Higher Education: Multiple Higher Education Tax Incentives Create Opportunities for Taxpayers to Make Costly Mistakes
Published: 2008-05-01T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Federal assistance helps students and families pay for postsecondary education through several policy tools--grant and loan programs authorized by Title IV of the Higher Education Act of 1965 and more recently enacted tax preferences. This testimony summarizes our 2005 report and provides updates on (1) how Title IV assistance compares to that provided through the tax code (2) the extent to which tax filers effectively use education tax preferences, (3) potential benefits and costs of simplifying federal student aid, and (4) what is known about the effectiveness of federal assistance. This hearing is an opportunity to consider whether changes should be made in the government's overall strategy for providing such assistance or to the individual programs and tax provisions that provide the assistance. This statement is based on updates to previously published GAO work and reviews of relevant literature.
section_title: What GAO Found
paragraphs: Title IV student aid and tax preferences provide assistance to a wide range of students and families in different ways. While both help students meet current expenses, tax preferences also assist students and families with saving for and repaying postsecondary costs. Both serve students and families with a range of incomes, but some forms of Title IV aid--grant aid, in particular--provide assistance to those whose incomes are lower, on average, than is the case with tax preferences. Tax preferences require more responsibility on the part of students and families than Title IV aid because taxpayers must identify applicable tax preferences, understand complex rules concerning their use, and correctly calculate and claim credits or deductions. While the tax preferences are a newer policy tool, the number of tax filers using them has grown quickly, surpassing the number of students aided under Title IV in 2002. Some tax filers do not appear to make optimal education-related tax decisions. For example, our analysis of a limited number of 2005 tax returns indicated that 41 percent of eligible tax filers did not claim either the tuition deduction or a tax credit. In so doing, these tax filers failed to reduce their tax liability by $219, on average, and 10 percent of these filers could have reduced their tax liability by over $500. One explanation for these taxpayers' choices may be the complexity of postsecondary tax provisions, which experts have commonly identified as difficult for tax filers to use. Simplifying the grants, loans, and tax preferences may reduce complexities in higher education financing, including reducing the number of eligible tax filers that do not claim tax preferences, but more research would be necessary to understand the full benefits and costs of any such changes. Little is known about the effectiveness of Title IV aid or tax preferences in promoting, for example, postsecondary attendance or school choice, in part because of research data and methodological challenges. As a result, policymakers do not have information that would allow them to make the most efficient use of limited federal resources to help students and families.

section_title: Letter
paragraphs: We are pleased to be here this morning to discuss the complexity of  multiple tax incentives targeted to postsecondary education. American  higher education has long been crucial to the development of our nation’s  cultural, social, and economic capital. At the dawn of the 21st century,  changing workforce demographics, a more integrated global economy, and  numerous technological advances are placing new demands on our  colleges and universities. For the United States to remain competitive in  the rising global knowledge economy, its citizens will need both the ways  and means to endow themselves with the tools necessary for the task.   Nevertheless, the affordability of American higher education remains a  topic of considerable attention as evidenced by the work of the current  Congress in both passing the College Cost Reduction and Access Act and  its ongoing efforts to reauthorize the Higher Education Act of 1965.
This hearing is an opportunity to consider whether any changes should be  made in the government’s overall strategy and the individual programs and  tax provisions that provide financial assistance to students and families  saving or paying for postsecondary education or repaying student loans.  This opportunity to review the programs and tax provisions is important  for several reasons. The fact that we face large and growing structural  deficits in the future—primarily driven by demographics and rising health  care costs—emphasizes the need to consider how the government  allocates resources. In addition, we have noted that fundamental  reexamination of government programs, policies, and priorities is  necessary to assure that they match the needs of the 21st century. We have  identified the coordination of student aid programsand the effectiveness  of those programs both as key topics needing congressional oversight.
GAO, Suggested Areas for Oversight for the 110th Congress, GAO-07-235R (Washington,  D.C.: Nov. 17, 2006). assistance made available under Title IV of the Higher Education Act and  postsecondary education tax preferences.
Postsecondary student financial assistance provided through programs  authorized under Title IV and the tax code differ in three key ways.  First, Title IV grant and loan programs traditionally provide aid to  students and families while students are in college, whereas tax  preferences help both during the college years as well as before and  after college by assisting with saving for or repaying college costs.  Additionally, while student aid programs and tax preferences serve  students and families across a wide range of income groups, some Title  IV programs—particularly the Pell Grant program—provide much of  their financial assistance to students and families whose incomes are  lower, on average, than students and families who receive student  loans, tax credits, and deductions, or who make use of tax-exempt  saving vehicles. Last, students and families have more responsibility for  appropriately using and thereby obtaining the benefits of tax  preferences than they do with Title IV aid.
Second, postsecondary tax preferences are difficult for families to  understand and use correctly. Perhaps due to the complexity of the tax  provisions, hundreds of thousands of taxpayers fail to claim tax  preferences to which they are entitled or do not claim the tax  preference that would be most advantageous to them.
Third, proposals to simplify the federal financial assistance programs  for postsecondary education may help to address the complexities in  the current system and improve tax filers’ use of education tax  preferences.  However, more research is needed to understand the  range of potential benefits and costs associated with any such changes.
Finally, we found that Congress has received little evidence concerning  the effectiveness of assistance provided under Title IV or through tax  preferences, including whether such assistance increases attendance or  choice.
Our statement today is drawn from reviews of relevant literature and  updates to previous GAO reports and testimonies covering postsecondary  Title IV programs and tax preferences.  We conducted our work in April  2008 in accordance with generally accepted government auditing  standards.  Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  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.
subsections: section_title: Background
paragraphs: Financial assistance to help students and families pay for postsecondary  education has been provided for many years through student grant and  loan programs authorized under Title IV of the Higher Education Act of  1965, as amended. Examples of these programs include Pell Grants for  low-income students, PLUS loans to parents and graduate students, and  Stafford loans.Much of this aid has been provided on the basis of the  difference between a student’s cost of attendance and an estimate of the  ability of the student and the student’s family to pay these costs, called the  expected family contribution (EFC). The EFC is calculated based on  information provided by students and parents on the Free Application for  Federal Student Aid (FAFSA). Federal law establishes the criteria that  students must meet to be considered independent of their parents for the  purpose of financial aid and the share of family and student income and  assets that are expected to be available for the student’s education.In  fiscal year 2007, the Department of Education made available  approximately $15 billion in grants and another $65 billion in Title IV loan  assistance. Title IV also authorizes programs funded by the federal  government and administered by participating higher education  institutions, including the Supplemental Educational Opportunity Grant  (SEOG), Perkins loans, and federal work-study aid, collectively known as  campus-based aid. Table 1 provides brief descriptions of the Title IV  programs that we reviewed in our 2005 report and includes two  programs—Academic Competitiveness Grants and National Science and  Mathematics Access to Retain Talent Grants—that were created since that  report was issued.
Postsecondary assistance also has been provided through a range of tax  preferences,including postsecondary tax credits, tax deductions, and tax- exempt savings programs. For example, the Taxpayer Relief Act of 1997  allows eligible tax filers to reduce their tax liability by receiving, for tax  year 2007, up to a $1,650 Hope tax credit or up to a $2,000 Lifetime  Learning tax credit for tuition and qualified related expenses paid for a  single student. According to the Office of Management and Budget, the  fiscal year 2007 federal revenue loss estimate of the postsecondary tax  preferences that we reviewed was $8.7 billion. Tax preferences discussed  as part of our 2005 report and December 2006 testimony include the  following:  Lifetime Learning Credit—income-based tax credit claimed by tax filers  on behalf of students enrolled in one or more postsecondary education  courses.
Hope Credit—income-based tax credit claimed by tax filers on behalf  of students enrolled at least half-time in an eligible program of study  and who are in their first 2 years of postsecondary education.
Student Loan Interest Deduction—income-based tax deduction claimed  by tax filers on behalf of students who took out qualified student loans  while enrolled at least half-time.
Tuition and Fees Deduction—income-based tax deduction claimed by  tax filers on behalf of students who are enrolled in one or more  postsecondary education courses and have either a high school  diploma or a General Educational Development (GED) credential.
Section 529 Qualified Tuition Programs—College Savings Programs  and Prepaid Tuition Programs—non-income-based programs that  provide favorable tax treatment to investments and distributions used  to pay the expenses of future or current postsecondary students.
Coverdell Education Savings Accounts—income-based savings program  providing favorable tax treatment to investments and distributions used to  pay the expenses of future or current elementary, secondary, or  postsecondary students.
As figure 1 demonstrates, the use of tax preferences has increased since  1997, both in absolute terms and relative to the use of Title IV aid.
section_title: Tax Preferences Differ from Title IV Assistance in Timing, Distribution, and Students’ and Families’ Responsibility for Obtaining Benefits
paragraphs: Postsecondary student financial assistance provided through programs  authorized under Title IV of the Higher Education Act and the tax code  differ in timing of assistance, the populations that receive assistance, and  the responsibility of students and families to obtain and use the assistance.
subsections: section_title: Title IV and Tax Programs Differ in Benefit Timing
paragraphs: Title IV programs and education-related tax preferences differ significantly  in when eligibility is established and in the timing of the assistance they  provide. Title IV programs generally provide benefits to students while  they are in school. Education-related tax preferences, on the other hand,  (1) encourage saving for college through tax-exempt saving, (2) assist  enrolled students and their families in meeting the current costs of  postsecondary education through credits and tuition deductions, and (3)  assist students and families repaying the costs of past postsecondary  education through a tax deduction for student loan interest paid.
section_title: Beneficiaries of Title IV Programs and Tax Preferences Differ
paragraphs: While Title IV programs and tax preferences assist many students and  families, program and tax rules affect eligibility for such assistance. These  rules also affect the distribution of Title IV aid and the assistance provided  through tax preferences. As a result, the beneficiaries of Title IV programs  and tax preferences differ.
Title IV programs generally have rules for calculating grant and loan  assistance that give consideration to family and student income, assets,  and college costs in the awarding of financial aid.For example, Pell Grant  awards are calculated by subtracting the student’s EFC from the maximum  Pell Grant award ($4,310 in academic year 2007—2008) or the student’s  cost of attendance, whichever is less.  Because the EFC is closely linked to  family income and circumstances (such as the size of the family and the  number of dependents in school), and modest EFCs are required for Pell  Grant eligibility, Pell awards are made primarily to families with modest  incomes. In contrast, the maximum unsubsidized Stafford loan amount is  calculated without direct consideration of financial need: students may  borrow up to their cost of attendance, minus the estimated financial  assistance they will receive.As table 2 shows, 92 percent of Pell financial  support in 2003—2004 was provided to dependent students whose family  incomes were $40,000 or below, and the 38 percent of Pell recipients in the  lowest income category ($20,000 or below) received a higher share (48  percent) of Pell financial support.
Because independent students generally have lower incomes and  accumulated savings than dependent students and their families, patterns  of program participation and dollar distribution differ. Participation of  independent students in Pell, subsidized Stafford, and unsubsidized  Stafford loan programs is heavily concentrated among those with incomes  of $40,000 or less: from 74 percent (unsubsidized Stafford) to 95 percent  (Pell) of program participants have incomes below this level. As shown in  table 3, the distribution of award dollars follows a nearly identical pattern.
Many education-related tax preferences have both de facto lower limits  created by the need to have a positive tax liability to obtain their benefit  and income ceilings on who may use them. For example, the Hope and  Lifetime Learning tax credits require that tax filers have a positive tax  liability to use them, and income-related phase-out provisions in 2007  began at $47,000 and $94,000 for single and joint filers, respectively.  Furthermore, tax-exempt savings are more advantageous to families with  higher incomes and tax liabilities because, among other reasons, these  families hold greater assets to invest in these tax preferences and have a  higher marginal tax rate, and thus benefit the most from the use of these  tax preferences. Table 4 shows the income categories of tax filers claiming  the three tax preferences available to current students or their families,  along with the reduced tax liabilities from those preferences in 2005.
section_title: Students and Families Have More Responsibility for Obtaining Benefits of Tax Preferences in Comparison to Title IV Aid
paragraphs: The federal government and postsecondary institutions have significant  responsibilities in assisting students and families in obtaining assistance  provided under Title IV programs but only minor roles with respect to tax  filers’ use of education-related tax preferences. To obtain federal student  aid, applicants must first complete the FAFSA, a form that requires  students to complete up to 99 fields for the 2007—2008 academic year.  Submitting a completed FAFSA to the Department of Education largely  concludes students’ and families’ responsibility in obtaining aid. The  Department of Education is responsible for calculating students’ and  families’ EFC on the basis of the FAFSA, and students’ educational  institutions are responsible for determining aid eligibility and the amounts  and packaging of awards.
In contrast, higher education tax preferences require students and families  to take more responsibility. Although postsecondary institutions provide  students and the Internal Revenue Service (IRS) with information about  higher education attendance, they have no other responsibilities for higher  education tax credits, deductions, or tax-preferred savings. The federal  government’s primary role with respect to higher education tax  preferences is the promulgation of rules; the provision of guidance to tax  filers; and the processing of tax returns, including some checks on the  accuracy of items reported on those tax returns. The responsibility for  selecting among and properly using tax preferences rests with tax filers.  Unlike Title IV programs, users must understand the rules, identify  applicable tax preferences, understand how these tax preferences interact  with one another and with federal student aid, keep records sufficient to  support their tax filing, and correctly claim the credit or deduction on their  return.
section_title: Some Tax Filers May Not Effectively Use Postsecondary Tax Preferences, Possibly Due to Complexity
paragraphs: According to our analysis of 2005 IRS data on the use of Hope and Lifetime  Learning Credits and the tuition deduction, some tax filers appear to make  less-than-optimal choices among them. The apparent suboptimal use of  postsecondary tax preferences may arise, in part, from the complexity of  these provisions.
subsections: section_title: Some Tax Filers Appear to Make Suboptimal Choices
paragraphs: Making poor choices among tax preferences for postsecondary education  may be costly to tax filers. For example, families may strand assets in a  tax-exempt savings vehicle and incur tax penalties on their distribution if  their child chooses not to go to college. They may also fail to minimize  their federal income tax liability by claiming a tax credit or deduction that  yields less of a reduction in taxes than a different tax preference or by  failing to claim any of their available tax preferences. For example, if a  married couple filing jointly with one dependent in his/her first 2 years of  college had an adjusted gross income of $50,000, qualified expenses of  $10,000 in 2007, and tax liability greater than $2,000, their tax liability  would be reduced by $2,000 if they claimed the Lifetime Learning Credit  but only $1,650 if they claimed the Hope Credit.
In our analysis of 2005 IRS data for returns with information on education  expenses incurred, we found that some people who appear to be eligible  for tax credits or the tuition deduction did not claim them. We estimate  that 2.1 million filers could have claimed a tax credit or tuition deduction  and thereby reduced their taxes.  However, about 19 percent of those  filers, representing about 412,000 returns, failed to claim any of them. The  amount by which these tax filers failed to reduce their tax averaged $219;  10 percent of this group could have reduced their tax liability by over  $500.
In total, including both those who failed to claim a tax credit or tuition  deduction and those who chose a credit or a deduction that did not  maximize their benefit, we found that in 2005, 28 percent, or nearly 601,000  tax filers did not maximize their potential tax benefit.  Regarding those  making a poor choice among the provisions, for example, 27 percent of tax  filers that claimed the tuition deduction could have further reduced their  tax liability by an average of $220 by instead claiming the Lifetime  Learning Credit; 10 percent of this group could have reduced their tax  liabilities by over $630.  Tax filers that claimed the Hope Credit when the  Lifetime Learning Credit was a more optimal choice failed to reduce their  tax liabilities by an average of $356.
Suboptimal choices were not limited to tax filers who prepared their own  tax returns. A possible indicator of the difficulty people face in  understanding education-related tax preferences is how often the  suboptimal choices we identified were found on tax returns prepared by  paid tax preparers. We estimate that 50 percent of the returns we found  that appear to have failed to optimally reduce the tax filer’s tax liability  were prepared by paid tax preparers. Generalized to the population of tax  returns we were able to review, returns prepared by paid tax preparers  represent about 301,000 of the approximately 601,000 suboptimal choices  we found. Our April 2006 study of paid tax preparers corroborates the  problem of confusion over which of the tax preferences to claim. Of the  nine undercover investigation visits we made to paid preparers with a  taxpayer with a dependent college student, three preparers did not claim  the credit most advantageous to the taxpayer and thereby cost these  taxpayers hundreds of dollars in refunds. In our investigative scenario, the  expenses and the year in school made the Hope education credit far more  advantageous to the taxpayer than either the tuition and fees deduction or  the Lifetime Learning credit.
section_title: The Suboptimal Use of Postsecondary Tax Preferences May Result from Their Complexity
paragraphs: The apparently suboptimal use of postsecondary tax preferences may  arise, in part, because of the complexity of using these provisions. Tax  policy analysts have frequently identified postsecondary tax preferences  as a set of tax provisions that demand a particularly large investment of  knowledge and skill on the part of students and families or expert  assistance purchased by those with the means to do so. They suggest that  this complexity arises from multiple postsecondary tax preferences with  similar purposes, from key definitions that vary across these provisions,  and from rules that coordinate the use of multiple tax provisions. Twelve  tax preferences are outlined in IRS Publication 970, Tax Benefits for  Education: For Use in Preparing 2007 Returns. The publication includes  four different tax preferences for educational saving. Three of these  preferences—Coverdell Education Savings Accounts, Qualified Tuition  Programs, and U.S. education savings bonds—differ across more than a  dozen dimensions, including the tax penalty that occurs when account  balances are not used for qualified higher education expenses, who may  be an eligible beneficiary, annual contribution limits, and other features.
In addition to learning about, comparing, and selecting tax preferences,  filers who wish to make optimal use of multiple tax preferences must  understand how the use of one tax preference affects the use of others.  The use of multiple education-related tax preferences is coordinated  through rules that prohibit the application of the same qualified higher  education expenses for the same student to more than one education- related tax preference, sometimes referred to as “anti-double-dipping  rules.” These rules are important because they prevent tax filers from  underreporting their tax liability. Nonetheless, anti-double-dipping rules  are potentially difficult for tax filers to understand and apply, and  misunderstanding them may have consequences for a filer’s tax liability.
section_title: Benefits to Simplifying Federal Student Aid Have Associated Implementation Challenges and Costs
paragraphs: Many researchers and policy analysts support simplifying the existing  federal grant, loans and tax preferences in the belief that doing so would  have a net benefit on encouraging access.  Indeed, suggestions put forth in  recent years to combine the federal grants and tax credits, for example,  may help address some of the challenges we identified in recent years  regarding tax filers’ suboptimal use of postsecondary tax preferences or  the confusion created by the interactions between direct student aid  programs, such as the Pell Grant, and existing tax preferences.  In this  case, reducing the number of choices students and their families have to  make would likely reduce tax filers’ confusion and mistakes.
To date, we have not undertaken any studies of how current Title IV  student aid programs or tax preferences could be simplified and, as a  result, have not developed any such models or proposals.  However, while  different aspects of simplification may provide students and their families  with various benefits, Congress would likely want to weigh those benefits  against a number of potentially related costs.
Simplifying the federal application for student aid—A better  understanding is needed about whether or to what extent simplifying the  application for federal aid would: (1) alter the administration of other  federal, state and institutional student aid programs, (2) be capable of  accommodating future federal policies designed to target aid, and (3)  affect current programs that are specifically tied to Pell Grant eligibility.   The current FAFSA is used to determine students’ eligibility for various  federal aid programs, including Pell Grants, Academic Competitiveness  Grants, SMART Grants, Stafford and PLUS loans, Supplemental  Educational Opportunity Grants (SEOG), Perkins Loans, and Federal  Work-Study.  In addition, many states and schools rely on the FAFSA  when awarding state and institutional student aid.  To the extent that  other programs require FAFSA-like information from applicants to award  financial aid, additional research is needed to determine whether  simplifying the FAFSA may actually increase the number of applications  students and families would be required to submit.
Simplifying eligibility verification requirements—Both grants and tax  credits are awarded based, in part, on students’ and their families’  incomes, which means students and families are required to document  their income to receive the benefit.  Under the current system, some  students and families are eligible to apply for Title IV student aid even  though they are not required to file a tax return; in such cases, eligibility is  computed based upon information reported on the FAFSA.  Any plan to  consolidate some or all of the current federal grants and tax preferences  would need to consider how to minimize burden on students and families  while also controlling federal administrative costs, for example, by  minimizing the use of multiple verification procedures that use multiple  forms of documentation and that are administered by multiple agencies.
Simplifying program administration while maintaining federal cost  controls —Federal grant and loan programs are administered by the  Department of Education while federal tax preferences are administered  by IRS.  Under a system where existing grant aid and tax credits are  consolidated, it is unclear without additional research, whether cost  efficiency is better achieved through having the Department of Education  or IRS assume federal budgeting and accounting responsibilities.  In  addition, the grant programs generally are subject to an annual  appropriation which enables Congress to control overall federal  expenditures by taking into account other federal priorities.  In contrast,  most tax preferences are like entitlement programs and their revenue  losses can only be controlled by changing the statutory qualifications for  the tax preference.
Simplifying aid distribution—Policymakers will need to consider costs  associated with the federal government recovering funds if students fail to  maintain eligibility requirements over the course of an academic year.   Families currently claim tax preferences after qualifying higher education  expenses have been incurred but receive federal grant benefits to pay  current expenses.  Program simplifications that consolidate grants and tax  preferences into a benefit paid before expenses are incurred likely will  require the implementation of new cost recovery mechanisms or other  means to allocate payments based on costs actually incurred.
Simplifying eligible expenses—Room and board expenses are  considered in the administration of the federal student aid programs  authorized under Title IV of the Higher Education Act but not in all tax  preferences, particular the Hope and Lifetime Learning Credits.  Careful  analysis will be needed of how such expenses could be accounted for in a  simplified scheme if it is changed to being structured as a tax preference  rather than a grant.  Room and board expenses vary based on where a  school is located or whether a student lives on or off campus, and they can  be a significant component of a student’s cost of attendance, particularly  at community colleges.  While certain strategies might be employed to  lessen tax filers’ recordkeeping requirements and result in fewer tax filer  compliance issues, further research is needed on how such an allowance  would be optimally set.  Establishing too high an allowance, for example,  could result in some students receiving a benefit in excess of the costs  they incur for room and board, especially for those students who choose  to live with their parents.  Alternatively, if tax assistance is provided in  advance of incurring costs, but the assistance is to be limited to costs  actually incurred, a cost recovery or other administrative mechanism  would be needed as discussed above.
section_title: Research on Effectiveness of Federal Postsecondary Assistance Is Incomplete
paragraphs: Little is known about the effectiveness of federal grant and loan programs  and education-related tax preferences in promoting attendance, choice,  and the likelihood that students either earn a degree or continue their  education (referred to as persistence). Many federal aid programs and tax  preferences have not been studied, and for those that have been studied,  important aspects of their effectiveness remain unexamined. In our 2005  report, we found no research on any aspect of effectiveness for several  major Title IV federal postsecondary programs and tax preferences. For  example, no research had examined the effects of federal postsecondary  education tax credits on students’ persistence in their studies or on the  type of postsecondary institution they choose to attend, and there is  limited research on the effectiveness of the Pell Grant program on  students’ persistence. One recently published study suggests that  complexity in the federal grant and loan application processes may  undermine its efficacy in promoting postsecondary attendance. The  relative newness of most of the tax preferences also presents challenges  because relevant data are just now becoming available. These factors may  contribute to a lack of information concerning the effectiveness of the aid  programs and tax preferences.
GAO, Student Aid and Tax Benefits: Better Research and Guidance Will Facilitate  Comparison of Effectiveness and Student Use, GAO-02-751 (Washington, D.C.: Sept. 13,  2002). in, or completion of postsecondary education.” Multiyear projects funded  under this subtopic began in July 2007. However, none of the grants  awarded to date appear to directly evaluate the role and effectiveness of  Title IV programs and tax preferences in improving access to, persistence  in, or completion of postsecondary education.
As we noted in our 2002 report, more research into the effectiveness of  different forms of postsecondary education assistance is important.Without such information federal policymakers cannot make fact-based  decisions about how to build on successful programs and make necessary  changes to improve less-effective programs. The budget deficit and other  major fiscal challenges facing the nation necessitate rethinking the base of  existing federal spending and tax programs, policies, and activities by  reviewing their results and testing their continued relevance and relative  priority for a changing society.
section_title: Concluding Observations
paragraphs: In light of the long-term fiscal challenge this nation faces and the need to  make hard decisions about how the federal government allocates  resources, this hearing provides an opportunity to continue a discussion  about how the federal government can best help students and their  families pay for postsecondary education. Some questions that Congress  should consider during this dialog include the following:    Should the federal government consolidate postsecondary education  tax provisions to make them easier for the public to use and  understand?
Given its limited resources, should the government further target Title  IV programs and tax provisions based on need or other factors?
How can Congress best evaluate the effectiveness and efficiency of  postsecondary education aid provided through the tax code?
Can tax preferences and Title IV programs be better coordinated to  maximize their effectiveness?
Mr. Chairman and Members of the Subcommittee, this concludes our  statement. We welcome any questions you have at this time.
section_title: Staff Contacts and Acknowledgments
paragraphs: For further information regarding this testimony, please contact Michael  Brostek at (202) 512-9110 or brostekm@gao.gov or George Scott at (202)  512-7215 or scottg@gao.gov. Individuals making contributions to this  testimony include David Lewis, Assistant Director; Sarah Farkas, Sheila R.  McCoy, John Mingus, Danielle Novak, Daniel Novillo, Carlo Salerno,  Andrew J. Stephens, and Jessica Thomsen.
section_title: Appendix I: Postsecondary Aid Programs
paragraphs: The federal government helps students and families save, pay for, and  repay the costs of postsecondary education through grant and loan  programs authorized under Title IV of the Higher Education Act of 1965, as  amended, and through tax preferences—reductions in federal tax  liabilities that result from preferential provisions in the tax code, such as  exemptions and exclusions from taxation, deductions, credits, deferrals,  and preferential tax rates.
subsections: section_title: Federal Grant and Loan Assistance to Postsecondary Students
paragraphs: Assistance provided under Title IV programs include Pell Grants for low- income students, the Academic Competitiveness and National Science and  Mathematics Access to Retain Talent Grants, PLUS loans, which parents  as well as graduate and professional students may apply for, and Stafford  loans. While each of the three grants reduces the price paid by the  student, student loans help to finance the remaining costs and are to be  repaid according to varying terms. Stafford loans may be either subsidized  or unsubsidized. The federal government pays the interest cost on  subsidized loans while the student is in school, and during a 6-month  period known as the grace period, after the student leaves school. For  unsubsidized loans, students are responsible for all interest costs. Stafford  and PLUS loans are provided to students through both the Federal Family  Education Loan program (FFEL) and the William D. Ford Direct Loan  Program (FDLP). The federal government’s role in financing and  administering these two loan programs differs significantly. Under the  FFEL program, private lenders, such as banks, provide loan capital and  make loans, and the federal government guarantees FFEL lenders a  minimum yield on the loans they make and repayment if borrowers  default. Under FDLP, the federal government makes loans to students  using federal funds.
The Department of Education and its private-sector contractors jointly  administer the program. Title IV also authorizes programs funded by the  federal government and administered by participating higher education  institutions, including the Supplemental Educational Opportunity Grant  (SEOG), Perkins loans, and federal work-study aid, collectively known as  campus-based aid.
To receive Title IV aid, students (along with parents, in the case of  dependent students) must complete a Free Application for Federal  Student Aid form. Information from the FAFSA, particularly income and  asset information, is used to determine the amount of money—called the  expected family contribution—that the student and/or family is expected  to contribute to the student’s education. Federal law establishes the  criteria that students must meet to be considered independent of their  parents for the purpose of financial aid and the share of family and student  income and assets that are expected to be available for the student’s  education. Once the EFC is established, it is compared with the cost of  attendance at the institution chosen by the student. The cost of attendance  comprises tuition and fees; room and board; books and supplies;  transportation; certain miscellaneous personal expenses; and, for some  students, additional expenses.If the EFC is greater than the cost of  attendance, the student is not considered to have financial need, according  to the federal aid methodology. If the cost of attendance is greater than the  EFC, then the student is considered to have financial need. Title IV  assistance that is made on the basis of the calculated need of aid  applicants is called need-based aid. Key characteristics of Title IV  programs are summarized in table 5 below.
section_title: Tax Preferences
paragraphs: Prior to the 1990s, virtually all major federal initiatives to assist students  with the costs of postsecondary education were provided through grant  and loan programs authorized under Title IV of the Higher Education Act.  Since the 1990s, however, new federal initiatives to assist families and  students in paying for postsecondary education have largely been  implemented through the federal tax code. The federal tax code now  contains a range of tax preferences that may be used to assist students and  families in saving for, paying, or repaying the costs of postsecondary  education. These tax preferences include credits and deductions, both of  which allow tax filers to use qualified higher education expenses to reduce  their federal income tax liability. The tax credits reduce the tax filers’  income tax liability on a dollar-for-dollar basis but are not refundable. Tax  deductions permit qualified higher education expenses to be subtracted  from income that would otherwise be taxable. To benefit from a higher  education tax credit or tuition deduction, a tax filer must use tax form  1040 or 1040A, have an adjusted gross income below the provisions’  statutorily specified income limits, and have a positive tax liability after  other deductions and credits are calculated, among other requirements.
Tax preferences also include tax-exempt savings vehicles. Section 529 of  the tax code makes tax free the investment income from qualified tuition  programs. There are two types of qualified tuition programs: savings  programs established by states and prepaid tuition programs established  either by states or by one or more eligible educational institutions.  Another tax-exempt savings vehicle is the Coverdell Education Savings  Account. Tax penalties apply to both 529 programs and Coverdell savings  accounts if the funds are not used for allowable education expenses. Key  features of these and other education-related tax preferences are  described below, in table 6.
Our review of tax preferences did not include exclusions from income,  which permit certain types of education-related income to be excluded  from the calculation of adjusted gross income on which taxes are based.  For example, qualified scholarships covering tuition and fees and qualified  tuition reductions from eligible educational institutions are not included in  gross income for income tax purposes. Similarly, student loans forgiven  when a graduate goes into certain professions for a certain period of time  are also not subject to federal income taxes. We did not include special  provisions in the tax code that also extend existing tax preferences when  tax filers support a postsecondary education student. For example, tax  filers may claim postsecondary education students as dependents after age  18, even if the student has his or her own income over the limit that would  otherwise apply. Also, gift taxes do not apply to funds used for certain  postsecondary educational expenses, even for amounts in excess of the  usual $12,000 limit on non-taxable gifts. In addition, funds withdrawn early  from an Individual Retirement Account are not subject to the usual 10  percent penalty when used for either a tax filer’s or his or her dependent’s  postsecondary educational expenses.
section_title: Appendix III: Effects of Tax Rules on Tax Preference Use
paragraphs: For an example of how the use of college savings programs and the tuition  deduction is affected by “anti-double-dipping” rules, consider the  following: To calculate whether a distribution from a college savings  program is taxable, tax filers must determine if the total distributions for  the tax year are more or less than the total qualified educational expenses  reduced by any tax-free educational assistance, i.e., their adjusted  qualified education expenses (AQEE). After subtracting tax-free assistance  from qualified educational expenses to arrive at the AQEE, tax filers  multiply total distributed earnings by the fraction (AQEE / total amount  distributed during the year). If parents of a dependent student paid $6,500  in qualified education expenses from a $3,000 tax-free scholarship and a  $3,600 distribution from a tuition savings program, they would have $3,500  in AQEE. If $1,200 of the distribution consisted of earnings, then $1,200 x  ($3,500 AQEE / $3,600 distribution) would result in $1,167 of the earnings  being tax free, while $33 would be taxable. However, if the same tax filer  had also claimed a tuition deduction, anti-double-dipping rules would  require the tax filer to subtract the expenses taken into account in figuring  the tuition deduction from AQEE. If $2,000 in expenses had been used  toward the tuition deduction, then the taxable distribution from the  section 529 savings program would rise to $700.For families such as  these, anti-double-dipping rules increase the computational complexity  they face and may result in unanticipated tax liabilities associated with the  use of section 529 savings programs.
section_title: Appendix IV: Point Estimates and Confidence Intervals
paragraphs: We used two data sets for this testimony: Education’s 2003-2004 National  Postsecondary Student Aid Study and the Internal Revenue Service’s 2005  Statistics of Income. Estimates from both data sets are subject to sampling  errors and the estimates we report are surrounded by a 95 percent  confidence interval. The following tables provide the lower and upper  bounds of the 95 percent confidence interval for all estimate figures in the  tables in this testimony. For figures and text drawn from these data, we  provide both point estimates and confidence intervals.