How Higher Ed Tax Breaks Serve as Welfare for the Wealthy

As I wrote in a previous blog entry, we may be able to make all public higher ed free, if we just use all current available resources in a more efficient manner. One thing I discovered in my research is the way that tax breaks for higher ed have been used as a form of welfare for the wealthy. As shown in the study, “Moving On Up: How Tuition Tax Breaks Increasingly Favor the Upper-Middle Class,” what has been occurring is that help for poor students is being reduced as support for wealthier students is being increased: “From 1999 to 2009, the government spent $70 billion on tax breaks aimed at subsidizing higher education for families . . . about 13 percent, or $9.4 billion, of that total went to families making more than $100,000 a year. At the same time, only 11 percent went to the neediest families, those making less than $25,000. Families in the middle—those making between $25,000 and $99,999— received the lion’s share of the aid, taking in slightly more than three-quarters of the benefits.” While this research makes it sound like middle-class parents were getting most of the benefit of these tax breaks, we are later told that the movement of the funding has continued to shift to the wealthiest Americans: “nearly 83 percent of the higher education tax benefits distributed from 1999 to 2001 went to families earning less than $75,000 per year. No benefits went to those earning more than $100,000. By contrast, in the last three tax years alone, families making between $100,000 and $180,000 received nearly a quarter of the benefits. The share going to middle-income families sharply declined.” This tax system for higher education is a great example of how so many of our governmental policies end up subsidizing the wealthy as poor and middle-class citizens are left paying more and getting less.

If we made all public higher education free, not only could we do away with this unjust tax system, but we could also stop the movement of public funds to expensive private and for-profit universities and colleges. What people do not notice is that the use of financial aid and tax subsidies for individual students has resulted in a system where much of the governmental support for higher education ends up going to private institutions that cater to the super-rich or to low-achieving for-profit schools. In fact, during a 2012 Congressional investigation of for-profit colleges, it was discovered that up to a quarter of all federal Pell grant money is now going to these corporate schools that charge a high tuition and graduate very few students. What this investigation did not uncover, however, was the amount of state and federal tax breaks that go to support for-profit institutions.

While recent research has been done on how much the federal government has spent on tax deductions and credits for higher education, as far as I can tell, no one has examined how much states are spending on these tax breaks for colleges and universities. However, it is safe to estimate that the total subsidy by the states is at least the same as the total federal level of support ($40 billion) since many of the states have tax deductions that exceed the national tax breaks for tuition, and most states have tax-advantaged 529 college savings plans. For example, in New York state, the tuition tax credit goes up to $5,000 per year per student, and the tuition tax deduction is $10,000 for each eligible student. It is important to point out that tax deductions favor the wealthy since so many low-income families pay little if any federal income taxes.

One of the great secrets in higher education funding is the role played by 529 College Savings Plans: “In 2000 a total of $2.6 billion was invested in 529 plans. This grew to $14 billion in 2001 and more than $92 billion in mid-2006. The student aid resource Finaid.org projects that total investment in 529 plans will reach $175 billion to $250 billion by 2010, with a total of 10 million to 15 million accounts opened.” Not only do state governments lose billions of dollars in tax revenue each year due to these 529 plans, but the wealthy have figured out how to use these plans as all-purpose tax shelters. For example, if a couple puts $26,000 a year for each child into account, and then decides later to use the money to buy a yacht, only the investment gains will be assessed a 10% penalty and taxed as income. Also, contributions made to a 529 are removed from a family's estate, and 529 plan owners can name a successor to the account when they die, which enables the plans to shelter money for multiple generations.

One way that wealthy people use these accounts to avoid paying taxes is by giving each other gifts. In this structure, gift taxes can be avoided if contributions into the plans over a five-year period do not exceed $65,000 for single taxpayers and $130,000 for married couples. Clearly, it is only the wealthiest Americans who are able to profit from this type of plan. In fact, according to a recent Department of the Treasury report, "Currently there are effectively no limits on Section 529 account balances. Because 43 states offer plans open to residents in other states, a beneficiary can have accounts in as many as 44 states, each state with a limit exceeding $224,465." It is obvious that only wealthy people can afford to save and invest this type of money. Moreover, the same study of 529 plans details how the richest families are using these plans for tax shelters: "data from the 2007 Survey of Consumer Finance found that among households in the top five percent of income — average income, $548,000 per year — those with education savings plans held an average balance of $106,250. That’s more than triple the average for households in the 90th-95th percentile, more than ten times the balance for the 50th-75th percentile, etc. Second, among households in Kansas who took a state income tax deduction for 529 contributions, the average deduction for households making over $250,000 per year was $10,323. For those in the $100K-$250K range it was less than $5,000, for everyone else, less than $3,000.” As this federal government report indicates, 529 plans have now become an effective way to subsidize wealthy people; meanwhile, states are forced to cut their higher education budgets due to their lack of tax revenue.

If we took all of the state and federal money that is lost each year due to these tax credits, deductions, and shelters, we could make public higher education free for millions of Americans; however, the tax code is rigged to provide aid to wealthy people, and one side-effect of this system is that private universities are able to charge higher tuition because they know that the parents of many of the incoming students will only pay a fraction of the full price due to merit aid, institutional aid, and tax breaks. Furthermore, once the private universities increase their tuition, they raise the bar for everyone else, and this makes tuition increases at public universities appear to be more tolerable. Furthermore, since the top public universities compete with the top private universities for star faculty and administrators, the more the privates are able to increase their tuition, the more the public institutions have to pay their star faculty.

To contain the rising tuition at private universities and the subsidization of high-cost, low-value for-profit schools, the government needs to move away from the current emphasis on tax breaks and tax shelters, and this can be done in part by making all public higher education free. Instead of relying on a mix of financial aid, institutional aid, tax subsidies, and grants, direct funding for public institutions could give the government a way to control costs at both public and private universities and colleges. The federal government could also require states to maintain their funding for public institutions in return for increased federal support, and once we stabilize funding and make higher education free, then we can eliminate the need for so many students and institutions to go into debt.