetics, chemical biology, and 

physics. Other new research and teaching fields opened because of ongoing changes in the world 

economy and international order. And yet, faculty growth between 1975 and 2005 simply kept 

pace with growth in enrollments and substantially lagged behind administrative and staff growth. 

When push came to shove, colleges chose to invest in management rather than in teaching and 

research. 
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A second common explanation given for the expansion of administration in recent years is the 

growing need to respond to mandates and record-keeping demands from federal and state 

govemments as well as numerous licensure and accreditation bodies. It is certainly true that large 

numbers of administrators spend a good deal of time preparing reports and collecting data for 

these and other agencies. But as burdensome as this paperwork blizzard might be, it is not clear 

that it explains the growth in administrative personnel that we have observed. Often, affirmative 

action reporting is cited as the most time consuming of the various governmental mandates. As 

the economist Barbara Bergmann has pointed out, however, across the nation only a handful of 

administrators and staffers are employed in this endeavor. 

More generally, we would expect that if administrative growth were mainly a response to 

external mandates, growth should be greater at state schools, which are more exposed to 

government obligations, than at private institutions, which are freer to manage their own affairs 

in their own way. Yet, when we examine the data, precisely the opposite seems to be the case. 

Between 1975 and 2005, the number of administrators and managers employed by public 

institutions increased by 66 percent. During the same time period, the number of administrators 

employed by private colleges and universities grew by 135 percent. These numbers seem 

inconsistent with the idea that external mandates have been the forces driving administrative 

growth at America's institutions of higher education. 

A third explanation has to do with the conduct of the faculty. Many faculty members, it is often 

said, regard administrative activities as obnoxious chores and are content to allow these to be 

undertaken by others. While there is some truth to this, it is certainly not the whole story. Often 

enough, I have observed that professors who are willing to perform administrative tasks lose 

interest when they find that the committees, councils, and assemblies through which the faculty 

nominally acts have lost much if not all their power to administrators. 

If growth-driven demand, governmental mandates, and faculty preferences are not sufficient 

explanations for administrative expansion, an alternative explanation might be found in the 

nature of university bureaucracies themselves. In particular, administrative growth may be seen 

primarily as a result of efforts by administrators to aggrandize their own roles in academic life. 

Students of bureaucracy have frequently observed that administrators have a strong incentive to 

maximize the power and prestige of whatever office they hold by working to increase its staff 

and budget. To justifY such increases, they often seek to capture functions currently performed 

by others or invent new functions for themselves that might or might not further the 

organization's main mission. 

Such behavior is common on today's campuses. At one school, an inventive group of 

administrators created the "Committee on Traditions," whose mission seemed to be the 

identification and restoration of forgotten university traditions or, failing that, the creation of new 

traditions. Another group of deans constituted themselves as the "War Zones Task Force." This 

group recruited staffers, held many meetings, and prepared a number of reports whose upshot 

seemed to be that students should be discouraged from traveling to war zones, unless, of course, 

their home was in a war zone. But perhaps the expansion of university bureaucracies is best 

illustrated by an ad placed by a Colorado school, which sought a "Coordinator of College 
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Liaisons." Depending on how you read it, this is either a ridiculous example of bureaucratic 

layering or an intrusion into an area of student life that hardly requires administrative assistance. 

The number of administrators and staffers on university campuses has increased so rapidly in 

recent years that often there is not enough work to keep all of them busy. To fill their time, 

administrators engage in a number of make-work activities. This includes endless rounds of 

meetings, mostly with other administrators, often consisting of reports from and plans for other 

meetings. For example, at a recent "president's staff meeting" at an Ohio community college, 

eleven of the eighteen agenda items discussed by administrators involved plans for future 

meetings or discussions of other recently held meetings. At a gathering of the "Process 

Management Steering Committee" of a Midwestern community college, virtually the entire 

meeting was devoted to planning subsequent meetings by process management teams, including 

the "search committee training team," the "faculty advising and mentoring team," and the 

"culture team," which was said to be meeting with "renewed energy." The culture team was 

apparently also close to making a recommendation on the composition of a "Culture 

Committee." Since culture is a notoriously abstruse issue, this committee may need to meet for 

years, if not decades, to unravel its complexities. 

When they face particularly challenging problems, academic administrators sometimes find that 

ordinary meetings in campus offices do not allow them the freedom from distraction they 

require. To allow them to focus fully and without interruption, administrators sometimes find it 

necessary to schedule off-campus administrative retreats where they can work without fear that 

the day-to-day concerns of the campus will disturb their deliberations. Sometimes these retreats 

include athletic and role-playing activities that are supposed to help improve the staff's spirit of 

camaraderie and ability to function as a team. For example, at a 2007 professional development 

retreat, Michigan Tech staffers broke into teams and spent several hours building furniture from 

pieces of cardboard and duct tape. Many staff retreats also include presentations by professional 

speakers who appear to specialize in psychobabble. Topics at recent retreats included "Do You 

Want to Succeed?" "Reflective Resensitizing," and "Waking Up the Inner World." In all 

likelihood, the administrators and staffers privileged to attend these important talks spent the 

next several weeks reporting on them at meetings with colleagues who had been deprived of the 

opportunity to learn firsthand how to make certain that their inner worlds remained on alert. 

Administrative budgets frequently include travel funds, on the theory that conference 

participation will hone administrators' skills and provide them with new information and ideas 

that will ultimately serve their school's interests. We can be absolutely certain that this would be 

the only reason administrators would even consider dragging themselves to Maui during the 

winter for a series of workshops sponsored by the North American Association of Summer 

Sessions. Given the expense and hardship usually occasioned by travel to Hawaii, it is entirely 

appropriate for colleges to foot this sort of bill. 

Another ubiquitous make-work exercise is the formation of a "strategic plan." Until recent years, 

colleges engaged in little formal planning. Today, however, virtually every college and 

university in the nation has an elaborate strategic plan. This is typically a lengthy documentsome are 100 pages long or more-that purports to articulate the school's mission, its 

leadership'S vision of the future, and the various steps that are needed to achieve the school's 
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goals. The typical plan takes six months to two years to write and requires countless hours of 

work from senior administrators and their staffs. 

A plan that was really designed to guide an organization's efforts to achieve future objectives, as 

it might be promulgated by a corporation or a military agency, would typically present concrete 

objectives, a timetable for their realization, an outline ofthe tactics that will be employed, a 

precise assignment of staff responsibilities, and a budget. Some university plans approach this 

model. Most, however, are simply expanded "vision statements" that are often forgotten soon 

after they are promulgated. My university has presented two systemwide strategic plans and one 

arts and sciences strategic plan in the last fifteen years. No one can remember much about any of 

these plans, but another one is currently in the works. The plan is not a blueprint for the future. It 

is, instead, a management tool for the present. The ubiquity of planning at America's colleges 

and universities is another reflection and reinforcement of the ongoing growth of administrative 

power. 

There is, to be sure, one realm in which administrators as a class have proven extraordinarily 

adept. This is the general domain of fund-raising. Even during the depths ofthe recession in 

2009, schools were able to raise money. On the one hand, the donors who give selflessly to their 

schools deserve to be commended for their beneficence. At the same time, it should still be noted 

that, as is so often the case in the not-for-profit world, university administrators appropriate 

much of this money to support-what else?-more administration. 

The stress on fund-raising has enabled more than a few university presidents to acquire luxurious 

offices, lavish residences, and an assortment of perks in addition to princely salaries. Some enjoy 

the services of a chauffeur when they commute to work and a household staff when they 

entertain or even relax at home. These and many other perquisites are usually defended by 

administrators as needed to carry out their social duties and, particularly, to impress their 

schools' wealthy benefactors. Yet no study has ever proved that presidents who arrive at 

fundraising events in chauffeur-driven limousines are more likely to succeed in their capital 

campaign goals or in any other endeavor than their counterparts who drive their own cars or 

come by taxi or, for that matter, by subway. I have personally known university presidents who 

were outstanding fund-raisers but, nevertheless, lived frugally and always traveled as cheaply as 

possible. Among college officials, though, the spendthrifts seem to outnumber the penny 

pinchers. 

College presidents are usually the guiltiest parties, since they are in the best position to authorize 

expenditures, and many are more than happy to use school funds to burnish their own images. 

One recent case in point is that of Benjamin Ladner, the former president of American University 

in Washington, D.C. Soon after arriving on the campus in 1994, Ladner and his wife, who 

dubbed herself AU's "first lady," declared that the president's official residence was inadequate 

and had the university build an expensive new house, which included a waterfall and pond 

behind the patio, a few blocks from the campus. They outfitted the house with expensive 

furnishings, china, and stemware. At university expense, the Ladners employed a chauffeur, a 

cook, a social secretary, and numerous other personal staff members. They hosted gala events to 

which they invited prominent Washington figures. They traveled abroad frequently, generally 

charging their first-class tickets to the university. 
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Matters came to a head in March 2005, when an anonymous whistleblower wrote to the board of 

trustees accusing the Ladners of "severe expense account violations." An extensive audit 

subsequently revealed hundreds of thousands of dollars in questionable spending, some personal 

but most associated with President Ladner's frenetic image-polishing efforts. Over the previous 

several years, the Ladners had charged the university for $6,000 in club dues, $54,000 in drivers' 

costs, $220,000 in chefs' services, $44,000 for alcohol, and $100,000 in services from their 

social secretary. 

After months of bruising battles within the AU board, Ladner's contract was terminated-though 

he and the first lady received a generous severance package. While Ladner mingled with the rich 

and famous at the school's expense, faculty members had to settle for miserly annual salary 

increases and students saw their tuitions rise markedly every year. 

The expansion of college and university administration has not been coupled with the 

development of adequate mechanisms of oversight and supervision, particularly for senior 

managers. University boards, which technically oversee the administrations, are generally not 

well prepared for the task. One recent study found that 40 percent of university trustees said they 

were not prepared for the job and 42 percent indicated that they spent less than five hours a 

month on board business. Many trustees serve because of loyalty to their school and say they 

have "faith" in its administration. They do not go out of their way to look for problems, and 

administrators are generally able to satisfy trustees with the rosy pictures of college life 

presented at weekend board meetings. 

Moreover, university boards do not have the same legal responsibilities borne by corporate 

boards. Most federal regulations establishing management standards for private-sector firms, 

such as the 2002 Sarbanes-Oxley Act, do not apply to nonprofit entities, and state regulation of 

university administration is spotty. At the same time, while schools have developed many 

internal rules and standards applying to the conduct of facility members and students, few if any 

have established standards governing administrative conduct or established oversight 

mechanisms. For the most part, senior administrators police themselves. 

The result of this lack of supervision is that a number of college and university administrators 

have, in recent years, succumbed to the temptation to engage in corrupt practices. In 2008, for 

example, the director of Tufts University's Office of Student Activities, Josephine NeaIley, was 

indicted on three counts oflarceny for embezzling more than $300,000 in student activities 

funds. She allegedly transferred the money to her personal bank accounts and used it for 

purchases and trips. While acting on an anonymous tip regarding Nealley's activities, university 

auditors uncovered a second, apparently unrelated case of embezzlement. Raymond Rodriguez, a 

budget officer, allegedly stole more than $600,000 from the university, which he spent on trips 

and luxury goods. Rodriguez was indicted on two counts of larceny for his alleged thefts. Both 

Nealley and Rodriguez entered guilty pleas and were sentenced to prison terms. 

In a similar vein, the president of the University of Tennessee was forced to resign when an audit 

revealed that he had spent hundreds of thousands of dollars in university funds on personal trips, 

entertainment, and purchases. The president's travel at university expense allegedly included 
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trips to Birmingham, Alabama, where he was said to have a "personal involvement" with the 

president of another school. 

Often, frauds go unnoticed for years because the perpetrators are the accountants and financial 

officers responsible for fiscal oversight. When fraudulent conduct is discovered, university 

officials often prefer to allow the perpetrators to resign or retire quietly rather than risk a public 

brouhaha that might upset donors and lead to questions about the quality of the school's 

leadership. Many professors can point to cases at their own school when crooked administrators 

were allowed to leave quietly, sometimes even without being compelled to make restitution for 

their offenses. 

When fraud is exposed and restitution demanded, the sums can be considerable. In January 2008, 

Roy Johnson, chancellor of Alabama's community college system, pled guilty to bribery and was 

required to forfeit the $18 million he admitted receiving in direct and indirect benefits from 

companies doing business with the colleges he oversaw. As the U.S. attorney who prosecuted the 

case observed, "Taxpayers must wonder how many more Alabama students could have been 

educated had money not been wasted on fraud." 

The priorities of the hyper-administrative university emerge most clearly during times of 

economic crisis, when managers are forced to make choices among spending options. Thanks to 

the sharp economic downturn that followed America's 2008 financial crisis, almost every 

institution, even Harvard, America's wealthiest school, has been compelled to make substantial 

cuts in its expenditures. What cuts did university administrations choose to make during these 

hard times? 

A tiny number of schools took the opportunity to confront years of administrative and staff bloat 

and moved to cut costs by shedding unneeded administrators and their brigades of staffers. The 

most notable example is the University of Chicago's Pritzker School of Medicine, which in 

February 2009 addressed a $100 million budget deficit by eliminating fifteen "leadership 

positions," along with 450 staff jobs, among other cuts. The dean also emphasized that faculty 

would not be affected by the planned budget cuts. Chicago's message was clear: administrators 

and staffers were less important than teaching, research, and-since this involved a medical 

school-patient care; if the budget had to be cut, it would be done by thinning the school's 

administrative ranks, not by reducing its core efforts. 

Unfortunately, few if any other colleges and universities copied the Chicago model. Facing 

budgetary problems, many schools eliminated academic programs and announced across-theboard salary and hiring freezes, which meant that vacant staff and faculty positions, including the 

positions of many adjunct professors, would remain unfilled until the severity of the crisis eased. 

Perverse administrative priorities were even more in evidence at a number of schools that 

actually raised administrative salaries or opted to spend more money on administrative services 

while cutting expenditures on teaching and research in the face of budget deficits. For example, 

in January 2009, facing $19 million in budget cuts and a hiring freeze, Florida Atlantic 

University awarded raises of 10 percent or more to top administrators, including the school's 

president. In a similar vein, in February 2009, the president of the University of Vermont 
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defended the bonuses paid to the school's twenty-one top administrators against the backdrop of 

layoffs, job freezes, and program cuts at the university. The university president, Daniel Fogel, 

asserted that administrative bonuses were based on the principles of "extra pay for extra duties" 

and "pay for performance." The president rejected a faculty member's assertion that paying 

bonuses to administrators when the school faced an enormous budget deficit seemed similar to 

the sort of greed recently manifested by the corporate executives who paid themselves bonuses 

with government bailout money. Fogel said he shared the outrage of those upset at corporate 

greed, but maintained there was a "world of difference" between the UVM administrative 

bonuses and bonuses paid to corporate executives. He did not specify what that world might be. 

In the meantime the president of Washington State University, Elson Floyd, accepted a $125,000 

pay raise, bringing his 2009 salary to $725,000 per year, soon after announcing that financial 

circumstances required the school to freeze hiring. At another university that had just announced 

a large budget deficit and mandated salary and hiring freezes, the outgoing president was feted 

by the board of trustees at a gala 350-person dinner, to which trustees, senior administrators, 

alumni, donors, and other notables-but no students or faculty-were invited. The dinner, which 

might as well have been held on the promenade deck of the Titanic, featured musical 

performances, videos, and a lounge area with hundreds of Chinese newspapers and a tea set to 

recognize the president's many trips to China. (No wonder university spending was frozen.) 

Later, this same university placed restrictions on the use of copy paper by graduate students. 

Maybe the Chinese newspapers should have been recycled. 

On any given campus, the only institution with the actual power to halt the onward march of the 

all-administrative university is the board of trustees or regents-which, as we've seen, tend to be 

unprepared or disinclined to make waves. But they need to do so if their institutions are to be 

saved from sinking into the expanding swamp of administrative mediocrity. 

To begin with, trustees interested in trimming administrative fat should compare their own 

school's ratio of managers and staffers per hundred students to the national mean, which is 

currently an already inflated nine for private schools and eight for public colleges. If the national 

mean is nine administrators per hundred students at private colleges, why does Vanderbilt need 

sixty-four? Why does Rochester need forty and Johns Hopkins thirty-one? Management-minded 

administrators claim to believe in benchmarking, so they should not object to being benchmarked 

in this way. 

The right kind of media coverage would embolden boards to ask the right questions. In 

particular, the various publications that rate and rank colleges-U.s. News is the most 

influential-should take account of administrative bloat in their ratings. After all, a high 

administrator-to-student ratio means that the school is diverting funds from academic programs 

to support an overgrown bureaucracy. I am certain that if Vanderbilt or Duke or Hopkins or 

Rochester or Emory or any of the other most administratively top-heavy schools lost a few 

notches in the U.S. News rankings because of their particularly egregious administrative bloat, 

their boards would be forced to act. 

But given the general fattening of administrative ranks in recent years, even schools with average 

administrator-to-student ratios could stand to see major cuts in their administrative staffs and 
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budgets. This could help not only to fill budget holes but, more importantly, to begin a healthy 

shift in the balance of bureaucratic power within universities. A lO-percent cut in the staff and 

management ranks would save millions of dollars but would have no effect whatsoever on the 

operations of most campuses. The deanlets would never be missed; their absence from campus 

would go unnoticed. A 20-percent or larger cut would begin to be noticed and would have the 

beneficial effect of substantially reducing administrative power and the ongoing diversion of 

scarce funds into unproductive channels. 

With fewer deanlets to command, senior administrators would be compelled to turn once again 

to the faculty for administrative support. Such a change would result in better programs and less 

unchecked power for presidents and provosts. Faculty who work part-time or for part of their 

careers as administrators tend to ask questions, use judgment, and interfere with arbitrary 

presidential and provostial decision making. Senior full-time administrators might resent the 

interference, but the university would benefit from the result. Moreover, with fewer 

administrators to pay and send to conferences and retreats, more resources might be available for 

educational programs and student support, the actual items for which parents, donors, and 

funding agencies think they are paying. 

Benjamin Ginsberg is a professor of political science at Johns Hopkins University. This article is adapted 

with permission from The Fall of the Faculty: The Rise of the All-Administrative University and Why It 

Matters, by Benjamin Ginsberg, published by Oxford University Press, 2011. 
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CBO 

STt OY 

Tax Arbitrage by 

Colleges and Universities 

April 2010 

The Congress of rhe United States _ Congressional Budget Office 
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Preface 

Because colleges and universities serve a public purpose-advancing higher education 

and promoting myriad forms of research-they enjoy a variety of tax preferences. In addition 

to being exempt from paying federal income taxes, institutions of higher learning can accept 

tax-deductible charitable contributions and use tax-exempt debt to finance capital expenditures. It is the latter preference that the Congressional Budget Office (CBO) focuses on in 

this study, which was prepared at the request of the Ranking Member of the Senate Finance 

Committee. The law explicitly prohibits the use of tax-exempt-bond proceeds for the purchase of investment assets, a practice known as tax arbitrage; however, issuers of tax-exempt 

bonds may use the proceeds for the purchase of operating assets while they simultaneously 

hold investment assets that provide a higher rate of return. To the extent that colleges and 

universities earn an untaxed return on investments that exceeds the interest they pay on taxexempt debt, they are benefiting from a form of indirect tax arbitrage. 

Using data from information remrns filed with the Internal Revenue Service by instimtions 

of higher learning and by issuers of tax-exempt debt, CBO created several measures of tax 

arbitrage under a broader definition of rhe term that includes indirect tax arbitrage. Over 

rime, if legislators were to expand the definition of tax arbirrage, nonprofit institutions 

would most likely respond by reducing their issues of tax-exempt debt. That response, in 

turn, could decrease the cost to the federal government of granting such tax preferences. In 

accordance with CBO's mandate to provide objecrive, nonpartisan analysis, the paper makes 

no recommendations. 

Kristy Piccinini of CBO's Tax Analysis Division wrote the study, under the supervision of 

Frank Sammartino and G. Thomas Woodward (formerly of CBO). Nabeel Alsalam, 

Robert Dennis, Mark Hadley, and Deborah Lucas provided helpful comments. In addition, 

Thomas Pollack of the National Center for Charitable Statistics provided assistance with the 

data, and William Gentry of Williams College, Thomas Holtmann of the Joint Committee 

on Taxation, Kim Reuben of the Urban Institute, and Dennis Zimmerman of the American 

Tax Policy Center commented on earlier drafts. (The assistance of external reviewers implies 

no responsibility for the fmal product, which rests solely with CBO). 

Loretta Lettner edited the study, and Kate Kelly proofread it. Maureen Costantino designed 

the cover, and Jeanine Rees prepared the report for publication. Lenny Skutnik primed the 

initial copies, Linda Schimmel coordinated the print distribution. and Simone Thomas 

prepared the electronic version for CBO's Web site (www.cbo.gov). 

April 2010 

~~w U~7- Douglas W. Elmendorf 

Director 
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Contents 

Summary and Introduction 

Tax Preferences for Higher Education 2 

Tax-Exempt Bonds and Tax Arbitrage 3 

The Use of Tax-Exempt Bonds 3 

Advantages and Disadvantages of Tax-Exempt Bonds 5 

Direct and Indirect Tax Arbitrage 6 

Approaches to Measuring the Extent of Indirect Tax Arbitrage 7 

Investmenr Assets and Tax-Exempt Debt 7 

Possible Approaches to Expanding the Definition of Tax Arbitrage 10 

Measuring the Volume of Arbitrage Bonds Under a Broader 

Definition of the Term 12 

Estimated Volume of Arbitrage Bonds Under a Broader Definition of the Teno 12 

Estimated Amount of Arbitrage Debt 13 

The Distribution of Arbitrage Debt 14 

Comparison with Arbitrage Debt for Nonprofit Hospitals 15 

Institutional Response to an Expanded Definition of Tax Arbitrage 16 

Appendix: Alternative Calculations of Tax Arbitrage as Practiced by Colleges and 

Universities 17 
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VI TAX ARBITRAGE BY COlLEGES AND UNiVERSITIES 

Tables 

1. Uses of Proceeds from Tax-Exempt Bonds Issued on Behalf of 

Colleges and Universities, 2003 

2. Selected Assets and Liabilities Held by Colleges and Universities, 2003 

3. Tax-Exempt Debt Classified as Earning Profits from Arbitrage in 2003 

Under a Broader Definition of the Term 

4. Colleges and Universities Conducting Tax Arbitrage in 2003 Under a 

Broader Definition of the Term 

Figures 

5 

9 

13 

14 

1. The Value of New Issues of Tax-Exempt Bonds, 1990 to 2007 4 

2. The Distribution ofInvestmentAssets and Outstanding Tax-Exempt Bonds 

Box 

Held by 251 Colleges and Universities in 2003 10 

3. The Distribution of Tax-Exempt Debt Held by 251 Colleges and 

Universities in 2003 That Would Be Classified as Earning Profits from 

Arbitrage Under a Broader Definition of the Term 15 

1. Estimating the Extent ofIndirect Arbitrage Practiced by Colleges and 

U niversi ties 8 
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Tax Arbitrage by Colleges and Universities 

Summary and Introduction 

Colleges and universities enjoy a variety of federal tax 

preferences that are designed to support a broader public 

purpose-the advancement of higher education and 

research. Not only are institutions of higher learning 

exempt from paying federal income taxes, they also are 

eligible m receive rax-deductible charitable contributions 

and allowed to use tax-exempt debt to finance capital 

expenditures. 

This Congressional Budget Office (CBO) study focuses 

on one of those tax advantages, the ability of colleges 

and universities to borrow funds by issuing tax-exempt 

debt. According to the staff of the Joint Committee on 

Taxation GCT), the cost of allowing institutions of 

higher learning to borrow using such debt-measured in 

terms of the revenues that could have been col1ecred if 

those institutions had borrowed using taxable debt-will 

be about $5.5 billion in 2010. The use of proceeds from 

lower~cost tax-exempt bonds to directly finance the 

purchase of higher-yield securities-a practice known as 

tax arbitrage-is prohibited by law. Nevertheless, the 

law as currently implemented allows many colleges and 

universities to use tax-exempt debt to finance investments 

in operating assets (buildings and equipment) while, at 

the same time, they hold investment assets that earn a 

higher return. {Investment assets are publicly traded and 

privately held securities, as well as land or buildings held 

for investment purposes.} To the extent thar colleges and 

universities can earn untaxed returns on investments 

that are higher than the interest they pay on tax-exempt 

debt, they are benefiting from a form of "indirect" tax 

arbitrage. 

Rules in the Internal Revenue Code (IRC) and regulations established by the Department of the Treasury limit 

tax arbitrage by restricting the yield on any investments 

held by the bond issuer that are deemed to be directly 

related to the tax-exempt bond issue (for example, an 

asset pledged as collateral), 1 Other investment assets are 

not yield~restricted even though they contribute indirectly to securing the bonds and are considered by rating 

agencies when rating the tax-exempt debt. A broader 

definition of tax arbitrage would include most or all 

investment assets held by an institution borrowing with 

tax-exempt debt. 

Using data from information returns filed with the 

Internal Revenue Service (IRS) by institutions of higher 

learning and by issuers of tax-exempt debt, CBO developed measures of tax arbitrage as practiced by colleges 

and universides under a broader defmition of the term 

that encompasses both direct and indirect tax arbitrage. 

Under one such definition, nearly all of the tax-exempt 

bonds that 25 I institutions issued in 2003 would be classified as earning profits from tax arbitrage. If some investment assets were set aside in a reserve, which would be 

excluded ftom the arbitrage measure under an alternative 

expanded defLnition, the amount of debt earning teturns 

from arbitrage would be lower; even so, about 75 percent 

of bonds issued in 2003 would still be classified as earning arbitrage profits under that expanded definition. By 

either measure, the amount of debt issued by colleges and 

universities that earns arbitrage profit would be considerably larger than that issued by nonprofit hospitals (which 

was the subject of a previous CBO study on broadening 

the definicion of tax arbitrage).2 Over time, iflegislators 

were to expand the definition of tax arbitrage and thereby 

eliminate some of the benefits of tax-exempt financing, 

1. Internal Revenue Code, 26 V.S.c. 148(b)(3)(A). The terms 

"debt" and "bond" are used interchangeably to refer to debt with 

maturities in excess of a year. The dollar figures for such debt cited 

in this analysis also include any leasing arrangements that are tax~ 

exempt. 

2. Congressional Budget Office, Nonprofit Hospitalr and Tax 

Arbitrage, letter to the Honorable William M. Thomas 

(December 6, 2006). 
115 


82271.083

2 TAX ARBITRAGE BY COIIEGF~ AIm m-lVERSITIES 

nonprofit institutions would probably respond by reducing the issuance of tax-exempt debt. That response, in 

turn, would decrease the cost to the federal government 

of the tax preference. 

Tax Preferences for Higher Education Institutions of higher learning, both public and private, 

benefit from several types of preferential tax treatment. 

Like other nonprofit organizations defined in section 

50I(c)(3) of the IRe, nonprofit private schools are 

exempt from the federal income tax, eligible to receive 

charitable contributions that donors may deduct from 

their taxable income, and allowed to use tax-exempt debt 

to finance capital expenditures.3 As state or local governmen t entities. public colleges and universities receive 

broadly similar tax preferences: they are exempt from federal income taxation, eligible for donations that are taXdeductible, and may have access to tax-exempt debt. 

Although there are no estimates of the cost to the federal 

government of exempting contributions made specifically 

to colleges and universities, the deduction of charitable 

contributions to educational institutions at all levels is 

expected to cost about $6.6 billion in forgone tax revenues in 2010; charitable contributions to colleges and 

universities account for about 70 percent of all contributions to educational institutions.4 JeT estimates that 

allowing institutions of higher Jearning to borrow using 

tax-exempt debt will cost the federal government-in the 

form of forgone tax revenues--about $5.5 billion in 

2010.' 

As is the case with other nonprofit organizations. colleges 

and universities receive preferential tax treatment because 

they are viewed as serving a public purpose. Institutions 

of higher learning perform two activities that are typically 

considered to serve the needs of society: providing education and conducting research. Education is associated 

with a wide range of favorable outcomes. Investment in 

3. Section 501 (c)(3) of the Internal Revenue Code deJ1neg a qualified nonprofit as any entity "organized and operated exclusively 

for religious, charitable, scientific, testing for public safety, literary, 

or educational purposes, Of to foster national or international 

amateur sports competition ... or for the prevention of cruelty to 

children or animals." A nonprofit may not engage in political 

activity, and none of i£5 earnings may henefit any private shareholder or individual. 

4. Joint Committee on Taxation, Estt'mates ofFetkrallnx Expenditures for Fucal Years 2008-2012, JCS-2-08 (October 31, 2008), 

p.53. 

human capital through education confers considerable 

private benefits on an individual, in the form of higher 

income and better health.6 Education probably also yields 

benefits for the community as a whole, including a more 

productive workforce, which leads to faster economic 

growth, as well as lower crime, a more informed electorate, and increased social mobility? How much education 

an individual prefers to invest in depends solely on the 

private benefit he or she might expect from that investment; in the absence of government intervention, that 

decision will yield fewer public benefits than is socialJy 

desirable.s 

Some colleges and universities also perform research that 

may have large spillover effects that benefit the rest of the 

economy.? Although businesses make substantial investments in researcb and development, private investors 

cannot retain all of the benefits from that spending 

because the knowledge produced by such research can be 

used by others. As is the case wirh individuals who must 

decide how much to invest in their own education, the 

private sector cbooses the amount of research and development it is willing to fund on the basis of private, rather 

than social, benefit. 

5, Estimates of tax expenditures are not intended to capture all of the 

ways in which taxpayers might respond to a change in law. In particular, the estimate discussed here assumes that if investors did 

not hold tax-exempt bonds, they would hold taxable bonds 

instead. In one study, researchers examined some of the other ways 

in which investors might change their portfolios in response to 

limits on tax-exempt bonds. That study found that because taxable bonds are one of the maS{ heavily taxed types of asset, investors would probably seek alternatives that are Jess heavily raxed 

and, therefore, the revenue loss to the federal government would 

probably be smaller than the tax-expenditure cosr discussed here. 

See James Poterba and Arturo Verdugo, Portfolio Subsh'tution and 

the Revenue Cost of F.x£mpting State and LocaJ Government Interest 

Paymen~ from Federal Income Tax, Working Papet No. 14439 

(Cambridge, Mass.: National Bureau of Economic Research, 

October 2008), available at www.nber.orglpapers/w14439. 

6. See David Card, "The Causa] Effe<:t of Education on Earnings," 

in OrIey Ashenfelter and David Card, eds., Handbook of Labor 

Economia, vol. 3 (Amsterdam: Elsevier Press, 1999), pp. 1801-

1863. Researchers in another study discuss the evidence for a pos~ 

itive relationship between education and health outcomes, paying 

particular attemion to the mechanisms through which education 

may lead to better health. See David M, Cuder and Adriana L1eras 

Muney, "Education and Health: Evaluating Theories and Evidence," in Robert F. Schoen! and others, eds., Making Americans 

Heabhier: Social and l:'conomic Policy aJ Health Policy (New York: 

Russell Sage Foundation, January 2008). 
116 


82271.084

Granting favorable tax treatment to postsecondary educational institutions is just one way in which policymakers 

may be able to increase investment in human capital and 

research. Other ways that the federal government curremly subsidizes educational institutions include direct 

grants to states and localities for elementary and second~ 

ary education. tax preferences for private institutions that 

provide elementary and secondary education, direct 

grants to schools for research, and subsidies and loan 

programs for individuals pursuing undergraduate and 

graduate degrees. 

Tax-Exempt Bonds and Tax Arbitrage State and local governments use tax-exempt bonds to 

finance their own capital projects and to provide the 

means for orner entities, including nonprofit and statesupported colleges and universities, to use tax-exempt 

7. See Enrico Moretti, "Estimating me Social Return to Highet Edu~ 

cation: Evidence from Longitudinal and Repeated Cross-Sectional 

Dara," Journal of&onometrics, vol. 121, no. 1-2 auly-August 

2004), pp. 175-212. In his analysis, Moretti found that college 

education creates positive spillovers in productivity and wages. See 

also Eric Hanushek and Ludger Woessmann, Do Better Schools 

Lead to More Growth? Cognitive SkilU, Economic Outcomes, and 

Causation, Worlcing Paper No. 14633 (Cambridge, Mass.; 

National Bureau of Economic Research, January 2009). In their 

analysis, the authors found empirical evidence of a causal relationship berween educational attainment and growth rates aCross 

countries. Other research has found that educational anainment is 

a~socia[ed with a decrea~ed likelihood of incarceration or arrest, 

See Lance I..ochnet and Enrico Moretti, "The Effect of Education 

on Crime! Evidence from Prison Inmates, Arrests, and Self~ 

~ports," American Economic &view, vol. 9-4, no. 1 (March 2004), 

pp. 155-189. Still other research suggests a positive correlation 

berween educational attainment and the likelihood of electoral 

participation. See Kevin Milligan, Enrico Moretti, and Philip 

Oreopoulos, "Does Education Improve Citi1..enship? Evidence 

from the United States and rhe United Kingdom," Journal ofPub~ 

lie Erol1omic5, vol. 88, no, 9~10 (August 2004), pp. 1667-1695. 

For a discw>sion of the relationship berween poS[secondary educa~ 

tion and social mobility, see Robert Haveman and Timothy 

Smeeding, "The Role of Higher Education in Social Mobility," 

Future ofChild1'Cn: Opportunity in America, vol. 16, no. 2 (Fall 

2006), pp. 12H 50. 

8. Individuals who face financial cnnmaints maY invest in less 

education than is either privately or 50cially desirable. Fed.eral 

student loan programs atf~ one way to reduce the impact of such 

constraint'l. See Congressional Budget Office, Cosfs Imd Policy 

Options [oj' redc>ral Student [01111 Programs (March 2010). -

9. for a more detailed. discussion of federal subsidies for research and 

development, see Congressional Budget Office, hdl'm! Support for 

Research and Dn'e/(Jpment Uune 2007). 

TAX ARBITRAGE BY CQllEGL'> AND ~"'IVERSITlES 3 

debt. The tax code contains provisions that are designed 

to prevent that tax preference from becoming an unlimited subsidy for all types of spending and to restrict its use 

to financing capital investment in operating assers {such 

as the construction or renovation of buildings and the 

purchase or repair of equipment}. Tax arbitrage-the use 

of proceeds from lower-cost tax-exempt bonds to finance 

the purchase of higher-yield securities-is specifically 

prohibited both by the IRe and by Treasury regulations. tO However, in most situations, the law does not 

prevent tax-exempt borrowers from engaging in what is 

essentially indirect tax arbitrage. 

Indirect tax arbitrage OCCurs when a borrower with taxexempt status earns interest on invesrment assets not 

directly financed with bond proceeds that exceeds the 

interest COSt incurred from contemporaneous tax-exempt 

borrowing. A borrower could sell those assets [0 finance 

the capital expenditure instead of borrowing with taxexempt debt. Holding those assets while borrowing on 

a tax-exempr basis is, in effect, equivalent to wing raxexempt proceeds to invest in those higher-yielding 

securities. 

The Use of Tax-Exempt Bonds 

About $290 billion in tax-exempt bonds was issued in 

2007, the most recent year for which aggregate data 

are available-up from about $100 billion in 1990 

(see Figure 1). About 70 percent of those were governmental bonds, which are typically issued by state and 

local governments for public projects such as the construction of highways or public schools. The payment 

of interest on {hose obligations is generally funded 

through tax revenues. 

The remaining tax~exempt bonds were "qnalified privateactivity bonds"-tax-exempt bonds issued by state and 

local governments on behalf of certain private entities or 

for designated activities,l1 Eligible activities include 

financing student loans Or mortgages for owner-occnpied 

10. Internal Revenue Code, 26 U,S.c. 1-48; Treas. Reg., 26 C.ER 

1.148-0. 

11. Such bonds can be issued on behalf of a private entity if more 

than 10 percent of the proceeds is used for any private business 

purpose and if more than 10 percent of the payment of principal 

or interest is secured by an interest in property used for a private 

business purpose at is derived from payments for property usfd 

for a private business purpose, Private-activity bonds are taxable 

unless they are issued for a qualified purpose or entity, 
117 


82271.085

4 TA.cXARBITRAGE BY COill'G}~~ 1,\]) C~fVERSfl'lliS 

1. 

1990 to 2007 

(Billions of dollars) 

300 

250 

200 

150 

100 

50 

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 ZOOl 2002 2003 2004 2005 2006 2007 

Source: Congressional Budget Office. 

Notes: Private-activity bonds are Issued on behalf of private entities by state and local governments. Unless they are issued for speci'fic 

tax-exempt activIties or entities, interest paid on such bonds !s taxable_ Activities that are eligible for tax~exempt status include the 

financing of student loans or mortgages for owner-occupied housjng, Entities that quallfy for tax-exempt status include nonprofit 

hospitals, schools, and other qualified 501{c)(3} organizations, Aside from nonprofit hospitals, the. Internal Revenue Service does 

not separate out data on bond issues tor any other type of 50l{c){3) org<lnization. 

The category "all Dther prlvate~activjty issues" consists prima.rlly of bonds issued on behalf of hospitals, mortgafjB bonds, and 

residential rental bonds. 

Governmental bonds are typically issued by state and loca! governments for pubHc projects such as the construction of schools or 

highways. 

Drganization. Of the remaining tax-exempt 

activity bonds, qualified mortgage bonds and qualified 

residential rental bonds ,,,'ere the largest categories by volume; $14 billion of the fonner and $7 bjUlon of the latter 

were issued that year. 

To estimate the amount of new bonds issued specifically 

for colleges and universities, eBO analyzed aU information returns submitted to the IRS for bond" Issued Dn 

behalf of 501 (c) (3) organizations in 2003." That year, 

bonds issued on behalf of institutions of higher learning 

accounted for just tinder $6 billion ofthe $14 billion in 

new issues for nonhospital SOl (c)(3) organizations. 

Including hospitals, total issues for all 501 (c)(3) orgaIlizadons wen: about $24 billion that year, while all raxexempt private··activity issues totaled $46 billion. 
118 


82271.086

Table 1. 

Uses of Proceeds from Tax-Exempt 

Bonds Issued on Behalf of 

Colleges and Universities, 2003 

Construction and/or 

Expansion of Buildings 

Academic buildings 

Residence halls 

Stu dent centers 

Athletic facilities 

Equipment 

Maintenance/Safety 

Total 

Number of 

Issues 

42 

34 

11 

10 

45 

105 

Percentage of 

Issues 

40 

32 

11 

10 

43 

n.a. 

Source: Congressional Budget Office based on data provided by 

issuing authorities in nine states. 

Notes: The number of issues in the various categories adds to more 

than 105 and the percentage of issues in each category adds 

to more than 100 percent because many projects span 

multiple categories. 

n.a, = not applicable. 

Since those data were collected. the market for taxexempt bonds issued by institmions of higher learning 

and the value of me assets that mose institutions hold 

have been greatly affected by the financial crisis that 

began in 2007. Intetest rates for tax-exempt debt rose 

shatply during that period, and issues by colleges and 

universities have probably declined since the crisis began. 

Howevet, there are signs that the pressures created by the 

financial crisis are beginning to ease. In particular, the 

difference between interest rates on tax-exempt debt and 

those on short-term Treasury bonds-a standard measure 

of the risk premium that investors require in order to 

hold the bonds-has fallen. The liquidity problems that 

some borrowers face may decrease the use of certain types 

of short-term debt, but that decrease seems unlikely to 

have a permanent effect on the availability of credit for 

long~terrn capital needs. Because of widespread declines 

in asset prices, educational endowments have fallen in 

value considerably from their peak, but they retain some 

of the benefit from previous years of growth. This analysis is intended to capture the effect of broadening the 

TAX ARBITRAGE BY COllEGES AIm lll'iIVERSITIES 5 

definition of tax arbitrage in the long term rather than 

the effects of the recent disruptions in financial markets. 

CBO also collected data on projects that were financed 

by tax-exempt bonds issued on behalf of institutions of 

higher learning from issuing authorities in nine states in 

2003, covering $2.3 billion in issues (about 40 percent 

of all issues in that year). The most common use of 

proceeds from tax-exempt bonds issued on behalf of colleges and universities in 2003 was for maintenance proj~ 

eers, such as improved heating and cooling systems, and 

safety enhancements, such as sprinkler systems. About 

43 percent of all bond issues .involved such projects. (Proceeds from a single issue may be used for projects in mul~ 

tiple categories; see Table 1.) About the same number of 

bond issues (40 percent) involved the construction and! 

or expansion of academic buildings; the next most common use (nearly 30 percent) was fot the construction 

andlor expansion of residence halls. The use of bond 

proceeds for athletic facilities, student centers, or the purchase of equipment was considerably less common. 

Advantages and Disadvantages of Tax-Exempt Bonds 

Compared with other ways the federal government could 

choose to subsidize colleges and universities, tax-exempt 

bonds have both advantages and disadvantages. Because 

nonprofit institutions of higher learning are exempt from 

the .income tax, any further subsidy through the tax code 

must be indirect, which leads to one disadvantage. The 

tax-exempt-bond subsidy is routed through investors, 

who are willing to accept a rate of return on a tax-exempt 

bond that is lower than the return on a taxable bond by 

the amount they would have to pay in taxes on income 

from the taxable bond. As long as the supply of taxexempt bonds exceeds the demand from taxpayers in the 

highest income tax bracker, the market interest rate on 

such bonds needs to fall below the rate on taxable bonds 

only by enough to induce taxpayers in a lower tax bracket 

to also hold the bonds; that rate is higher than what 

would be necessary to attract investors in the highest tax 

bracket. Therefore, investors in the highest bracket 

receive the interest tax-free at their higher marginal tax 

rate, retaining some of the value of the subsidy rather 

than passing it on to the issuer of the bonds. 

Another disadvantage is that, in contrast with federal 

spending programs, tax expenditures-including forgone tevenues on tax-exempt bonds-are not explicitly 
119 


82271.087

6 TAX ARlliTRAGE BY COUllGES AJ,1l UNIVERSITIES 

identified in the budget,13 Also, unlike discretionary 

spending programs. they are not governed by the annual 

appropriation process. Thus, the federal government 

does directly control the issuance of tax-exempt bonds. 

which is determined by state and local issuers in 

accordance with federal rules on the total volume and 

type ofissue. Though state and local governments may be 

better equipped to identify beneficial capital investments 

by their local institutions, delegating decisionmaking 

power away from the federal government increases the 

probabiliry that bond issues will be evaluated on the basis 

of their benefit to the locality, rather than to the federal 

taxpayers who finance the subsidy. 

One advantage to using tax-exempt bonds as the means 

for offering a subsidy is rhat they provide a srandard 

framework through which educational institutions can 

access capital markets. Access to the tax-ex:empt-bond 

market may increase the availability of bond financing for 

some educational institutions, although the schools most 

likely to be affected by the expanded definition of arbitrage discussed in this study have investment-grade credit 

ratings and therefore probably would be able to obtain 

funding in the taXable-bond market. 

The use of tax-exempt bonds also affects the allocation of 

resources. The lower cost of financing for projects funded 

by tax-exempt bonds diverts resources toward those projects and away from other activities. Whether that is an 

advantage or a disadvantage depends in part on whether 

the subsidized investment would have been undertaken 

even in the absence of the subsidy. On the one hand, if 

colleges and universities use tax~exempt financing for 

projects that they would complete even without the sub~ 

sidy, resources are just reallocated from taxpayers to the 

schools with no additional social benefit. On the other 

hand, if the subsidy finances capital projects that would 

not otherwise have been undertaken and that create a 

social benefit in addition to the benefit to the institution, 

it could improve the nation's overall welfare. 

13. The Administration provides estimates of tax expenditures in the 

Analytical PeNpectives volume of the budget. See Office of Management and Budget, Antllytical PerspectiveJ, Budget of the US. 

Gowrnment, Fiscal Year 20 1 1, Chapter 16. The Joint Committee 

on Taxation also repons annually on tu: expenditures. See Joint 

Committee on Taxation, Etimam ofFedrral Tax Expenditures 

for Piscal Years 2009-2013, JCS-I-I0 Oanuary 11, 2010). 

Direct and Indi1'ect Tax Arbitrage 

Because the purchasers of tax-exempt bonds do not pay 

income tax on the interest those bonds earn, they are 

willing to accept a lower rate of interest than they would 

otherwise earn on taxable bonds of comparable risk and 

maturity. That yield differential presents an opportunity 

for some issuers of tax-exempt debt to engage in tax 

arbitrage-borrowing with tax-exempt debt and investing the proceeds in higher-yidding taxable assets. Those 

who meet the criteria for borrowing using tax~exempt 

bonds-whether qualified 501(e)(3) organizations or 

state and local government enoties----have an added 

incentive because they do not pay tax on their net 

income. regardless of whether it is from an operating 

surplus (the excess of revenue over cost) or from invest~ 

ment income. The higher return on those taxable assets 

not only finances the lower interest cost of the tax-exempt 

debt but also provides untaxed earnings to be used for 

other purposes. 

To restrict such activity, the tax code specifies that 

"arbitrage bonds" are not tax-exempt. Section 148 of 

the IRe defines an arbitrage bond as "any bond whose 

proceeds are reasonably expected to be used directly or 

indirectly to acquire higher-yielding investment assets 

or to replace funds which were used directly or indirectly 

co acquire higher-yielding securities."14 The tax code has 

provisions that prevent the direcr diversion of bond pro~ 

ceeds away from investment in physical capital to rhe 

earning of investment income. In general. those provisions allow earnings from tax arbitrage only for temporary periods before the proceeds are needed to fund the 

project for which they were designated or for specific 

types of investments such as reserve funds. (Such funds 

typically contain a portion of the proceeds from a bond 

issue that is set aside to pay debt service in case the 

expected sources of funds for that purpose are not available), Outside of those limited exceptions, however, 

any earnings from tax arbitrage must be rebated to the 

Treasury. 

The Treasury regulates arbitrage using a "replacement 

proceeds rule" that requires the yield to be restricted 

on any investment assets or other amounts that have a 

connection {nexus} to a tax-exempt-bond issue that is 

sufficiently direct for one to conclude that, in the absence 

of proceeds from tax-exempt borrowing, the assets or 

14. Interoal Revenue Code, 26 V.S.c. 148(a). 
120 


82271.088

amounts would have been used to fmance the project.15 

For example, if a school uses securities as collateral for 

its debt-service obligation on a tax-exempt bond. the 

securities are treated as replacement proceeds subject to 

yield restriction. The Treasury restricts the yield on 

investment assets in one of two ways. Under one method, 

the borrower may be tequired to return to the federal 

government any excess yields earned on an amount of 

assets thar is equal to the value of the tax-exempt bonds 

issued. 16 (Excess yields are defined as earnings that exceed 

the interest paid on the bond.) Under a second method, 

the borrower may be required to sell an amount of assets 

that is equal in value to the bonds issued and to invest 

thar money in a specially designed Treasury debt instrument that earns a discounted rerum to offset the federal 

government's implicit contribution to the return on the 

tax-exempt bonds. 

Those provisions do not eliminate all opportunities for 

tax arbitrage, however. Because financial statements typically do not report the use of particular assets as collateral, 

the replacement proceeds rule is difficult to enforce. In 

addition, if assets are not specifically pledged to pay the 

debt sen'ice on a tax-exempt bond or if the assets have no 

other direct connection to the bonds, the arbitrage 

restrictions do not apply. However, it is widely recognized 

that assets and their earnings can be used to pay the interest on debt or to cover other expenses to free up funds for 

interest payments, regardless of whether they are direcrly 

pledged to do SO.17 Such use of higher-yielding assets to 

finance tax~exempt debt constitutes indirect tax arbitrage. 

The limited scope of the tax code's restrictions on arbitrage is not unique to colleges and universities. It applies 

equally to other nonprofit institutions, such as nonprofit 

hospitals, which have sizable financial assets. For all such 

institutions, the current tax arbitrage rules ensure that a 

bond issue is associated with the acquisition of new capital, and they reduce its cost. Nonetheless, a change in the 

rules that broadened the definition of tax arbitrage would 

15. T"" Reg., 26 CIR. 1.148·1(c). 

16, Such payments must he made every five years during the life 

of the issue, with the first payment made no later than five year:s 

after the issue date of a bond. If the computation in later years 

shows no arbitrage profit because the yield on restricted assets 

has declined. previous payments are refunded to the issuer. 

17, It is also standard practice for rating agencies to base credit ratings 

for a particular debt issue on all available assets, nor just on those 

directly pledged to that debt issue. 

TAXARBITRAGE BY COllEG~ A.'ID mlVERSITIES 7 

identify bonds earning arbitrage profits on the basis of 

the total assetS that were implicitly available as collateral 

rather than requiring a direct relationship between proceeds from tax-exempt bonds and investment assets 

explicitly pledged as collateral. Thar expanded definition, 

which would encompass indirect tax arbitrage, would 

decrease the value of the federal subsidy that is currently 

available to institutions of higher learning through taxexempt-bond issues and reduce the net cost of the tax 

exemption to the federal government. 

Approaches to Measuring the Extent of 

Indirect Tax Arbitrage 

Determining the degree to which colleges and universities 

benefit from the practice of indirect tax arbitrage requires 

data on the volume of new and outstanding issues of taxexempt bonds and on the value of investment assets held 

by those institutions of higher learning. CBO collected 

data on assets and liabilities from IRS information 

returns (specifically, Forms 990 and 8038), adjusting the 

data to account both for the misreporting of tax-exempt 

liabilities and for the presence of assets he1d by other 

organizations for the use of colleges and universities (see 

Box 1). To estimate the extent to which indirect tax arbitrage occurs, CBO compared an institution's outstanding 

bond issues (bonds that have not been completely retired) 

or new bond issues with the value of its existing investment assets. If an institution held assets that were greater 

in value than its holdings of either outstanding or new 

bond issues. those bond issues were classified as earning 

returns from tax arbitrage. Presumably, the school chose 

to use tax-exempt debt to finance capital projects rather 

than selling investment assets because it could earn a rate 

of return on those assets that was higher than the inrerest 

it was obligated to pay on the bonds. If the dollar value of 

investment assets was less than that of outstanding or new 

bond issues, only the portion of capital spending that 

could have been financed with the assets was considered 

to be earning arbitrage profit. CBO also calculated estimates of tax arbitrage allowing some investment assets to 

be set aside in a reserve that would be exempt from the 

broader definition of arbitrage. 

Investment Assets and Tax-Exempt Debt 

Colleges and universities in aggregate hold investment 

assets that are significantly higher in value than the stock 

of outstanding tax-exempt bonds, although the distribution of both is highly skewed. That relationship holds 

both for amounts reported on IRS Form 990 returns and 
121 


82271.089

6 I~ ARlllTRAGll BY GOWiGES A'iD FNI'lEl~mE-" 
122 


82271.090

TAXARBITRAGE BY COllEGES MlnJ);J,ERSITIR5 9 

Table 2. 

Selected Assets and Liabilities Held by Colleges and Universities, 2003 

(Millions of dollars) 

Net Investment Assets (Unadjusted) 

Net Investment Assets (Adjusted) 

OUtstanding Tax-Exempt Debt (Reported) 

Mortgage Debt (Reported) 

Outstanding Tax-Exempt Debt (Adjusted) 

Memorandum: 

New Bond Issues 

Number of Institutions 

All Institutions 

Total Median 

262,151 

44,326 

17,524 

60,442 

n.8. 

913 

n.a. 

n.a. 

Institutions that 

Borrowed in 2003 

Total Median 

151,053 37 

152,324 39 

16,901 10 

5,935 3 

22,199 22 

5,703 10 

251 n.a, 

Source: Congressional Budget Office based on data from information returns (Forms 8038 and 990) filed with the Internal Revenue Service. 

Notes: Investment assets indude publicly and privately held securities as well as land and buildings held for investment purposes, net of 

accumulated depreciation. 

Tax-exempt debt is frequently misreported as "mortgages and other notes payable." If no ta){-exempt debt is reported, the adjusted 

stock of tax-exempt debt includes all mortgages reported by the institution. If both tax-exempt debt and mortgages are reported, 

the adjusted stode: of tax~eltempt debt includes 84 percent of mortgages reported. 

The value of investment assets reported on a school's Form 990 return does not include any assets in related organizations dedicated 

to the support of the instiMion and separately incorporated as a public charity. Of the group of 251 borrowers, CBO was able to 

identify 27 institutions that held assets in other 501(c)(3) organizations and adjusted their stock of investment assets and tax~eltempt 

liabilities to reflect the assets and liabilities of those related organizations. 

n.a. = not applicable. 

a. CBO identified related organizations just for new borrowers in 2003 . • ,"",,,~,_=,,,~.,, -CV' 

for those amounts adjusted to correct for misreporting 

(see Box 1). Colleges and universities reported about 

$260 billion in total investment assets and about 

$45 billion in liabilities for tax-exempt bonds in 2003 

(see Table 2). After adjusting for misreporting, CBO 

estimated that the outstanding stock of taX-exempt debt 

was about $60 billion. The median amount of investment assets reported on Form 990 returns for 2003 was 

about $4 million (that is, half of the institutions had 

more than $4 million in assets and half had less), and the 

median amount of tax-exempt debt was zero. With 

adjustments for misreporting, the median stock of taxexempt debt increased [0 about $2 million. 

The subset of schools that borrowed using tax~exempt 

debt in 2003 also had total investment assets that far 

exceeded tax-exempt liabilities. Those schools' total 

investment assets, at about $150 billion, were nine times 

larger than the total reported stock of outstanding taxexempt bonds and seven times larger than the total 

adjusted stock of outstanding tax~exempt bonds. The 

median school that borrowed in 2003 had an estimated 

$39 million in investment assets. The median stock of 

tax-exempt liabilities was about $22 million for schools 

that borrowed in 2003, about 40 percent less than the 

median amount of investment assets. 

Within the group of 2003 borrowers. the distributions of 

investment assets and tax~exempt bonds were highly 

skewed (see Figure 2). The top 10 schools that borrowed 

in 2003, ranked by investment assets, made up about 

4 percent of the sample but held almost 75 percent of the 

total amount of investment assets held by the entire 

group. The top 50 schools that borrowed in 2003, ranked 

by investment assets, made up about 20 percent of the 

sample but held about 95 percent of total investment 

assets. The group of institutions with the largest share of 

investment assets had also issued a substantial share of the 

tax-exempt bonds, but the distribution of the bond issuances was less skewed. The rap 10 schools that borrowed 
123 


82271.091

1 I\) nx ARBITR\GE BY COllEGES N\;1) IJNfVERSrm:S 

2. 

The Distribution of Investment Assets Outstanding Tax-Exempt 

Held 251 and Universities in 2003 

(Percent) 

80 r---------------------------------~==============~ 70 

60 

50 

40 

30 

20 

1 to 10 11 to 50 51 to IDO 101 to 150 

e Investment Assets (Adjusted) 

Outstanding 

Stock of 

o Tax-Exempt 

Bonds 

IS1 to 200 201 to 251 

Institutions Ranked According to Report~d Investment Assets 

Source: Congressional Budget Office. 

Notes: In an earlier study of tax-exempt-bond ISsues made on behalf of nonprofit hospitals, CBO found that tile majonty of ta)N~){emptbond HabHitfes were ffiisreported as "mortgages and other notes payable" on Rmn 990 returns (see Congressional Budget Office, 

T.'fN Arofuage, Jetter to the Honorab!e WBHam M. Thomas, December 6, 2006}. Issuers of tax-exempt bonds 

for educational institutions confirmed that such mlsreporting is present in returns for coHeges and universities as well. CBO therefore 

adjusted the stock of tax~e}{empt bonds reported on Form 990 returns to account for that misrepQrting using the factors estHTIated 

in the earlier study. 

Some public schools hold assets in separate SOl(c}(3} foundations dedicated to the support of the instituHort< CBO adjusted the 

amQunt of investment assets held by 27 institutions to reflect such assets held by foundations, 

in 2003 accounted for about 40 percent of the outstandingva!ue of such bonds, and the top 50 accounted 

for almost 71 percent of the outstJnding value. 

held 

investment assets, which 

vifOuld probably allow them to borrow even if tax-exempt 

borrowing was not an option. This suggestS that, as currently implemented, not used 

to financial markets would 

otherwise have diff-knIty undertaking capital proje<:ts. 

Possible Approaches to Expanding the Definition of 

Tax Arhitt"age 

Any specification of the investment assets that would be 

covered under an definition of ta.x arbitrage 

should account for role that sllch assets 

play in the and universities. Those 

institutions "JCJ..:umuiJt(' investment assets for a variety of 

reasons: to earn income to fulfill the purposes that qualjfY 

them for tax-exempt sratus; to against uncertainty; to obtain mting; to e-nhance their 

reputation; and to honor gift restrictions, Some of those 

certain investment assets should not 

be 

limit such 

dons when income 

rating agencies offer higher credit ratings 

expendable flnancial resources (which include 

reserves) to yeady expenses inueases, and those 
124 


82271.092

ratings lead to lower costs for borrowing. III A comparison 

of investment assets and annual expenses shows that, by 

rating agencies' standards, many schools that borrowed in 

2003 appear to have substantial operating reserves. For 

instance, the median ratio of investment assets to annual 

expenses was 1 for schools that borrowed in 2003; that is, 

investment assets were equal to about a year's worth of 

expenses. (That ratio ranged from a high of89.5 to zero.) 

Some .investment assets held by colleges and universities 

are subject to restrictions by the donor. Because educational institutions cannot use such assets for purposes 

other than those specified by the donor, it could be 

argued that those assets should not be included when 

measuring earnings from tax arbitrage. It might be possible, however, to implement a broader measure of tax arbitrage without fordng schools to violate most of those 

resrrictions. For instance, if a donor restricted a gift to an 

academic institution's endowment-that is, specified that 

the gift be used to generate furore earnings rather than to 

help pay for current operating expenses-the requirement, under a broader measure of arbitrage, that earnings 

on the gift be rebated if they exceeded the interest paid on 

a tax-exempt bond would not necessarily violate the 

donor's restriction. The gift itself would not be used to 

purchase the asset financed by the bonds; only me earnings on the gift would be affected. 19 In cases where the 

donor directed that a gift (but not the earnings on that 

gift) be used for a specific purpose, similar reasoning 

would apply. Even in cases where the donor directed that 

bom me gift and irs earnings be used for a specific purpose, many restricted purposes-research, certain types of 

academic suppon, athletics-would be consistent with 

using earnings on mat gift to finance the construction 

of academic and athleric buildings, laboratory facilities, 

and libraries.20 

Another consideration is that exempting restricted gifts 

from an expanded definition of tax arbitrage would 

strengthen the incentive for schools to pursue restricted 

gifts. Colleges and universities frequently cite restrictions 

18. According to Moody's Investors Service. the median ratio of 

unrestricted net re.murces to expenses was 0.9 in 2006. See Private 

College and University Mediam 2007 (New York: Moody's 

Investors Service, May 2007). 

19. According to a survey conducted by the National Association of 

College and University Business Officers, about 60 percent of the 

assets in college and university endowments in 2003 were 

restricted to income-generating purposes. 

TAX ARBITRAGE BY COllEGES ,,'ill UNIVERSITIES 11 

on gifts as one reason they require federal subsidies for 

other types of spending that are less preferred by donors 

or to justify their tax-exempt endowments' freedom from 

fedetally mandated spending requirements such as those 

that apply to charitable foundations. Currently, schools 

must weigh the support that additional restricted gifts 

lend to those arguments against the fact that unrestricted 

gifts allow the institution more flexibility in setting budgetary priorities and eliminate the possibility of later disagreement between donor and institution regarding the 

use of a gift.21 Explicitly exempting restricted gifts from 

the calculation of taX arbitrage under an expanded definition would increase the attractiveness of restrictions to 

schools, but encouraging such restrictions could reduce 

the social benefit of charitable giving-for instance, 

individual donors may impose restrictions on gifrs mat 

diminish the public benefits that a school provides.ll 

To reflect schools' legitimate need for investment assets, 

CBO calculated measures of rax arbitrage that would 

allow some investment assets to be ser aside in a reserve 

that, by definition, could not earn returns from tax arbitrage. In calculating those measures, the value of investment assets considered in the arbitrage calculation was 

reduced by an amount equaling one year's operating 

expenses-the median amount of investment assets held 

by schools issuing debt in 2003. CBO did not separately 

adjust the arbirrage estimates for investment assets subject 

to restricted uses; reliable data on the type and strength of 

20. Although no dara exist that detail the exact purposes of accumulated restricted endowment assets, the Council on Aid to Educa-

<ion collects information on the restricted purposes of current gifts 

to school endowments. In 2008, the most common restriction for 

endowment gilts was for student financial aid. accounting [or 

34 percent of restricted giving. Athletics and academic departments each accounted for about 20 percent of restricted gifts to 

endowments. 

21. Disagreements about such restrictions have increasingly resulted 

in costly legal battles between schools and donors. (See John 

Hechinger, "New Unrest on Campus as Donors Rebel," Wall 

Street Jouma~ April 23, 2009). In the most prominent example of 

such a dispute, a donor's heirs filed a lawsuit against Princeron 

University's Woodrow WiL~on School of Public and International 

Affairs, alleging that the school was not using a large donation 

dating to 1961 in accordance with the donor's intent. Princeton 

paid a settlement of$100 million to end the ligation, which had 

stretched on for six years. 

22. Sec Burton A. Weisbrod, Jeffrey P. Ballou, and Evelyn D. Asch, 

Mission and Money: Understanding the University (New York: 

Cambridge University Press, September 2008), p. 121. 
125 


82271.093

12 TAX ARBITMGE BY COllEGES A.'IDllNlVllRSITIES 

restrictions that apply to existing endowments are not 

available.23 

Measuring the Volume of Arbitrage Bonds Under a 

Broader Definition of the Term 

CBO used two main measures to determine how much of 

the value of outstanding bonds issued by colleges and 

universities and their new tax-exempt borrowing could be 

considered (0 earn returns from tax arbitrage under a 

broader definition of the term. Each approach compared 

an institution's investment assets with a measure of its 

tax-exempt-bond liability. With the ('historical" measure, 

CBO considered only the outstanding stock (in 2003) 

of previously issued bonds. According to that backwardlooking measure, if the value of a college's or universicy's 

investment assets exceeded the value of the institution's 

outstanding stock of tax-exempt bonds, all the bonds 

were classified as earning returns from tax arbitrage. If the 

value of the stock of tax-exempt bonds exceeded the value 

of the investment assets, the volume of bonds equal to the 

value of the investment assets was classified as earning 

arbirrage profit. 

The second, more forward-looking, measure of tax arbitrage considered the position of colleges and universities 

in the years immediately following an expansion of the 

definition of arbitrage. That "first-year" measure compared an institution's new issues of tax-exempt bonds in 

2003 with its stock of investment assets that year. Under 

the first-year measure, if the value of investment assets 

exceeded the value of the new bond issues, all of the 

bonds were classified as earning arbitrage profit. If the 

value of the new issues of bonds exceeded the value of the 

institution's investment assets, the amount of the new 

issues that was equal in value to the investment assets was 

considered to be earning profit from tax arbitrage. In the 

first few years after the implementation of such a policy, a 

relatively large share of new issues would probably be 

considered arbitrage bonds because the amount of investment assets newly available for yield restriction would 

be large compared with new issues in any single year. 

Analogous to an estimate of tax expenditures, the firstyear measure is not meant to capture all of the ways in 

which issuers might respond to a change in the definition 

23. Of the 251 schools that borrowed in 2003, 238 provided information on temporary and permanent restrictions on theif total net 

assets. About 55 percent of all net assets were under permanent 

restriction and 24 percent were under temporary restriction. No 

information is available on the nature of the restrictions. 

of tax arbitrage. It does, however, capture the immediate 

effect of broadening that definition.24 

Estimated Volume of Arbitrage Bonds 

Under a Broader Definition of the 

Tenu 

A substantial portion of rhe tax-exempt debt issued by 

colleges and universities is outstanding at the same time 

those institutions hold higher-yielding investment assets. 

Such debt would earn profit from tax arbitrage under an 

expanded definition of the term that considered all 

investment assets, not just those directly telated to the 

tax-exempt debt. CBO's analysis indicates the following: 

• If no reserve was allowed, close to 100 percent of the 

outstanding tax-exempt debt would be classified as 

earning full or partial returns from arbitrage under 

the broader definition. If schools were allowed to 

exempt investment assets equal to one year's operating 

expenses as a reserve, 72 percent of the currently outstanding debt would be earning full or partial returns 

from arbitrage. 

• Considering only new issues, the share of debt with 

full or partial arbitrage profit would be about 99 percent if no assets were set aside in a reserve and about 

75 percent if a reserve equal to one year's expenses was 

allowed. 

24. CBO also calculated a related measure of arbitrage bonds, not 

reponed in the tables, based on both ourstanding bond~ and new 

issues. If schools continued to \l..'te tax~exempt debt to finance capital projects and accumulate investment assets as they have in me 

pa.<.t, their new bond issues would tend to exhaust the assets subject to yield restriction, lowering the share of new issues that 

would be earning arbitrage proBes in later years. If that was the 

case, the current balance betWeen the stock of investment assets 

and the outstanding stock of tax-aempt bonds would remain the 

relationship berween the rwo. Under that assumption, another 

way to estimate the amount of2003 issues that would be consid~ 

ered arbitrage bonds would be to measure me new hond issues 

against the investment ao;sets that remained after the outstanding 

siOck of previously issued bonds was applied to those asseLS. By 

that measute, if the value of a new bond issue was less than the 

difference berween investment assets and the ouestanding stock of 

tax-exempt debt, tbe issue was classified as earning tax arbitrage. If 

a new issue was greater than tbe residual investment assces, the 

amount of the issue equal to residual investment assets was dassi~ 

Bed as earning returns from arbitrage. By tbis definition, the proportion of debt that would be earning tax arhitrage was lower than 

that under the first year measure, by about 10 percentage points. 
126 


82271.094

TAX ARBITRAGE BY COllEGES Mlll~IYERSIl1ES 13 

Table 3. 

Tax-Exempt Debt Classified as Earning Profits from Arbitrage in 2003 

Under a Broader Definition of the Tenn 

(Percent) 

No Assets Set Aside 

asa Reserve 

Assets Set Aside 

as a Reserve 

Debt Classified as Earning 

Arbitrage Profits Under a 

Broader Definiti{)n 

Full Arbitrage 

Partial Arbitrage' 

Debt Not Oassified as Earning 

Arbitrage Profits Under a 

Broader Definition 

Memorandum: 

Total Tax-Exempt Debt 

{Millions of dollars) 

Historical 

Measure8 

100 

90 

10 

22,199 

First-Year Historical First-Year 

Measureb Measurea Measureb 

99 72 75 

84 60 56 

14 12 19 

28 25 

5,703 22,199 5,703 

Source: Congressional Budget Office based on information returns (Forms B038 and 990) filed with the Internal Revenue Service by 

institutions that borrowed in 2003. 

Note: *;::: less than 0.1 percent. 

a. The total volume of tax~exempt bonds issued as a percentage of net investment assets (adjusted for misreporting). 

b. Estimated volume of tax-exempt bonds in the first year under a broader definition of tax arbitrage {approximated by the volume in 2003} 

as a percentage of net investment assets {adjusted for misreporting}. 

c. Issues held contemporaneously with investment assets lower in value than the total issue. 

Most of the debt that would be classified as earning 

returns from arbitrage is held by the schools that have the 

largest stocks of investment assets. Compared with 

CBO's previous estimates of the volume of arbitrage 

bonds held by nonprofit hospitals, institutions of higher 

learning hold considerably more debt that would be 

classified as earning returns from arbitrage under a 

broader definition. 

Estimated Amount of Arbitrage Debt 

The historical measure applies the broader definition 

of arbitrage to already outstanding tax-exempt debt. 

Although the measure does not directly address the effect 

of a policy change-because such a change would affect 

only future: issues-it provides a useful starting point 

for comparing the outstanding stock of tax-exempt debt 

with investment assets. Using data corrected both for 

misdassified tax-exempt debt and for underestimates 

of investment assets owned by institutions that hold 

assets in foundations, CBO found that in 2003 dose co 

100 percent ofthe $22 billion in previously issued taxexempt debt would be classified as earning rettuns from 

arbitrage undet the broader definition (see Table 3).2.5 In 

other words, almost all of the outstanding debt was issued 

by schools that also held higher-yielding investment 

assets. Furthermore, the majority of the debt that would 

be classified a.."1 arbitrage debt was fully arbitraged-that 

is, almost all of it was issued by schools that held investment assets greater in value than their outstanding srock 

of bonds. In the first years after an expansion of the definition of arbitrage, a high proportion of new issues would 

be subject to yield restriction because accumulated investment assets are large relative to any single year's issues. In 

2003, about 99 percent of new bond issues would have 

been considered to be earning profit from tax arbitrage 

under a hroader definition. 

25. The appendix presents alternative calcwations of bond holdings 

that would earn profits from tax: arbitrage under a broader defini~ 

tion using no adjustments for misreporring tax~cxempt-bond 

liability or for assets held by supporting organizations. 
127 


82271.095

14 TAX ARBITRAGE BY COllEGES A'llllNMRSITIES 

Table 4. 

Colleges and Universities Conducting Tax Arbitrage in 2003 Under a 

Broader Definition of the Teno 

(Percent) 

No Assets Set Aside as a Reserve Assets Set Aside as a Reserve 

Historical First-Year Historical First-Year 

Measureit Measureb Measureit Measureb 

Institutions Conducting Arbitrage 

Under a Broader Definition 89 98 44 52 

Full arbitrage 66 82 31 37 

Partia! arbitrage\: 23 16 14 15 

Institutions Not Conducting Arbitrage 

Under a Broader Definition 11 56 48 

Memorandum: 

Total Institutions 251 251 251 251 

Source: Congressional Budget Office based on information returns (Forms 8038 and 990) filed with the Internal Revenue Service by 

institutions that borrowed in 2003. 

a. Total.volume of tax·exempt bonds issued as a percentage of net investment assets (adjusted for misreportfng). 

b. Estimated volume of tax-exempt bonds in the first year under 11 broader definition of tax arbitrage (approximated by the volume in 2003) 

as a percentage of net investment assets (adjusted for misreporting). 

c. Issues held cont~,~poran~~"~;~~",~!!~,,~~,~~:tme~:,,~~s~~~ low~~ in value than the total issue. 

The amount of debt that earns returns from arbitrage falls 

when some assets are set aside as an exempt reserve. Using 

the historical measure (which compares the outstanding 

stock of tax-exempt bonds to investment assets not set 

aside for a reserve), the amount of debt earning arbitrage 

profits in 2003 fell co about $16 billion, or about 

72 percent of the stock of outstanding tax-exempt debt. 

For issues in 2003, about 75 percent of new tax-exemptbond issues would be classified as earning returns from 

tax arbitrage under a broader definition that allowed an 

exempt reserve equal to one year's expenses.26 

26. By that measure, the total amount of debt that would be classified 

as earning returns from arbitrage under a broader definition is 

about the same if the exempt reserve is ca1cu!ated as 70 percent of 

investment asse[5 rather than as one year of operating expenses. 

However, the distribution of arbitrage debt among the schools 

would differ. Defining the exempt reserve on the basis of assets 

rather than expenses lowers the amount of arbitrage debt for 

schools with assets that are large in relation to expenses and 

increases it for schools with assets that are small in relation to 

expenses. In other words, defining an exempt reserve on the basis 

of assets favors schools that have better access to faxable 

borrowing, 

The Distribution of Arbitrage Debt 

The percentage of institutions engaging in the practice 

of tax arbitrage is generally lower than the percentage of 

debt that generates arbitrage profits because the 50 

institutions with the most investment assets account for a 

large share of that debt. If the expanded definition of 

arbitrage was applied to the already outstanding stock of 

tax-exempt debt, about 90 percent of institutions would 

be characterized as profiting from the practice of tax 

arbitrage (see Table 4). According to the first-year measure, nearly all of the institutions issuing new debt in 

2003 would be classified as earning arbitrage profits if a 

broader definition had been in effect that year. 

Even if the broader definition of arbitrage allowed colleges and universities to set aside substantial investment 

assets in a reserve, the majority of tax-exempt debt held 

by those institutions would be classified as earning 

returns from tax arbitrage, regardless of the measure used. 

Becawe the distribution of arbitrage earnings is not uniform, however, if a reserve was allowed, only about half of 

the tax-exempt colleges and universities that borrowed in 

2003 would be viewed as conducting arbitrage at all, 

under either measure. Under the historical measure, the 

number of institutions conducting arbitrage would fall 
128 


82271.096

3. 

Distribution of Tax-Exempt Debt Held 

2003 That Would Be Classified as Eaming 

251 Colleges and Universities in 

from Arbitrage Under a 

Broader Definition of the Term 

(Percent) 

80r---------~====================================~ 70 

60 

so 

1 to 10 11 t(}50 51 to 100 lin to 150 151 to 200 201 to 251 

Institutions Ranked According to Reported Investment Assets 

Source: Congressional Budget Office, 

Notes: eso used two main measures to determine how much of the outstanding stock of bonds held by colleges and universities and theirnew tax-exempt borrowing could be classified as earning profits from tax arbitrage under a broader definition of the term. With the 

"historical" measure, CSO considered only the historical (outstanding) stock of previously issued bonds. The second, more forward~ 

looking meaSlire considered the position of colleges and universities jn ttle ye.ars immediately fo!lowjng an expansion of the definition 

of arbitrage. 

Allowing some assets to escape the broader de'finttlon of arbitrage lowers the. share of debt considered to be earning arbitrage profits 

by Sdlools with lower (lmolJnts of investment assets, 

from 223 to 111, or to ahout 44 percent of ail 2003 borrowers, if some assets 'i'Vere set aside in an exempt reserve, 

Using the first-year measure, based on the volume of nev{ 

issues, 52 percent of institutions would have been d.assi~ 

ned as engaging in arbitrage..> \vith new hsues in 2003 after 

accounting for an exempt reserve. 

Broadening the ddlnltl0n of tax arhitrage w{)uld 

institutions wirh large holdings of investment assets more 

than institutions with fewer holdings. The majority of 

bonds that would be classifIed as earning arbitrage profit 

using the fIrst-year measure were issued oy the 

tions with the largest investment assets. The 50 bOffO'l-vcrs 

with the largest investment asset balances (which com·· 

prised about 20 percent of all schools that issUt.',d new taxexempt debt in 2003) accounted for just oyer 60 percent 

of the honds earning tax arhitruge (see Figure 3). If assets 

equal in value to one year's operating expensts were set 

aside, about 80 percent of the honds earning returns from 

behalf of the 50 borrowers with the 

<:0111"" ... 1"011 will! Arbitrage Debt for Nonprofit 

definition, and a larger 

and universities than debt issued by hospitals 

would be classified as earning arbitrage profits. 

Using da.ta adjusted for misreporting, eRa found that 

about 60 percent of the ourstanding stock of tax-exempt 
129 


82271.097

16 TAX ARIIlTRAGE BY COlLEGES AND UNIYF= 

bonds issued by nonprofit hospitals in 2002 had been 

issued by hospitals that contemporaneously held higheryielding investment assets. Using the first-year measure, 

64 percent of bonds issued by nonprofit hospitals in that 

year would be classified as earning arbitrage profits under 

a broader definition. For colleges and universities, those 

figures were dose to 100 percent. 

Because different criteria are used to rate hospital bonds 

and those issued on behalf of colleges and universities, 

CBO used a different method in its prevlous study to calculate the amount of assets that might reasonably be set 

aside as a reserve.18 According to those estimates, if an 

exempt reserve had been allowed under an expanded definition of tax arbitrage in 2002, about 33 percent of the 

outstanding stock of bonds issued by nonprofit hospitals 

would be earning arbitrage profits in that year. Under the 

first-year measure, and assuming that an exempt reserve 

for hospitals would be allowed, CBO determined that 

32 percent of new issues of tax-exempt bonds would be 

classified as earning arbitrage profits under a broader definition. The corresponding figures for colleges and univetsities were over 70 percent. 

Institutional Response to an Expanded Definition of 

Tax Arbitrage 

Schools could adjust to a broadened definition of arbitrage in several different ways. They could issue fewer 

bonds and reduce their capital spending. They could sell 

or reduce their srock of investment assets in order to 

finance capital spending, rather than issuing tax-exempt 

debt and rebating the yield on investment assets to the 

federal government. They could also replace borrowing 

that would result in yield restriction with taxable debt. In 

all cases, the net cost of the tax preference to the federal 

government would be reduced. 

Another possibility is that decreasing the attractiveness of 

tax-exempt private-activity bonds might encourage institutions of higher learning to pursue taX-exempt financing 

rhrough other channels. For example, when the Tax 

Reform Act of 1986 limited the use of private-activity 

bonds for the financing of sports stadiums, agreements 

between local governments and SPOftS teams led to the 

issuance ofbonds specifically designed for stadium 

financing but legally considered general revenue bonds 

because they were backed by revenue from general 

sources. In those cases, the requirement that debt service 

28. The reserve was set equal to 100 days of operating expenses; the 

median hospital in the sample had 117 days of cash on hand. 

be paid from revenues not generated by the stadium 

essentially ensured that local governments would offer 

teams very favorable lease terms and that the tax burden 

of such facilities would be shared by all local raxpayers 

rather than the users of the facility. who most benefited 

from it.29 

Local governments could allow both public and private 

universities to circumvent expanded tax arbitrage rules 

for private-activity bonds in a similar fa<;hion. Although 

colleges and universities do not enjoy the monopoly 

power of major sports teams, many institutions of higher 

learning are large landowners and employers at the local 

level, giving them substantial negotiating power with 

local governments. Local governments could also designate public schools as separate units of government for 

the purpose of issuing bonds, allowing those schools to 

issue general revenue bonds on their own. Although careful regulation could in theory citcumvent that problem. it 

is likely that at least some issuance of tax-exempt privateactivity bonds would simply shift to the issuance of taxexempt revenue bonds, limiting the revenue gain to the 

federal government. 

Broadening the rule would reduce the tax preference for 

schools with large asset portfolios to a greater degree than 

it would for schools with fewer resources. Because the 

new rule would be more likely to apply to the few schools 

with very large portfolios, those schools would effectively 

face an increase in interest costs relative to schools with 

smaller portfolios. However, those schools with significant investment assets already tend to have investmentgrade credit ratings, suggesting that limiting their ability 

to issue tax-exempt debt would probably not prevent 

them from accessing financial markets. Whether diverting the tax-exempt-bond subsidy away from schools with 

larger endowments would be a more efficient use of 

scarce resources would depend on the marginal social 

benefit of subsidies to such schools. If the marginal social 

benefit of the subsidy decreased as endowments rose, a 

reduction in the subsidy to schools with large endowments could improve the allocation of the nation's 

resources. If the marginal social benefit of the subsidy 

increased as endowments rose, a reduction in the subsidy 

to schools with large endowments would worsen resource 

allocation. 

29. Dennis Zimmerman, "Subsidizing Stadiums: Who Benefits, Who 

Pays," in Roger G. Noll and Andrew S. Zimbalist, OOs., Sport;, 

Jobs, lInd Taxes: the Economic Impact of Sports Teams and Stadiurm, 

(Washington, DC: Brookings Institution Press, 1997), 

pp.1I9-145. 
130 


82271.098

Appendix: 

Alternative Calculations of Tax Arbitrage as 

Practiced by Colleges and Universities 

In the main text of this report, the Congressional 

Budget Office (CBO) calculated the extent of [ax arbitrage that colleges and universities would be practicing 

under an expanded definition of the term. To do S0, 

CBO adjusted the outstanding stock of rax-exempt bonds 

held by those institutions (0 reflect the fact that they 

often misreporred. such debt as mortgages and expanded 

their measured investment assets [0 include assets held by 

related organizadons. In this appendix, CBO presents 

estimates based on the same data-taken directly from 

information returns (specifically, Form 990 returns) filed 

with the Internal Revenue Service (IRS)-but without 

making such adjustments. 

According to unadjusted data from Form 990 returns. 

which nonprofit entities are required to submit to the 

IRS on an annual basis, the percentage of previously 

issued outstanding debt that would be classified as eam~ 

ing returns from arbitrage under a broader definition 

would be similar to the percentage produced using 

adjUsted data, (In determining those percentages, CBO 

used the historical stock of previously issued bonds. 

which it terms the "historical" measure). However, 

148 institutions-slightly less than 60 percent of the 

251 schools that borrowed in 2003-had investment 

assets with a value that exceeded the reported stock of 

tax-exempt liabilities, a considerably smaller percentage 

than was the case when adjusted data were used. Most of 

the additional stock of debt added by the adjustment was 

for institutions that reported no tax-exempt debt at all on 

Form 990 returns; but [he additional stock of bonds 

attributable to the adjustment would be small relative to 

the total stock of bonds. 

Estimates that were produced using what CBO terms the 

"first-year" measure-which considers the position of 

colleges and universities in the years immediately 

following an expansion of the definition of arbitrage--do 

not include information on the outstanding stock of 

tax-exempt bonds, so they are affected only by the adjustment to investment assets. Using that measure and 

unadjusted data, CBO determined that the share of debt 

earning returns from arbitrage would be slightly lower, by 

about 1 percentage point. than when adjusted data were 

used. Using that measure and unadjusted data. the number of institutions conducting arbitrage would be slightly 

lower as weB, by about 2 percentage points. Again, both 

the adjusted and unadjusted data show that a majority of 

the new issues of tax-exempt bonds for institutions of 

higher learning would be classified as earning arbitrage 

profits after an expansion of the definition of tax 

arbitrage. 
131 


82271.099

STATEMENT OF HON. ORRIN G. HATCH, RANKING MEMBER 

U.S. SENATE COMMITTEE ON FINANCE HEARING OF JULY 25, 2012 

EDUCATION TAX INCENTIVES AND TAX REFORM 

WASHINGTON - U.S. Senator Orrin Hatch (R-Utah), Ranking Member of the Senate Finance 

Committee, today released the following opening statement at a committee hearing examining 

the role of education incentives in the U.S. tax code: 

The focus oftoday's hearing is a narrow, but very important, one - the role of 

education incentives In our tax code. Traditionally, the federal government has supported 

millions of individuals seeking higher education through grants and loans. Over the last 15 

years, however, federal support for higher education has increasingly relied on incentives in the 

tax code. 

These education tax incentives can generally be classified Into one of three categories. 

The first category includes tax incentives for current expenditures for higher education. 

These incentives include the Hope, American Opportunity and Lifetime Learning Credits; a 

deduction for higher education expenses; and the exclusion for scholarships and fellowships. 

The second category Includes tax Incentives for student loans. These incentives include the 

deduction for interest paid on student loans and the exclusion from income for certain student 

loans that have been forgiven. The third category includes tax incentives for savings for college. 

These incentives include qualified tuition plans, generally referred to as 529 plans; Coverdell 

plans; education savings bonds; and IRA withdrawals to pay for college expenses without 

penalty. 

Generally, two reasons have been given for the various education tax incentives. First, 

college education costs are increasing and are a barrier to entry for those who cannot afford 

the costs. Second, college education is a good investment that produces external benefits 

sometimes referred to as positive externalities. 

According to the National Center for Education Statistics, the cost of college education 

for the 2009-10 academic year -- annual prices for undergraduate tuition, room and board --

were estimated to be $12,804 at public institutions and $32,184 at private institutions. 

Between 1999-2000 and 2009-10, costs for undergraduate tuition, room and board at public 

institutions rose 37 percent, and costs at private institutions rose 25 percent, after adjustment 

for inflation. 

The high cost of a college education does create a barrier to entry. However, some 

portion of the barrier is alleviated by the U.S. Department of Education's Direct Loan Program 

(such as Stafford Loans), Federal Perkins Loans, Federal Work Study, Federal Supplemental 

Educational Opportunity Grants and the Federal Grant Program (such as Pell Grants) for lower 

income students. In fact, according to the John William Pope Center for Higher Education 

Policy, ofthe 16.4 million undergraduate students enrolled in college in the United States in 

2010, approximately 58 percent or 9.6 million students received Pell Grants. 
132 


82271.100

As to the external benefits of a college education -- some benefits from higher 

education may benefit not just the individual student in the form of higher wages, but also 

society as a whole. Since these external benefits may not be considered by individual students 

when considering higher education, individuals may invest less in higher education than is 

optimal for society. Providing educational tax incentives may induce potential students to 

enroll in higher education, increasing Investment in education, and thereby creating external 

benefits. 

A frank conversation about these incentives must also consider whether Congress is 

encouraging a higher education bubble. Are these incentives encouraging students to take on 

more debt and degrees than is warranted by the economic and professional gain these students 

are likely to realize from their educational achievements? 

In evaluating the education tax incentives, we use the same three factors that are used 

in evaluating all tax incentives: equity, efficiency and simplicity. Some critical questions in 

evaluating education tax incentives are whether federal subsidization of higher education is 

good policy and whether a tax subsidy would be provided more efficiently by direct spending. 

In 1987, then Secretary of Education William Bennett stated that in the long run, Federal 

financial aid programs lead to higher tuition as colleges capture some of the Federal aid to 

students. Some studies have shown some evidence of the Bennett hypothesis. I would be 

interested to hear from our witnesses if they believe the Bennett hypothesis applies to Federal 

student aid in the form of education incentives in the tax code. In other words, do colleges and 

universities capture the financial benefits of education tax incentives at the expense of eligible 

students and families? One recent economic paper indicates that is the case. 

As to simpliCity, one noted tax scholar, Michael Graetz, has written, "The education tax 

incentives represent the greatest increase in federal funding for higher education since the GI 

Bill. But no one can tell you what they are, how they work, or how they interact. Planning to 

pay for college around these tax breaks is essentially impossible for middle-Income families." I 

think there is a lot of agreement that the education tax incentives are very complex and, at a 

minimum, should be consolidated and reformed. 

We have a very distinguished panel with us today. I look forward to hearing what they 

have to say. 

### 
133 


82271.101

"Are Tax Credits the Proper Tool for Making 

Higher Education More Affordable?" 

Testimony by 

Scott A. Hodge 

President, Tax Foundation 

Hearing Before the U.S. Senate Committee on Finance 

July 25, 2012 

Mr. Chainnan and members of the Committee: 

I am Scott Hodge, president of the Tax Foundation. Thank you for the opportunity to speak to 

you today on the issues surrounding education and taxes. 

Founded in 1937, the Tax Foundation is the nation's oldest organization dedicated to promoting 

economically sound tax policy at the federal, state, and local levels of government. We are a 

non-partisan SOI(c )(3) organization. 

For 75 years, the Tax Foundation's research has been guided by the immutable principles of 

economically sound tax policy that were first outlined by Adam Smith taxes should be neutral 

to economic decision making, they should be simple, transparent, stable, and they should 

promote economic growth. 

In other words, the ideal tax system should do only one thing - raise a sufficient amount of 

revenues to fund government activities with the least amount of harm to the economy. By aU 

accounts, the U.S. is far from that ideal. According to the National Taxpayer Advocate, tax 

complexity is the number one issue facing taxpayers and the IRS today. The main cause of that 

complexity has been the proliferation of credits, deductions, and preferences built into the tax 

code. 

Introduction 

Inequality is on the minds of many these days and it is commonly thought that the Bush-era tax 

rates are a principle cause. The reality is very different, however. One of the biggest contributors 

to rising inequality in America today is the growing earnings gulf between workers with college 

degrees and those without. Indeed, as can be seen in Chart 1, the median income for a worker 

with a 4-year coUege degree was $75,568 in 2010. By contrast, the median income for a worker 

with only a high school diploma was nearly half as much - $38,976. There is even greater 

income disparity between those with high school diplomas and those with advanced degrees. 
134 


82271.102

As Chart #2 clearly shows, 

America's income is really 

an edncation gap. At $140,000 

Chart 1: Median Incomes Vary Greatly by Educational 

Attainment 

bottom end of the income scale, 

about 70 percent oflow-income 

Americans have a high school 

degree or less, whereas at the 

$119,825 

other extreme 78 of 

those earning over 

have a college education or 

better. 

$120,000 

$100,000 

$80,000 

$60,000 

$40,000 

$20,000 

$ 

nots, but at the heart ofthal 

disparity is that some have a 

sheepskin while the others 

don't 

No HS High School Median Bachelor's Professional 

Source: CensR?p!oma Graduate Income Degree Degree 

Considering the financial benefits 

in recent years away from 

toward the use of various tax credits and deductions. 

The question is, is the tax code the proper 100110 increase access to higher education and make 

college more affordable" 

Generally speaking, the answer is no, 

First, these lax 

credits violate 

the principles of 

sound ta'{ policy 

by greatly 

increasing the 

complexity and 

distortions in the 

tax code. But 

there are serious 

practical reasons 

we should be 

90% 

80% 

70% 

60% 

50% 

40% 

30% 

20% 

10% 

0% 

Chart 2: America's Income Gap is Really an Education Gap 

69% 

H.S. Degree or 

Percent with 

Higher 

18% 

focus of my 

testimony today. ,"<::P·~<§:>·~,"'"~,,"·~,"'"·~,"'"··~,"'"··~,"'"·~,"'"·:s,,"·~,","·~,","·~,","··~,"'"'~,"'""~,"'""~,"'""~'"'"'~,"""~,","' 

<,-$>' <,-f" <,?'"' ",t.'"' <,,,,"' ",o'"' r:;."" <,'0"" .,DP~"'"'"~",,,,\,,,-f'~,,,?\:r-"'~,,"'"~,,,'o\':;''''~''y'b'''~~Q~-f''"' 

C;rll!(('w IPJ"lqt<;; Total Money income in 2010 
135 


82271.103

I will discuss four of the more serious unintended consequences of using tax policy to promote 

higher education: 

1. Tax credits and subsidies undermine market forces and can actually cause price inflation 

for the very thing they are intended to make more affordable. It is clear that higher 

education is headed down the same path as health care and housing for the same reasons. 

2. The extensive use of tax credits has already knocked a record 58 million Americans off 

the tax rolls - 41 percent of all filers have no income tax liability after taking their credits 

and deductions. In addition to the lost revenues from having so many people off the tax 

rolls, and the social cost of having so many Americans with no skin in the game, our 

research suggests that the 20 year growth in nonpayers is associated with more than $200 

billion in higher transfer spending this year. There is also a strong correlation between the 

growth in nonpayers and increases in the national debt. 

3. Education tax credits and deductions tend to benefit high-income taxpayers much more 

than low income families. About one-third of the benefits of these credits accrue to 

families earning over $100,000. 

4. The over-use of tax credits has turned the IRS into an extension of - or substitute forother government agencies. The IRS is not equipped to be a social welfare agency. As a 

result, these credits tend to be abused and fraud rates are very high. 

It is time to call a truce to using the tax code for social and economic engineering. Instead, the 

tax code should be overhauled by eliminating all of these provisions while flattening tax rates. 

Education Going the Way of Health Care and Housing 

It should be no surprise that the sectors suffering the biggest financial crises today - health care, 

housing, and now higher education - all receive the most government intervention through the 

tax code and other mechanisms such as subsidized loans. 

The effect of these policies is well known. For example, the tax preference for employerprovided health insurance creates a classic third-party payer problem in which patient-consumers 

are disconnected from the cost of service. The cost of health care is soaring because we have an 

unlimited demand for health care due to the belief that someone else is paying the bills. The 

market forces that deliver quality goods at low prices for everything from toasters to automobiles 

have been disrupted in the health care system because it is tax preferred. 

Housing suffers a similar problem because of the plethora of tax and spending subsidies intended 

to promote home ownership.l Economists find that the mortgage interest deduction gets 

I While the lion's share ofthe blame for the CDITent housing crisis properly rests with government-sponsored 

enterprises Fannie Mae and Freddie Mac, the MID certainly played a role in encouraging some families to purchase 

homes that they really could not have afforded otherwise. Canada does not have a mortgage interest deduction, yet 

its rate of homeowners hip is equal to that in the U.S. Professor Dennis J. Ventry, lr. ofthe UC Davis School of Law, 

calls the Mortgage Interest Deduction (MID) the "accidental deduction," because the authors ofthe original tax code 
136 


82271.104

capitalized into the price of homes and may amplify price volatility\ which then offsets 

whatever effect it has on promoting home ownership. The actual economic benefits ofthose 

capitalized costs tend to flow to the home builders and realtors, who have naturally been the 

most vocal opponents of eliminating the deduction. One study determined that the mortgage 

interest deduction is "an ineffective policy to promote homeownership and improve social 

welfare.,,3 

Subsidized student loans and education credits are similarly fueling higher college costs by 

disconnecting student-consumers from the true cost of higher education. In turn, the benefits of 

these programs get capitalized into tuition costs because universities can boost tuitions without 

suffering the normal market backlash. 

In the wake of the housing bubble, the next loan bubble is in student loans. The Consumer 

Financial Protection Bureau reports that the amount of outstanding student loan debt has topped 

$1 trillion. Americans now have more student loan debt that consumer debt. And, unlike housing 

and consumer debt, people cannot walk away from these loans in bankruptcy or dump them in 

short sales. The loans are with people forever. While the interest deduction for student loans may 

give them some relief, the benefits of that deduction accrue largely to upper-middle class 

households. 

The cure for what ails these industries is to be weaned off the tax code, not the granting of more 

subsidies through increased credits and deductions. 

Tax Credit Proliferation 

Over the past two decades, lawmakers have increasingly asked the tax code to direct all manner 

of social and economic objectives, such as encouraging people to buy hybrid vehicles, purchase 

health insurance, buy a home, replace the home's windows, adopt children, put them in daycare, 

take care of grandma, purchase school supplies, go to college, and the list goes on. 

In too many respects, the IRS has become an extension of, or rather a substitute for, every other 

Cabinet agency - from Energy and Education to HHS and HOD. But perhaps the most troubling 

development in recent years is that the efforts of lawmakers to use the tax code to help low and 

middle-income taxpayers has knocked millions of taxpayers off the tax rolls and turned the IRS 

into an extension of the welfare state. 

Today, as can be seen in Chart 3, a record number of Americans - 58 million, or 41 percent of all 

filers - now have no direct connection with the basic cost of government because they pay no 

income taxes. We have not had such a large share of people off the tax rolls since 1940 when the 

income tax became a "mass tax." 

never intended the deduction for personal interest expenses to subsidize home ownership. See: Dennis J. VentJy, Jr., 

"The Accidental Deduction: A History and Critique of the Tax Subsidy for Mortgage Interest," UC Davis Legal 

Studies Research Paper Series, Research Paper No. 196, November 2009. 

2 Dan Andrews, "Real House Prices in OECD Countries: The Role of Demand Shocks and Structural and Policy 

Factors," OEeD Economics Department Working Papers, No. 831, OECD Publishing, 20]0. 

3 Christian A. L. Hilber and Tracy M. Turner, "The mortgage interest deduction and its impact on homeownerhip 

decisions," August 2010. 
137 


82271.105

If we add this group to the people who have some income but don't tile a tax 

American households outside the income tax system rises to nearly 50 percent 

the ranks or 

Many of these 58 million tax filers now look to the IRS as a source ofincome thanks to the more 

than $100 billion in refundable tax credits paid out to people who have no income tax liability. 

70 

60 

50 

f! 

,g40 

!le 

if130 

~ 

i 20 

10 

0 0 

Ul 

;'2 

Chart 3: Number and Percentage of "Non-Payers": 1950 to 2010 

~ 0 '" 0 <0 <0 

;'2 ll: ~ ~ " ;'2 

45% 

40% 

35% 

30% 

f! 

., 25%ii: 

'0 

20%;; c 

15%~ a. 

10% 

5% 

0% 

As a result of removing millions off the hottom of the tax rolls, we have dramatically 

reduced the number of people with in the game:' According to the Congressional Budget 

Office, the bottom two representing the bottom 40 percent of taxpayers - now have a 

negative income tax 1111S means, they don't pay income taxes, they simply get checks 

back from the IRS. 

As we can see in Chart 4, people in the lowest quintile have an 

of -9.3 percent while those in the second quintile have an average tax rate of -2,6 

percent. More worrisome is the fact that the middle quintilc representing the middle 20 percent 

of taxpayers - has an overall effective tax rate nearing zero, just 1.3 percent. 

'Robcrton Williams, "Why Nearly Half of Americans Pay No Federal Income Tax," Tax NOles, June 7, 2010, p. 

1149, 
138 


82271.106

The means that fl)r all 

practical purposes, the 

bottom 60 percent of 

taxpayers have little or no 

connection with the basic 

cost of government 

Indeed, to them the IRS 

a source of eash benefits 

because of the growth in 

refundable tax credits, 

Chart 5 details the growing 

25 

20 

15 

10 

o 

cost of non-refundable and ,5 

refundable tax 

,10 

Chart 4: Average Effective income Tax Rates 

by O,llintile in 2009 

All Quintiles = 7,2% 

,9.3 

21,0 

the past two decades, In 

1990, the combined value 

of these credits was 

roughly $20 billion, after 

adjusting for inflation, Of 

that amount, the bu,j.",tm-v 

,15 Income Group Minimums for 2 person family 

Lowest 

Qulntlle 

$0+ 

Source: CSO 

Second 

Quintile 

$32,000+ 

Middle 

Quintlle 

$49,400+ 

Fourth 

QUinti!e 

$70,900+ 

Highest 

QulntHe 

$104,700+ 

Top 1 

Percent 

$400,100+ 

cost of basic tax was around $8 billion, while refundable credits totaled $12 billion, 

By 2000, non-refundable tax credits had gro\vn to a budgetary cost of$46,5 billion, in 2012 

dollars, The child credit was, far, the biggest portion of this at more than $25 billion, after 

adjusting for inflation, Some million taxpayers took advantage of the child credit that year, 

Refundable credits amounted to $43,4 billion in 2000, nearly all of which was attributed to the 

ETTe 

A decade later, the combined cost of both the non-refUndable and refundable tax 

credits reached a remarkable in 2010, To put this cost in perspective, it is larger than 

the budgetary cost for the tax exclusion for employer'provided health insurance, which is the 

largest tax expenditure in the federal budget In 2010, the budgetary cost of non-refundable la;,\ 

credits was $104 billion. Roughly two-thirds of these costs were comprised of the nonrefundable portions oftha Making Work Pay Credit and the Child Credit Another 24 percent of 

these costs were attributable (0 the foreign tax credit and to the education credits, 

As of201O, refUndable cash payments to nonpayers over half ($120 

(otal cost of tax credits, The largest rdimdable credits in were the EITC ($59 and 

the refundable portions oftha child credit ($27,5 billion) and the Making Work Pay Credit ($16 

billion), 

; Internal Revenue Service, Table A, Selected Income and Tax ltems for Tax Years, 1990,2009, 

in Current and Constant 1990 
139 


82271.107

The Growth of Education Credits 

In the scope of federal assistance for higher education expenses, tax credits and deductions arc 

relatively new." Prior to the enactment of the Hope Scholarship Credit and the Lifetime Lcaming 

Credit in 1997, the governmenfs tools for helping students had been direet assistance 

(such as the GJ. Bill and Pel! Grants) loan progranlS. Since 1997, however, lawmakers have 

lII<;,lO;;idM.HgI'Y tumed to the tax code to help students and families with education costs. 

$250 

$200 

$150 

$100 

$50 

Chart 5: Tax Credits Have Grown Considerably In Recent Years 

Billions of 2012 Dollars 

Refundable Credits 

NDn~refundable Tax 

Credits 

$0 ill l1li .. 1 IIII I 

Chart 6 illustrates the gradual growth of the budgetary costs of education tax credits since J 998, 

while Chart 7 documents the number of tax relums claiming those credits each year since 1998. 

In 1998, some 4.7 million taxpayers claimed $4.5 billion in credits, atter adjusting for inflation. 

Within five years, the number of taxpayers these credits had climbed to over 7 million. 

while the inflation-adjusted costs increased to over billion. In oth(~r words, the average 

taxpayer claimed roughly $1,000 in education tax credits. 

The cost of these programs held steady until 2009 with the enactment of the American 

Opportunity Tax Credit The AOTC more generous than the Hope Credit ~ it is worth 

100 percent of the tirst of education expenses compared to $1,200. It also allowed 

taxpayers with higher incomes can claim the credit ~ it phases out at $180,000 for joint filers 

compared to $! 20,000 for the Hope Credit. Lastly, the AOTC was made refundable for those 

with no income tax liability. 

affederal assistance for 

for Higher Education: 

education costs, see Elaine M, Maog and Katie 

and Prospects," Urban Institute: January, 
140 


82271.108

$20.0 

$18.0 

$16.0 

$14.0 

$12.0 

$10.0 

$8.0 

$4.0 

$2.0 

$0.0 

Chart 6: Growth of Education Credits Since 1998 

Constant 2012 Dollars 

$4.5 

I 

l1li Non-refundable credits 

.NRefundable Credits 

$7.9 $7 $8.1 

$7.2 $7.2 $7.1 .s $6.3 $6.3 $6.6 $6.3 

$11.4 

$11.4. 

6.1 

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 

Source: IRS 

14.0 

12.0 

10.0 

8.0 

Chart 7: The Number of Tax Credit Recipients has 

Grown Steadily Since 1998 

In Millions 

!Ill Taxpayers Claiming StandardCreclits 

l': Taxpayers Claiming Refundable Credits 

6.4 6.8 7.2 

6.5 

7.3 1.2 7.1 

7.7 7;4· 

12.0 12 

7.7 

6.0 

4.0 

2.0 

0.0 

4.7 

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2Dl0 

Source: IRS 
141 


82271.109

As can be seen in Chart 6, the inflation-adjusted cost of non-refundable education credits jumped 

from $8.1 billion in 2008 to $11.4 billion in 2009 and then to $17.4 billion in 20 I O. Moreover, 

the IRS distributed $8 billion in refundable American Opportunity credits in 2009 and another 

$6.7 billion in 2010. 

Meanwhile, as is shown in Chart 7, the number of taxpayers claiming various education credits 

more than doubled between 2008 and 2010, from 7.7 million to over 16 million. In 2010, some 

12 million taxpayers received refundable AOTC credits even though they had no income tax 

liability. 

The table below compares the current value of the non-refundable credits and refundable credits 

relative to the other large credits in 2010. Education credits are the third-most costly basic tax 

credit, behind the Making Work Pay Credit and the Child Tax Credit, and the fourth-most costly 

refundable tax credit. 

Non-Refundable Portions 

Making Work Pay Credit 

Child Tax Credit 

Education Credits 

Foreign Tax Credit 

Residential Energy Credit 

Source: IRS 

Distributional Issues 

Largest Tax Credits Claimed by Taxpayers in 2010 

In Billions Refundable Portions 

$37.30 EITC 

$28.70 Child Credit 

$16.80 

$13.10 

$6.30 

Making Work Pay Credit 

American Opportunity Credit 

First Time Homebuyer 

Adoption Credit 

In Billions 

$60.47 

$28.12 

$17.40 

$6.43 

$1.00 

$1.00 

One of the dominant issues in any discussion of tax preferences is who benefits from them. 

Because the value of a tax deduction depends upon the marginal tax rate faced by the taxpayer, 

many of the largest and well known tax preferences - such as the mortgage interest deduction, 

deduction for state-local taxes, and the deduction for student loan interest -tend to benefit upperincome taxpayers because they are the taxpayers who itemize. 

Credits are only of value to taxpayers to the extent that they have an income tax liability to which 

those credits may be applied. As we've seen, this is becoming increasingly difficult because so 

many taxpayers are off the tax rolls because of the plethora of generous tax credits. The only way 

to provide more tax benefits to these taxpayers is to simply write them a check in the form of a 

refundable tax credit. 

As Chart 8 illustrates, roughly 30 percent of the current benefits of education tax credits accrue 

to taxpayers earning over $100,000 and an additional 18 percent accrues to those earning over 

$75,000. By most accounts, these tax preferences are becoming upper-middle class entitlements. 
142 


82271.110

Chart 8: Income Distribution of Eduction Credits in 2010 

35% 

30% 

25% 

20% 

10% 

5% 

0% 

Distribution of Returns Claiming Credits 

Distribution of Credit Dollars 

8% 

10% 

.8% 

Sourcp: Joint Committpp on Taxation 

The IRS is tf) Manage Tax Credits 

29% 

The cost of tax are often larger than their budgetary costs. They increase the cost of 

compliance for taxpayers and the IRS, and they are susceptible to lfaud. As it stands, simply 

complying with the tax code costs taxpayers an estimate $163 billion each year. About 62 

percent of all taxpayers use tax retum preparers, but the percentage climbs to about 73 percent 

for those claiming the ElTe, for example. 7 The complexity of EITC eligibility is a contributing 

factor to the estimated $11 billion to $13 billion in improper overpayments according to the 

IRSs 

Problems with education credits have not reached this level, but there is cause for concem. For 

instance, the Treasury Inspector General for Tax Administration found that, "Some taxpayers 

afe claiming the Hope Credit for more years than allowed by law. The limit is two years but 

some were found to claim the credit for three and even four years. In one investigation, the IG 

fonnd that '·the inappropriately claimed averaged close to $1,400 and totaled 

Furthermore, the IU reported that: 

7 National Taxpayer Advocate, Report to Congress: Fiscal 20 I 0 ObjeCTives. June 30, 2009, p. xxii. 

Payments in the Tax Credits," Testimony of J. Russell George, 

for Tax Administration. before the Committee on \Vays and Means, Subcommittee 

HOllse of Representatives. May 2011. p. J. 

"Improvements and Needed in the Administration of Education Credits and Reporting for 

Edueation.llllstitlltiolls," Treasury Inspector G<neral for Tax Administration. September 200g. Reference 

Number: 2009-30,141, p. 2. 

10 Ibid. 
143 


82271.111

"educational institutions are spending millions of dollars and staff hours each year to 

provide taxpayers and the IRS with copies of Tuition Statements (Form 1098-T). 

However, the IRS does not use this Form in its compliance programs, or accept the Form 

as documentation to support claims for education credits."t 

More recently, the IG has raised red flags about taxpayers improperly claiming the American 

Opportunity Tax Credit. Again, reports the IG: 

"The IRS requires no documentation to be provided to verify eligibility, including 

whether an individual claimed as a student even attends a required accredited educational 

institution. Our review is identifying significant improper payments being made to 

taxpayers claiming the credit and using ineligible students.,,12 

I would argue that while we should be appalled by such abuse, we should not be surprised by it. 

As the IG testified, "Although each of these refundable credits provides benefits to individuals, 

the unintended consequences of these credits is that they are often the targets of unscrupulous 

individuals who file erroneous claims for those benefits.,,13 

Moreover, enforcing these credits is simply asking the IRS to be more than a tax collection 

agency. It is asking it to manage a social program - a role far beyond what it is designed to 

perform. 

Conclusion 

While we all understand the value and financial benefit of getting a college degree, using the tax 

code to "make college more affordable" not only violates the principles of sound tax policy, but 

also produces serious unintended consequences. 

These "tax programs" - for lack of a better word - are likely contributing to the rising costs of 

higher education while helping to knock millions of people off the tax rolls. This, in turn, is 

disconnecting millions of people from the basic cost of government and transforming the IRS 

into an extension of the Department of Education and the welfare system. 

These are not the kind of consequences that can be cured by a simple reform of tax credits, but 

by a wholesale reform of the entire tax code. 

Thank you very much for the opportunity to discuss these issues with the Committee today. I 

look forward to any questions that you may have. 

11 Ibid., p. 1. 

12 Testimony of J. Russell George, Ibid., p. 7. 

l3lbid., p. 2. 
144 


82271.112

TESTIMONY of 

LYNNE MUNSON 

Before the 

COMMITTEE ON FINANCE 

of the 

UNITED STATES SENATE 

July 25, 2012 
145 


82271.113

Chairman Baucus, Ranking Member Hatch, 

committee members, thank you inviting me back to 

testify on the issue of runaway tuition and what might 

be done about it. 

When you asked me to come here five years ago to 

describe how unaffordable college had become, I 

shared some analyses that many found surprising. I 

took the prices of milk and of gas in 1980 and told you 

how much those goods would cost in 2007 if their 

prices had gone up as rapidly as had in-state tuition at 

public, four-year universities. I've now updated those 

prices to the current day. 

Whereas, back in 2007, the "tuition-adjusted" price of 

gasoline was $9.15 a gallon - today it stands at $13. 

The price of milk? Up from $15 in 2007 to $22 per 

gallon today.1 I do these pocketbook analyses to help 

put the rapid rate of tuition increase in to graspable 

terms. 

Everyone wants to do something about college costs, 

but no one, including the President, has a plan. We've 

satisfied ourselves for decades by accommodating the 

problem rather than holding schools accountable for 

what they charge. As Dean Zerbe, a former staffer on 

the committee, has written: "Colleges and universities 

have been raising tuition faster than a monkey can 

1 This analysis is based on data contained in the College Board's research series, 

"Trends in College Pricing." 
146 


82271.114

shell nuts (and of course Washington's response has 

been to throw a lot of peanuts their way)."2 

Of course, the most popular accommodation is to 

increase the number and size of federal student loans 

and grants. But Bill Bennett's hypothesis has held 

true-this only incentivizes colleges to deliver 

students bigger bills. The same is the case with 

education tax credits. Do not for a moment entertain 

the illusion that these credits end up in the bank 

accounts of families. Tuition cost will keep pace with, 

if not exceed, any subsidy you create. 

We have also accommodated tuition excess by 

establishing ways for parents to sock away significant 

portions of their income, tax-free, for their child's 

education before they are even born. These are 

dollars that would undoubtedly be better spent 

meeting other family needs in these challenging times 

rather than being set aside, decades early, to pay a 

future college bill of fear-inspiring proportions. 

I don't need to tell you that these methods have failed. 

What's worse: They have created the dangerous 

impression that we are addressing a problem that 

worsens rapidly every single day. 

2 http://bJogs.forbes.com Ideanzerbe / 
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We need to stop accommodating. We need to stop 

searching for an endless number of ways to pay the 

tuition bill and, instead, begin holding colleges and 

universities accountable for the price tag they put on 

American education. 

Let's remember that higher education's take on the 

public purse cannot be exaggerated. In addition to 

the billions in research dollars and the massive 

subsidies that flow from federal and state loans and 

grants, there are tax-free bonds, tax-free charitable 

donations, tax-free endowments, tax-free real estate 

holdings-worth at least $10 billion annually. 

Let's also remember that our colleges and universities 

are sitting on more wealth than has been amassed by 

any other group of non-profit institutions in the 

history of our nation-including private 

foundations. 3 Now, I shouldn't say they are "sitting" 

on these billions, because they are actually very busy 

investing them in some of the most complex and 

illiquid long-term experimental investments that man 

has ever created. Their focus is on amassing these 

funds, not on spending them. 

Currently, 143 schools have endowments larger than 

$500 million. Seventy-four colleges and universities 

have endowments over $1 billion. About 25% of our 

3 According to the Foundation Center's "Top 100 U.S. Foundations by Asset Size" 

rankings, there are 65 private foundations in the United States with wealth 

exceeding $1 billion. See 

http://foundationcenter.org/findfunders/topfunders/top 1 0 Oassets.html. 
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nation's wealthiest universities are public institutions 

including the University of Michigan, Texas, 

Oklahoma, Nebraska, Virginia, Minnesota, and 

Florida. Numerous liberal arts schools, that support 

no graduate programs or big medical research 

facilities, and enroll just a few thousand students, are 

among the wealthiest. They include Grinnell College 

in Iowa and Swarthmore College in Pennsylvania. 4 

Keeping in mind this abundant wealth, and the litany 

of accommodations and tax benefits higher education 

enjoys, I suggest tuition accountability is long 

overdue. Here are three ideas that will get the ball 

rolling: 

• One is to require colleges and universities to do 

what private foundations must: Spend a certain 

percentage of the value of their endowments each 

year. Foundations are required to spend 5%, 

which is an old number that likely needs to be 

revised upwards. Requiring schools to spend 

more would let loose tens of millions which could 

be spent on decreasing the cost of college. Let me 

emphasize that this will not be a burden to 

schools with smaller endowments - as they 

42011 NACUBO-Commonfund Study of Endowments, 

http://www.nacubo.org/ResearchINACUBOCommonfund Study of Endowments/Public NCSE Tables .htm!. See Table: "U.S. 

and Canadian Institutions Listed by Fiscal Year 2011 Endowment Market Value and 

Percentage Change in Endowment Market Value from FY 2010 to FY 2011" 
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82271.117

already spend their endowments more 

aggressively than do the wealthier institutions.s 

• Second, and again this mirrors what already is 

required of foundations, make colleges and 

universities publicly disclose the amount and 

purpose of each and every endowment 

expenditure. If you require schools to spend 

more, you do not want it to go for more opulent 

fundraisers at the university president's house or 

more climbing walls at the gym. Let's get the 

sunshine we need to encourage colleges and 

universities to spend their funds on bringing the 

cost of education down . 

• And, lastly: Let's make the university president, 

administrators, and professors pay tax on the free 

college education their children receive.6 This is 

a gratuitously unfair and excessive freebie that 

reeks of privilege, corrupts admissions processes, 

and undermines the very notion of fairness. At 

very least, it should be taxed. 

These three moves would not solve the problem of 

runaway tuition. But they would demonstrate that 

policymakers are willing to begin setting the kind of 

tax policy, and demanding the sunshine, required to 

begin holding schools accountable. 

5 See NACUBO/Commonfund Study of Endowments. 

6 https://www.jct.gov /publications.html?func=startdown&id= 1524 
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82271.118

*** 

When this committee focused its attention on the 

issue of college affordability five years ago, there were 

some good effects. Unfortunately, they were shortlived. 

A few of schools instituted "no loan" policiespromising, in most cases, to allow students whose 

parents earned less than $75,000 per year to attend 

college without taking out loans. Most of those 

programs, including at Williams and Dartmouth 

colleges, were cancelled two years after they were 

created.? No one who'd enrolled under the program 

even had time to graduate. 

Some schools also increased scholarship and grant 

expenditures five years ago. But, according to a study 

Sallie Mae just released, college and university grants 

and scholarships fell 15% during the last academic 

year.s That's more than $1000 per student. 

Also, in 2008 an IRS questionnaire was sent out to 

400 colleges and universities to inform work on a new 

schedule to the 990 requiring disclosure of 

information about education endowments. But the 

schedule never appeared. I suggest, Chairman Baucus 

7 http://www.insidehighered.com/news/20 10/02/09/ dartmouth 

8 Wall Street Journal, July 16, 2012. 

http://online.wsj.com/articie/SB10001424052?023036128045775287700151469 

82.html 
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82271.119

and Ranking Member Hatch, you write to the IRS and 

ask what happened. 

Affordability is an illusion the higher education 

establishment adopts when public or government 

relations demand it. In order to have lasting impact 

on the problem of runaway tuition, your attention to it 

must be enduring. 

Our colleges and universities have been given every 

opportunity, for decades, to do the right thing with 

regard to controlling the cost of college. They've not 

done it and there is abundant proof that they will 

never deliver American families a fair and honest 

tuition bill unless our nation's political leaders join 

the public and insist on it. 
152 


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GAO 

For Release on Delivery 

Expected at 10:00 a.m. EDT 

Wednesday, July 25, 2012 

GAO-12-863T 

United States Government Accountability Office 

Testimony 

Before the Committee on Finance, 

U.S. Senate 

HIGHER EDUCATION 

Improved Tax Information 

Could Help Pay for College 

Statement of James R. White 

Director, Strategic Issues 

George A. Scott 

Director, Education, Workforce, and Income Security 

Issues 

GAO 

Accountability * Integrity· Reliability 
153 


82271.121

Chairman Baucus, Ranking Member Hatch, and Members of the 

Committee: 

We are pleased to be here to discuss federal assistance for higher 

education. The federal government provides billions of dollars in 

assistance each year to help millions of students and families meet the 

costs of higher education. This assistance is provided through federal 

student aid programs authorized under Title IV of the Higher Education 

Act of 1965, as amended, (Title IV) and through tax expendituresreductions in federal tax liabilities that result from provisions in the tax 

code such as tax credits, deductions, exemptions, and tax-preferred 

savings programs. Providing federal financial assistance in these varied 

ways presents students and their families with multiple tools to help them 

pay higher education expenses. However, it may be difficult for families to 

understand and apply for higher education assistance. 

This statement summarizes our recently issued report that addressed 

how tax information could help families pay for college. ' In response to 

your request, our report: (1) described the size and distribution of federal 

grants, loans, and tax expenditures available to assist students and 

families with higher education expenses; (2) assessed the extent to which 

tax filers select higher education provisions that maximize their tax 

benefit; (3) summarized what is known about the effect of grants, loans, 

and tax expenditures on student attendance, choice, persistence,2 and 

completion; and (4) described factors that contribute to the effectiveness 

and efficiency of federal higher education student assistance programs. 

To address these issues, we analyzed data from the Department of 

Education (Education), Internal Revenue Service (IRS), and the Board of 

Governors of the Federal Reserve, and conducted a literature review for 

original empirical research. 3 We also developed a framework for 

evaluating federal assistance and validated it with recognized experts of 

lGAO, Higher Education: Improved Tax Information Could Help Families Pay for College, 

GAO-12-560 (Washington, D.C.: May 18, 2012). 

2Persistence is the likelihood that students will continue their education. 

Jyye conducted this performance audit from June 2011 to May 2012 in accordance with generally 

accepted government audrting standards. Those standards require that we plan and perform the audit 

to obtain sufficient, appropriate evidence to provide a reasonable basis fOf our findings and 

conclusions based on our audit objectives. We believe that the evidence obtained provides a 

reasonable basis for our findings and conclusions based on our audit objectives. 

Page 1 GAO~12~863T 
154 


82271.122

higher education finance. Detailed information on our findings as well as 

our scope and methodology is available in the report. 

We found that multiple Hie IV programs and tax expenditures provided 

substantial aid to populations across income levels. Figure 1 summarizes 

the Title IV programs and tax expenditures we reviewed. 4 

Figure 1: Title IV Programs and Tax Expenditures Available to Save, Pay. or Repay Higher Education Expenses 

Grants 

Key: 

D Programs used to pay for current expenses 

o Programs used to save for future cxpenSlils 

o Programs used to repay <!)(penses 

SO\.l~;OAO. 

4Details on each program can be found in GAO-12-560 

Page 2. GAO-12-863T 
155 


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In 2009. 12.8 million students received Title IV aid. and approximately 18 

million tax filers claimed a higher education tax benefit for current 

expenses. 5 The number of students receiving Title IV aid increased from 

10.4 million to 12.8 million. or 23 percent. from 2006 to 2009. The number 

of tax filers benefiting from an education tax expenditure was larger. and 

increased from 14.4 million to 18 million. or 25 percent. from 2006 to 

2009. Recent increases in both Title IV aid and tax expenditures from 

2008 to 2009 may be because of enrollment increases and legislative 

actions. among other factors. Title IV grants tend to benefit students and 

families with incomes below the national median (about $52.000 from 

2006 to 2010). while loans and work-study serve these students as well 

as students at family incomes above the median. Most tax benefits from 

the tuition and fees deduction and the parental exemption for dependent 

students went to families with incomes above $60.000. whereas the 

majority of benefits from the other higher education tax expenditures in 

our review-such as the American Opportunity Credit-went to families 

with lower incomes. 

In our analysis of 2009 IRS data for selected returns with information on 

education expenses. we found that tax filers do not always choose tax 

expenditures that maximize their potential tax benefits· We found about 

14 percent of filers (1.5 million of almost 11 million eligible returns) failed 

to claim a credit or deduction for which they appear eligible. On average. 

these filers lost a tax benefit of $466. We estimate that the total amount of 

tax benefits filers did not claim was approximately $726 million in 2009. 

We found no cases where filers' combined state and federal tax liability 

would have been higher if they had claimed one of those benefits on their 

federal return. Taxpayers might not maximize their tax benefits because 

they are unaware of their eligibility for the provisions or confused about 

their use. IRS and Education have taken steps to provide information on 

these provisions. but the number of filers failing to claim a higher 

5Tha total number of Title IV and tax recipients should not be added together, as in some cases 

students and families may be eligible for benents from both types of programs. The most current year 

for which data are available for both tax and ntle IV programs is 2009. 

sOur analysis is limited to tax tHers who appeared eligible for the lifetime learning credit (LLC) or the 

tuition and fees deduction in 2009, had a Form 1098-T Tuition Statement with infotmation on the 

student's education expenses, and had a tax liabllity after claiming other tax benefits. After eliminating 

returns where eligibility was not clear, we included only 29 percent of returns in our analysis affilars 

with a 1098-T but selecting neither the LLC nor the tuition deduction in 2009. Estimates have 95 

percent confidence intervals that are within 10 percent of the estimate itself. Details on our 

methodology and its limitations can be found in GAO-12·560, 

Page 3 GAO-12-863T 
156 


82271.124

education tax provision suggests more could be done. For example, IRS 

stated that it coordinated with tax preparation software providers to 

provide links to relevant higher education forms, while Education's 

Federal Student Aid website provides a link to IRS's Publication 970, Tax 

Benefits for Education. Developing a coordinated, comprehensive 

strategy to belter inform eligible students could improve take-up of these 

tax provisions. 

We also found that despite Education's research efforts, evaluative 

research on the effects of federal assistance for higher education on 

student outcomes-such as the likelihood students will complete their 

education-remains limited, as shown in table 1. Researchers have 

examined the effects of federal assistance on a limited basis, such as 

only for certain states or groups of students, but these studies provide an 

incomplete view of the effects of federal assistance. Education's efforts to 

sponsor and undertake research represent an important step, but 

research available at present still lacks evaluative information on the 

effects of federal grants, loans, and work-study. Continuing gaps in 

research on the effectiveness of federal assistance may be due, in part, 

to data and methodological challenges that have proved difficult to 

overcome. Recent changes in Title IV aid and tax expenditures-such as 

the introduction of the American Opportunity Credit in 2009-may provide 

opportunities for evaluative research, but Education officials told us they 

have not conducted such research due in part to the level of resources 

Education officials told us they devote to such research. In an 

environment of constrained budgets, evaluative research can help inform 

policy decisions. 

Page 4 
157 


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Table 1: Research We Reviewed on the Effects of Federal Assistance Is Limited and Cannot Be Generalized 

Federal assistance for higher education Attendance Choice Persistence Completion 

Grants" 

Student !oans 

Work-study 

Tax expenditures 

Tuition and Fees Deductlon 

Student Loan Interest Deduction 

Parental exemption for students age 19 to 23 

American Opportunity Credit 

Hope Credit 

Lifetime Learning Credit 

Earned Income Tax Credit for students age 19 to 23 

Coverdell Education Savings Account 

529 Qualified Tuition Program 

Source: GAO analySis 

Note: We did not find research that could be generalized. A check mark indicates that one or more 

Title IV aid or tax provisions in the category has been studied for certain states, types of school, or 

groups of students. 

"Research conducted into the effects of Pell Grants but not Federal Supplementa! Educational 

Opportunity Grants. 

Finally, we identified factors that contribute to effective and efficient 

higher education assistance programs to help policymakers allocate 

limited resources among multiple programs. 7 These factors can be used 

as a policy tool for considering improvements to current programs, 

consolidating programs, eliminating programs, or designing features of 

new programs. They can be used as a framework for assessing whether 

a higher education program:' 

achieves program goals and produces demonstrable results, 

provides appropriate incentives for targeted populations, 

facilitates beneficiaries' use of the program, 

7We consulted SUbJect-matter experts and our prior work as we identified these factors. See 

GAO-12-560 for details on the framework and our methodology. 

Bprograms include federal assistance through Title IV grants, loans, and work-study, and tax 

expenditures directed at future, current, and past education expenses. 

Page 5 GAO~12·863T 
158 


82271.126

GAO Contact and 

Staff 

Acknowledgments 

interacts effectively with other programs, 

minimizes costs and risks, and 

establishes monitoring and evaluation mechanisms. 

Based on our work, we recommended the Commissioner of Internal 

Revenue and the Secretary of Education work together to: 

identify characteristics of tax filers who are not claiming a higher 

education tax expenditure when they appear to be eligible for one and 

possible reasons for this, and 

use this infonmation to identify strategies to improve information 

provided to eligible students and families. 

We also recommended that the Secretary of Education take advantage of 

opportunities presented by recent and anticipated substantive program 

changes to sponsor and conduct evaluative research into the 

effectiveness of nle IV programs and higher education tax expenditures 

at improving student outcomes. 

Education and IRS agreed with our recommendations. Education noted 

that while it does not have access to tax data, it will work with IRS to 

assist in taxpayer outreach. A complete discussion of agency comments 

and our evaluation are provided in the report. 

Chairman Baucus, Ranking Member Hatch, and Members of the 

Committee, this completes our prepared statement We would be happy 

to respond to any questions you and Members of the Committee may 

have at this time. 

For further infonmation regarding this testimony, please contact James R. 

White, Director, Strategic Issues, at (202) 512-9110 or whitej@gao.gov, 

or George A. Scott at (202) 512-7215 or scottg@gao.gov. Contact points 

for our Offices of Congressional Relations and Public Affairs may be 

found on the last page of this statement 

Page 6 GAO-12-863T 
159 


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(451 D03} 

Individuals making key contributions to this statement and the related 

report include David Lewis and Tranchau (Kris) Nguyen, Assistant 

Directors; Shannon Finnegan, Analyst-In-Charge; Patrick Dudley; John 

Mingus; Amy Moran Lowe; Tom Moscovitch; Erika Navarro; and Mark 

Ramage. JoAnna Berry, Jessica Botsford, Amy Bowser, Andrew Ching, 

Susannah Compton, Michele Fejfar, Lois Hanshaw, Donna Miller, Edward 

Nannenhorn, Mimi Nguyen, and Melanie Papasian provided technical 

support. 

Page 7 GAO-12-863T 
(161) 

COMMUNICATIONS


82271128.eps
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This prov,ision has been an important means of building and adding to the competencies of the 

work force, and is a critical tool to help our nation accelerate its economic engine. The top majors 

among recipients of tax-free tuition include science, technology, engineering and mathematics. More 

than 35 percent of degrees pursued by employees using education assistance are master's degrees. It is 

essential that Sec. 127 be extended as soon as possible to provide certainty to employers and student 

employees as they make plans for the coming year and beyond. 

Also scheduled to expire this year are improvements originally made to SLID and Coverdell 

ESAs in the Economic Growth and Tax Relief Reconciliation Act of2001. Ifnot extended, SLID will 

be drastically limited by reduced income thresholds and a five-year limit and Coverdell ESAs will 

revert to allowing only $500 in tax-free annual contributions (currently $2,000). During this 

challenging economic time which has led to reduced home equity values for many families, it is 

particularly important to maintain mechanisms, such as the enhanced Coverdell ESAs, to incentivize 

college savings. 

The tuition deduction allows students or parents to deduct up to $4,000 in eligible higher 

education expenses from their taxable income. Like the AOTC, the tuition deduction enhances access 

to higher education by helping to reduce the cost of attending college. The tuition deduction is 

particularly beneficial to graduate students who are ineligible for the AOTC. 

It is broadly acknowledged, however, that the current set of higher education tax credits and the 

tuition deduction are overly complicated and difficult for taxpayers to correctly use. t These provisions 

include the AOTC, the Hope Scholarship Credit, the Lifetime Learning Tax Credit, and the tuition 

deduction, which are intended to enhance access to postsecondary education. We have long supported 

legislative efforts to consolidate and simplity these tax incentives in order to maximize their impact 

and enhance access to higher education. We strongly support reform of the current tax credits and 

tuition deduction to create a simpler, consolidated higher education tax credit that provides assistance 

towards a baccalaureate degree, post-baccalaureate education and lifelong learning. We would 

welcome the opportunity to work with the committee on such an effort during overall tax reform. 

It is for this reason that we strongly support legislation introduced in this Congress by Sen. 

Charles E. Schumer (D-NY), the "American Opportunity Tax Credit Permanence and Consolidation 

Act of2012" (S. 3267), which will make a number ofimportant reforms to the AOTC and Lifetime 

Learning Credit benefiting families across income categories. The bill significantly improves the 

current AOTC and Lifetime Learning Credit by consolidating them into one simplified, permanent 

AOTC that will provide up to $3,000 per year in tax relief. In addition, the act incorporates the 

expanded eligible expenses of the current AOTC, increases income phase-out thresholds and replaces 

current limits on the number of years a student can utilize the AOTC with a $15,000 lifetime cap. 

Moreover, in steps that will particularly benefit low- and moderate-income students, the act maintains 

1 See GAO Report to the Committee on Finance, U.S. Senate, Higher Education - Improved Tax Information Could Help 

Families Pay for College (May 2012); GAO Testimony before Subcommittee on Select Revenue Measures, Committee on 

Ways and Means~ U.S. House of Representatives, Afu/tiple Higher Education Tax Incentives Create Opportunities/or 

Taxpayers to Make Costly Mistakes (May 1, 2008). 
163 


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the 40 percent partial refundability of the current AOTC and better coordinates the interaction of the 

credit with the Pell Grant, making postsecondary education more affordable. 

II. College Costs: 

The condition of our economy has elevated the cost of attendance and avenues of access to 

higher education to sources of genuine anxiety for many American families. While these concerns are 

understandable, there are also a number of misperceptions about the true cost of attendance that have 

fueled this dynamic: 

According to the College Board in 2001, two-thirds of full-time students attended four year 

institutions with a published tuition price less than $15,000. In addition, 45 percent of all 

undergraduates attended community colleges, where the average published tuition for a fulltime student is $2,963. 

Analysis of data reveals that the net price of attendance--the actual cost after incorporating 

financial aid or tuition discounts, as opposed to the "sticker" price--remains within reach of 

many students and families, particularly at community colleges. According to the College 

Board in 2011, students at public four-year schools were paying a net price of$2,490 per year 

on average. 

Over the five years from 2006--07 to 2011-12, after taking into account grants and education 

tax benefits, the estimated average net tuition (adjusted for inflation) decreased at community 

colleges and private, nonprofit four-year colleges by $840 and $550, respectively. The average 

net tuition increased by just $170 at public four-year campuses after inflation, compared with 

the $1,800 increase in published tuition. 

The total amount of institutionally provided student financial aid has more than doubled over 

the last 10 years, increasing faster than the rate of increase in tuition. Indeed; the investment by 

colleges and universities in student aid has increased over the last decade from $20.5 billion to 

$38.1 billion in 2011. 

Among multiple reasons for rising college costs, there are four particularly strong drivers: 

• State Appropriations 

For public institutions, which enroll 80 percent of all students, the single largest factor in 

driving up college costs is declining state support. In the last 20 years, states have systematically 

reduced spending on higher education, resulting in increased tuition at public institutions to offset the 

reduced state revenue. Indeed, there is a direct and inverse relationship between the level of state 

appropriations and the level of tuition increases, as illustrated in the chart below. For example, at many 

institutions, a I percent decrease in state appropriations may result in a 3-5 percent increase in tuition. 
164 


82271.131

Annual Percent Change in Public 4 Year Tuition and State suppon 

{1990-91to 201Q-11; inflation adjusted) 

15% 

In 2010, state and local support for general higher education operations fell to a 25-year low in 

inflation-adjusted tenns, while full time equivalent enrollment increased by 61 percent. Over the 

decade from 1998-99 to 2008-09, state appropriations as a share of institutional revenues per student 

dropped from 49 percent to 34 percent at public research institutions, 56 percent to 43 percent at state 

colleges and 64 percent to 57 percent at community colleges. As a result of declining state support, the 

share oftotal institutional revenue from tuition rose from 25 percent to 32 percent at public research 

institutions, 33 percent to 43 percent at state colleges and 22 percent to 27 percent at community 

colleges. The increases were insufficient to offset declining state support. Between 2007-08 and 2010-

II, state appropriations for higher education per student declined by 18 percent in real tenns, the 

largest three-year decline in 30 years. 

Private colleges and universities face a different set of circumstances. Few independent 

institutions receive significant amounts of state support for their operating budgets. Some states 

provide financial aid that helps students attend these institutions. When state financial aid is reduced as 

a result of budget cuts, colleges must use even more of their own funds to fill the gap. 

• Technology and Knowledge Creation 

With the rapidly changing nature of infonnation technology, the technological expectations and 

requirements of students, faculty and staff are rising. Beyond initial costs for IT infrastructure, a 

significant investment of institutional resources goes to the creating and upgrading oftechnologyenhanced instruction and research media, student services and faculty and staff training. Today's 

college students expect institutions to provide infonnation and technological services that allow them 

to access instructional resources and campus services anywhere and anytime. This is evidenced by the 

rising use of wireless classrooms, lecture capture and podcasting, mobile apps and e-portfolios, for 

example. No one wants colleges and universities to be equipped with scientific and technological 

resources from 2000 as they try to meet the needs of students in 20]2 and beyond. 
165 


82271.132

Moreover, knowledge in most scientific disciplines doubles every seven to 10 years. Whole 

new fields of science--such as nanotechnology-have emerged from obscure specialties to essential 

fields of study that can be found at most institutions. Over the past three decades, the annual volume of 

paper and electronic subscriptions at academic libraries grew sharply from less than 4,700 to more than 

25,000. 

Government Regulation 

The persistent growth of federal, state and local regulation creates costs for colleges and 

universities that institutions cannot control but must consider every year in their budgets as they 

determine tuition. While some of this regulation may be necessary, a substantial share is burdensome, 

duplicative and contrary to campus mission. Given the range of their activities, colleges and 

universities are among the most heavily regulated entities in America. In addition to being regulated by 

state and local governments, higher education is the only industry regulated by every federal agency. 

According to Sen. Lamar Alexander (R-TN), in 2005, there were more than 7,000 federal regulations 

governing colleges and universities. 

Regulations impose a heavy toll on colleges and universities in the form of additional staff, 

increased staff development and training, additional paperwork, creation of computer systems and 

software to support record-keeping requirements, and higher legal fees. These regulations, in tum, 

increase operating costs . 

• WorkForce 

Higher education is among the most labor- and skill-intensive sectors of the economy, with 

college graduates comprising almost 70 percent of its employees. Higher education institutions 

typically spend 60 percent or more of their budgets on human resource costs. In recent years, 

institutions had sharp increases in benefit expenses that now comprise nearly 25 percent of total human 

resource costs. Colleges and universities compete with the private sector to hire outstanding 

individuals-such as engineers, biologists, chemists, doctors and lawyers--for faculty positions. 

Efforts to increase productivity or reduce academic personnel costs by increasing class sizes or 

hiring fewer full-time faculty can have a direct, detrimental impact on academic quality and are very 

unpopular with students and faculty. Further, student demands for increased non-instructional 

academic support services (e.g. counseling, health services and campus security) also drive up human 

resource costs. 

Ill. Federal Financial Aid and Efforts to Control College Costs 

During the hearing, some of the witnesses raised the so-called Bennett hypothesis, which 

claims that increases in federal student aid drive increases in tuition. A landmark federal study on 

college costs conducted by the Department of Education in 1998 found that increases in federal 
166 


82271.133

financial aid had absolutely no impact on tuition at any type of institution, public or non-profit private.2 

More recent extensive analysis of the issue by economists Robert Archibald and David Feldman not 

only found no relationship between Pell Grants and increases in tuition at public universities but a 

reverse effect at private institutions: Increases in the Pell Grant generally reduced private sector 

tuitions.3 The bottom line is there is !ill empirical data that suggests federal aid significantly drives up 

college prices. 

Colleges and universities have taken a wide range of steps to contain and cut costs as well as 

help students pay for education. On the cost containment side, these steps have included: layoffs, pay 

or hiring freezes; improving administrative efficiency; reducing course offerings, enrollments, or fulltime faculty; eliminating academic departments; and imposing budget cutbacks and reallocating 

resources to pay for other institutional needs. On the affordability side, these steps have included: 

increasing institutional financial aid, imposing tuition freezes, adopting fixed-tuition guarantees, 

initiating accelerated degree completion, instituting curriculum innovation, and reducing textbook 

costs. 

IV. Conclusion: 

We strongly support extensions of the American Opportunity Tax Credit, the above-the-line 

deduction for qualified tuition and related expenses, the Employer-provided Educational Assistance 

benefits, the expanded Student Loan Interest Deduction, and the expanded Coverdell Education 

Savings Accounts. These tax provisions enhance access to higher education by providing needed 

support to students or their families, and all of them should be extended this year. We also, however, 

support efforts to simplifY and consolidate several of the higher education tax credits and deductions to 

make them easier to use and therefore more effective. We thank the committee for the opportunity to 

submit this statement for the hearing record and for considering our views. 

MCB/ldw 

Sincerely, 

~fJ.~ 

Molly Corbett Broad 

President 

2 Wellman, Jane V. 2008. Cost, Prices, and.4ffordability: A Background Paper for the Secretary's Commission on the 

Future of Higher Education. 

3 Archibald, Robert B., and David H, Feldman. 2011. Why Does College Cost So Much? New York. NY: Oxford University 

Press. 
167 


82271.134

On behalf of: 

American Association of Community Colleges 

American Association of State Colleges and Universities 

American Council on Education 

Association of American Universities 

Association of Community College Trustees 

Association of Jesuit Colleges and Universities 

Association of Public and Land-grant Universities 

Council of Graduate Schools 

National Association of College and University Business Officers 

National Association ofIndependent Colleges and Universities 

National Association of Student Financial Aid Administrators 
168 


82271.135

American Institute of Certified Public Ac:c:ountants 

Written Testimony for the Record 

Senate Finance Committee Hearing on Education Tax Incentives and TliX Reform 

July 25, 2012 

The American Institute of Certified Public Accountants (AI CPA) has long been an advocate for 

sound tax policy that promotes simplification and fairness of the tax law, as well as ease in 

compliance with and administration of that law, We appreciate the importance and the role that 

education tax incentives play tor families seeking to pay for higher education costs, Thank you 

tor the opportunity to submit our statement on behalf of the members of the AICP A for the 

hearing record. 

Present Law 

Included in the Internal Revenue Code are education incentives that may be divided into two 

general categories: (1) those that are intended to help taxpayers meet CUJ'l'ent higher education 

expenses and (2) those that encourage taxpayers to save for future higher education expenses. 

The first category includes proviSions that may be divided into three main subcategories: (I) 

exclusions from taxable income such as scholarships (section 117) and employer-provided 

educat4 ion assistance (section 127); (2) deductions including the student loan interest deduction 

(section 221) and the tuition and fees deduction (section 222). and (3) credits including the Hope 

Credit (for tax years 2009 through 2012, referred to as the American Opportunity Tax Credit) 

and Lifetime Learning Credit (section 25A). Changes to some of these provisions have already 

occurred while other provisions wi\! see changes on January I, 2013 unless Congress takes 

action to extend the cunen! provisions. 

The second category, intended to fund future education, includes educational savings bonds 

(section 135), qualified tuition programs or QTPs (section 529), and Coverdell Education 

Savings Accounts or ESAs (section 530). 

The various provisions contain numerous and differing eligibility rules sunuruuized in the 

accompanying table. 

Background and Analysis 

Tax incentives are meant to encourage certain types of economic behavior, but taxpayers will 

only respond if they are aware of and understand those incentives. Few, if any, taxpayers are 

both aware of all the education tax incentives and familiar with their details. Fewer still, can 

pertorm the analysis to determine which incentive is most advantageous to them. 

The Internal Revenue Code (IRC) contains at least 14 compie" incentives to encourage saving 

tbr and spending on education. I Requirements, eligibility rules, definitions, and income phase1 The 14 education taX incentive\! are (\) non-itemized tuition deduction; (2) non-itemized college lO8J\ interest; (3) 

itemized deduetion for work related education; (4) HOPE (American Opponunity Tax) Credit; (S) Lifetime 

Learning Credit; (6) lax-free treatment of student loans cancelect; (7) tax-free studentlo8J\ repayment assistance: (8) 
169 


82271.136

outs vary from incentive to incentive, For example, eligibility for one of the two education 

credits depends on numerous factors including the academic year in which the child is in school, 

the timing of tuition payments, the nature and timing of other eligible expenditures, and the 

adjusted gross income ("AGI") level of the parents (or possibly the student). Further, in a given 

year a parent may be entitled to different credits for different children, while in subsequent years 

credits may be available for one child but not another. 

Another complication is that some of the provisions, such as section 222, qualified tuition and 

related expenses, are temporary provisions that are sometimes renewed retroactively, making it 

difficult for taxpayers to plan for optimal usage of the education provisions. Section 222, 

qualified tuition and related expenses expired on December 3, 2011 unless Congress acts to 

extend the provision. 

Further complicating the statutory scheme, the Code precludes use of the Lifetime or Hope 

(American Opportunity Tax) Credit if the child also receives tax benefits from a Coverdell 

Education Savings ACCOWlt. Although the child can elect out of such benefits, this decision also 

entails additional analysis. The IRS publication to explain the income tax rules on education 

incentives (Publication 970) is 87 pages long. 

For many taxpayers, analysis and application of the intended incentives are too cumbersome to 

deal with compared with the benefits received. The U.S. Government Accountability Office 

("GAO") estimated that for tax year that for 2009 returns, about 14% of eligible taxpayers failed 

to claim education incentives resulting in an average lost tax benefit of $466.2 Further, 

according to GAO research, although the number oftaxpayers using the educational tax credits is 

growing quickly, the complexity of the tax provisions prevents hundreds of thousands of 

taxpayers from claiming tax benefits to which they are entitled or which would be most 

advantageous to them.3 Finally, there is evidence that the regressive nature of the provisions 

prevents low·income taxpayers from getting the tax benefit that Congress envisioned.4 

Furthermore, there is evidence from government studies that erroneous application of the Hope 

Credit contributes significantly to the ''Tax Gap." A 2009 U.S. Treasury Inspector General for 

Tax Administration (''TIOTA'') report identified approximately 203,000 taxpayers who claimed 

the Hope Credit for the same student for the three ccnsecutive years ending in Tax Year (TY) 

tax exc'mption for scholar.hips used for wition, fees, and books; (9) CoverdeU Education Savings Accounts; (10) 

penalty-free withdrawal from IRAs to pay for education; 11) interest ellclusion for savings bonds used to finance 

college education; (12) Section 529 qualified tuition plans; (13) tax-free education benefits provided by employer 

plans: and (14) additional dependent exemption for .tudents age 19-23. There is also one disinoentivc for saving 

ou~,id. these pragrllms; income from savings of fulltime students age 19-23 can be l8l\ed at their parents' marginal 

tax rate. 

2 U.S. Govcrrunent Accountability Office, Testimony Before the Subcommitteo: on Select Revenue Measures, 

Committee on Ways and Mean." HaU$. of Representatives, Higher Education - Multiple Higher Education Tax 

Incentives Create 0pPQrlun ilies for T QJlpayers to Make C wtly Mi./akes, May L, 2008, GAO-OS-71 Tf. A May 2012 

report from GAO indicated that for 2009 rotums, about 14% of eligible taxpayers failed to claim education 

inoentives resulting in an average lost taX benefit of $466. GAO, Higher Educalion: Improved T ca: Infomration 

Could Help Families Pay for CollL'g" GAO- 12-560, May 2012. 

3 Ibid. 

, lbid. 
170 


82271.137

2006 (TYs 2004, 2005, and 2006).5 The TIGTA report explained that the amounts of the credits 

inappropriately claimed in TY 2006 averaged close to $1,500 and totaled just over $300 million.6 

Further, over 58,000 of these taxpayers claimed the credit for the same student for four 

consecutive tax years (TYs 2004 through 2007).7 The amounts of the credits inappropriately 

claimed for a fourth year totaled almost $80 million.8 In a separate -report, more than 169,000 

taxpayers were identified who claimed the Hope Credit for the same student for the three 

consecutive tax years ending in TV 2007 (TYs 2005, 2006, and 2007).9 The amounts of the 

credits inappropriately claimed averaged close to $1,400 and totaled just over $232 million. 1o 

In terms of tax policy, the numerous tax incentives to assist with college expenses are not the 

only way the federal government provides assistance to college students and their families. 

Through the Department of Education, the federal government assists low-income individuals 

through various scholarship and grant programs. We encourage Congress to consider all of these 

programs together to determine if the desired goals are being met in an effective and efficient 

manner. The current tax provisions do not always meet the goal of helping low to middle-income 

families with college expenses. Consideration should be given to where assistance can best be 

provided through the tax law (such as incentives to save tor future college expenses) versus grant 

and scholarship programs while the student is in college (where assistance is needed at the start 

of the school year rather than when the ttV< -return is filed). Consideration should also be given to 

identifying the targeted income group that the federal government should be providing financial 

assistance to for higher education expenses. When assessing whether this goal is met, aid 

distributed through scholarships, grants or tax provisions should be considered. 

AlCPA Proposals 

1. Replace tax incentives (i.e., Hope Credit, American Opportunity Tax Credit, 

Lifetime Learning Credit and the tuition and fees deduction) intended to help 

taxpayers meet current higher education expenses with one new or revised credit. 

Combining features of these into one credit would simplifY the tax benefits and 

remove duplicative provisions relating to higher education expenses. 

a. The credit should be on a ''per student" -rather than a ''pe-r taxpayer" basis, 

offering II potentially larger tax benefit per family. 

b. The credit should be available for any year of postsecOndary education, 

including graduate-level and professional degree courses. 

c. The credit should only be available to students meeting the definition of 

"student" under section 2SA(b)(3). 

5 Treasury Inspector General for Tax Adminislt!llioll (2009). Improvl!I1Ients Are Needed in the Administration 0/ Education Credits and Reporting Requirements/or Educational Irutitution.; September 30, 2009, ReE No. 2009.30. 

141. 

e Ibid. 

7 Ibid. 

S Ibid. 

~ Ibid. 

10 Ibid. 
171 


82271.138

d. The credit should have a lifetime limit rather than an annual limit. 

e. The tax return reporting requirement should continue including the SSN of 

the student associated with the expenses claimed with respect to the credit 

taken for the tax year. Accordingly, amounts claimed over time could be 

tracked by the student's SSN. These changes may result in improved 

compliance and enforcement. 

f. The credit should be 100% refundable and phased-out for high income 

taxpayers. The phase-out limitations should be consistent with any other 

education-related incentive. 

g. The credit should be claimed on the parents' return as long as the child is a 

qualifying dependent of the parent. 

2. Create a uniform definition of qualified higher education expenses" (QHEE) for 

all ooucation-related tax provisions. Specifically, QHEE should include tuition, 

books, fees, supplies and equipment. Also, the tenns "special needs services" 

and "special needs beneficiary" should be clearly defined. 

3. Coordinate the phase-out amounts for the student loan interest deduction and the 

educational savings bonds and Coverdell Education Savings Accounts exclusions 

with the new or revised tax credit intended to help taxpayers meet current higher 

education expenses. All education-related tax provisions should have the same 

AGI limitations. The concern for excessively high marginal rates resulting from 

coordinating phase-out provisions should be alleviated by substituting one credit 

for the several benefits that exist today. In addition, any remaining concerns could 

be addressed by widening the phase-out range which would still penni! 

coordination that could simplify matters for taxpayers and improve their 

understanding of eligibility. A single definition of modified AGI should be used 

for the phase-out determination of any education provision. 

82271.139

127 Exclusion for 

employer-provided 

education 

· .. .....(, .' ".' 

Excludes scholarship from income to 

the extent it covers qualified educalion 

expenses foe degree-seeking 

undergraduate student 

For tax years beginning before 2013 Tuition and fees for undergraduate I None 

Employee excludes from income up to and graduate courses; books, 

$5,250 of employer-provided qualified supplies, equipment; but no! room 

education expenses under educational and board 

assistance program 

Docs not have to be foe wock-£elatcd 

82271.140

221 

222 

25A 

Student ID8n inlerest 

deduction 

Qua1ified tuition and 

lees deduction 

Expired 12/31111 

Hllpe credit 

(For tax years 2009 

througb 2012, tile 

For AGI deduction of $2,500 for I Tuition, fees, books, supplies, I s: S60,000 - $75,000 

interest paid on qualifying student loan <:quipmeot, room and board, MFI: $125,000 _ $15

transportation, other necessary MAGI 

For AGI deduction of up to $4,000 

expenses 

Tuition, fees; but not room and 

board 

Student-activity fees and expenses 

for COIIDle-related books, supplies, 

and equipment are included in 

QHEE only if the fces and expenses 

must be paid to the institution as a 

condition of enrollment. Cannot 

include room & board. 

MFS: No deduction 

After 12131112 the th

and phase outs return levels of: 

s: $40,000- $55,000 

MFJ: $60,000- $75,0

Indexed for inflation

S, HOR: If AGI is n

than $65,000, may de

$4,000; if between $6

and $80,000, may de

$2,000 

MFJ: If AGl is not m

$130,000, may deduc

if between $130,000 

$160,000, may deduc

MFS: No deduction 

Credit of up to $2,500 per eligible! Tuition, fees, and course materials I S: $80,000 - $90,000 

stud""l: 100% of first $2,000; plus 25% including books, during first MFJ: $160,000 _ $18

of next $2,000. years of post-secondary educatIon; . MFS: No credIt 

82271.141

25A 

American 

Opportunity Tax 

Credit as described 

in 25A{i» 

Lifetime Learning 

credit 

but not room and board. 

Must be enrolled al least half-time 

Courses must be associated with 

40 percent of modified credit is I degree program or recognized 

refundable (bul no! for child subject to education credential 

section l(g) Kiddie tax) 

If parent pays the expenses, must be 

able to claim exemption for student on 

tax return 

No felony drug conviction 

New regulations explain who gets 

Athletic fees, insurance, activity fees 

are not eligible unless required as a 

condition of enrollment and paid 

directly to the irultitution 

Credit of up 10 $2,000 per return: 20% ,TuitiOn and fees including for I S; $52,000 - $62,000 

on up to $10,000_ The credit is not per graduate courses/continuing 

cbild but per taxpayer. education; bul not room and board I MYJ: $104,000 - $12

A non-refundable elective credit I for all I MFS: No credit 

educatIOn not necessarily assocIated 

If parent pays tbe expenses, must be I with degree 

able 10 claim exemption for student on 

laxretum 

eKplain who gets 
175 


82271.142

Comments for the Record 

United States Senate 

Committee on Finance 

Education Incentives and Tax Reform 

Wednesday, July 25, 2012,10:00 AM 

215 Dirksen Senate Office Building 

By Michael Bindner 

Center for Fiscal Equity 

4 Canterbury Square, Suite 302 

Alexandria, VA 22304 

Chainnan Baucus and Minority Leader Hatch, thank you for the opportunity to address 

this topic. As always, our r·mnments will be in the context of our four part proposal for 

tax refonn, which is as follows: 

• A Value Added Tax (V AT) to fund domestic military spending and domestic 

discretionary spending with a rate between 10% and 13%, which makes sure very 

American pays something. 

• Personal income surtaxes on joint and widowed filers with net annual incomes of 

$100,000 and single filers earning $50,000 per year. 

• Employee contributions to Old Age and Survivors Insurance (OASI) with a lower 

income cap, which allows for lower payment levels to wealthier retirees without 

making bend points more progressive. 

• A VAT-like Net Business Receipts Tax (NBRT), which is essentially a 

subtraction V AT with additional tax expenditures for family support, health care 

and the private delivery of governmental services, to fund entitlement spending 

and replace income tax filing for most people (including people who file without 

paying), the corporate income tax, business tax filing through individual income 

taxes and the employer contribution to OASI, all payroll taxes for hospital 

insurance, disability insurance, unemployment insurance and survivors under age 

60. 

To a large extent, our comments will mirror those of two weeks ago on how tax refonn 

affects the ability of young people to realize the American Dream, since it is largely 

through education that this occurs. 

Our proposal shifts education tax incentives from individuals to employers and from the 

personal income tax to a V AT -like Net Business Receipts Tax that every employer of a 

certain size pays, with some finns who now employee consultants adding them as statute 

employees. The NBRTwouid both fund public collegiate and vocational education and 

allow offsets for providing tuition assistance to employees for pursuing education after 

grade 14 (until that point, education would be free). 
176 


82271.143

We propose that tuition assistance take two forms - the creditable portion which need not 

be paid back and a loan portion that would be paid back with a service requirement, with 

the federal government offering student loans only when the employment situation does 

not work out or the degree is not completed. Involving employers more closely after 

grade 14 allows for the negotiation of volume discounts - which is a hallmark of the 

success of such programs as the H-lB Technical Skills Training Grant and the more 

recent community college initiative. Such employers might also provide housing or pay 

housing and living expenses through some kind of stipend. 

Our proposals go beyond incentives for higher education to other tax incentives to help 

people obtain adult education, either through employers or through an employer-based 

tax payment or charitable contribution in lieu of taxes. 

Some young people have learning deficits. We propose that instead of placing them in 

job training right away, we first pay them to achieve literacy at the tenth grade level, with 

either vocational or college prep/community college after that. In all such cases, students 

who have families or are living outside the home should be paid a minimum wage for 

their study time, with the wage funded either by an employee-sponsor or directly by the 

taxpayer through the training provider, with the funding coming from the NBRT. This 

training can be arranged either by local government, a local public or private school 

system or by employers directly as an offset to the NBRT levy. This would replace 

Temporary Aid to Needy Families. Program providers would also receive a subsidy for 

providing insurance to participants through the policy under which their employees are 

covered, replacing Medicaid for needy families. 

The other problem that young families face is low wages. While there are certainly tax 

credits that make having children more affordable, they are not adequate to meet 

expenses. We propose increasing the Child Tax Credit to $6000 per year (federal share) 

and making it refundable. This would consolidate assistance now provided by the current 

CTC, the Earned Income Tax Credit, the exemption for children, the Supplemental 

Nutrition Assistance Program, the Mortgage Interest Deduction, and the Property Tax 

Deduction. 

Note again that this proposal will likely result in a higher birthrate, as well as lower 

wages for non-parents or for parents whose children have moved away. As such, this 

provision will also decrease the use of both abortion and contraception. If support for it 

is not considered an essential vote for scoring the by National Right to Life Committee, 

then that scoring is hopelessly partisan, as this particular proposal will prevent more 

abortions than any criminal sanction ever would (the Guttmacher Institute estimates that 

72% of abortions are for economic reasons, including the financial well-being of teen 

parents). 

Thank you for the opportunity to address the committee. We are, of course, available for 

direct testimony or to answer questions by members and staff. 
177 


82271.144

The 

Education 

12 

The Employer 

1 

14 

1 
178 


82271.145

The Coalition to Preserve Employer Provided Education Assistance is a broad-based group of 

organizations, companies and associations dedicated to ensuring the tax protection of employees 

who wish to take advantage ofan employer's tuition assistance program. Coalition leadership is 

comprised of the National Association oflndependent Colleges and Universities, Society for 

Human Resource Management, American Council on Education, National Association of 

Independent Schools, University of Michigan, Harvard University, College and University 

Professional Association for Human Resources, National Association of Manufacturers, 

American Federation of Teachers, United Auto Workers and the National Association of College 

and University Business Officers. 

Providing tax-free educational assistance is an important tool employers use to attract the best 

available employees and build a skilled workforce. Additionally, this benefit enables employees 

to continue their education, advance within their positions and obtain new knowledge to ensure 

their competitiveness in the workplace. 

As you may know, Section 127 of the Internal Revenue Code allows an employee to exclude 

from income up to $5,250 per year in assistance provided by their employer for any type of 

educational course at the associate, undergraduate and graduate level. Employers are not required 

to provide assistance under Section 127 to their employees. However, if an employer chooses to 

do so, the benefit must be offered to all employees on a nondiscriminatory basis that does not 

favor highly compensated employees. Congress has extended Section 127 nine times since it was 

created in 1978, most recently in 2010. Section 127 will expire at the end of this year unless 

Congress acts to renew it or make it pennanent. 

Section 127 of the IRC was enacted first as part of the Revenue Act of 1978. Prior to 1978, only 

educational assistance provided by an employer to an employee that related to the individual's job 

was excluded from an employee's gross taxable income. The "job-related" test contained in Internal 

Revenue Regulation 1.162-5 was confusing and resulted in both the Internal Revenue Service and 

the courts making arbitrary decisions as to what types of employer-provided educational assistance 

successfully met the test of job relatedness. Additionally, most entry-level employees were unable 

to claim an exemption for an educational expense because their job descriptions and responsibilities 

were not broad enough to meet the test. In effect, only highly skilled individuals were able to use 

job-related educational assistance. 

The 1978 effort to enact legislation to cover employer-provided educational assistance was led by 

Representatives Guy Vander Jagt (R-MI) and Frank Guarini (D-NJ) and received wide bipartisan 

support. The sponsors of the legislation believed that enactment of the provision would help to meet 

three goals: (1) clarify the tax treatment of employer-provided non-job-related educational 

assistance and job-related educational assistance; (2) reduce the inequity among taxpayers; and (3) 

provide less-educated and skilled employees with opportunities for upward mobility and 

advancement through employer-provided educational assistance. Since the 1978 enactment, 

supporters of Section 127 inside and outside of Congress believe the provision continues to meet the 

goals expressed by the original supporters of the legislation. 

Over the past few years, there have been several failed attempts to make Section 127 benefits 

pennanent. Instead, the provision is continually extended, most recently in the "Tax Relief, 
179 


82271.146

Unemployment Insurance Reauthorization, and Job Creation Act of2010." The approach of 

extending the tax treatment of this provision on a temporary basis causes confusion for both 

employers and their employees who are trying to take advantage of the benefit. Individual 

recipients of Section 127 benefits -- as well as employers -- encounter the tax implication of this 

uncertainty every year as they wonder whether Congress once again will temporarily extend Section 

127 or make it permanent. Consequently, many employees who would like to continue their 

education through Section 127 benefits curtail or terminate their education. When Section 127 

expires, employers still may offer educational assistance but must include the dollar value of the 

benefit in the individual's compensation, which makes it subject to federal and state income tax 

withholding as well as Social Security and Medicare Hospital Insurance taxes. As a result of the 

inclusion ofthe benefits in their compensation, many employees must terminate their continuing 

educational pursuits because of tax liability. 

Attempts to extend or make permanent any tax reductions will be difficult in the current political 

environment due to concerns about the rising federal deficit. Providing tax-free educational 

assistance is an important tool for employers. Section 127 helps to build and maintain an 

increasingly skilled workforce, and positions the United States to remain competitive in the 

global economy. Almost 20 percent of Section 127 recipients are pursuing science, technology, 

engineering and mathematics (STEM) degrees. More than 35 percent of all degrees pursued by 

Section 127 beneficiaries are master's degrees and, according to the National Postsecondary 

Student Aid study ofthe most recent data, use of Section 127 benefits has doubled since 1994. 

Today, more than 1 million employees use Section 127 benefits. 

Employers use Section 127 as a tool to attract and retain their employees. It also allows 

employers to prepare their workforces to be responsive to an ever-changing, evolving workplace. 

By utilizing Section 127, employers are able to train their employees in a variety of disciplines 

which provides job security and versatility for their workers. Likewise, it enables employees to 

advance their education, increase their earning potential and, ultimately to contribute to a 

competitive, adaptive U.S. workforce. 

Employers have demonstrated their commitment to providing education assistance to their 

employees. According to the Society for Human Resource Management (SHRM), 61 % offer 

undergraduate assistance to their employees, up from 58% in 2011. In ajoint report by the 

National Association ofIndependent Colleges and Universities and SHRM, using data from the 

National Postsecondary Student Aid Study (NPSAS:08), individuals who took advantage of the 

benefit were evenly distributed across ages, with the exception of employees who were 44 or old 

who took advantage of the benefit at a higher rate. The same survey also informed us that 

employers' contributions to education assistance were generally over $2,500. 

As demonstrated over the past 34 years, Section 127 has met and exceeded Congressional intent. 

By reducing administrative inequities arising from what is considered "job-related" education, 

eliminating the confusion created by overlapping provisions in the tax code, and finally by 

giving employees the opportunity to advance themselves within their careers, this provision has 

provided millions with a unique opportunity and benefit. 
180 


82271.147

With the current economy in a recession, a benefit such as Section 127 provides the workforce 

with the opportunity for advancement and development within their careers. Likewise, 

employers can utilize Section 127 to increase employee recruitment, loyalty, and retention, 

increasing their global competitiveness and strengthening the skill sets of their workforce. 

Section 127 is a critical provision that develops and enhances the U.S. workforce and economy 

and cannot be overlooked. Section 127 is an efficient and cost-effective provision that deserves 

to be made a permanent part of the tax code. 
181 


82271.148

Statement for the Record 

College Savings Foundation 

2111 Wilson Blvd. Suite 700 

Arlington, VA 22201 

before the 

Committee on Finance 

The United States Senate 

July 25, 2012 

Education Tax Incentives and Tax Reform 

Chairman Baucus, Ranking Member Hatch, and Members of the Committee: 

The College Savings Foundation ("CSF") appreciates the opportunity to provide comments for 

the record regarding the important role of Federal education savings incentives in helping 

Americans meet their higher education costs. CSF is a not-for-profit organization with the 

mission of helping American families achieve their education savings goals. CSF members 

include States, program managers, investment managers, and organizations providing services to 

529 plans, including legal, accounting, and general consulting firms. The primary focus ofCSF 

is building public awareness of, and providing public policy support for, 529 college savings 

plans. 

A post-secondary education is often critical to helping Americans reach their full personal and 

professional potential, and research shows that college degrees produce greater financial success. 

Simply put, higher education leads to higher earnings. l Financing a child's college education 

can be the chief economic goal of an entire extended family, but the costs of a college education 

can be daunting. Too often, families take on the cost of college through "pay-as-you-go" 

financing and "pay-after-you-go" loans. Section 529 college savings plans offer a third option --

an opportunity to save in advance. By saving before a child reaches college age, families can 

help ensure that adequate funds will be there to allow their children to attend college. Moreover, 

research shows that students with college savings are more likely to attend college than students 

without any college savings. 2 

Section 529 college savings plans have been a very successful tool in helping families save for 

college. Generally, under the Federal income tax rules, individuals can make after-tax 

I Sandy Baum et aI., Education Pays 20 I 0: The Benefits 0/ Higher Education/or Individuals and Society, 

College Board Advocacy & Policy Center available at http://trends.collegeboard.orgleducation pays. 

2 William Elliott & Sondra Beverly, The Role o/Savings and Wealth in Reducing "Wilt" Between Expectations and 

Col/ege Attendance, 17 JOURNAL OF CHILDREN & POYERTY 165 (2011), available at 

http://csd. wustl.eduiPublicationslDocuments/WP 1 0-0 l.pdf 
182 


82271.149

contributions into 529 plans, have the earnings grow tax-free, and receive tax-favored 

distributions for amounts used for qualified higher education expenses. 

American families are sending a message that 529s are a successful savings vehicle as 

demonstrated in CSF's most recent quarterly data report. Representing nearly 70 percent of the 

529 marketplace, the CSF data was analyzed by the Financial Research Corporation (FRC). The 

findings are encouraging -- even in these difficult economic times, people are saving and using 

529s. During the first quarter of 2012, CSF members reported $3.4 billion in new contributions 

-- or new money being invested in 529 college savings plans -- representing a 7.2 percent 

increase from $3.1 billion in the fourth quarter of 2011. Overall, 529 college savings plan assets 

climbed to $158.3 billion in the first quarter of2012, reflecting a 9.6 percent increase from 

$144.4 billion in the fourth quarter of2011. The growing utilization of these plans demonstrates 

that they are an important means to assist families in addressing the escalating costs of educating 

their children. 

With the growing popularity of 529 plans, there must be a continued commitment to encourage 

savings by all families -- including those of modest income. Section 529 plans in every State 

have a clear focus or mandate to (I) educate all families on the importance of higher education 

and ways to finance those goals, (2) encourage and assist low- and moderate-income families to 

aspire to higher education for all family members, and (3) provide programs that are available to 

a broad segment ofthe population, including low- and moderate-income families and 

individuals, to help them prepare and save for college. 

Some of the many ways in which State 529 plans help to make college more accessible and 

affordable for all families include: (I) low minimum balance requirements for 529 accounts, (2) 

low monthly contribution minimums, (3) access to mutual fund options that otherwise would 

require contributions in the thousands of dollars, (4) low fee options through direct-sold 

programs with no sales commissions or loads, (5) a range of conservative and/or nearlyguaranteed investment and savings options (including FDIC-insured bank accounts, Guaranteed 

Investment Contracts ("GICs"), money market funds, and Treasury inflation-protected options), 

and (6) State benefits, including in many States income tax credits or deductions and creditor 

protection for 529 accounts. 

Several State 529 plans provide scholarship and matching grant programs targeted at various 

populations, including low- and moderate-income families. A number of 529 plans also are 

involved in financial aid programs such as providing assistance to State partners in conjunction 

with the federal GEAR UP ("Gaining Early Awareness and Readiness for Undergraduate 

Programs"). GEAR UP uses Federal and State funds to create scholarship accounts for lowincome children for post-secondary education. 
183 


82271.150

Many of the scholarship and matching grant programs are still relatively new and developing, 

and while it takes time to truly assess the full effectiveness of these efforts, the commitment of 

529 plans to make a difference and help low- and moderate-income families is certain. Everyone 

involved with 529 plans understands the tremendous potential of these programs to help children, 

parents, young adults, and others believe that a college education is possible and financially 

achievable. 

Another significant component of all 529 plans is a variety of outreach programs created and 

administered by the States -- alone or in conjunction with public and private partners. All of 

these efforts are targeted to that broad segment of the population 529 plans attempt to reach --

including low- and moderate-income families. A small sampling of typical activities of 529 

plans include the following: (I) outreach in public schools, K-12, including work with school 

administrators, parents, and parent-teacher organizations, (2) public service radio and television 

segments, (3) inserts regarding 529 plans with DMV notices, with birth certificates, with State 

income tax mailings, and in conjunction with other public-sector communications, (4) 

collaborations and partnerships with State councils on higher education, colleges and 

universities, financial aid offices, and educational foundations counseling at-risk students about 

higher educational opportunities and financing options, (5) partnerships with employers, both 

public and private, to provide seminars on saving for college, (6) financial literacy outreach and 

seminars, (7) creative use of websites to provide financial literacy information, college savings 

calculators, financial aid information, and other pertinent information, and (8) outreach at State 

and county fairs, children's expos, sporting events, and other kinds of fairs and festivals. 

CSF appreciates the interest of the Finance Committee in exploring the use of the tax code to 

encourage savings for education. While section 529 college savings plans have already helped 

millions of American families be better prepared for the expense of educating their children and 

less dependent on crushing debt, CSF continues to examine ways to make 529 plans even more 

effective. CSF has endorsed several federal legislative proposals that would enhance the ability 

offamilies to better use 529 college savings plans to help meet their education savings goals. 

These include: 

• Allowing the Saver's Credit for contributions to 529 plans. This proposal would provide 

incentives for low- and moderate-income taxpayers to save for higher education by 

making 529 contributions eligible for up to a $1,000 tax credit. The Saver's Credit 

currently is available only for contributions to retirement savings programs such as lRAs 

and 401 (k)s. 

• Clarifying that computers are a qualified higher education expense. Computers are a 

necessary educational tool, and there should be no question that college students should 

be able to use 529 funds for their purchase. 

• Allowing increased flexibility in making investment changes. Permitting States to 

modify their 529 plans to allow more than one change in a 529 plan's investments per 

calendar year would provide 529 plan owners the flexibility to better protect the principal 
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in their plans during times of extreme market volatility. Additionally, the sense that 529 

plan investments are "locked in" could even discourage some families from beginning to 

save for college. 

There is no greater investment this country can make than in educating its citizens. Throughout 

America's history, education has been the gateway to financial prosperity. Today, in the face of 

a challenging economy, affordable higher education is more important than ever, and section 529 

college savings plans are a critical piece in a family's overall college financing strategy. Every 

dollar saved in advance significantly reduces the cost of college, and every dollar saved is one 

less that a family must borrow. The College Savings Foundation looks forward to working with 

the Finance Committee to help ensure that these important college savings vehicles remain 

viable and available to all American families. 
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Statement 

Submitted for the Record 

by 

The College Savings Plans Network 

for the Hearing Held July 25, 2012 by the Senate Committee on Finance 

Entitled "Education Tax Incentives and Tax Reform" 

August 8, 2012 

Mr. Chairman, Ranking Member and Members of the Committee: 

The College Savings Plans Network (CSPN), an affiliate of the National Association of State 

Treasurers, appreciates this opportunity to submit for the record our comments to supplement the 

testimony provided to the Senate Committee on Finance (the Committee) at its hearing on July 25, 2012 

on Education Tax Incentives and Tax Reform. CSPN represents state entities and officials which create 

and administer Section 529 college savings plans (529 Plans) with the goal of helping make higher 

education more accessible and affordable for all families and individuals. At the cnd of 20 II, 529 Plans 

had more than 10.7 million accounts and over $164 billion in assets invested by Americans across the 

country to help prepare to meet the challenge of funding current and future higher education costs. 

In 2009, the U. S. Department of the Treasury (Treasury) researched and wrote a report in 

response to a request from the White House Task Force on Middle Class Working Families on "Financing 

the Dream: Securing College Affordability for the Middle Class." That report, An Analysis of Section 

529 College Savings and Prepaid Tuition Plans, issued on September 9, 2009 (the Report), found that 

"Section 529 plans are an attractive and convenient means of saving for college." The Report also noted 

it could be argued that "the most effective way to help low income families with college expenses is 

through direct student aid, and that Section 529 plans are therefore naturally targeted to higher income 

families." The Report then focused on rccommendations to make Section 529 Plans more accessible, 

effective and reliable for the middle class. We note that, as in most instances in which participation in 

529 Plans is discussed, that term "higher income families" is not defined but used more to differentiate 

from participation by low income families. 

Wc take the time at the beginning ofthese comments to highlight the findings of the Report 

because so much attention in discussions about the effectiveness of 529 Plans centers on who benefits 

from participation in 529 Plans. CSPN believes that 529 Plans encourage and assist a broad cross-section 

of people from all levels of household income to plan and save for post-secondary education, with the 

greatest benefit recognized by that large segment of the popUlation in the so-called "middle class" or with 

moderate incomes. In short, 529 Plans are available to assist those who are not likely to qualify for large 

amounts of need-based aid (except loan packages) but who also are not able to pay for the ever rising cost 

of higher education out of current income or resources. The vast majority of parents and students today 

need a long term plan to cover the cost of higher education and 529 Plans provide incentives to save for 

those post-secondary goals. 

Families and individuals with low or low-moderate income households, however, are certainly 

not ignored or forgotten by 529 Plans. Quite to the contrary, as described in greater detail below and in 

the Appendix to this comment, 529 Plans and the states that sponsor them, are dedicated to outreach and 

education to all families of all socio-economic levels about the importance of higher education, about the 

importance of financial literacy generally, and about the need to plan and save to meet those higher 

education goals. 
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The vast majority of 529 Plans provide very low cost, low initial contribution options in their 

plans, to encourage everyone to save. For many plans, the initial required contribution is as low as $15 to 

$25, with no monthly minimums or service charges. What distinguishes 529 Plans is the variety of 

options provided to families and individuals saving for higher education. Depending on the individual's 

income and ability to contribute, their risk tolerance and their college savings time horizon, the best 

investment or savings options will vary. 529 Plans offer investment options that suit nearly every family 

by providing a range of affordable, quality investment options for those desiring to save for higher 

education and providing complete and accurate information and education about those options to allow 

individuals to choose the 529 plan(s) and investment option(s) best suited to their individual needs, 

savings time horizon and risk tolerance. An example of this is seen in the large number oflow-cost, 

index fund options, the number of low-cost FDIC-insured bank CD and savings account options and the 

other low-risk investment options such as stable value funds and money market funds. 

The July 25 hearing in the Senate Committee on Finance and other previous hearings on 

education have well documented the growing challenges to families and individuals seeking to pay for 

higher education. In the context of tax refonn, as Congress considers how to structure tax incentives for 

education in the most appropriate ways, maintaining and enhancing savings incentives for education 

should be a significant policy pursuit. One dollar of tax expenditure put toward encouraging savings for 

education when a child is very young has the potential to return perhaps three times that amount when the 

child is attending coUege, through the power of compounded growth. That multiplier effect of education 

savings in 529 Plans is a powerful policy basis on which to build in tax reform. Funds saved for higher 

education that are invested in certain investment options offered by 529 Plans are one of the only ways 

families have the potential to keep pacc with the high rate of growth for higher education. That unique 

aspcct of 529 Plans is an important policy factor to consider in the context of how to best structurc 

education incentives in tax reform. 

Families have recognized the power of saving for collcge using 529 Plans as well. Even during 

the challenges to the economy in recent years and the volatility of investment markets, 529 Plans have 

experienced significant growth. College savings plans started several decades ago as state-sponsored 

prepaid tuition programs created to assist families with the then-rising cost of higher education. With the 

passage of Section 529 in 1996, the opportunities in 529 Plans expanded, as Congress recognized the 

desirability of encouraging saving generally and of providing tax incentives to encourage families to 

tackle early the challenges of paying for higher education. The advent of savings programs allowcd more 

states to offer 529 Plans and to broaden the reach of their programs. And families have accepted the 

challenge and committed to planning and saving. In just ten years - and even with the impact of the 

recession in 2008 and 2009 - investments in 529 Plans have grown from $8.3 billion in 2001 to over $164 

billion at the end of2011. And this growth has come slowly and steadily, by and large, from modest 

contributions by millions of people. The average value of a 529 account has grown in recent years but 

remains at a modest $15,349. This figure includes all open 529 accounts, and so reflects both new 

accounts that are just beginning the process of accumulating savings as well as those accounts which are 

currently being used to pay for higher education costs. But the relatively low average balance also 

reflects that the primary owners of 529 accounts are those families in middle America who are willing to 

sacrifice every month, or as often as they can, to save for their future dreams. The most recent data 

compiled by CSPN shows that approximately 39% of 529 accounts receive monthly electronic 

contributions or payroll deduction. The average amount of that monthly contribution is $148. 

529 Plan administrators understand the link between their programs and the aspirations of 

millions of Americans, and they recognize the importance of just getting started by opening a college 

savings account. A recent study indicates that students with even nominal amounts of savings dedicated 

to their college education results in a greatly increased likelihood that students will complete high school, 

attend college, and obtain a degree. The study concluded that "family income, household net worth, and 
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parent savings for youth are not significant predictors of college attendance for youth who expect to 

graduate from college," but instead found that "whether or not youth have accounts and whether or not 

they have savings set aside for school are important predictors" in college attendance.' It would appear 

that the message that college is accessible and possible has tremendous resonance with parents and 

students. Even with recent discussions about whether college is still worth the cost, there is little 

disagreement that a college education - or some post-sccondary training - is an important factor in future 

success and employment. The challenge is in how to make that a reality for everyone at a time when 

costs are rising and, to some, a college education may seem out of reach. State-sponsored 529 Plans are 

at the forefront oftrying to find solutions to that problem. 

Just a small sampling ofthe outreach programs, scholarship programs and matching grant 

programs conducted by 529 Plans across the country provides insight into the steps being taken by 529 

Plans to assist low and moderate income families. 529 Plans meet with individuals and families at 

employer benefits fairs, State Fairs, Kids' Expos, science museums and zoos anywhere significant 

numbers of families gather - to talk about the importance of higher education and the benefits of 529 

programs. In addition, 529 Plans across the country work closely with their institutions of higher 

education to search for ways to make college more accessible and affordable to all citizens. Twentythree 529 Plans offer one or more matching grant programs, in which the 529 Plan will match 529 

account contributions by individuals meeting certain criteria (generally some moderate income threshold) 

up to a designated amount. Another fourteen 529 Plans provide a variety of scholarship programs, also 

aimed at low and moderate income families, to encourage college attainment. Many 529 Plans are 

involved in financial literacy programs in their states, working either alone or with national organizations 

like the Federal Reserve Banks, YMCA, Junior Achievement and their Departments of Education to 

provide the important personal finance and economics education needed to be successful. These 

programs are aimed at both parents and students, in recognition that planning and preparing for higher 

education is a joint effort and that parents and students need to understand why post-secondary education 

is important and strategies for reaching those goals. Finally, a number of 529 Plans administer or partner 

with their states' GEAR UP (Gaining Early Awareness and Readiness for Undergraduate) program, a 

federally created program providing federal funding and state matching funds to assist low-income 

students. This program will be instrumental in evaluating the effectiveness of dedicated college savings 

on college attainment in coming years as part of a study initiated by the U.S. Department of Education 

and 529 Plans will be participating in that study. All of these efforts have the goal of increasing 

awareness of and participation in 529 Plans across a broad segment of the population. Specific examples 

from around the country of 529 Plan outreach efforts, scholarship and grant programs and other 

educational programs are included in the attached Appendix. 

529 programs across the country provide every American with access to a wide range of 

affordable, quality, professionally managed investment options offered by some ofthe best, most highly 

regarded institutional asset managers in the country. In addition, the plans offer access to these quality 

investments at a minimum contribution that is substantially lower than the minimum required to invest in 

many of these same investments outside of a 529 plan. The opportunity to invest in 529 Plans is not only 

a valuable service to our citizens but it is an important part of enhancing the lives of our participants by 

assisting in making their higher education dreams a reality. 529 Plans already have made a positive 

impact on the lives of millions of Americans currently participating in 529 programs, and they have the 

potential to do so much more. Every program in the country is committed to continually improving 

programs and outreach efforts and financial literacy initiatives and programs aimed at low and moderate 

income families. In addition, 529 Plans also encourage efforts to streamline and simplifY the education 

tax incentives, including those provided by Section 529, and look forward to working with Congress in 

the coming months on ways to accomplish that goal. State-sponsored 529 Plans have accomplished a 

great deal in a relatively short period of time to assist families in meeting their higher education goals and 

we realize that much remains to be done. With increased awareness of 529 Plans and their advantages, 
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along with the education efforts of 529 Plans in financial literacy and about the importance of higher 

education, 529 Plans look forward to remaining an important part of the solution to increase college 

attainment by Americans in the coming years. 

i Elliott, W. and Beverly, S. (20 II). The role of savings and wealth in reducing "wilt" between 

expectations and college attendance. Journal C!f Children & Poverty, 17(2), 165-185. 
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APPENDIX 

Examples 0(529 Plan Outreach and Education Programs by State 

ALABAMA 

Will be launching a statewide scholarship program in Fall 2012 for students based on need. 

ARIZONA 

The Arizona 529 Plan engages in the following outreach activities: (i) built a partnership with Valley of 

the Sun and the Tucson YMCAs to distribute college savings planners throughout the month of October; 

(ii) promoted its 529 Plan through a coloring contest in Bear ESsential New with the contest distributed to 

over 400 elementary and middle schools statewide and the $250 first place scholarship sponsored by the 

Collcge Savings Bank; (iii) promoted its 529 plan in Arizona College and Career Guide publication and 

website; (iv) held a promotion on Arizona Collegc Goal Sunday website; (v) created a college savings 

planner describing the Plan and its benefits; (vi) promotes the 529 plan on the Arizona Department of 

Education website, which receives 340,000 visits every 2 weeks; (vii) offers promotional brochures in 

Spanish; and (viii) incorporated infonnation on the Arizona 529 Plan into the "Rapid Guide to Financial 

Aid" publication, which is distributed to state-wide college access programs and Title I schools. 

CONNECTICUT 

The Connecticut Higher Education Trust ("CHET") is committed to making the program more accessible 

to low and moderate income families by providing low fees and low minimum initial and continuing 

contributions, as well as making sure that the program manager aggressively markets CHET in these 

communities. CHET also engages in the following outreach and educational efforts: (i) gives away 

school supplies each summer to underserved children as part of its annual Book Bag Donation to help 

families get ready for the new school year by providing notebooks, pencils, markers, a string bag and 

other materials, to get kids off to a good school-year start and in 2011 CHET partnered with the 

Department of Children and Families (DCF) to distribute 1,529 book bags to the various DCF locations 

across the state; (ii) runs an annual drawing and essay competition, "Dream Big!" where children grades 

K-5 tell what they want to be, or how they want to change the world after college, the competition is open 

to all students, with an emphasis on creating awareness and driving participation among Connecticut's 

underserved school districts and larger cities and towns, the competition awards a $300 contribution to a 

CHET account, for 96 students equally dispersed across all Eight CT Counties, and the competition 

culminates with an awards ceremony at Rentschler Field in East Hartford, CT, where the winners receive 

a certificate and get their pictures taken for their local paper; (iii) 'adopted' an after-school program in 

Waterbury, providing a $5,000 donation to allow the organization to hire a grant writer to apply for 

sustaining funds to support their program and CHET has donated a year's subscription to 

TestPrepFun.com, an online learning tool to help kids develop skills that will help them succeed on the 

Connecticut Mastery Test (CMT); (iv) sponsors three minor baseball leagues the Connecticut Tigers, 

the Bridgeport Bluefish and the New Britain Rockcats and provides game tickets to various local nonprofit organizations whose main focus is to provide services to low-to moderate-income families; (v) 

runs a parent workshop series with Arte, Inc., as part of the SLATE program (Socialization & Learning 

Adventures through Exposure) and the SLATE program providing underserved inner city students with 

skills and opportunities to help them succeed in school and life with the parental component provides 

workshops such as personal finance and college savings and planning for parents and guardians; (vi) 

started a new program in 2012, the School Supply Program, to provide "Friday Folders," Kindergarten 

orientation kits and other school supplies to every elementary school across Connecticut to help defray 

the cost of school supplies for teachcrs and families; (vii) has a Hispanic Consultant in place to ensure 

that CHET is effectively reaching the Latino community and has translated all of the educational 
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materials, enrollment book, Disclosure Booklet and account forms into Spanish so that Spanish-speaking 

individuals can read, understand and interact with CHET in the language they prefer; and (viii) has a fulltime bi-lingual Field Consultant on staff to reach out to the Hispanic community, give presentations and 

workshops in both English and Spanish, and to meet one-on-one with Spanish speaking individuals 

regarding CHET. 

INDIANA 

Indiana Education Savings Authority ("IESA") engages in the following outreach activities: (i) partners 

with the Community Action of Greater Indianapolis "Money Management" Financial Literacy camps and 

through this partnership, both students and parents learn financial skills and the importance of saving, 

including saving for college; (ii) promotes its "Little By Little" program, teaching families that saving, 

even a little at a time, adds up by visiting various kindergarten and elementary school events and 

distributing its "Little By Little" storybook teaching children about the importance of savings, through 

various languages and storylines; (iii) promotes the "Save, Share, Spend" lesson, by distributing 

ColiegeChoice branded banks that have three sections, for saving, sharing, and spending; (iv) visited 

college preparation fairs around the state, including reaching out to financial aid and guidance counselors, 

supplying them with our "Career Chaser" and our "College Prep Book" both are financial literacy and 

savings tools that help middle school and high school students begin preparing for their future education, 

while learning that saving and preparing now is important; (v) partners with LearnMore Indiana, a 

division of its Commission on Higher Education, and a number of their campaigns with a focus on 

planning, preparing and paying for college; (vi) partners with the Money Smart Week Indiana program 

designed to educate consumers about money management and generate awareness of financial education 

available on a wide range of topics such as saving, investing, and using credit wisely; (vii) makes it 

simple for employers to offer the program to employees, as an added benefit, free of charge to the 

employer and affordable for employees to participate; and (viii) sponsors, partners, and appears at 

numbers of community, civic and family friendly events throughout the entire state ranging from 

community center events, state and county fairs, and family focused community events to a partnership 

with the Boy and Girl Scouts, promoting financial literacy through a badge earning program. 

LOUISIANA 

Louisiana's START Saving Program has partnered with the GEAR UP Program, which works with a 

group oflow to moderate income students, to create "Rewards for Success". This program provides an 

opportunity for students to earn scholarship money that in turn is deposited into a START Savings 

account for them. An overview of the program can be found at: http://lagearup.com/standard-initiatives2!rewards-for-success/. Statistics regarding the scholarship disbursements are found at: 

http://louisianagearup.files.wordpress.com/20 12/07 Irfs-slide.pdf. 

MAINE 

The Finance Authority of Maine (FAME), administrator of the NextGen College Investing Plan® 

(NextGen) has engaged in the following outreach activities: (iJ if either the account owner or the account 

beneficiary is a Maine resident, then the NextGen account is considered a "Maine Account" and may be 

eligible for matching or automated funding grants to help open and fund accounts; (ii) FAME continues 

to administer the Harold A1fond College Challenge Grant, which provides a one-time $500 grant for all 

Maine resident babies to open a NextGen account by the baby's first birthday with FAME hosts 

enrollment sessions throughout the state to edncate and assist families with opening a N extGen account; 

(iii) the Maine Department of Labor, in partnership with FAME and others, established the Maine LiLA 

Program (Lifelong Learning Accounts) to help Maine workers upgrade their skills and education while 

meeting the demands of businesses for a skilled workforce (the Maine LiLA Program also provides free 
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advising services to employees to assist in education and career planning and employers match 

contributions to NextGen accounts to help their employees finance lifelong learning); and (iv) NextGen 

also provides a unique vehicle to first generation, low income students from Maine to save for college 

ealled The SAVER Program, launched July 1,2006 in collaboration with the University of Maine at 

Presque Isle - TRiO Upward Bound (TRiO Upward Bound students open a NextGen account and 

contribute a portion of the TRiO Upward Bound stipend to their NextGen account). 

MARYLAND 

The following are Maryland's 529 Low and Moderate Income Initiatives for fiscal 2012: (i) attendance at 

BTS Nights and distribution of BTS flyers across the State including areas that have a larger population 

oflow and moderate income families; (ii) attendance at Parent Information Nights across the State; (iii) 

employer payroll deduction programs with the State and County employees; (iv) attendance at African 

American Heritage Festival in Baltimore City, Prinee George's County Fair, Charles County Fair, 

College Education is Within Reach - A College Fair in Spanish at University of Maryland, Financial 

Empower Day, Columbia International Day, Baltimore County African American Cultural Festival, 

Greenbelt Labor Day Festival, Enoch Pratt Children's Book Celebration, International Festival, Elijah 

Cummings How to Pay for College Seminar, Nativity Miguel College Fair for Baltimore City (Nativity 

Miguel middle schools students are in an underserved community in the inner-city), Money Power Day in 

Baltimore City, MD Annual Black Caucus Foundation Annual Weekend, Annual Church Compliance 

Conference vendor, and seven Church college fairs in Baltimore City and PG County; (v) partners with 

Six Flags America in Bowie, Baltimore Ravens, Maryland Cash Campaign (by distributing brochures at 

Cash Academy events and tax preparation events across the State), Libraries (by sponsoring summer 

reading programs in 8 countics across the State), the AFRO American Newspaper Character Education 

Essay Contest, Prince George's County Schools (by distributing a spccial tcchnical flyer across student 

services), African American Heritage Museum (by sponsoring the Black History Month lecture serics), 

Minor League baseball teams (by sponsoring Summer Reading Programs), and Maryland Scicnce Center 

(by b>1ving out free tickets to families with children 8 and under on a College Savings Plans of Maryland 

Day); and (vi) distribution ofliterature to PG County Children's Services, Human Services Coalition 

(large group ofPG County group of non-profits), Libraries, Hospitals, Goodwill Industries (for 

distribution to new hires), and YMCA of Central MD (for distribution to all new hires and employees). 

MASSACHUSETTS 

The Massachusetts Educational Financing Authority ("MEFA") has produced a video which in part 

features low and moderate income families who have started saving for college. The video is available at: 

http://www.youtube.comlwatch?v= RYa5Y7pWjs& feature=player embedded. The following are 

MEFA Savings Outreach to Low- and Moderate Income Families: (i) partner on research project with 

Harvard University and Stanford University (The Early College Planning Initiative ECPI) examining the 

effects of a program that attempts to increase awareness about college savings options, simplify the 

process of opening an account, encourage take-up saving by contributing to the initial balance, and 

encourage continued savings through automatic monthly contributions (to date, 262 families have 

participated and 30 U.Fund accounts have been opened); (ii) works with Compass Working Capital, a 

nonprofit organization that helps working, low-income families save toward a first-time home, a college 

education, or a small business to provide education about college savings to families (to date, 148 college 

savings accounts have been opened with 100 of those accounts opened at workshops and 48 opened 

through IDA programs); (iii) assisted FUEL (Families United in Educational Leadership), an organization 

providing knowledge, resources, connections, and financial incentives that empower parents to propel 

their children into higher education, with putting together program to offer 529 plan savings option and 

presentations reaching families and opening college savings accounts; (iv) in partnership with Upward 

Bound, an organization serving high school students from low-income tamilies and high school students 

from families in which neither parent holds a bachelor's degree, presented on Early College Planning and 
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Saving for College to parents of students in middle and high schools; (v) with assistance from ACCESS 

and Boston Interfaith organization staff, presented and supported workshops on savings in Spanish, 

Portuguese, and Haitian Creole; (vi) held workshops with graduates of the One Family Scholar program, 

an organization with a mission to end homeless in Massachusetts through education, to educate them 

about how to open college savings accounts for their own children; (vii) presented on "saving for college" 

and "paying for college" as well as staffed a table at The Money Conference, a free one-day event 

presented by The Office of Massachusetts State Treasury and the Massachusetts Financial Literacy Trust 

Fund, in conjunction with local cities and community partners to help households build their financial 

knowledge and improve their financial behavior through quality financial education; (viii) participates in 

post-deployment events with the National Guard and Reserve to talk with families about saving and 

paying for college; (ix) presented to groups of young students about planning for college in partnership 

with the Girl Scouts of Central and Western MA, an organization dedicated to helping girls develop 

qualities that will serve them all their lives, like leadership, strong values, social conscience, and 

conviction about their own potential and self-worth; (x) presented to students and parents at College 

Readiness Workshop in partnership with Southeast Asian Coalition (SEAC), an organization with the 

mission of helping Southeast Asians in Central MA successfully integrate into the mainstream society 

while maintaining their unique cultural identity; and (xi) holding seminars and webinars regularly that are 

open to the public. 

NEVADA 

The Nevada Plan engages in the following outreach and educational efforts: (i) hosted 2 Nevada Women 

Money Conferences in May of 20 12 and included granting 200 low to moderate income women access to 

the conference free of charge; (ii) raised awareness and participation in the Silver State Matching Grant 

program, a program providing low to moderate income NV families with up to $300 per year, per child 

towards their SSgAUpromise529 account (127 families applied for this program in 2012, vs. the 88 

families who applied in 2011); (iii) coordinated a "Financial Fitness for Life" pilot in 10 High Schools in 

the State of Nevada, with over 1000 students participating with a portion of the participating schools with 

low to moderate income families and included lessons on the importance of saving for college through a 

"Millionaire Facts or Fiction" game among other key lessons aimed at increasing financial literacy 

amongst youth and the importance of obtaining a college degree; (iv) worked with USAA 529 Program 

Managers to expand the existing USAA Matching Grant Distinguished Valor program to include all 

active Nevada Military families making less than $75,000/year; (v) worked with Putnam 529 for America 

Program Managers to develop a merit based matching grant program to provide matching grant money up 

to $1000 annually, with a $3500 lifetime maximum for bencficiaries of Putnam 529 accounts who meet 

merit based eligibility criteria; and (vi) conducted a '529 Day' contest with all Nevada Elementary 

Schools with five $529 account prizes awarded to families in May to jump start their college savings 

accounts. 

RHODE ISLAND 

The Rhode Island Plan engages in the following outreach and educational efforts: (i) Matching Grant 

Program with funds deposited in CollegeBoundfund® matching contribution accounts established for the 

benefit of income-qualifying students and their families (this program is geared toward low- and middleincome families); (ii) CollegeBoundfund Baby Program for beneficiaries of College Bound fund accounts 

established before the child's first birthday or within one year of the child's adoption (eligible 

beneficiaries are awarded a $100 grant into their CollegeBoundfund account); (iii) each year under the 

Academic Promise Scholarship Program, RIHEAA provides grants of up to $2,500 per academic year and 

$10,000 for four years ($12,500 for qualifying 5 year programs) to a cohort of 100 per year (400+ over 

four years) of the highest achieving and neediest Rhode Island students; and (iv) WaytoGoRI.org is a 

college and career exploration and planning website available free of charge to all Rhode Islanders 

and helps students identify and build upon their aspirations, guiding them through high school planning, 

college planning and onto their career. 
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UTAH 

The Utah Educational Savings plan (HUESP") actively campaigns across Utah to promote saving for 

collcge. While UESP encourages familics of all cconomic levels to plan and prepare for higher education 

expenses, many local UESP outreach efforts specifically target families with low-to-moderate incomes. 

To accomplish this, UESP makes the following initiatives and partners with the following community 

organizations that support UESP's mission: (i) backpack brochures are distributed annually to Utah's 

elementary schools, 42 percent of which are Title I elementary schools (reaches approximately 125,000); 

(ii) Fast Forward Matching Program for economically challenged Utah residents matches up to $400 

annually per beneficiary (brochures are distributed through Title I schools; Utah Food Bank Services; Big 

Brothers Big Sisters; Junior Achievement; United Way of Salt Lake; the Utah Department of Workforce 

Services; and Women, Infants, and Children (WIC) offices); (iii) mails information about UESP, in 

conjunction with the Utah Department of Vital Statistics, to every Utah parent with a four-to-six-weekold newborn (information reaches more than 15,500 mothers under the age of25'); (iv) sponsor of the 

Road to Success program, encouraging children from kindergarten to sixth grade to read 20 minutes a day 

with a parent by entering a child into a drawing to win a $50 UESP college savings certificate when he 

achieves specific milestones (currently, 260 of Utah's 556 elementary schools are enrolled in the 

program, including 46,800 students in Title I schools); (v) created and sponsors the Transition to Adult 

Living (TAL) Scholarship designed for qualified youth who are transitioning out offoster care and are 

ready to begin their post-secondary education with recipients selected based on financial need, potential 

for academic success, and their desire to complete a post-secondary program of study (a study' performed 

by DHS reported that only 33.8 percent of youth who left foster care between 2000 and 2006 attended 

post-secondary education and training programs within three years ofleaving care); (vi) partnership with 

the Utah chapter of the American Heart Association with their program to help the Hispanic popUlation 

learn about improving their quality of life, including maintaining good health and achieving a higher 

education; (vii) partnership with Boys & Girls Club an organization focused on serving boys and girls 

between ages 6-18 through initiatives that promote such topics a. gender inclusion, family involvement, 

education achievement, career exploration, leadership development, and community service; (viii) 

supporting Head Start, a comprehensive child development program that provides educational, nutritional, 

medical, and social services to children and families living in poverty, by donating college savings 

certificates for fundraising activities and giving presentations about UESP Head Start's Family Advocates 

group; (ix) partnering with the Junior Lcague of Salt Lake City, a charitable organization of women 

committed to promoting volunteerism, developing the potential of women, and improving communities 

through the effective action, education, and leadership of volunteers, by promoting the UESP Fast 

Forward Matching Program to low-income women, children, and families through the league; (x) 

partnering with the United Way of Salt Lake, an organization supporting a community-wide safety net to 

meet critical needs and working toward long-term solutions in the areas of education, income, and health, 

by providing information about UESP for its newsletters and links to uesp.org appear on its website; (xi) 

partners with Utah Community Action Partnership (UCAP), an organization advocating for, supporting, 

and training agencies funded by Utah's Community Service Block Grant, utilizing their collective 

strength to eradicate poverty, by promoting the importance of a higher education in eliminating poverty; 

(xii) partnering with the Utah Council on Financial and Economic Education, an organization with a 

mission to educate Utah residents and their children about the importance of financial literacy, by helping 

drive the mission of this council; (xiii) partnersbip with Utah Individual Development Account Network 

(UIDAN) with UIDAN providing a designated match ($3 for every $1 deposited) toward purchasing an 

approved asset (Individual Development Accounts (IDAs) are matched savings accounts that help lowincome families break tbe cycle of poverty). 

: Utah's Vital Statistics: Births and D~aths~ 2010, Office of Vital Records and Statistics, health.utah,goVfvi~alrecordsfpUb_vsfial0fl0bx_10122011.Pdf2QIQ. 

Assessing Outcomt:'5 a/Youth Tronsltionmg from Foster Care, State of Utah, Department of Human SerVices, 2010. 
194 


82271.161

VIRGINIA 

'The Virginia College Savings Plan (Virginia 529) engages in the following outreach and educational 

efforts: (i) SOAR Virginia® is an early commitment scholarship program created by Virginia 529 to 

inspire and assist high school students from low to moderate income households to rcach their postsecondary education goals and to participate, eligible studcnts, commencing with mostly loth graders, 

pledge to meet program rcquirements with participating students receiving a range of assistance and 

accumulate scholarship support of up to $2,000 to apply toward their post-secondary cducation expenses 

(participating SOAR Scholars must qualify for the National School Lunch Program as certified by the 

participating high school) (ii) commitment to enhancing financial literacy initiatives throughout Virginia 

led Virginia 529 to a statewide partnership with Junior Achievement, which provides financial literacy 

curricula to K-12 students across Virginia (earlier this year Virginia 529 awarded a $1,000 college 

savings account to the winner of the Junior Achievement "Dream Job" contes)t; (iii) partnership with the 

Virginia Department of Education and the Virginia Bankers Association Education Foundation to develop 

a year-long web-based curriculum on Economics and Personal Finance to meet statutory Standards of 

Learning requirements and provided to all Virginia high schools without cost (56 school divisions will be 

offering the Economics and Personal Finance courses during the 2012-2013 school year, the course is also 

available online through Virtual Virginia and will initially be taught by 29 teachers throughout the state); 

(iv) partnership with Partnership for the Future (PFF), which affords one high school student an 

opportunity to experience a real life work environment during the summer and Virginia 529 conducts 

annual presentations to prospective PFF members about setting up college savings accounts and how 

bcnefits can best be utilized, (the selected student will be eligible to receive wages for their work, and will 

also receive up to $2,000 towards a VEST college savings account, to be used for future college costs 

with 99% of the 500+ PFF students who have participated in the program have matriculated at postsecondary educational programs); (v) partnership with the Virginia College Access Network (VCAN) to 

help enhance and support access to post high-school educational opportunities for students (annually, 

Virginia 529 presents information to 250+ members of the organization, which is then distributed across 

the state) (vi) partnership with the Virginia Council on Economic Education to sponsor the annual Color 

the Economic Concepts contest, which engages teachers and students in grades K-8 to illustrate their 

knowledge of economic concepts in a creative and fun way (winning posters are distributed across the 

state, with winning entries receiving a $100 VEST College Savings Account); (vii) each year on May 

29th, Virginia 529 partners with 10+ hospitals across the state to award $529 collcge savings accounts to 

529 day babies those born closest to 5:29 pm at participating hospitals (additionally, this year Virginia 

529 awarded ten $529 college savings accounts to others throughout the state to promote general college 

savings awareness); (viii) in an effort to enhance reading and writing curriculums across the 

Commonwealth, Virginia 529 partners with WCVE (Richmond PBS affiliate) to sponsor the annual PBS 

Kids GO! Writers Contest, which recognizes students in grades K-3 for original, creative stories, which 

are written and illustrated by the student; (ix) partnership with the Virginia Parent Teacher Association 

(VPT A) to increase awareness of college savings opportunities throughout the ycar (Virginia 529 

annually makes 20+ presentations to parents and leadership groups, reaching over 5,000 families 

throughout the state); (x) partnership with the Science Museum of Virginia and NASA Education 

Specialists to develop and coordinate the Virginia 529 Kids Zone at Richmond International Raceway, 

Children and adults who visit Richmond's two annual NASCAR races are able to learn about the 

influence of science and aerodynamics on the sport of auto racing. Our premier partnership with the 

Science Museum extends into the museum, with our support helping to fund exhibits while underwriting 

educational opportunities for students; and (xi) sponsorship of Big Brothers Big Sisters Duck Race, 

Council ofindependent Colleges of Virginia, Hampton Roads 200+ Men Scholars Academic 

Achievement Breakfast, Organization of Virginia Homeschoolers, Radio One's Teacher of the Week, 

Virginia High School League, WTVR-6 Battle of the Brains Contest. 
195 


82271.162

Statement on behalf of the National Association of Home Builders 

120115th St NW 

Washington, DC 20005 

Committee on Finance 

Hearing on 

Boosting Opportunities and Growth Through Tax Reform: Helping More Young People 

Achieve The American Dream 

July 10,2012 

The National Association of Home Builders (NAHB) appreciates the opportunity to submit this 

statement on "Boosting Opportunities and Growth Through Tax Reform: Helping More Young 

People Achieve The American Dream." 

The National Association of Home Builders is a Washington-based trade association 

representing more than 140,000 members involved in home building, remodeling, multifamily 

construction, property management, subcontracting, design, housing finance, building product 

manufacturing and other aspects ofresidential and light commercial construction. NAHB is 

affiliated with 800 state and local home builders associations around the country. NAHB's 

builder members will construct about 80 percent of the new housing units projected for this year. 

Importance of Focusing on Lifecycle Impacts in Addition to Income Distribution Impacts 

NAHB believes that relying solely on income distribution tables-which is the traditional 

measure for evaluating the distributional impact of tax changes-when making policy decisions 

provides only a narrow glimpse into the effects of tax reform. Changes in tax policy can also 

have significantly different impacts on taxpayers based on their age, which can dramatically alter 

economic opportunities over a taxpayer's lifetime. NAHB first raised this issue to the committee 

in the testimony of Dr. Robert Dietz on October 6,2011, at a hearing focusing on the incentives 

for homeownership. NAHB is pleased that the committee is holding this hearing on the impact 

of tax reform on young people. 

Homeownership is one of the primary means for young people to invest in their future. The tax 

code contains several provisions that facilitate homeownership by younger buyers. The 

importance of this deduction to younger buyers can be seen by looking at the United Kingdom. 

In the 1980s and 1990s, the U.K. phased out its mortgage interest deduction. Some opponents of 

the mortgage interest deduction cite the U.K. when calling for eliminating the deduction in the 
196 


82271.163

U.S. However, the changes in the U.K. have had a dramatic impact on younger homebuyers. 

From 1984 to just recently, the average age of a first time homebuyer in the UK rose from 31 to 

38. This is a significant delay that will have dramatic demographic impacts. 

NAHB believes that any policy change that makes it harder to buy a home, or delays the 

purchase of the home until an older age, will have significant long-term impacts on household 

wealth accumulation and the makeup of the middle class as a whole. Delayed investment in 

homeownership may translate into lower assets at retirement or a later retirement. Despite recent 

price declines, equity in a home constitutes a substantial proportion of a typical American 

family'S wealth. According to the 2007 Federal Reserve Survey of Consumer Finances, the 

median net worth of a homeowner is $234,600; for renters, it was $5,100. 

It is also worth noting in this vein that the largest homeownership declines as a result of the 

Great Recession have occurred among younger homeowners. This has two causes. One, fewer 

households are being formed as younger individuals double up or, as a second reason, such 

individuals choose to live with their parents or other family. NAHB estimates that 2.1 million 

households have not formed for these reasons, and thereby constitute "pent-up housing 

demand." The Census Bureau has found similar estimates.! 

Given that the MID offers large benefits, as a share of household income, for younger 

homeowners, the loss of this benefit will only make homeownership less-accessible to those 

younger households who have been devastated by the ongoing housing crisis. Weakening the 

mortgage interest deduction, particularly in high cost areas (which are high cost because housing 

demand is high, typically because jobs are in supply), means shutting out younger, aspiring 

middle class Americans from homeownership, which could have far reaching social and 

economic outcomes. As an example, CDC fertility rate data indicate that as a result of the Great 

Recession, the number of births in the United States is declining, and this decline is particularly 

being recorded among those future middle class Americans. 

Housing Tax Incentives Are Targeted To Young Americans 

NAHB's research has also shown a direct correlation between the age of the homeowner and 

their resulting benefit from the housing tax incentives. Unlike other itemized deductions, the 

total benefits of housing-related deductions, such as the mortgage interest deduction, generally 

decline with age. After all, it is younger households who typically have new mortgages, less 

amount of equity, and growing families. 

1 http://blogs.census.gov!censusblog!2011!09/households.doubling-up.html 
197 


82271.164

Using IRS data, NAHB examined the age characteristics of taxpayers claiming the mortgage 

interest deduction. Figure I plots the average mortgage interest deduction2 by age cohort. 

$16,000 

$14,000 

$12,000 

$10,000 

$8,000 

$6,000 

$4,000 

$2,000 

$0 

Figure 1: Average Mortgage Interest Deduction 

18 under 35 35 under 45 45 under 55 55 under 65 65 and over 

This is consistent with the deduction for mortgage interest peaking soon after the taxpayer moves 

from renting to homeowning and then declines as homeowners pay down their existing mortgage 

debt. 

Figure 2 shows this data as shares of AGL The data reveal that the mortgage interest and the real 

estate tax deductions fall as a share of taxpayer income for older taxpayers, while the share 

increases for non-housing itemized deductions. 

2 This includes the deduction for home equity loans and real estate tax deductions. See Housing Tax Incentives: 

Age Distribution Analysis, by Robert Dietz, May, 2, 2010. 

http:Uwww.nahb.org/fileUpload details.aspx?contentiD=149284&fromGSA=1 
198 


82271.165

18% 

16% 

a 14% 

c( 12% ::: 

co 10% U 

., 8% :t 

'0 6% 

?I. 4% 

2% 

0% 

Figure Z: Aggregate Deductions Claimed 

18 35 45 

under under under 

35 45 55 

55 

under 

65 

65 and 

over 

~Non-Housing Itemized 

Deductions 

___ Real Estate Tax 

Deduction 

,.*. Mortgage Interest 

Deduction 

As a share of household income, the largest benefit goes to those aged 18 to 35. Together, this 

data highlights the fact that the mortgage interest deduction strongly benefits younger households 

who tend to be recent homebuyers with less home equity. 

As an example of how a change in tax policy could impact younger Americans in an unintended 

but negative fashion, President Bush's 2005 tax reform panel recommended limiting the real 

estate and mortgage interest deduction to pay for, among other items, a reduction in the AMT. 

As Figure 3 shows, the average AMT tax paid increases significantly with age. 

Figure 3: Average AMT Tax Paid 

$12,000 .,----------------------

$10,000 

$8,000 +------------------

$6,000 

$4,000 +--:-::=::-----

$2,000 

$0 

18 under 35 35 under 45 45 under 55 55 under 65 65 and over 
199 


82271.166

While the tax refonn panel's suggestion may not have shown as a major change in an income 

distribution analysis, Figure 3 and the results outlined above indicate that such a proposal would 

reduce a tax benefit that is of relative importance to younger households in order to increase a 

tax benefit for older households. Generational impacts like this are often not discussed by tax 

policy analysts in lieu of traditional income distributional analysis, but the long-tenn effects are 

potentially significant. This is why NAHB believes that part of designing a fair tax system 

involves looking at the effects on both income distribution and across age groups. 

Lifecyle Targeting 

The current tax code contains a number of tax incentives that target taxpayers at certain points in 

their life, and as a result can be unfairly characterized as a "loophole" benefiting only a narrow 

group of taxpayers. Such arguments fail to account for the lifecycle effect of some tax 

provisions, especially those that target younger workers. 

As an analogy, consider the following non-housing example. The 2005 IRS SOl data reveal that 

only 8 million taxpayers benefited from the tax code's interest deduction for student loans. This 

represents approximately 6 percent of all taxpayers. Nonetheless, the student loan interest 

deduction is, like the mortgage interest deduction, a tax preference claimed at a particular time in 

an individual's life, and does not represent a tax preference that benefits only a narrow set of 

taxpayers, despite its low number of claimants in a single year. 

Opponents of the mortgage interest deduction note, for example, that only a quarter of tax filers 

itemize, leading some to conclude that only a small percentage of homeowners claim the MID. 

This is false. 

The most important detenninant of taxpayer itemization is homeownership. The Joint 

Committee on Taxation (JCT) estimates reveal that 34.6 million taxpayers claimed the MID for 

tax year 2009. While this number represents 22% of all tax returns, it is in fact 46% of all taxable 

returns and nearly 70% of itemizing returns. The more relevant numbers, however, are the 

shares of homeowners. There are 75 million homeowners in the U.S., so approximately half in a 

given year claim the MID. However, approximately 25 million of that 75 million own their 

homes free and clear of a mortgage (but likely benefited from the MID in the past). This means 

ofthe homeowners with a mortgage, 70% claim the MID. 

Of those who do not, most are older homeowners in the later years of the mortgage when they 

are paying relatively more principal and relatively less interest. For these homeowners, the 

standard deduction is a better option. 

Using Bureau of Economic Analysis data, NAHB estimates that over the last decade, 86% of 

mortgage interest paid has been claimed as a deduction on Schedule A. Taxpayers benefit from 

the homeownership tax deductions at specific times during their lives, and as the data above 

illustrated, this benefit is claimed predominately by younger taxpayers. And cumulatively, these 
200 


82271.167

numbers illustrate that over the tenure of homeownership, almost all homeowners will claim the 

MID for years at time, particularly as first-time homebuyers paying large amounts of interest and 

relatively little principal. 

Home Equity Deduction and Higher Education 

Present tax law also permits homeowners to deduct interest allocable to up to $100,000 of home 

equity loan debt. Such loans are defined as mortgages taken against a home that are not used for 

purchase, construction or improvement purposes. This distinction carries over in the rules for the 

Alternative Minimum Tax. In general, deductions for mortgage interest may be claimed against 

AMT taxable income. However, there is an exception for home equity loans not used for home 

improvement purposes. 

According to the 2009 American Housing Survey, half of all home equity loans are used for 

remodeling purposes. Remodeling is, of course, another form of housing investment which 

creates jobs and improves the nation's housing stock, particularly with respect to energy 

efficiency. Disallowing a deduction for interest for home remodeling provides a disincentive for 

homeowners to improve the nation's existing housing stock and hurts job creation in the 

remodeling industry. 

There is no data that indicates what the remaining half of home equity loans are used for, but 

anecdotal evidence suggests that those purposes include college expenses, health emergencies 

and some consumption purposes. 

There has been a lot of attention paid to the rising amount of student loan debt. Some of this 

commentary goes as far as saying that recent data indicate a bubble exists for student loans, one 

that will burst with negative consequences for housing and other parts ofthe economy. 

It is true that outstanding student loan debt has risen. But the data suggest that, in part, this rise in 

explicit student loan debt is in fact a shift of the source of higher education financing--one 

related to housing itself. Namely, with the onset of the housing crisis, there was a decline in the 

availability of home equity loans, often used to finance higher education of children by 

homeowning parents or to finance other large expenditures, thus freeing resources for college 

expenses. Consequently, students are more likely to take out student loans on their own behalf? 

3 For more details, see: http://eyeonhousing.wordpress.com/2012/06/21/student·loans·and·housing/ 
201 


82271.168

Figure 4: Shifting the Financing of College 

$1,200,000 

$1,100,000 

$1,000,000 

§ $900,000 '" 

---- ~ 

~ 

c:: 

$800,000 

-----

$700,000 

-- -

$600,000 --- $500,000 

00 00 

---en en en en en en 0 0 0 0 0 0 ..... ..... ..... ..... ..... ..... '" '" ~ 0 'i' ~ 'i' 'i' 'i' ~ '7 ..... ..... '7 ..... ..... ..... ..... ..... '7 ..... ..... ..... ..... 

~ " ~ :; 0- c: .!. >- :; a. > ~ .!. >- :; a. > ~ .!. OJ '" '" OJ 0 '" '" ~ OJ 0 '" '" OJ 0 

v;> z ,. :::; :::; '" ,. v;> z ,. :::; ;:!; v;> z ,. :::; :::; ,. ~ z ,. :::; ..... rl ..... rl rl ..... ..... rl ..... rl rl ..... rl ..... rl rl ..... rl ..... rl 

--Student Loan debt --Home Equity Loan debt 

The data thus do not necessarily reveal a sharp increase in borrowing for college education, but 

rather a shifting in the form of borrowing. And this is yet another consequence of the harm 

inflicted on the middle class as home prices fell, leading to a nearly 40% decline in median 

household net worth according to the 2010 Survey of Consumer Finances. 

This issue is once again a reminder of the importance of housing wealth for the middle class. 

When that wealth declines, or otherwise becomes inaccessible (as is the case with home equity 

loans), it causes significant changes for the economy as a whole. The rise in student loan debt is 

a good example, where it seems to be the case the decline in home equity loans has resulted 

in some changes for how higher education is fmanced. 

The Pew Charitable Trusts sponsored similar research indicating the critical relationship between 

housing market health, family wealth, and educational access.4 The study found: "the model 

shows that low- and middle-income students whose families experienced increases in housing 

wealth just before reaching college age were more likely to attend college, more likely to attend 

higher-quality universities, and more likely to graduate." 

This relationship between housing and education is a reminder that debt used for investment 

purposes - including buying a home (residential capital), obtaining an education (human capital), 

and starting a business (business capital) - is economically justified and should not be penalized. 

Debt for these purposes is how young people enter and remain in the middle class. This is a 

4 http://www .pewstates. orgjresearch/reports/h ousing-wealth-a nd-higher -education-85899380316. Housing 

Wealth and Higher Education. December 1, 2011. 
202 


82271.169

useful reminder given ongoing tax reform debates about the justifications of deductions for 

interest payments. 

Conclusion 

Since most homeowners benefit from the mortgage interest deduction, and most ofthat benefit 

flows to younger, middle class families, making homeownership less accessible is likely to 

diminish the financial success of future generations. And as owning a home is a significant 

means for savings for most homeowners, the capitals gains exclusion protects that investment. 

Without the mortgage interest deduction, NAHB believes that disparity in economic income 

would increase, opportunities for younger Americans to move up the economic ladder would 

diminish, and the middle class would continue to shrink. 

NAHB supports the goal of many in Congress to reform the tax code. NAHB believes that lower 

rates, simplification, and a fair system will spur economic growth and increase competitiveness. 

And that's good for housing, because housing not only equals jobs, but jobs means more demand 

for housing. To foster that virtuous cycle for economic growth, we believe strongly that you 

must look upon the homeownership tax incentives with caution. 

NAHB also renews its call to the committee, when considering tax reform, to request that the 

Joint Committee on Taxation look beyond the typical income distribution analysis. Specifically, 

NAHB believes that any tax reform proposal also examine the generational or age-cohort 

consequences. As the committee moves forward on tax reform, NAHB wants to be a 

constructive partner and help this committee with this important issue. 
203 


82271.170

Grrol/1d!licSchol1ls 

ftrr EI!"" Sh#Jf'IIr 

[201 16th SL N W Wa<;htngton, DC 2(Jv36 Phone· (2021833-4000 

July 24, 2012 

Committee on Finance 

United States Senate 

Washington, DC 20510 

Dear Senator: 

Dt'nnis Van Rockel 

President 

Lily Eskclscn 

I~ice President 

Rebecca S, Pringle 

SecrefaJ:v-T'reasufrr 

John Stocks 

t,\"ecutive Director 

The National Education Association, representing more than three million educators across the 

country, would like to provide you with the following comments in advance of this week's 

hearing in the Senate Finance Committee on "Education Tax Incentives and Tax Reform." NEA 

calls on the Finance Committee to: 

Extend the educator tax deduction 

Provide tax incentives for new building, refurbishing, and technology upgrades in postsecondary and K-12 education, including by extending the Qualified Zone Academy 

Bond program 

Expand access to and affordability of higher education through expanded tax credits. 

NEA strongly supports an extension of the educator tax deduction. This critical deduction, 

which expired at the end of the 2011 tax year, helps recognize the financial sacrifices made by 

teachers and education support professionals. 

Educators often reach into their own pockets to purchase classroom supplies because they want 

to make sure students have what they need to succeed. Studies show that educators are spending 

more of their own funds each year to supply their classrooms and purchase essential items. 

According to NEA's most recent survey, 97 percent of educators surveyed indicated that they 

had spent some of their own money to meet the needs of their students -- an average of $477 a 

year to purchase classroom supplies such as books, pencils, paper, and art supplies. 1 

According to a 20 I 0 report by Otfice Max. seven in ten teachers report their schools are not able 

to provide them with all the necessary tools to effectively teach their students, and 79 percent of 

educators say their classrooms are in need of more items that they currently lack such as essential 

classroom supplies, paper products, and arts and crafts supplies. The majority (82%) of teachers 

think it is their responsibility to ensure students have the best learning experience possible no 

matter the price tag - spending their own money on supplies for their students each year. 

Everyday classroom supplies such as pencils and pens (78%), prizes and incentives (72%), and 

arts and crafts supplies (72%) top the list of purchases teachers make using their own cash. 2 

! National Education Association, Status of the American Public School Teacher 2005-2006, March 2010. 

2 OfficeMax Teacher Survey, May 2010, http://multi,,u,pmewswire,com/mnr!ofticemaxl43900J 
204 


82271.171

Many educators are finding the need to buy supplies for their students has increased in these 

difficult economic times, as funding cuts lead to shortages in essential materials and more 

students come to school without basic learning tools. A large majority of educators also spend 

canan average of $15 a month out of their own pockets to feed students. (Status of the American 

Public School Teacher 2005-2006, March 2010i 

The need for these expenditures is not surprising. According to First Focus: 

• 2.7 million more children lived with an unemployed parent during a typical month in 2011, 

compared to 2007 (an increase of71%), bringing the 2011 total to 6.5 million children; 

3 million (47% of those living with an unemployed parent) lived, during a typical 2011 

month, with a parent unemployed six months or longer; 

• 8 million more additional children relied upon SNAP for food in 2011, compared to 2007, 

bringing the total number of children receiving SNAP to 21 million (one in four); 

• 16 million children (more than one in five) currently live in poverty4 

• One in three working families today find that employment does not guarantee a decent living 

standard. Forty percent of all children 30 million kids grow up in such households.s 

The educator tax deduction is a bipartisan recognition of educators' financial sacrifices as well as 

of the needs of students who lack even the basic necessities for success in school. Extending it 

will make a real difference for many educators, who often must sacrifice other personal needs in 

order to pay for classroom supplies and instructional materials. 

NEA also supports providing tax deductions for new building, refurbishing, and technology 

upgrades. To this end, we support: 

• Extending the Qualified Zone Academy Bond (QZAB) Program 

On average, the buildings that house our public schools are more than 40 years 01d.6 The 

American Society of Civil Engineers gives the condition of our schools a grade of"D" and 

attributes the failure to upgrade them to "problems in the financial sector and declining 

revenues for states and local governments."? According to Fix America's Schools Today 

(FAST!), a project of the Economic Policy Institute and the 21st Century School Fund 

schools need an estimated $500 billion in repairs and upgrades. 

The QZAB program has proven to be an efficient and cost-effective way to help 

disadvantaged communities address pressing renovation and repair needs. QZABs assist 

school districts in rural and urban communities by providing a financing mechanism to 

renovate buildings and invest in equipment and technology. Investors receive a federal tax 

credit equal to the amount of interest payable on the bonds, thereby relieving local taxpayers 

and municipalities of the interest burden. A school that is awarded a QZAB may use the 

funds to renovate and repair buildings; invest in equipment and up-to-date technology; 

develop challenging curricula; or train quality teachers. 

'Ibid. 

, The Recession's Ongoing Impact on America's Children: Indicators afChiidren's Economic Well-Being Through 

201 I, Julia Isaacs, Brookings Institution, December 2011. 

, Living an the Edge: America's Low-Earning Families, Sophia Parker, The Resolution Foundation, September 

2011. 

6 National Center for Education Statistics 

7 Report Card for America's Infrastructure, 2009 
205 


82271.172

Providing Tax Incentives for Higher Education Infrastructure Investments 

Investments in higher education infrastructure will save and create jobs in the construction 

and supporting industries and will help ensure postsecondary students access to the state-ofthe-art learning environments so critical for the 21 st Century. 

NEA believes that anyone who is qualified and interested in post-secondary education should 

have the opportunity, regardless of ability to pay. To that end, NEA supports: 

Expanding Existing Tax Credit Programs to Augment Access and Affordability 

Having more college educated workers in the American workforce is crucial to growing our 

economy. In order to compete in the 21 st century global economy, we need to give all 

Americans the opportunity to pursue a college degree. 

Tax credits like the American Opportunity Tax Credit (AOTC) are critical to increasing 

access to and affordability of higher education, particularly for lower income students. The 

AOTC, created as palt of the American Recovery and Reinvestment Act, provides a $2500 

per year tax credit for working families and students attending college. The tax credit is 

partially refundable, meaning it can help lower income students afford a college education 

that might otherwise be out of reach. The AOTC covers many of the expenses associated 

with sending a child to college, including textbooks and computers. Making this tax credit 

permanent would mean students could get up to $10,000 for four years of college. 

Expanding Loan Forgiveness Programs for Educators 

NEA supports expanding loan forgiveness programs for students who enter public service 

careers. Spiraling college costs have made it increasingly difficult for many students to 

afford postsecondary education. And, far too many of today' s students rely on loans in order 

to attend college. The resulting debt burden often limits career choices and prevents many 

talented students from pursuing careers in public service, including as teachers. 

We thank you for the opportunity to provide these comments. 

Sincerely, 

Kim Anderson Mary Kusler 

Director, Center for Advocacy Director of Government Relations 
206 


82271.173

REBUILD 

~ AMERICA'S 

SCHOOLS 

A /lr'utiMui Cos/idQIJ 

SCHOOL DISTRICTS 

Akron,OH 

Aldinc,TX 

Birmingham City, AL 

Birmingh91l\ Public, AL 

Bosto11, MA 

Rroward County, FL 

Brownsville, TX 

Chicago,IL 

Cincinnati, OH 

Clark County, NV 

Compton, CA 

Corpus Christi, TX 

Da}1on,OH 

Delroit,Ml 

Escambia, FL 

Houston, TX 

Jefferson Parish, LA 

]erseyCity,NJ 

McAllen, TX 

Memphis, TN 

Miami-Dade, FL 

Milwaukee, WI 

Minneapolis, MN 

Montgomery, AL 

Nashville, TN 

Newark,Nl 

New Orleans, LA 

New York, NY 

Norfolk, VA 

Oklahoma City, OK 

Omaha, NE 

Pharr-San Juan-Alamo, TX 

Philadelphia, P A 

Providence, R! 

Richmond, V A 

Rochester, NY 

Savannah-Chatham, GA 

St. Louis, MO 

St. PauL MN 

foJedo, Oil 

Tuisa,OK 

Ysleta. TX 

1440 N Street, NW 

Suite 1016 

Washington, OC 20005 

PHON!; 202462-5911 

nx 202-986-4569 

!"~MAJl. 

RebuildAmerica~Schools@ 

comcastnet 

National Parent Teacher Association 0 Council of The Great City Schools 0 National Education Association 

American Federation of Teachers 0 American Association of School Administrators a National School Boards Association 

National Association of Elementary School Principals 0 National Association of Secondary School Principals 

NAACP 0 National Association of Federally Impacted Schools 0 American Institute of Architects 

Organizations Concerned About Rural Education 0 National Rural Education Association 

Califomians tor School Facilities 

Statement for the Record 

U.S. Senate Committee on Finance 

Hearing on 

Education Tax Inceutives aud Tax Reform 

July 25, 2012 

Chairman Baucus and Members ofthe Finance Committee: 

Rebuild America's Schools, a national coalition, is writing to express our 

support for the extension of the Qualified Zone Academy Bond CQZAB) as 

well as the Qualified School Construction Bond programs, QZABs enacted 

in the Taxpayer Relief Act of 1997 and extended with bipartisan support in 

subsequent Congresses allow schools districts to modernize school facilities 

and to improve curriculum, QZABs are a cost effective program being used 

by school districts in every state to renovate, repair and modernize school 

buildings and classrooms, School districts in Montana, Utah, West Virginia, 

Michigan, Arizona, Texas and every state from Maine to Florida to Alaska 

and Hawaii have used QZABs to modernize classrooms and schools, The 

federal tax credits provided to finance QZABs are a small federal investment 

improving America's school facilities where students can better succeed, 

Rebuild America Schools also supports the extension of the Qualified School 

Construction Bond program which has benefited local school districts in 

forty-nine states, 

QZABs and QSCBs are helping school districts provide modem, more 

energy efficient schools improving the learning environment for students and 

enhancing the workplace for students, teachers and staff. Equally important, 

local jobs are generated as modem schools advance student achievement in 

urban, rural and suburban communities in every state, 

Rebuild America's Schools asks that the Qualified Zone Academy Bonds and 

Qualified School Construction Bonds supporting school modernization and job 

creation be included among tax extension provisions considered by the Finance 

Committee this year, 

Rebuild America's Schools appreciates the Finance Committee's consideration 

of these comments, 

Robert P. Canavan, Chair 
207 


82271.174

United States Senate 

Committee on Finance 

Hearing on Education Tax Incentives and Tax Reform 

July 25,2012 

Submission for the Record 

Lidia Carneiro 

Manager, Employee Scholar Program 

United Technologies Corporation 

4 Farm Springs Road 

Farmington, CT 06034 

I am writing to provide input on the critical topic of education tax incentives 

and tax reform from the perspective of an employer that provides education 

benefits for its workforce. 

United Technologies Corporation (UTC) is an American company with 

headquarters in Hartford, Connecticut. We provide high-technology 

products and services to the global aerospace and building systems 

industries. Our diverse product offerings include heating, air-conditioning 

and refrigeration solutions; aerospace systems; elevators and escalators; 

jet engines; helicopters; and fire and security systems. 

At UTC, we recognize that a highly educated workforce is critical to our 

future success. In today's globalized environment, employers cannot 

promise lifelong employment to every worker. We can, however, provide 

employees with meaningful opportunities to expand their skills. 

UTC demonstrates its commitment to this principle by providing our 

workforce with an employee education program that is second to none. 

Through our Employee Scholar Program, UTC covers our employees' 

expenses for tuition, fees, and books at approved educational institutions 

for undergraduate, graduate, and professional degree programs regardless 

of whether they are related to the employee's current job. We make 

payments directly to schools to minimize out-of-pocket costs. We even 

provide paid time off for studying. 

Since the creation of our Employee Scholar Program, UTC employees 

have earned over 33,000 degrees. This year, UTC is celebrating a 
208 

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