Student Aid And Postsecondary Tax Preferences: Limited Research Exists on Effectiveness of Tools to Assist Students and Families through Title IV Student Aid and Tax Preferences
Published: 2005-07-29T00:00:00

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. In fiscal year 2004, about $14 billion in grants and $56 billion in loans were made under title IV while estimated outlay equivalents for postsecondary tax preferences amounted to $10 billion. In light of the relative newness and financial significance of tax preferences, this report examines (1) how title IV assistance compares to that provided through the tax code, (2) the extent to which tax filers effectively use postsecondary tax preferences, and (3) what is known about the effectiveness of federal assistance.
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. While both serve students and families with a range of incomes, 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. While both require students and families to fill out forms, tax preferences require more responsibility on the part of students and families because they 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, among the limited number of tax returns available for our analysis, 27 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 $169, 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. Little is known about the effectiveness of title IV aid or tax preferences in promoting, for example, postsecondary attendance or 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: In recent decades, Congress has provided billions of dollars in assistance  each year to help the nation’s students and families meet the costs of  postsecondary education.  In the past, this assistance has primarily been  provided through student grant and loan programs authorized under title IV  of the Higher Education Act of 1965, as amended.  Much of this aid, called  need-based 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. More recently, however, postsecondary assistance has also  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 2005, up to a  $1,500 Hope tax credit and/or a $2,000 Lifetime Learning tax credit for  tuition and course-related fees paid.  Furthermore, the 2001 Economic  Growth and Tax Relief Reconciliation Act created a new tax deduction for  tuition expenses, which eligible tax filers may use to deduct, in tax year  2005, up to $4,000 from their taxable income for tuition and course-related  fees paid.
Providing federal financial assistance in these varied ways presents  students and their families with an array of tools that may help them pay  postsecondary education expenses. There is concern, however, that the  postsecondary tax preferences create opportunities that are difficult for  families to understand and use correctly.  Additionally, Congress has been  provided with little evidence concerning the effectiveness of assistance  provided under title IV or through tax preferences, such as whether student  assistance increases the rate at which students enroll in postsecondary  education or whether assistance increases the likelihood that students will  either earn a degree or continue their education (often referred to as  persistence).
You asked us to explain how the federal government assists students and  families in meeting the costs of postsecondary education, and to examine  the opportunities and challenges associated with these policies.  To address  your interests, we answered the following questions: (1) How does title IV  grant and loan assistance compare with that provided through the tax  code? (2) To what extent are tax filers effectively using the opportunities  presented by postsecondary tax preferences? (3) What is known about the  effectiveness of federal assistance in promoting college attendance,  providing students with a wider range of choices among postsecondary  institutions, or encouraging students to persist in their studies?
To compare title IV federal grant and loan assistance with that provided  through the tax code, we used Department of Education (Education) and  Internal Revenue Service (IRS) data, as well as agency documents and  statutory provisions describing federal student financial assistance  programs and tax preferences related to student financial assistance for  postsecondary education. For the purpose of this review, we focused on  federal grant and loan programs or tax preferences that served 500,000 or  more students and families. We also used two data sets, the 2003-2004  National Postsecondary Student Aid Study (NPSAS) from Education and  IRS’s 2002 Statistics of Income (SOI) individual tax file. We analyzed SOI  data to determine, among other things, whether tax filers made effective  use of the Hope and Lifetime Learning tax credits and the tuition  deduction.  However, information required to analyze whether tax filers  made effective use of the tax credits and deduction was not consistently  available for tax filers included in the SOI data.  Educational institutions  must provide IRS and students with Forms 1098-T, which document  students’ enrollment status at the institution.  Educational institutions may  also, but are not required to, report on students’ qualified tuition and  related expenses, scholarships, and grants.  Consequently, our analysis of  SOI data for this purpose was limited to the approximately 1.8 million tax  filers for whom Forms 1098-T reported such information.  We were unable  to determine whether these tax filers were representative of the  approximately 12.4 million tax filers for whom such information was  unavailable.  To address issues of complexity as students and families use  postsecondary tax preferences, we reviewed relevant statutes, regulations,  and IRS documents, government reports, and academic research. We  assessed the reliability of NPSAS and SOI data sets in light of our data  reliability standards and found them to be useful for the purpose of this  review. Details of our data reliability assessment and other aspects of our  scope and methodology can be found in appendix I. To learn what is known  about the effectiveness of federal grant and loan programs and tax  preferences, we reviewed the academic literature on financial aid and  education-related tax preferences. We conducted our review from May  2004 through June 2005 in accordance with generally accepted government  auditing standards.
subsections: section_title: Background
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, 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.  In fiscal year 2004, Education made approximately $14 billion in  grants and provided another $56 billion in loan assistance (face value)  through the title IV programs.  The fiscal year 2004 outlay equivalent cost of  the postsecondary tax preferences reviewed in this study was estimated to  be $10 billion.
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, parent loans known as PLUS loans, and Stafford loans.   While Pell Grants reduce 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 (FFELP) 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 FFELP, private lenders, such as  banks, provide loan capital and make loans, and the federal government  guarantees FFELP lenders a minimum yield on the loans they make and  repayment if borrowers default. Under FDLP, federal funds are used as loan  capital and loans are provided through participating schools.  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 (FAFSA) form.  Information from the FAFSA, particularly income and  asset information, is used to determine the amount of money—called the  expected family contribution (EFC)—that the student and/or family is  expected to contribute to the student’s education.  Statutory definitions  establish the criteria that students must meet to be considered independent  of their parents for the purpose of financial aid, and statutory formulas  establish the share of 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; 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 1, 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, 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 2.
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.   We also did not include special provisions in the tax code that also extend  existing tax preferences when tax filers support a postsecondary education  student.  Appendix IV lists all tax preferences reported by IRS, including  ones not included in this review.
section_title: Tax Preferences Are More Recent Than Most Title IV Programs
paragraphs: Title IV programs have been in place for decades, while most education- related tax preferences were created much more recently.  Between the  late 1950s and the early 1980s each major federal initiative to assist  students with the costs of postsecondary education was provided either  through grant or loan programs.  From 1981 through 1995 no new federal  grant or loan-financing vehicles were adopted; however, new financing  options, such as loan consolidation, and new delivery systems, such as  direct student lending, were introduced for student loan programs.  Since  1995, on the other hand, every federal initiative for the financing of  postsecondary education has been implemented through the federal tax  code, primarily through the Tax Relief Act of 1997 and the Economic  Growth and Tax Relief Reconciliation Act of 2001.  By 2002 the number of  tax filers claiming a tax credit or tuition deduction was broadly comparable  to the number of students aided through title IV programs: about 8.4 million  students received a title IV grant and/or loan, and about 9.6 million tax  filers filed returns claiming a Hope tax credit, Lifetime Learning tax credit,  or tuition deduction. (See fig. 1.)
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 three key ways. First, tax preferences and title IV programs differ  in the timing and the distribution of benefits they provide.  Title IV grant  and loan programs primarily provide aid to students and families while  students are in college, whereas tax preferences help both during the  college years and before and after college by assisting with saving for or  repaying college costs.  Additionally, although student aid programs and  tax preferences assist students and families across a wide range of income  levels, some title IV programs, such as the Pell Grant and subsidized  Stafford student loan programs, provide much of their financial assistance  to students and families whose incomes are lower, on average, than  students who receive unsubsidized Stafford loans, tax deductions, or 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 compared with title IV aid.
subsections: section_title: Tax and Title IV Programs Differ in Benefit Timing
paragraphs: Title IV programs and education-related tax preferences differ significantly  as to when eligibility is established and in the timing of the assistance they  provide.  Eligibility for title IV programs is generally established at the time  of enrollment and prior to each subsequent school year thereafter, and title  IV programs generally provide benefits to students while they are in school.  Education-related tax preferences reach widely across the life span. They  encourage saving for college, especially among families with dependent  children through tax-exempt saving; assist enrolled students and their  families in meeting the current costs of postsecondary education through  credits and a tuition deduction; and assist students and families repaying  the costs of past postsecondary education by allowing tax filers to claim a  deduction for student loan interest paid.  Thus, tax filers must determine  their eligibility for these preferences every year that contributions are  made to Coverdell Education Savings Accounts or every year that a former  student claims a student loan interest deduction. Table 3 shows a  comparison of the timing of title IV assistance and the assistance provided  through various tax preferences.
section_title: Beneficiaries of Title IV Programs and Tax Preferences Differ
paragraphs: While title IV programs and tax preferences assist many students and  families, a variety of program and tax rules affect students’ and families’  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, as  discussed below.
subsections: section_title: Title IV Assistance
paragraphs: Title IV programs have rules for calculating grant and loan assistance that  give different consideration to family income, assets, and college costs in  the award of financial aid. Pell Grant awards are calculated by subtracting  the student’s expected family contribution (EFC) from the maximum Pell  Grant award ($4,050 in academic year 2004-2005), or the student’s cost of  attendance, whichever is less.  Because the expected family contribution 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 eligibility, Pell awards are received primarily by families  with modest incomes.  The maximum subsidized Stafford loan that a  student may obtain is based upon his or her cost of attendance, minus the  expected family contribution and the estimated financial assistance that  the student will receive. For a given cost of attendance, therefore, the  amount of a subsidized Stafford loan increases as EFC decreases.  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.
The different award rules for Pell Grants and subsidized and unsubsidized  Stafford loans result in different patterns of program participation among  students of different incomes, and different distributions of dollar support  among students.  As table 4 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.  With respect to subsidized Stafford loans, 67 percent of  recipients had family incomes of $60,000 or less and received a  proportional share of total subsidized loan volume.  In contrast, 65 percent  of unsubsidized Stafford loan recipients had family incomes above $60,000  and received 69 percent of total unsubsidized loan volume.
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 5, 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 in order 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 2004 that  begin at $42,000 and $85,000 for single and joint filers, respectively.  The  income-related phase-out provision for the tuition deduction, in  comparison, begins in 2004 at $65,000 and $130,000 for single and joint  filers, respectively. As a result, the majority of tax filers claiming the Hope  and Lifetime Learning tax credits in 2002 had incomes under $40,000.   Among those who claimed the tuition deduction, in contrast, 38 percent of  tax filers had incomes in this range, while 62 percent had incomes over  $40,000.  Table 6 shows the income categories of tax filers claiming the  three tax preferences available to current students and/or their families  along with the distribution of dollars through those preferences in 2002.
The reduction in tax liability associated with the use of the Hope and  Lifetime tax credits also differs from that associated with the use of the  tuition deduction.  In 2002 tax filers claimed Hope credits worth about $3.2  billion and Lifetime Learning credits totaling about $1.7 billion.  As shown  in table 6, below, about 80 percent of the 2002 Hope and Lifetime credits’  reduction in tax liability went to tax filers with incomes between $20,001  and $80,000.  The distribution of benefits for the tuition deduction shows a  substantially different pattern: more than half (52 percent) of the  approximately $1.3 billion reduction in tax liability associated with the use  of the deduction in 2002 went to families with incomes of $80,001 and  above.
Although many families are eligible to participate in tax-exempt savings  programs, the programs are more advantageous to those with higher  incomes and tax liabilities. Families with higher than average incomes are  more likely to use tax-exempt savings opportunities for a range of reasons,  including, among others, that (1) these families hold greater assets to invest  in these vehicles; (2) these families have a higher marginal tax rate, and  thus benefit the most from the use of these vehicles; and (3) higher-income  families may gain a reduction in tax liability even if withdrawals are not  used for postsecondary expenses.
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 form, which in its 2004 paper  version was over eight pages long and contained more than 100 questions.   While concerns have been raised that the FAFSA application may deter  potentially eligible students from participating in title IV grant and loan  programs, filling out the FAFSA and submitting it to the Department of  Education completes, by and large, students’ and families’ responsibility in  obtaining aid.  To benefit from title IV programs, students need not learn  the rules of the federal student aid methodology, eligibility rules for  individual programs, or understand the ways in which federal student aid  programs interact with one another.  Rather, the Department of Education  is responsible for calculating students’ and families’ EFC on the basis of the  FAFSA, and a student’s educational institution is responsible for  determining aid eligibility and the amounts and packaging of aid awards.  In  addition, title IV educational institutions assist Education in verifying the  information submitted on the FAFSA form for a sample of aid applicants.
Higher education tax preferences, in contrast to federal grants and student  loans, require more responsibility on the part of students and families.   Although postsecondary institutions provide students and 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 limited to the promulgation of rules;  the provision of guidance to tax filers; and to the processing of tax returns,  including some checks on the accuracy of items reported on those tax  returns. In contrast, the primary responsibility for selecting among and  properly using tax preferences rests with tax filers:  they must understand  the rules in light of their own situation, 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 IRS data on the use of Hope and Lifetime tax  credits and the tuition deduction, some tax filers appear to make less-than- optimal choices among them.  The apparently suboptimal use of  postsecondary tax preferences may arise, in part, from the complexity of  using these provisions; however, our analysis of tax data does not permit us  to identify why they are making these choices.  Tax policy analysts  consistently identify 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.  Additional complexity associated with the  use of postsecondary tax preferences also arises from the interaction of tax  preferences and title IV student aid.
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  2004, 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  $1,500 if they claimed the Hope credit.
To assess whether tax filers faced difficulty with choosing among these  preferences, we examined whether tax filers who were confronted with a  relatively common tax choice—whether to claim the Hope or Lifetime  Learning credit or the tuition deduction—chose the tax preference that  minimized their tax liability.  We analyzed information that IRS was  provided with by educational institutions using Form 1098-T and tax return  information in IRS’s 2002 Statistics of Income sample.  Because 87 percent  of Form 1098-T returns did not contain educational expense information,  we were able to analyze only the remaining 13 percent of tax returns  (representing about 1.8 million returns) in the SOI sample that received a  Form 1098-T and contained information concerning students’ educational  expenses. We were unable to determine if this 13 percent of returns is  representative of the entire population of Form 1098-Ts.  (See appendix I  for details.)  All estimates and their associated confidence intervals can be  found in appendix II.
We found that some people who appear to be eligible for tax credits and/or  the tuition deduction did not claim them.  The filers of about 77 percent of  the tax returns that we were able to review were apparently eligible to  claim one or more of the three tax preferences: the tax filers appear to have  had a positive income tax liability, qualified educational expenses, an  adjusted gross income below statutory phase-out limits, and were  otherwise eligible.   Among filers who were apparently eligible to claim  one of the three tax preferences, 27 percent, representing about 374,000 tax  filers, failed to do so.  The amount by which these tax filers failed to reduce  their tax averaged $169; 10 percent of this group could have reduced their  tax liabilities by over $500.
Some tax filers used a higher education tax credit or the tuition deduction  but chose one that yielded a smaller reduction in their tax liability than they  could have otherwise realized.  Among those who claimed the tuition  deduction, we estimate that 21 percent (representing about 51,000 tax  filers) would have been better off claiming the Lifetime Learning tax credit  while 8 percent (representing about 22,000 tax filers) of those claiming the  Lifetime Learning credit would have reduced their taxes by a greater  amount if they had claimed the tuition deduction instead.  The average  amount by which these tax filers failed to reduce their taxes was $83 for tax  filers claiming the tuition deduction and $138 for those claiming the  Lifetime Learning credit.  Some tax filers making these decisions failed to  realize larger reductions in their tax liabilities—10 percent of suboptimal  tuition deduction claimants could have reduced their tax liabilities by  about $158 or more and 10 percent of suboptimal Lifetime Learning credit  claimants could have reduced their tax liabilities by about $237 or more. On  the other hand, we found no cases where tax filers claiming a Hope credit  would have been better off by claiming a Lifetime Learning credit instead.
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 about 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 223,000 of the approximately 447,000  suboptimal choices we found.
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.   Additional complexity associated with the use of these provisions may  arise from the interaction of tax preferences and title IV student aid.   Complexity may lead some not to claim a credit because they judge the  added costs of filing for the credit to outweigh its benefits.
subsections: section_title: Multiple Tax Preferences
paragraphs: Multiple tax preferences with similar purposes may place substantial  demands on the knowledge and skills of millions of students and families.   Twelve tax preferences are outlined in the IRS publication, Tax Benefits for  Education, including 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.  Attempting to learn about, compare, and choose from  among these tax-preferred higher education savings options may require  substantial knowledge and skill on the part of parents with young  dependents beyond that required of savings and investment decisions in  general.
Among the tax preferences we reviewed, three help students meet current  costs—the Hope credit, Lifetime Learning credit, and the tuition deduction.  These tax preferences also differ across many dimensions.  Though  similar in purpose, the three preferences have different eligibility criteria,  benefit levels, and income-related phase-outs.  For tax filers to obtain the  maximum benefit from these preferences, they must first ascertain which  preference they are eligible to use, and then correctly calculate which  preference minimizes their tax liability by making separate calculations  between the Hope and Lifetime Learning credits.  If filers are within the  phase-out range, they must calculate whether the tuition deduction is  preferable to either credit.  Tax filers with more than one student in  postsecondary education may be eligible to claim multiple preferences, and  may need to test different combinations of benefits to optimize tax savings.
section_title: Varying Qualified Expense Definitions
paragraphs: Additional demands on the skill and knowledge of students and families  may result from the fact that higher education tax preferences do not all  use the same definition of qualified higher education expenses.  What tax  filers are allowed to claim as a qualified higher education expense varies,  for example, between tax-exempt savings vehicles and tax credits.  For  example, while Coverdell Education Savings Accounts and section 529  Qualified Tuition Programs permit tax filers to include tuition, fees, books,  supplies, and equipment required for enrollment as part of their qualified  educational expenses, higher education tax credits permit only tuition and  fees required for enrollment to be counted as qualified higher education  expenses.  These dissimilar definitions require that tax filers keep track  of expenses separately, applying some expenses to some tax preferences,  but not others, and the Joint Committee on Taxation has suggested that  they may increase the likelihood of inadvertent errors and may also  increase taxpayer frustration.
section_title: Tax Rules Coordinating the Use of Multiple Preferences
paragraphs: 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.
Consider, for example, how the use of college savings programs and the  tuition deduction is affected by these rules. To calculate whether a  distribution from a college savings program is taxable, a tax filer 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.
subsections: section_title: Interaction between Tax Preferences and Student Financial Aid
paragraphs: Because the use of federal higher education tax preferences may affect a  student’s eligibility for title IV federal student assistance—and the receipt  of title IV federal student assistance may affect a student’s ability to use  federal higher education tax preferences—many students and families  must develop knowledge and skill sufficient to understand the relationship  between the two. For example, the Internal Revenue Code requires tax  filers to reduce the qualified higher education expenses they apply toward  higher education tax credits by the amount of nontaxable aid they receive,  including federal aid such as a Pell Grant.  As a result, receiving a Pell  Grant has the potential to reduce the amount of Hope or Lifetime Learning  tax credit for which a filer is eligible.  More generally, tax filers must take  care to reduce their qualified higher education expenses by the amount of  all nontaxable assistance that they receive—federal and nonfederal— applying only adjusted qualified higher education expenses toward credits,  deductions, and distributions from tax-exempt savings vehicles.
While some federal higher education tax preferences, such as tax credits,  have no effect on one’s eligibility for title IV federal student assistance,  others do: like other family savings, assets held in tax-exempt savings  vehicles, such as a Coverdell Education Savings Account or a section 529  savings account, are included in the calculation of the expected family  contribution.  In those instances where students are on the margin of  eligibility to participate in need-based title IV federal aid programs, using  these accounts may reduce the aid for which a student is eligible.
The federal financial aid methodology in place prior to January 2004  treated assets held in different savings vehicles in widely varying ways.   According to one set of calculations, each dollar of funds held in a 529  savings program resulted in a reduction of 15 cents in need-based aid, while  each dollar of funds held in a Coverdell Educational Savings Account  resulted in a $1.22 reduction in need-based aid. For families close to the  income limit for eligibility for need-based aid, a $1,000 pretax investment in  a Coverdell Educational Savings Account yielded a simulated final return  (net of income taxation and foregone student aid) of -$1,194, leaving the  family worse off than if they had not saved, or if they had saved using a  regular savings account (+$490) or a traditional individual retirement  account (+$844).  In response to recommendations contained in our 2002  report on student aid, the Department of Education modified its guidance  concerning federal financial aid methodology, announcing that Coverdell  assets would be treated as assets of the parent, rather than the student— and, therefore, result in the same reduction in need-based aid as 529  savings program assets. Nonetheless, families that save in prepaid tuition  programs remain subject to a dollar-for-dollar reduction in federal aid for  each dollar distributed by the program.
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 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.  When research exists, it reaches  varying conclusions about the effects of federal programs and tax  preferences.  Some studies identify no measurable effects on college  attendance and persistence, while others find positive effects.  (A  bibliography listing the studies we reviewed is included at the end of this  report.)  Data and methodological challenges limit the certainty with which  the effects of title IV programs and tax preferences, especially the effects of  the latter, can be identified and result in widespread gaps in the knowledge  of their effectiveness.  In 2002 we recommended that Education sponsor  research into key aspects of effectiveness of title IV programs and that  Education and the Department of the Treasury collaborate on such  research into the relative effectiveness of title IV programs and tax  preferences.  Since our prior report, little has been done to implement  these recommendations, although Education is the process of establishing  a postsecondary research center.
subsections: section_title: Little Is Known about the Effectiveness of Federal Title IV Postsecondary Programs and Tax Preferences
paragraphs: We found no research on any aspect of effectiveness for several major title  IV federal postsecondary programs and tax preferences, including the  Federal Work-Study program, the tuition deduction, tax-exempt savings  programs, and others.  For other federal programs, no research exists on  important aspects of program effectiveness.  For example, no research has  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.
section_title: Limited Research about Federal Assistance Reaches Varying Conclusions about Some Aspects of Effectiveness
paragraphs: When research on the effectiveness of federal assistance does exist, it  reaches varying findings about title IV student aid and tax preferences.   Some studies find that title IV programs increase the rates of college  attendance and persistence, while others have identified no positive  effects. Research on Pell Grants shows that they generally have little or no  impact on attendance, with the exception of one study that found Pell  Grants to have increased attendance for students from 22 to 35 years of  age.  The study attributed the program’s impact to the fact that older  students generally attend less-expensive institutions where Pell Grants  represent a larger share of the cost of college than the same size grants  provided to students in general.  The study also suggests that the limited  impact of Pell Grants on attendance in general may be due to the fact that  institutional aid awards may decrease at the same time as Pell Grant  awards increase, creating a substitution effect that could diminish the  impact of Pell Grants on attendance.  According to the study, this occurs  less often for older students because they tend to go to institutions that  have less institutional aid for which Pell Grant awards might substitute.
Some research has also found that Pell Grants, like other grant programs,  appear to increase students’ persistence toward completing their studies.
Student loans have been found to modestly increase college attendance,  persistence, and choice, but there are various limitations to consider.  Of  the three studies examining the effect of borrowing on college attendance,  only one focuses on lower-income students. The study estimates that a  $1,000 increase (in 1977 dollars) resulted in a 4.3 percentage point increase  in college enrollment among dependent students with family incomes  below $15,000.  However, given long-term changes in lending markets,  returns to schooling, and other conditions, students’ behavioral responses  to equivalent changes in loan amounts may be different today from what  they were in 1977.  Findings about the impact of loans on persistence and  choice are each based on only one study, and focus only on middle-income  students.
We found one study concerning how the Hope and Lifetime Learning tax  credits affect college attendance.  The study found the credits to have no  effect on college attendance.  This may be because the students who  receive these credits are likely to attend college anyway.   The author  acknowledges several limitations of the study.  For example, the study uses  income categories—as opposed to actual income—thereby introducing  measurement error and attenuating the estimated effects of the credits on  attendance.  We also note that the study measured eligibility for the credits,  rather than the receipt of tax credits.  Measuring eligibility rather than the  receipt of credits tends to underestimate the effect of credits on attendance  because many tax filers who appear to be eligible for the credits do not  claim them. This study did not examine whether federal student tax  credits affect persistence or choice.
In addition to the research into the federal tax, grant, and loan programs  described above, a large body of research estimates the effects of both  tuition changes and non-title IV financial aid programs on postsecondary  attendance.  These studies all found either an inverse relationship  between the cost of tuition and level of enrollment or that financial  assistance increased enrollment.  One survey of this work concludes that  a $1,000 reduction in net costs (in 2001 dollars) would result in a 3 to 6  percent increase in college enrollment rates.  Federal Pell Grants and  postsecondary tax credits do not show similar effects in the studies we  examined.  Substitution effects caused by offsetting reductions in  nonfederal aid may diminish the enrollment effect of Pell awards.  Also, the  impact of tax credits on enrollment may be limited by the fact that tax filers  receive higher education tax credits the year following tuition outlays.   Program design and information may also account for some of these  differences: tuition information and many nonfederal aid benefits are  known when a person is choosing whether or not to attend college;  however, students may not be aware of tax credits and Pell Grants or their  effects on price until after they have already decided to go to college.
While federal grants, student loans, and tax credits were created to result in  beneficial consequences, such as increasing college attendance, they have  also been found to result in the raising of tuition by institutions in some  circumstances.  One potential explanation is that institutions raise tuition  because federal aid increases the amount students are able to pay.   Alternatively, federal aid may increase the demand for education, and with  no offsetting factors, this drives the price of tuition up.
section_title: Data and Methodological Challenges Hinder Research
paragraphs: Gaps in the research-based evidence of federal postsecondary program  effectiveness may be due, in part, to data and methodological challenges  that have proven difficult to overcome. The relative newness of most of the  tax preferences also presents challenges because relevant data are just  now becoming available.  Additionally, to analyze the tax programs, actual  tax return data are preferred to indirect or processed data, but researchers  are often limited to publicly available data containing self-reported  information on income because of tax data confidentiality protections.
Methodological challenges add to the difficulty of estimating the effects of  these programs.  In general, researchers can reliably identify the behavioral  effects of a program when one factor changes while all others remain  unchanged.  For example, if no other factors change, a researcher could  identify the impact of postsecondary tax credits on enrollment by  comparing enrollment rates before and after the tax credits are enacted.   Typically, however, many factors change simultaneously, either offsetting  or enhancing the effect of the policy intervention being studied.  For  example, tuition rates may rise at the same time that postsecondary tax  credits are introduced, or other sources of postsecondary assistance—such  as federal, state, or institutional grants—may decrease.  These changes  undermine researchers’ ability to reliably isolate the behavioral effects of  the policy under study.  While researchers in some fields address this  problem through the use of experiments, few opportunities exist for  experimentation in the study of postsecondary education finance.   Alternatively, researchers may address this problem through the use of  quasi-experimental research designs, which attempt to approximate the  random assignment of participants to treatment and control groups by  matching participants to nonparticipants having similar characteristics. In  practice, however, data limitations often make this difficult to implement.   To isolate the impact of tax credits on college attendance, for example,  researchers may need to compare credit recipients with nonrecipients who  are similar in a range of ways—including academic preparation, family  income and wealth.  National surveys often do not contain complete data  on all of these necessary factors both for those who attend and do not  attend college.
section_title: Steps to Support Effectiveness Research
paragraphs: In 2002, we recommended that Education sponsor research into key  aspects of effectiveness of title IV programs, and that Education and the  Department of the Treasury collaborate on such research into the relative  effectiveness of title IV programs and tax preferences.  In order to provide  Congress with information about the effectiveness of title IV programs, we  recommended in 2002 that Education sponsor research on the impact of  title IV programs on postsecondary attendance, choice, completion, and  costs.  To provide information about the relative effectiveness of  Education’s direct expenditure programs and Treasury’s postsecondary tax  provisions, we recommended that the Secretaries of Education and  Treasury collaborate in studying the combined effects of tax preferences  and title IV aid.  Few steps have been taken to implement these  recommendations.  However, Education is in the process of establishing a  postsecondary research center that will, among other things, examine the  impact of title IV programs.
As we noted in our 2002 report, 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.  As we stress in our recent report  21st Century Challenges: Reexamining the Base of the Federal  Government, 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.
In our January 2004 report on OMB’s Program Assessment Rating Tool  (PART), we recommended that OMB target PART assessments based on  such factors as the relative priorities, costs, and risks associated with  related clusters of programs and activities and that OMB select related or  similar programs for review in the same year to facilitate comparisons and  trade-offs.  Furthermore, in our June 14, 2005 testimony before the Senate  Committee on Homeland Security and Governmental Affairs,  Subcommittee on Federal Financial Management, Government  Information, and International Security, we reported that it is often critical  to understand how programs fit with a portfolio of tools and strategies in  order to capture whether programs complement and support related  programs, are duplicative or redundant, or work at cross purposes to other  initiatives. The different tax preferences and title IV programs in place to  help students and families finance postsecondary education are a good  example of the sort of related clusters of programs and activities to which  we were referring.
section_title: Concluding Observations
paragraphs: Congress has adopted a range of tools to help students and families pay for  postsecondary education, including grants, loans, and tax preferences.   Many title IV financial aid programs have a long history, while most of the  tax preferences do not. The addition of tax preferences to the title IV grant  and loan programs has increased the number of options and given students  and families new choices about how to combine saving, borrowing, and  current income to meet the costs of postsecondary education.   Postsecondary tax preferences are widely thought to present challenges of  complexity to students and families.  As we have shown, tax filers appear  to have some difficulty in making fully effective use of some postsecondary  tax preferences now in the tax code.  Also, although millions of tax filers  are receiving billions of dollars in assistance with postsecondary costs  through both title IV programs and tax preferences, little is known about  the effectiveness of any of these forms of assistance in part because of data  and methodological issues.  As we recommended in our 2002 report on  federal financial aid, it is important that information about the  effectiveness of both tax preferences and title IV federal grant and loan  programs be developed so that decision makers in Congress and in the  executive branch can make efficient use of limited federal resources and  reexamine, if necessary, the tools used to help students and families pay for  postsecondary education.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Internal Revenue Service, the  Department of the Treasury, and the Department of Education for review  and comment.   The Internal Revenue Service provided technical  comments, which we incorporated.  The Department of the Treasury did  not provide comments on our report.
In its written comments, Education disagreed with our conclusion on the  extent that title IV programs have been studied.  Education also said that  we did not properly acknowledge the role that its National Postsecondary  Student Aid Study (NPSAS) played in our analysis and that the report did  not cite many Departmental publications prepared on the basis of NPSAS  and other Departmental data collections, such as Persistence and  Attainment of Beginning Students with Pell Grants.  In our report, we  describe NPSAS as a comprehensive study examining how students and  their families pay for postsecondary education and note that we relied  upon NPSAS data to conduct our analysis.  Further, we explain in our  report that our findings about the effectiveness of federal postsecondary  assistance are based upon studies that meet professional standards of  econometric analysis and contain acceptably identified statistical estimates  of program effects.  We do not include publications that fail to meet these  standards.  While the data collections cited by the Department provide  useful descriptive information concerning title IV programs, they do not  provide data sufficient to determine key program effects.  In particular,  because these data collections do not contain information about those who  do not attend postsecondary institutions, they are of limited use in  establishing the effectiveness of title IV programs, especially with respect  to postsecondary attendance—a challenge we note in our report.   Consequently, publications based upon these data share this limitation.
With respect to the study specifically cited by the Department—Persistence  and Attainment of Beginning Students with Pell Grants—it does not  contain acceptably identified estimates of Pell Grant effects on persistence.   In particular, the study does not implement a design and include variables  that can isolate the effect of Pell Grant receipt on persistence from other  factors that are associated both with persistence and with Pell Grant  receipt, including academic preparation, changes in family income, and the  net cost of education. Thus the study’s estimate of the effect of Pell Grants  on persistence may reflect not only the influence of the Pell Grant, but also  the influence of these other factors.  Consequently, its results cannot be  used to reliably assess the impact of Pell Grant receipt on persistence.
Although Education stated that our report presented an incomplete and  inaccurate assessment of its research, it nonetheless agreed that more  research should be done and that it is “committed to continuing to increase  its research associated with the effectiveness of the  programs.”  The  Department expressed a similar commitment in response to our September  2002 report which found that Education had undertaken little work  identifying the impact of its grant and loan programs and recommended  that the Department sponsor research on the impact of title IV programs on  postsecondary education attendance and choice, completion, and costs.
As agreed with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days after its  date.  At that time, we will send copies of this report to The Commissioner  of Internal Revenue, The Secretary of Education, The Secretary of the  Treasury, and other interested parties.  This report is available at no charge  on GAO’s web site at http://www.gao.gov.
If you or any of your staff have any questions, please contact Michael  Brostek at (202) 512-9110 or Cornelia Ashby at (202) 512-7215.  You may  also reach us by e-mail at BrostekM@gao.gov and AshbyC@gao.gov.   Contact points for our Offices of Congressional Relations and Public  Affairs may be found on the last page of this report.  Key contributors to  this report were David Lewis, Assistant Director, Jeff Appel, Assistant  Director, Eric Mader, Thomas Weko, John Mingus, Cynthia Decker, Jeffrey  Weinstein, and Katherine France.
section_title: Objectives, Scope, and Methodology
paragraphs: Our review focused on answering the following three questions:  (1) How  does title IV grant and loan assistance compare with that provided through  the tax code? (2) To what extent are tax filers effectively using the  opportunities presented by postsecondary tax preferences? (3) What is  known about the effectiveness of federal assistance in promoting college  attendance, providing students with a wider range of choices among  postsecondary institutions, or encouraging students to persist in their  studies?
To compare title IV programs and tax preferences, we reviewed articles,  studies, and reports on federal assistance for postsecondary education  published by the Joint Committee on Taxation, the Internal Revenue  Service (IRS), the Department of Education’s National Center for  Education Statistics and Office of Federal Student Aid, and other sources.   Programs or tax preferences that served more than 500,000 participants  were judged to be, for the purpose of our review, major.  To obtain  information on participant numbers and other comparative information,  we used (1) fiscal year 2004 information from the President’s fiscal year  2006 budget request, (2) IRS’s 2002 Statistics of Income (SOI) data set  including IRS Form 1098-T information for all tax filers in the 2002 SOI  sample, (3) 2003-2004 school year data from the National Postsecondary  Student Aid Study (NPSAS), (4) data as of December 31, 2004, on the  number of accounts and amounts invested in section 529 Qualified Tuition  Programs from the College Savings Plans Network, and (5) tax year 2002  data on the estimated number of contributions to Coverdell Education  Savings Accounts from IRS. We also reviewed studies conducted by  Congressional Research Service, the Congressional Budget Office, GAO,  the Department of the Treasury, the Urban Institute, and the College Board.   We also interviewed individuals from the Congressional Research Service,  Education, IRS, Treasury, and universities.
The 2002 SOI data and 2003-2004 NPSAS data were the most recent data  available.  The SOI individual tax return file is a stratified probability  sample of income tax returns filed with IRS.  The SOI sample of 175,000  returns represented the approximately 130 million tax returns filed for  2002.  NPSAS is a comprehensive study that examines how students and  their families pay for postsecondary education.  It includes nationally  representative samples of 79,852 undergraduates, 9,611 graduate students,  and 1,283 first-professional students enrolled during the 2003-2004  academic year.  The NPSAS data are based on student interviews and  administrative records, and NPSAS includes survey results from both  students who received financial aid and those who did not.  To assess the  reliability of the SOI and NPSAS sample data, we reviewed existing  information about the samples and performed electronic testing of the  required data elements to detect obvious problems in accuracy and  completeness.  We determined that SOI and NPSAS data, as well as other  data used to provide certain specific pieces of information, were  sufficiently reliable for this report.
Because estimates from the SOI and NPSAS data are based on samples,  they are subject to sampling errors.  These sampling errors measure the  extent to which the point estimates may vary from the actual values in the  population of tax filers.  Each of our estimates is surrounded by a 95  percent confidence interval: an interval that 95 times out of 100 will contain  the true population value.  The upper and lower bounds of the 95 percent  confidence intervals for each estimate are presented in the tables in  appendix II.
To examine the extent to which tax filers are effectively using  postsecondary education tax preferences, we used much of the same  information we obtained for the description and comparison of the  programs and tax preferences. In addition we estimated the number of tax  filers who were eligible for an education tax credit or tuition and fees  deduction but either did not claim one at all or appeared to make a less- than-optimal choice among these tax preferences and the amounts of tax  benefits lost as a result.  To do this analysis we used IRS’s SOI sample of  individual tax returns for tax year 2002 and all Form 1098-T information  returns for tax filers in the sample. Postsecondary institutions participating  in Education’s student aid programs are required to issue Form 1098-Ts to  all enrolled students.  Form 1098-Ts include the student’s name, address,  and social security number, and the school’s taxpayer identification  number (TIN).  Form 1098-Ts also indicate if the student was a graduate  student and if he or she was enrolled at least half-time.  Postsecondary  institutions had the option of providing information concerning students’  educational expenses, scholarships, and grants but were not required to do  so.  By combining information on the Form 1098-Ts with information on the  tax return, we were able to identify the postsecondary student population  in the SOI sample and the choices that tax filers made concerning  education-related tax preferences.
To conduct the analysis, we had to exclude two types of tax returns from  consideration.  Because a person cannot claim the tuition deduction or the  Hope or Lifetime Learning credits if he or she is claimed as a dependent on  someone else's tax return, we excluded dependent tax returns in the SOI  sample from our analysis.  We also excluded the tax returns of tax filers  that received a Form 1098-T with no information concerning students’  educational expenses because we could not analyze the tax returns without  these data.  This included the tax returns of individuals who received an  education tax credit or tuition deduction but did not receive a Form 1098-T.   These limitations excluded 87 percent of the returns in the sample.
We considered different explanations for why those tax filers with  education expenses did not claim an education tax credit or tuition  deduction.  For example, we examined whether tax filers had (1) income  that exceeded the program thresholds for tax year 2002, (2) no taxable  income, (3) no tax liability after claiming other tax credits, or (4) no net  educational expenses after accounting for scholarships and grants as  reported on the Form 1098-T.  We also examined whether tax filers were  married filing separately or filed a Form 1040EZ because this would  prevent tax filers from being able to claim the education tax credits or  tuition deduction.
We calculated tax filers’ optimal choice among the Hope and Lifetime  Learning credits, and the tuition deduction on the basis of program  eligibility criteria for tax year 2002.  Tax filers are limited to claiming either  a tuition deduction or an education tax credit for the same student.   Eligibility is restricted by modified adjusted gross income and, in the case  of the Hope tax credit, whether or not students are enrolled at least half- time.
We shared our methodology for this analysis with tax policy researchers  outside of GAO and incorporated their comments into our analysis.
To identify available academic research on the effectiveness of major  federal financial aid programs, we reviewed studies that examined whether  the programs or tax preferences affect college attendance, persistence, and  choice.  We looked for these measures because they have been the focus of  congressional concern as expressed in committee reports, statutorily  established study commissions, and requests for our work from Congress.  We examined studies we found through searches in EconLit, Digital  Dissertations from ProQuest, and the National Bureau of Economic  Research web site. These online sources are nationally recognized  repositories of research results.  In addition, we also examined relevant  studies cited in studies found from our searches.  Some of these studies  were excluded from further assessment because they did not undertake  original data analysis that could identify the effectiveness of federal  financial aid programs.  We assessed studies that provided an original  empirical analysis according to professional standards of econometric  analysis for their methodological rigor.  The results of the studies that we  judged to contain acceptably identified statistical estimates formed the  basis for our findings about the availability of information concerning the  relative effectiveness of major federal financial aid programs.
We conducted our review from May 2004 through June 2005 in accordance  with generally accepted government auditing standards.
section_title: Confidence Intervals
paragraphs: We used two data sets in this review: Education’s 2003-2004 National  Postsecondary Student Aid Study and the Internal Revenue Service’s 2002  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 report.  For figures drawn from these data, we provide both  point estimates and confidence intervals.
section_title: Postsecondary-Education-Related Tax Preferences
paragraphs: We analyzed the following postsecondary-education-related tax  preferences in detail in this review.
Lifetime Learning Credit: Income-based tax credit claimed by tax filer  on behalf of students enrolled in one or more postsecondary education  courses.
Hope Credit: Income-based tax credit claimed by tax filer 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 filer 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  filer on behalf of students who are enrolled in one or more postsecondary  education course 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.
The following postsecondary-education-related tax preferences were not  included in this review.
Scholarships, Fellowships, Grants, and Tuition Reductions Income  Exclusion: Scholarships and fellowships paid directly to degree-candidate  students or to their educational institutions for tuition and fees are not  taxed as income. However, scholarships and fellowships covering room  and board or transportation or paid in return for services, such as teaching,  are taxable. Also, tuition reductions, for example discounts given to  employees of an educational institution or their children, are not counted  as income for tax purposes.
Employer-Provided Education Benefits Exclusion: Financial  assistance provided by employers to employees up to $5,250 in 2004 to pay  for employee educational expenses is not counted as income for tax  purposes. Only funds used to pay for tuition, fees, books, equipment, and  similar expenses qualify. Funds from an employer and used to pay for  meals, lodging, or transportation count as income for tax purposes.
Student Loan Forgiveness Exclusion: Student loan repayment  assistance or cancellation provided in exchange for working for a period of  time in certain professions for any of a broad class of employers is not  treated is taxable income.
Education Savings Bonds: Interest earned on U.S. savings bonds is not  taxed if the bond holder is paying postsecondary education tuition and fees  or making contributions to a 529 qualified tuition program or a Coverdell  education savings account. The exclusion is available to tax filers with  modified adjusted gross incomes below $74,850 ($119,750 if married filing  jointly or qualified widow(er)).
Business Expense Deduction of Work-Related Education: Tax filers  may deduct the cost of work-related education if the education is required  by their employer or the law to maintain the tax filer’s present salary,  status, or job and maintains or improves skills needed in the tax filer’s  present work. Education to meet the minimum educational requirements of  the tax filer’s present trade or business or education towards a new trade or  business does not qualify. The tax filer must itemize deductions on form  1040 Schedule A, C, or F. The amount of the deduction is the total of work- related education expenses plus other job and certain miscellaneous  expenses that is in excess of 2 percent of adjusted gross income.
Uniform Transfers to Minors: Money paid directly to an educational  institution for another person’s tuition are not subject to gift taxes.
Early Withdrawals From Individual Retirement Accounts:  The 10  percent additional tax that applies to withdrawal of funds from an  Individual Retirement Account does not apply if the funds are used to pay  for the postsecondary education expenses of the account holder or his or  her dependent.
Parental Personal Exemption for Dependent Students: The tax code  definition of “dependent” for tax filing purposes involves 5 tests, including  whether the dependent is (1) a member of your household or related to  you, (2) a U.S. citizen or resident, (3) filing a joint tax return, (4) earning  less than $3,100, and (5) receiving more than half of their support from the  taxpayer claiming the dependent.  In 2004, someone over age 18, earning  more than $3,100, and not living with the tax filer throughout the year  would likely not qualify as a dependent.  However, the tax code makes  exceptions to these rules for students under age 24, thus postsecondary  education students are still dependents for tax purposes while they are in  school.
section_title: Bibliography
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