How the Stimulus Helps You Pay for College

The government is poised to spend about $13 billion in stimulus funds on improvements to education tax credits that will offset up to $2,500 in college costs for millions of low- and middle-income families. But the changes probably won't immediately stimulate the economy or make much of a difference to the many families now living paycheck to paycheck, tax experts say.

Other education provisions in the stimulus bill, such as a several-hundred-dollar increase in the Pell grant, the biggest federal grant awarded to low-income students, have won bipartisan support. The education tax changes are more controversial, though, and have drawn criticism from some education organizations for their high costs and comparatively small impact.

Congressional Democrats defended all aspects of the stimulus bill, including the education tax breaks. "For the first time, Congress is making these tax cuts refundable, which means that even if people don't earn enough to pay taxes, they are still eligible for a refund. We also simplified the process by combining two existing tax credits, which will make the tax credit less confusing for eligible students. Both the tuition tax credit and the significant boost in the Pell grant scholarship will be a huge help for low-income and middle-class families struggling to pay for college," says Melissa Salmanowitz, press secretary for the House Education and Labor Committee.

And while the education tax break didn't quite match up to President Barack Obama's campaign promise of a $4,000 credit payable when bills come due (instead of making students wait for tax refunds) in return for public service, the administration said it was happy with the provision. "This is a good step forward, and we will look at ways we can take the next step," said a spokesman for the Department of Education.

Under the stimulus bill, starting next year, taxpayers earning up to $80,000 (or $160,000 for joint filers) will be able to reduce their tax bills dollar for dollar for the first $2,000 of tuition and books. A portion of education expenditures above that will get a partial credit. Best of all: Those who don't happen to owe any taxes could still be able to get at least a few hundred dollars in refunds.

That's an improvement over the smaller and more confusing tax credits and deductions in the current law. Anyone with education expenses filling out a 1040 this year has to decide whether to take the Hope tax credit of up to 100 percent of the first $1,200 spent on tuition or fees for freshman or sophomore years in 2007, plus 50 percent of the next $1,200; or the Lifetime Learning credit of 20 percent of up to $10,000 in tuition or fees paid in 2007; or whether to deduct qualified education expenditures from last year's income. The credits go only to filers with incomes up to $58,000 a year ($116,000 for joint filers). To make things even more complicated, there is an exception for filers from an officially designated Midwestern disaster area, such as Pulaski County, Ark. Students in those areas have more generous tax credit rules. The deductions have different income limits and rules, depending on whether the education is work related or not. Students are allowed to take only one of these education credits or deductions each year.

This eye-crossing complexity, studies show, causes many filers to make costly mistakes. One study found that about one third of the approximately 8 million students who are eligible for an education tax credit didn't file for it.

In addition, other research shows that the current tax breaks are so small, compared with most college bills, and kick in so much later than the bills must be paid that they don't make much of a difference to struggling families. IRS data show that the average Hope or Lifetime Learning tax credit is about $780. That's welcome cash, no doubt. But it is less than one- third of the average annual tuition and fees charged by community colleges, the lowest-priced colleges in the country.

And that $780 is only a reduction in the student's tax bill a year after the tuition bill had to be paid, of no help to anyone trying to scratch up several thousand dollars to register for September or January classes. Little wonder, then, that research on the tax breaks has found no evidence that they have encouraged a single student to enroll who otherwise would not have done so. The importance of getting students the money when they need it to pay their bills—not a year later—is widely recognized. This led Obama during his presidential campaign to promise an educational tax credit that would be paid when a student enrolled.

Tax researchers say the stimulus bill education tax changes, while improving the generosity and simplicity of the credits, don't appear to fix some of the other faults that make the current tax breaks comparatively expensive and inefficient. Including textbook costs and granting even those with low incomes a tax refund "are steps in the right direction," says Andrew Reschovsky, a tax expert at the Robert M. La Follette School of Public Affairs at the University of Wisconsin-Madison.

"But the timing of the payments isn't right," and many taxpayers will still get back only a small percentage of their education costs. "This is a program that is fairly expensive and is not going to help stimulate the economy," Reschovsky says.

"What Obama originally proposed would have had a much more direct effect," although delivering the payments to schools each fall might have been a logistical nightmare, says Kim Rueben, a tax expert at the Urban Institute. Her group gave the education tax credit stimulus proposal a C because of the small, delayed payments.

Many other financial aid experts supported the overall stimulus bill because it has so many other improvements, such as the plan to raise the Pell grant.

The National Association of Student Financial Aid Administrators, for example, issued a press release supporting the overall bill. A NASFAA spokesman declined to comment specifically on the tax break provisions. But in 2003, NASFAA called for Congress to take the billions it gives away in education tax credits and use that money to increase the size and number of Pell grants. "Tax credits to middle- and upper-middle-income students do not encourage college attendance-they simply reward behavior that would have taken place in the absence of the tax credits," the NASFAA wrote. "On the other hand, Pell grants awarded to the neediest of students enable them to attend college, which was previously out of their reach." Pell grants are considered more effective because they are automatically credited against students' bills at the time of enrollment, reducing the need to scrape together ready cash.

Shifting the $10 billion to $14 billion a year that taxpayers most likely will be spending on education tax breaks to Pell grants would probably not be of much help to many in the middle class, however. The government is spending about $17 billion this year to send out checks of up to $4,731 to about 6 million students who generally come from families earning $40,000 or less. The stimulus bill will very likely raise the maximum Pell grant to about $5,350 in the fall of 2009 and by an additional $200 or so in the fall of 2010. It would also widen the Pell net to include about 800,000 more students from families earning a little above $40,000 a year. The additional cost: about $4 billion to $5 billion a year. Raising the Pell even further would help more students from families earning slightly higher incomes but still wouldn't be likely to help many families earning more than, say, $60,000 a year, estimates Rueben of the Urban Institute.

"Middle-income people are feeling squeezed" by rising tuition costs, and there aren't many other good options for helping them, Rueben says.