The New Federal Tuition Tax
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Federal Tuition Tax Credits
Page 5 of 10

Section Three
Recommendations and Considerations for State Policy

The 1997 Taxpayer Relief Act adds a major new revenue stream to the public financing of higher education. Earlier sections of this paper describe and analyze the new tuition tax credits, savings incentives, and loan interest deductions. State policy responses to this new federal law contain both opportunities and dangers. The major opportunity is that the federal action can prompt states to enhance their own efforts to increase college accessibility for all residents. The major danger is that the neediest current and prospective students may be overlooked. Our recommendations in this section are aimed at enhancing the opportunity and reducing the danger.

The purpose of the federal initiative is to make college more affordable. Whether that purpose will be achieved depends to a large degree upon state policy--on how each governor and legislature adapt their state's unique policies and practices for financing higher education to the new federal tax provisions. If budget numbers alone were the criterion, then states would no doubt seize the new federal tax provisions as offering an "opportunity" to reduce their commitment to higher education. By increasing tuition or by reducing need-based financial aid or both, states could substitute federal dollars for state dollars, thereby shifting more costs to the federal government. But budget numbers are not the only important criterion; accessibility and affordability are critical state policy considerations. It is for this reason that this policy guide offers two fundamental recommendations, on which the following seven specific recommendations are based:

  • Governors and legislatures should assure that affordability problems are addressed for all income groups. Indeed, the new federal tax policies create an opportunity for many states to assist middle income families and address the financial needs of low income families.

  • Governors and legislatures should affirm that any state policies that are adopted in response to the new federal tax provisions at least maintain current levels of state support for higher education.

Student financial aid is enormously complex. Over the past 30 years, federal grant programs have primarily supported low income students. Federal loan programs, initially aimed at low income students, have expanded to benefit all students regardless of family income. During this period, states invested heavily in establishing, expanding and supporting public colleges and universities. In addition to this institutional support, most states maintained or initiated their own student aid programs for low income students. Under most state policies, tuition at public colleges and universities has remained low in comparison to that at private campuses, and--even accounting for need-based student aid--middle and upper income families have been the major beneficiaries of low tuition.

From 1998 to 2002, the new federal tax policies will add $40 billion to the total of federal and state student aid. These tax provisions represent two major shifts in federal policy: (1) the new law provides financial support under the tax code rather than through grant and loan programs; and (2) as this guide reveals, families with annual incomes from $40,000 to $80,000--not low income families--will benefit most from the new law.

Specifically, in response to the higher education provisions of the 1997 Taxpayer Relief Act, states should:

1. Actively inform prospective and current college students and their families about the new federal income tax provisions regarding postsecondary education. States should make information about the new federal law widely available--at a minimum, through public service announcements, high schools and guidance councilors, and employers. States should also seriously consider offering "bridge loans" and other means to encourage their use.

2. Examine public financing of higher education and the state policies behind the numbers. The analysis should include state and federal support, college participation and completion rates by income levels, and state social and economic goals for college education. In particular, each state should:

  • Evaluate its own financial aid programs and the financial aid programs of its postsecondary institutions in light of the new federal tax policies. Gaps in college opportunity and options for addressing them should be identified.

  • Assure that state-level policies are in place to prevent any tuition increases that are not accompanied by sufficient increases in need-based financial aid to meet the needs of low income students.

  • Examine the impact of state and federal policies on current and prospective student populations. Data should include: student and family income; the distribution of enrollment in public and private two-year and four-year colleges; and tuition and fees.6

  • Begin gathering data for long-term analyses. Tax return data after April 1999 should be used to analyze which students and families benefit from the tax credits, the amounts they claim, and changes in claims over time.

3. Conform the state tax code to incorporate the new federal provision for making interest on student loans deductible for state income tax purposes. Students from all income levels are projected to benefit from the new federal deductions for interest on student loans. This action would confer these benefits at the state level. It could also prevent complexity in filing state taxes and promote effective auditing by the state.7

4. Do not conform the state tax code to accommodate the federal tuition tax credits. Conformation would duplicate at the state level the benefits already afforded to middle income students and their families by the federal tax credits. Conforming the state tax code to the new federal tax credit provisions could also increase the complexity of state income tax returns.

5. Do not increase tuition or fees for the sole purpose of capturing federal revenues. Increasing tuition to capture federal dollars may adversely affect low-income populations who are not eligible for federal tax credits.

6. Treat federal tax credits as income for purposes of determining eligibility for state financial aid. By considering these credits as income, states could be shifting a portion of state financial aid to meet the needs of low income students. That is, low income students could benefit from the portion of state financial aid that would otherwise be awarded to those higher income students now served by the new federal tax credits.

7. Seriously consider establishing a state tuition prepayment or savings program similar to those that many states now have in place. Under the new federal program, qualified state savings programs provide significant federal tax advantages to middle income families.


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