Just Taxes Blog by ITEP

School’s In: Tackling College Affordability Through State Tax Codes

School’s In: Tackling College Affordability Through State Tax Codes

January 11, 2022

Brakeyshia Samms
Brakeyshia Samms
State Policy Analyst

Federal Policy Alone Won’t Fix the College Affordability Crisis

For decades, postsecondary education has been described as a path to a better life and a stronger economy. But the exorbitant cost of college makes it out of reach for far too many people, especially people of color. Among those who attend college, student debt is rapidly rising for all students, and the average Black college graduate owes $25,000 more in student loans than white college graduates. The Build Back Better Act, which recently passed the House, would take small steps toward combatting the ongoing college affordability crisis, like expanding Pell Grants. However, more ambitious proposals, such as free college and student debt cancellation, are not in the bill.  

Given that a sweeping federal solution to the college affordability crisis does not appear to be on the immediate horizon, it is even more important that states take whatever steps they can to expand college access and affordability. While most of that effort will need to occur on the spending side of the ledger—such as through lowering tuition costs, expanding financial aid, or perhaps even funding free college outright—tax policy also has a role to play. Specifically, states could restructure their higher education tax policies to be more equitable and effective by moving beyond tax policies that incentivize college savings, which benefits higher-income families, and instead create policies that make college more accessible for families with more modest incomes. 

Today’s Federal and State Higher Education Tax Policy Advantages the Wealthy

On the federal level, households can receive higher-education tax breaks before, during and after college. Families benefit before sending their kids to college by receiving annual tax breaks for money put into a 529 plan. They benefit during college with the American opportunity tax credit (AOTC), or after college with the student loan interest deduction, among other programs. The costs are substantial, too. In 2020, these exclusions, tax credits, and deductions totaled over $28 billion, which is more than the $27 billion spent on Pell Grants. While Pell Grants overwhelmingly provide support to students from families with low incomes, the opposite is true for these tax breaks.   

Most states already have higher education tax policies in place, but too many are poorly targeted and likely offer larger benefits to high-income or wealthy white families. For example, tax breaks for investment earnings in 529 accounts overwhelmingly benefits wealthy, predominately white families able to put aside large amounts of college savings. Tax deductions for 529 contributions are similarly flawed. People of color tend to have lower family wealth on which to draw upon in paying for college, and are therefore more likely to find themselves paying for college with loans instead of savings. 

Deductions for student loan interest or tuition and fees are less problematic than the tax breaks associated with 529 accounts, but even these policies can have inequitable effects because—by taking the form of a deduction—the benefit per dollar deducted will tend to be lower for people of color with lower incomes . 

Tax Policy Is a Tool Policymakers Can Use to Fight Challenges Within the Higher Education System

One of the main tenets of good tax policy is simplicity, but state tax policies for higher education fall short of that principle. States could do better by streamlining existing programs. And they should de-couple from federal higher education tax breaks and create a refundable credit  for pre-college, during college, and post-college qualified education expenses. This would support the objective of simplicity because, unlike current policies where there are many requirements to meet and there are many tax policies to understand, this credit would be applied to any postsecondary education expense. For example, this credit could cover contributions to a 529 plan, books for classes, and interest on student loans. This would also be universal for all postsecondary education, such as community colleges, four-year universities, and trade schools, among other eligible institutions 

Designing such a tax program would help ensure equity and fairness because lawmakers could design it to target people who need it the most. This is where refundability comes into play because it helps ensure that people with no personal income tax liability – typically low-income households – can receive some help. Designing the policy in a way that has a low income ceiling also make sense as a way of targeting available dollars in such a way that those most in need of assistance will receive a meaningful boost.  

The Big Picture

When it comes to higher education affordability, policymakers face many competing polices such as providing college at no cost, cancelling student debt, bolstering financial aid programs, or increasing public funding for postsecondary institutions. Given the size and scope of the college affordability crisis, policymakers should explore a wide and ambitious range of options. Redesigning state-level tax breaks related to higher education is an admittedly modest policy shift compared to some of the more transformational investments lawmakers might consider. But if states are intent on using their tax codes to promote college affordability (and every state with a personal income tax has at least one higher education related tax preference), then it is worthwhile for them to do so in the most efficient way possible.  

The proposal advanced in this article—an income-limited, refundable credit for a broad range of college expenses—would curb the inequities present in many of the income tax preferences states offer today. Low-income and middle-income families confronting college expenses would receive a larger and more uniform benefit through a refundable credit than they do through the current tax deduction regime while high-income families would see their benefits curtailed through new phase-outs on the tax subsidies provided on their contributions to 529 accounts or their direct tuition payments. 

The net result would represent a reshuffling of state priorities away from subsidies for high-income and high-wealth families that are disproportionately white, and toward a more focused policy offering more substantial benefits to a diverse group of past, present, and future college students of more modest means.  

With upcoming legislative sessions for most states, lawmakers have an opportunity to redress a problem that faces too many Americans: college affordability. Taking the time to create a tax program that helps steer postsecondary tax breaks in a better direction, toward equity and effectiveness, can be a worthwhile part of such an endeavor. Where federal policymakers fall short, state policymakers should do what they can to move us forward.