The American Opportunity Tax Credit: A Wasteful Way to Provide Student Aid

President Obama proposed today to permanently extend the American Opportunity Tax Credit, a partially refundable $2,500 tax credit that families with incomes up to $180,000 can claim to help offset the costs of higher education. But as I wrote in the “Student Aid Perspectives” column that ran this morning on the National Association of Student Financial Aid Administrator’s website, providing financial aid through the tax code is an ineffective and wasteful way to help students and families pay for college.

Here are three reasons why:

• As many student-aid experts have pointed out, tuition tax breaks are not well-targeted, with a substantial share of the benefits going to affluent families who can afford to send their children to college without the aid. According to the College Board, 26 percent of the savings derived from the higher education tax credits in 2009 went to taxpayers with incomes over $100,000. In comparison, the Department of Education reports that more than 90 percent of dependent students who receive Pell Grants come from families making less than $50,000.

• The tax breaks arrive months after students and their families pay their tuition bills. This disconnect in timing is not only impractical but serves to obscure the purpose of the benefits as well. Suzanne Mettler, a professor of government at Cornell University, conducted a survey of tuition tax credit recipients and found that nearly 60 percent didn’t realize that they had received help from the government to pay for college. These types of “social tax expenditures,” Mettler wrote in the Washington Monthly last summer, “are largely hidden from the public: through them, the government benefits people, providing them with opportunities and relieving their financial burdens, often without them even knowing it.” (Italics in original.)

• The tax breaks are complicated and confusing. Because of the complexity of navigating the tax code, many families do not appear to know whether they are qualified for these benefits. The Government Accountability Office reported in 2008 that it had found that “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.” Meanwhile, the U.S. Treasury Inspector General for Tax Administration revealed in October that more than two million taxpayers may have mistakenly claimed the AOTC in 2009.

Trying to help make college more affordable for students and families is an extremely important goal. However, at a time when federal policymakers can barely find the money to keep the Pell Grant program afloat, providing billions of dollars in tax benefits to upper-middle-income families who can afford to send their children to college without the government’s help is a luxury that the government can ill-afford.

For the sake of preserving access and equity in higher education, the Obama administration and Congress should eliminate, or at least significantly scale back, the AOTC and the other tuition tax benefit programs and use the savings to ensure that the Pell Grant program is on a sustainable path.