State tax law cannot discriminate against federal pensioners, Supreme Court holds

IRS Tax News – State tax law cannot discriminate against federal pensioners, Supreme Court holds
The U.S. Supreme Court held that West Virginia cannot provide a tax exemption to state law enforcement retirees while denying that exemption to federal law enforcement retirees who performed similar jobs.
Source: IRS Tax News – State tax law cannot discriminate against federal pensioners, Supreme Court holds

Evaluating Education Tax Provisions

Tax Policy – Evaluating Education Tax Provisions

Key Findings

  • The tax code contains several provisions designed to make higher education more affordable and to encourage educational attainment. These include credits, deductions, exclusions, and tax-neutral savings plans.
  • Many of these benefits overlap and are complex, creating confusion for taxpayers that leads to underutilization of current policies as well as administrative and oversight difficulties.
  • Research shows that the current menu of education-related benefits is not effectively promoting affordability or the decision to attend college.
  • Lawmakers wishing to provide education assistance should reconsider whether the tax code is the best tool to achieve that goal.

Introduction

The tax code contains several provisions which are intended to make higher education more affordable. While traditionally the goal of affordability was pursued with loan programs and direct subsidies,[1] the policy toolkit now contains at least a dozen tax-related provisions such as credits and deductions.

Some provisions are available after education expenditures are made, while others are designed to incentivize long-term savings for higher education. Despite being touted as benefits for lower- and middle-income taxpayers, a disproportionate share of the provisions’ benefits flow to higher-income earners. Many of the benefits overlap and create confusion for taxpayers, while evidence is lacking as to whether these provisions work and whether they result in higher levels of education.

This leads to questions of whether the tax code is the most effective way for lawmakers to address the affordability of higher education, or whether traditional means offer a better way to pursue this goal.

This paper provides background information on the arguments for and against education-related tax provisions; an overview of the different provisions under current law, including how they function, who they benefit, and what they cost; and a discussion of areas lawmakers should evaluate when looking to reform these provisions.

Background

Two of the primary considerations for the tax treatment of education expenditures are whether they constitute investment spending or consumption spending, and whether higher education creates a social benefit.[2] For the tax code to be neutral, it should not affect a household’s decision whether to invest or consume. This can be easily illustrated with an example:

The tax treatment of an investment in an Individual Retirement Account (IRA) is neutral. A person may save $1,000 pretax in an IRA, and then pay income taxes when taking distributions from the account—resulting in one layer of tax. Likewise, if the person wished to immediately spend their income on consumption they would face only one layer of federal income tax. This individual would pay just one layer of federal income tax on their income whether they invest it or spend it immediately. Their decision is unaffected by the tax code. On the other hand, the tax code would create a bias against the investment if both the principle placed in the IRA and the return earned on the IRA were subject to tax.

It can be argued that higher education is an investment in human capital, similar to investments in physical capital. Individuals pay for higher education in order to earn higher income in the future, on which income taxes will be paid—in other words, education is the cost of investment in human capital and should be tax-deductible.[3]

This theory makes sense when viewed in the light that “individuals should be allowed to deduct from their income the expenses incurred as part of earning that income.”[4] This argument would favor a simple, above-the-line deduction for educational expenses.

However, if portions of education-related expenditures represent consumption, rather than investment, it would call for different tax treatment. To the extent that students obtain utility from pursuing higher education, the consumption portion of spending, it should not be deducted and instead taxed as any other type of consumption.[5]

If the mix of deductions and tax credits available to a student more than offset the cost of obtaining an education, this would in effect serve as a subsidy for education. For a subsidy to be justified, it would need to de demonstrated that higher education creates positive social returns, or benefits which spill over to society at large.[6]

The likely answer is that higher education expenditures represent a mix of investment and consumption spending, which has conflicting implications for the appropriate tax treatment.

Education Provisions under Current Law

The size and scope of education provisions in the tax code have greatly expanded over the past two decades.[7] A mix of credits, deductions, exclusions, and savings plans[8] are available to households as they plan and pay for higher education. The stated intent of many of these policies, especially the tax credits, is to increase investment in higher education and provide a tax cut to middle-class households that invest in higher education to make it more affordable.[9]

Credits

Two permanent credits, the American Opportunity Credit and the Lifetime Learning Credit, provide tax benefits for tuition and related expenses.

The American Opportunity Credit[10] provides a maximum annual amount of $2,500 per student, calculated as 100 percent of the first $2,000 in qualifying expenses and 25 percent of the next $2,000 in qualifying expenses for the first four years of undergraduate education. If the credit reduces a taxpayer’s liability to zero, then up to $1,000 may be refunded. The credit is subject to income limits: to claim the full credit, modified adjusted gross income (MAGI)[11] must be below $80,000 for single taxpayers ($160,000 married filing jointly). Taxpayers cannot claim the credit if MAGI exceeds $90,000 ($180,000 married filing jointly).

The Lifetime Learning Credit[12] provides a maximum annual amount up to $2,000 per tax return, calculated as 20 percent of the first $10,000 of qualified expenses, and it is nonrefundable. The Lifetime Learning Credit is subject to income limitations: for tax year 2018, the amount phases out if MAGI is between $57,000 and $67,000 ($114,000 and $134,000 married filing jointly) and cannot be claimed if MAGI exceeds that threshold.

Provision Annual Limit Qualifying Expenses Qualifying Education Level Income Phaseout
American Opportunity Tax Credit Partially refundable credit of up to $2,500 per student Tuition and required enrollment fees   Course-related books, supplies, and equipment             First four years of undergraduate education $80,000-$90,000 (single) $160,000-$180,000 (married joint)
Lifetime Learning Credit Nonrefundable credit of up to $2,000 Tuition and required enrollment fees Undergraduate, graduate, and job skills courses $57,000-$67,000 (single) $114,000-$134,000 (married joint)

Taxpayers cannot claim more than one education benefit for the same students and the same expenses;[13] instead they must choose which education benefit is best for their situation. In tax year 2016, nearly 9 million returns claimed nonrefundable education credits,[14] while 8.7 million claimed refundable American Opportunity Credits. The average credit sizes for filers with $30,000 to $50,000 in AGI were $1,054 for nonrefundable credits and $859 for the refundable portion of the American Opportunity Credit (see Appendix Table 1).[15]

Who benefits from education credits?

The Joint Committee on Taxation (JCT) estimates that in 2018, the credits for postsecondary education cost $18.9 billion.[16] Over the five-year period from 2018 to 2022, the JCT estimates they will cost $95.5 billion.

Deductions

The tax code provides one permanent and one temporary deduction related to higher education costs: the Student Loan Interest Deduction and the Tuition and Fees deduction, which at the time of writing had expired.[17] Both are “above-the-line” deductions, which means taxpayers do not have to itemize in order to take the deductions.

The Student Loan Interest Deduction[18] allows taxpayers to deduct up to $2,500 of qualifying interest paid during the year. The deduction phases out for MAGI between $65,000 and $80,000 for single filers and between $135,000 and $165,000 for married filing jointly.

The Tuition and Fees Deduction allowed taxpayers to deduct up to $4,000 of qualified expenses. Taxpayers could not take the deduction if they claimed either of the two higher education tax credits, if the expenses were paid using certain monies,[19] or if MAGI exceeded $80,000 (or $160,000 married filing jointly). Because both tax credits are a permanent part of the code, generally provide a larger benefit, and cannot be used in conjunction with the deduction, most taxpayers utilize the credits rather than the deduction.[20] However, the deduction is beneficial for taxpayers who do not qualify for the credit.

The Tuition and Fees deduction is part of a group of tax provisions which are enacted on a temporary basis, regularly expire, and are then reauthorized on a temporary basis. At the time of writing, this deduction had expired.

Provision Annual Limit Qualifying Expenses Qualifying Education Level Income Phaseout
* At the time of writing, this deduction had expired.
Source: Margot L. Crandall-Hollick, “Higher Education Tax Benefits: Brief Overview and Budgetary Effects,” Congressional Research Service, Aug. 27, 2018.
Student Loan Interest Deduction Up to $2,500 deduction Tuition and required enrollment fees   Course-related books, supplies, and equipment   Room and board   Other necessary expenses, including transportation            Undergraduate and graduate $65,000-$80,000 (single) $135,000-$165,000 (married joint)
Tuition and Fees Deduction* Up to $4,000 deduction Tuition and required enrollment fees  Undergraduate and graduate $65,000-$80,000 (single) $130,000-$160,000 (married joint)

In tax year 2016, 12.4 million returns claimed the student loan interest deduction for a total of $13.4 billion while 1.7 million claimed the tuition and fees deduction for a total of $3.9 billion. In 2016, taxpayers with AGI between $30,000 to $50,000 took an average tuition and fees deduction of $2,207 and an average student loan interest deduction of $1,142 (see Appendix Table 2).

Note that the value of a deduction varies with the marginal tax rate of the taxpayer; for example, deducting $4,000 against a 22 percent tax rate reduces tax liability by $880, while deducting the same $4,000 against a 12 percent tax rate reduces tax liability by $480.[21]

Who benefits from education deductions?

The JCT estimates the student loan interest deduction cost $2.2 billion for 2018 and will cost $11.8 billion for the five-year period from 2018 to 2022.[22] Because the tuition and fees deduction had expired, it is not included in current expenditure reports. However, in a May 2018 report, the JCT estimated the 2017 revenue cost of the deduction for higher education expenses at $0.4 billion.[23]

Exclusions

Several types of education-related income are excluded from taxable income:[24] scholarships, grants, and tuition reductions; certain discharged student loans; and employer-provided education assistance.

  • As long as scholarships, grants, and tuition reductions are used to pay for qualifying expenses and are not work-based, there is no limit on the amount that may be excluded from income.
  • If students work for a certain period in certain professions, their student loan debt may be canceled, and that cancellation is not included in taxable income. Likewise, the cancellation of student debt due to death or permanent disability of a student is nontaxable.
  • If an employee receives education assistance from their employer under a qualified program, up to $5,250 may be excluded from the employee’s taxable income.

The JCT estimates that in 2018, the exclusion for scholarship and fellowship income cost $3.0 billion, the exclusion of income attributable to the discharge of certain student loan debt and loan repayments cost $0.2 billion, the exclusion of employer-provided tuition reduction benefits cost $0.3 billion, and the exclusion of employer-provided education assistance benefits cost $1.1 billion.[25] Over the five-year period from 2018 to 2022, these exclusions together are estimated to cost $25.1 billion.

Tax-Neutral Savings Accounts

Lawmakers have also created a variety of college savings vehicles, which allow taxpayers to set aside funds that can grow tax-free.

529 Plans

529 Plans[26] can be established for a designated beneficiary to take tax-free withdrawals to pay for qualifying education expenses, such as tuition, fees, books, supplies, equipment, and room and board at eligible institutions and up to $10,000 of tuition at elementary or secondary schools.[27] While there are no income limits for contributors or beneficiaries of 529s, overall lifetime limits for contributions range from $250,000 to nearly $400,000 per beneficiary. The tax code provides two types of 529 plans.

The first type of account, a 529 “prepaid” plan, allows the contributor to save for a specified number of academic periods, course units, or percentage of tuition costs at current prices. This type of plan essentially purchases education at today’s price to be used in the future. The JCT estimates that this was a negative tax expenditure of $3 billion in 2018, but over the five-year period from 2018 to 2022 will reduce federal revenues by $0.3 billion.[28]

The second type, a 529 “savings plan,” allows contributors to invest savings that can later be withdrawn tax-free for education purposes. The JCT estimates this will reduce federal revenues by $1.0 billion in 2018, and by $7.2 billion over the five-year period from 2018 to 2022.[29]

Coverdell Education Savings Accounts

Coverdell education savings accounts[30] are tax-neutral accounts which allow taxpayers to save and then make tax-free withdrawals to pay for higher-education, elementary, and secondary school expenses. The JCT estimates that Coverdell accounts will reduce federal revenue by $0.1 billion in 2018 and $0.6 billion between 2018 and 2022.[31]

Contributions are limited to $2,000 a year per beneficiary (usually the taxpayer’s dependent), unless the contributor’s income exceeds $110,000 ($220,000 for married filing jointly), in which case contributions are prohibited. However, contributions may be gifted to an intermediary individual under the income limit and the intermediary may contribute the gift to the Coverdell.

Miscellaneous

In addition to the two categories of savings accounts, the tax code contains other provisions which provide preferential tax treatment for funds used for education.

First, taxpayers may take early distributions from any type of IRA to use for education costs without paying the 10 percent tax on early distributions.[32] Another option is that taxpayers may cash in savings bonds to use for education costs without paying tax on the interest, as long as they make no more than $93,150 ($147,250 married filing jointly).[33] And finally, a direct transfer to an educational institution to pay for tuition on behalf of a minor is not a taxable gift.[34]

Reform Considerations

The structure of the education provisions creates a host of problems and falls short of ideal tax policy, as well as the stated intent of the programs. Specifically, issues arise with regard to neutrality, administrability, simplicity, and efficiency.

Neutrality

When determining the appropriate tax treatment for higher education, Congress should consider that there are both investment and consumption elements to higher education. Research also indicates that at least some education may be a form of signaling to employers, and as such there may be an over-investment in higher education. [35]

Given these elements of educational expenses, it is not straightforward that the tax code should subsidize education.

While theory would suggest that it is neutral to allow a deduction for educational expenditures in that they reflect an investment, it would not be neutral to allow a deduction for, or to subsidize, the consumption and signaling components of educational expenses.

As previous Tax Foundation research suggests, “Overall, the net effect of these conflicting proper tax policies suggests that actually allowing no deductibility and having little subsidization of higher education may be the proper policy.”[36]

Recently, Senators Amy Klobuchar (D-MN) and Ben Sasse (R-NE) introduced Senate Bill 275 which would provide lifelong learning accounts to pay for education expenses including skills training, apprenticeships, and professional development.[37] This raises another neutrality issue: most tax provisions apply to undergraduate or graduate level education, and not other types of education.

Administrability and Simplicity

The mix of credits and deductions under current law creates a complex system of education provisions which taxpayers must navigate.

For example, eligibility for the American Opportunity Credit, the Lifetime Learning Credit, and the tuition and fees deduction can overlap, leaving families to decide which to claim for each student.

In 2009, the Government Accountability Office found that about 14 percent of filers failed to claim a credit or deduction for which they appeared eligible, leaving an average of $466 on the table for a total of $726 million.[38] The report also found that another 275,000 made a suboptimal choice of which credit or deduction to claim, with the result of failing to increase their tax benefit by an average of $284.[39] With a simpler system, filers could more easily find the credits and deduction they qualify for.

These complexities lead to administrative problems as well. Similar to the difficulty taxpayers face in navigating the swath of provisions, the Internal Revenue Service (IRS) is not well suited to be a benefits agency. The IRS lacks many of the resources and competencies required to educate taxpayers about the provisions and undertake enforcement actions necessary to prevent fraud. The Treasury Inspector General for Tax Administration (TIGTA) released a report in 2011 that found billions of dollars of education credits that appeared to be erroneous. Some of the key findings included:[40]

  • 7 million taxpayers received $2.6 billion in education credits for students for whom there was no supporting documentation in IRS files that they attended an educational institution.
  • 370,924 individuals claimed as students who were not eligible because they did not attend the required amount of time and/or were postgraduate students, resulting in an estimated $550 million in erroneous education credits.
  • 63,713 taxpayers erroneously received $88.4 million in education credits for students claimed as a dependent or spouse on another taxpayer’s tax return.

If lawmakers want to provide tax benefits for higher education, they ought to consider consolidation so that the provisions are simpler for taxpayers and administrators to navigate. A simpler system would lead to greater understanding among filers and better administration at the IRS.

Efficiency

Given that lawmakers have decided that the tax code should be used to make higher education more affordable and help more individuals attend college,[41] we can evaluate whether current policies are successfully accomplishing those goals. Evidence suggests that they are not.

Despite the expanding size and scope of federal benefits for higher education, student loan debt is growing, reaching $1.56 trillion in Q3 2018.[42] The Federal Reserve has observed that “federal student loans are the only consumer debt segment with continuous cumulative growth since the Great Recession….Student loans have seen almost 157 percent in cumulative growth over the last 11 years.”[43] The growth in debt indicates that current policy is not addressing the fundamental issue of growth in the cost of college.[44]

Further, economic evidence casts doubt on the ability of the programs to even influence decisions of whether to pursue higher education. For example, a 2014 paper examined the federal tax credits and their effect on college outcomes, finding “no or very small causal effects” on attending college and further, that the federal government and society will earn zero return on the tax credits.[45] Another study by the same authors in 2015 found no evidence that the tuition and fees deduction affects attending college at all, attending full-time versus part-time, attending four- versus two-year college, or a number of other factors.[46]

Reform Discussions

These tax provisions fail to address the underlying causes of increasing costs for higher education, lead to complexity and administrability issues for taxpayers and the IRS, and violate principles of sound tax policy, all while not effectively helping the people Congress intended to help. Lawmakers have recently considered ways to consolidate the education provisions; however, a more thorough review is warranted.

Recent Efforts

An early version of the Tax Cuts and Jobs Act in the House of Representatives included a subtitle, “Simplification and Reform of Education Incentives.”[47] This proposal would have consolidated the tax credits into a single, expanded American Opportunity Tax Credit. It would have consolidated Coverdell education savings accounts into section 529 plans, prohibiting new Coverdell contributions and allowing tax-free rollovers from Coverdell accounts into section 529 plans. It also would have repealed the deductions for interest payments on qualified education loans and tuition and fees and the exclusions for interest on U.S. savings bonds, qualified tuition reductions, and employer-provided education assistance.

Other Solutions

Past proposals range from addressing some overlapping provisions to adding even more options for taxpayers. These proposals have lacked the analysis necessary to be considered true reform. Consolidation of existing provisions should be pursued in conjunction with broader discussions about the effectiveness of tax-related policy tools compared to others that lawmakers could use.

For example, lawmakers could consider solutions that do not use the tax code to effectuate spending priorities and instead pursue policies such as Pell Grants and prepayment plans.[48] Focusing on spending programs like Pell Grants could better target government resources to lower-income students, as opposed to deductions and credits. Likewise, prepayment plans, such as the 529 “prepaid” plans, can help address affordability issues, as families are able to lock in prices and save for college.

Conclusion

The tax code contains several provisions relating to higher education affordability and attainment. Over the past few decades, these provisions have increased in size and scope, but evidence of whether they are accomplishing the stated goals is lacking. Many of the benefits flow to higher-income taxpayers, despite the rhetoric that these provisions are designed to help lower- and middle-income taxpayers. Likewise, research indicates that tax credits and deductions have little to no influence on whether an individual chooses to pursue higher education.

Lawmakers should address questions of administrability, simplicity, neutrality, and efficiency as they relate to the educational provisions. Questions of whether the tax code is the appropriate tool to work toward goals of affordability and attainment should also be explored. Options such as prepaid tuition plans and grants may be a more effective way to help manage the cost of education, while the efficacy of credits, exclusions, and deductions is less clear.

Appendix Table 1
Nonrefundable Education Credit
AGI Number Amount Average
Source: IRS Table 3.3 All Returns: Tax Liability, Tax Credits, and Tax Payments, by Size of Adjusted Gross Income, Tax Year 2016 (Filing Year 2017), author’s calculations.
No AGI 2,119 $862,000 $406.80
$0 under $30,000 2555261 $1,614,258,000 $631.74
$30,000 under $50,000 2,079,000 $2,192,193,000 $1,054.45
$50,000 under $100,000 2,667,197 $3,420,327,000 $1,282.37
$100,000 under $200,000 1,694,393 $2,425,416,000 $1,431.44

Refundable American Opportunity Tax Credit

AGI

Number

Amount

Average

No AGI 103,458 $98,279,000 $949.94
$0 under $30,000 3,706,301 $3,201,494,000 $863.80
$30,000 under $50,000 1,473,865 $1,266,405,000 $859.24
$50,000 under $100,000 1,938,030 $1,816,291,000 $937.18
$100,000 under $200,000 1,541,631 $1,482,048,000 $961.35
Appendix Table 2
Tuition and Fees Deduction
AGI Number Amount Average
Source: IRS Table 1.4.  All Returns: Sources of Income, Adjustments, and Tax Items, by Size of Adjusted Gross Income, Tax Year 2016 (Filing Year 2017), author’s calculations.
No AGI 82,835 $297,976,000 $3,597.22
$0 under $30,000 567,468 $1,518,572,000 $2,676.05
$30,000 under $50,000 163,279 $360,363,000 $2,207.04
$50,000 under $100,000 384,761 $795,196,000 $2,066.73
$100,000 under $200,000 488,759 $938,119,000 $1,919.39

Student Loan Interest Deduction

AGI

Number

Amount

Average

No AGI 79,192 $78,810,000 $995.18
$0 under $30,000 2,424,392 $2,227,231,000 $918.68
$30,000 under $50,000 3,118,877 $3,562,222,000 $1,142.15
$50,000 under $100,000 4,496,698 $5,146,880,000 $1,144.59
$100,000 under $200,000 2,277,021 $2,431,008,000 $1,067.63

Notes

The author would like to thank Alec Fornwalt for his research contributions.

[1] Scott A. Hodge and Kyle Pomerleau, “Is the Tax Code the Proper Tool for Making Higher Education More Affordable?” Tax Foundation, July 15, 2014, https://taxfoundation.org/tax-code-proper-tool-making-higher-education-more-affordable/.

[2] See generally Michael Schuyler and Stephen J. Entin, “Case Study #8: Education Credits,” Tax Foundation, Aug. 7, 2013, https://taxfoundation.org/case-study-8-education-credits/.

[3] Gerald Prante, “Education Tax “Subsidies” – Justified or Not?” Tax Foundation, May 13, 2008, https://taxfoundation.org/education-tax-subsidies-justified-or-not/.

[4] Ibid.

[5] Ibid.

[6] Michael Schuyler and Stephen J. Entin, “Case Study #8: Education Credits.”

[7] Ibid.

[8] A tax credit directly reduces tax liability. A deduction reduces the amount of income subject to tax. An exclusion excludes certain types or amounts of income from tax.

[9] George B. Bulman and Caroline M. Hoxby, “The Returns to the Federal Tax Credits for Higher Education,” National Bureau of Economics, December 2015, 27-29, https://www.nber.org/chapters/c13465.pdf.

[10] Internal Revenue Service, “American Opportunity Tax Credit,” https://www.irs.gov/credits-deductions/individuals/aotc.

[11] Modified adjusted gross income is the same as adjusted gross income for most tax filers. It is calculated by adding back certain exclusions and deductions to adjusted gross income. These include the foreign earned income exclusion, foreign housing exclusion, foreign housing deduction, and exclusion of income by bona fide residents of American Samoa or Puerto Rico. See Internal Revenue Service, “American Opportunity Tax Credit.”

[12] Internal Revenue Service, “Lifetime Learning Credit,” https://www.irs.gov/credits-deductions/individuals/llc.

[13] Internal Revenue Service, “Education Benefits — No Double Benefits Allowed,” https://www.irs.gov/credits-deductions/individuals/education-benefits-no-double-benefits-allowed.

[14] Meaning, the portion of the education credit the taxpayer used to offset tax liability and not receive as a refund.

[15] Internal Revenue Service Statistics of Income, Table 3.3 All Returns: Tax Liability, Tax Credits, and Tax Payments, by Size of Adjusted Gross Income, Tax Year 2016 (Filing Year 2017)

[16] Joint Committee on Taxation, “Estimates Of Federal Tax Expenditures For Fiscal Years 2018-2022,” Oct. 4, 2018, https://www.jct.gov/publications.html?func=startdown&id=5148.

[17] It is likely that Congress will reauthorize this provision.

[18] Internal Revenue Service, “Publication 970 (2017), Tax Benefits for Education,” https://www.irs.gov/publications/p970.

[19] For example, if expenses were paid using the tax-free portion of a distribution from a Covedell education savings account or qualified tuition program or other tax-free educational assistance.

[20] Joint Committee on Taxation, “Federal Tax Provisions Expired in 2017,” March 9, 2018, 20, https://www.jct.gov/publications.html?func=startdown&id=5062.

[21] Note that the maximum benefit of the tuition and fees deduction in 2018 would be $880, because eligible taxpayers would be in the 22 percent bracket or below.

[22] Joint Committee on Taxation, “Estimates Of Federal Tax Expenditures For Fiscal Years 2018-2022.”

[23] Joint Committee on Taxation, “Estimates Of Federal Tax Expenditures For Fiscal Years 2017 – 2021” May 25, 2018, https://www.jct.gov/publications.html?func=startdown&id=5095.

[24] See Internal Revenue Service, “Publication 970 (2017), Tax Benefits for Education.”

[25] Joint Committee on Taxation, “Estimates Of Federal Tax Expenditures For Fiscal Years 2018-2022.”

[26] Margot L. Crandall-Hollick, “Tax-Preferred College Savings Plans: An Introduction to 529 Plans,” Congressional Research Service, March 5, 2018, https://fas.org/sgp/crs/misc/R42807.pdf.

[27] Internal Revenue Service, “Publication 970 (2018), Tax Benefits for Education,” 83.

[28] Joint Committee on Taxation, “Estimates Of Federal Tax Expenditures For Fiscal Years 2018-2022.”

[29] Ibid.

[30] Margot L. Crandall-Hollick, “Tax-Preferred College Savings Plans: An Introduction to Coverdells,” Congressional Research Service, March 13, 2018, https://fas.org/sgp/crs/misc/R42809.pdf.

[31] Joint Committee on Taxation, “Estimates Of Federal Tax Expenditures For Fiscal Years 2018-2022.”

[32] Internal Revenue Service, “Publication 970 (2017), Tax Benefits for Education.”

[33] Ibid.

[34] 26 U.S. Code § 2503 – “Taxable gifts,” https://www.law.cornell.edu/uscode/text/26/2503.

[35] Gerald Prante, “Education Tax “Subsidies” – Justified or Not?”

[36] Ibid.

[37] Senate Bill 275 – “Skills Investment Act of 2019,” 116th Congress, https://www.congress.gov/bill/116th-congress/senate-bill/275?q=%7B%22search%22%3A%5B%22S.275%22%5D%7D&s=3&r=1.

[38] Government Accountability Office, “Higher Education: Improved Tax Information Could Help Families Pay for College,” May 2012, 27, https://www.gao.gov/assets/600/590970.pdf.

[39] Ibid.

[40] U.S. Department of the Treasury, “Recovery Act: Billions of Dollars in Education Credits Appear to be Erroneous,” Treasury Inspector General for Tax Administration, Sept. 16, 2011, https://www.treasury.gov/tigta/auditreports/2011reports/201141083fr.html.

[41] George B. Bulman and Caroline M. Hoxby, “The Returns to the Federal Tax Credits for Higher Education.”

[42] The Federal Reserve, “Consumer Credit outstanding (Levels),” Board of Governors of the Federal Reserve System, https://www.federalreserve.gov/releases/g19/HIST/cc_hist_memo_levels.html.

[43] Riley Griffin, “The Student Loan Debt Crisis Is About to Get Worse,” Bloomberg, Oct. 17, 2018, https://www.bloomberg.com/news/articles/2018-10-17/the-student-loan-debt-crisis-is-about-to-get-worse.

[44] Scott A. Hodge and Kyle Pomerleau, “Is the Tax Code the Proper Tool for Making Higher Education More Affordable?”

[45] George B. Bulman and Caroline M. Hoxby, “The Returns to the Federal Tax Credits for Higher Education.”

[46] Caroline M. Hoxby and George B. Bulman, “The Effects of the Tax Deduction for Postsecondary Tuition: Implications for Structuring Tax-Based Aid,” National Bureau of Economic Research, September 2015, https://www.nber.org/papers/w21554.

[47] Tax Cuts and Jobs Act, H.R. 1, As Ordered Reported by the Committee, Section-by-Section Summary, https://republicans-waysandmeansforms.house.gov/uploadedfiles/tax_cuts_and_jobs_act_section_by_section_hr1.pdf.

[48] Scott A. Hodge and Kyle Pomerleau, “Is the Tax Code the Proper Tool for Making Higher Education More Affordable?”


Source: Tax Policy – Evaluating Education Tax Provisions

Opportunity Zone Rules Hike Concerns Over Tax Breaks for NFL Stadiums

Tax Policy – Opportunity Zone Rules Hike Concerns Over Tax Breaks for NFL Stadiums

Earlier this month, OpportunityDb highlighted 15 National Football League stadiums that are in Opportunity Zones. While the Opportunity Zone program is meant to spur long-term investment in economically distressed areas, these NFL franchises are now eligible for capital gains tax breaks on stadium-related investments.

Here are a few examples (you can read the entire article here):

  • Baltimore Ravens (M&T Bank Stadium in Baltimore, MD)
    M&T Bank Stadium is an eligible candidate for improvements. In fact, some improvements are already underway. Construction of a new escalator and elevator system is part of a $120 million renovation that may be completed by the start of the 2019 season. Renovations to club level concessions and an upgrade of the stadium’s sound system are already underway as well.
  • Las Vegas Raiders (Las Vegas Stadium in Paradise, NV) 
    The new Las Vegas Stadium is a $1.8 billion project that is expected to open in time for the 2020 NFL season. The new construction sits in an opportunity zone tract, potentially making certain investments in the project eligible for Opportunity Zones tax breaks if the developers decide to structure funding under a Qualified Opportunity Zone fund.
  • Denver Broncos (Broncos Stadium at Mile High in Denver, CO) 
    Broncos Stadium opened in 2001. There are plans to tear up the parking lots to the south of the stadium to make way for a new entertainment district. So while there are no announced plans to improve the stadium itself, the adjacent district development may very well benefit from the new Opportunity Zones program.

The OpportunityDb article demonstrates that the program’s requirement that investments must “substantially improve” zone property in order to qualify for tax breaks is quite loose. For instance, while an investment may substantially improve the value of zone property, that does not mean the investment will aid zone residents. It’s unlikely, for example, that any tax break given for a new escalator at M&T Bank Stadium will significantly improve the economically distressed communities in Baltimore.

Ultimately, though, the Opportunity Zone program could be written and implemented perfectly, and it would still be unlikely to help economically distressed communities. Evidence suggests other place-based incentive programs fail to create new economic opportunity because they are structured in a way that encourages firms to cross borders for tax breaks. Even worse, place-based incentive programs could actually displace zone residents if the roles brought into a zone aren’t a good fit for residents.

It’s possible that this program could be different, and opportunity zones could be successful. But decades of experience with place-based incentive programs suggests we should be skeptical. For this reason, future rounds of regulation should focus on gathering the data we’ll need to make this determination.


Source: Tax Policy – Opportunity Zone Rules Hike Concerns Over Tax Breaks for NFL Stadiums

Opportunities for Pro-Growth Tax Reform in Austria

Tax Policy – Opportunities for Pro-Growth Tax Reform in Austria

Executive Summary 

Making Austria a more attractive place to do business has been a core focus of the new government, which has been in charge since 2017. In contrast to previous governments–which offer up tax reform ideas but managed to implement few—the current Austrian administration is in prime position to implement a comprehensive tax reform. Since economic growth is solid and above-average in comparison to other EU member states, now is an opportune time to follow through with these plans. 

In the 2018 International Tax Competitiveness Index, which compares the tax systems of 35 OECD countries, Austria ranks in tenth place overall, despite only coming in in 15th place on business taxes and 21st on individual income taxes. The government collected taxes equal to 41.8 percent of GDP in 2017, mainly levied through taxes on labor, such as income taxes, social security contributions, and payroll and workforce taxes. 

The income tax system has clear deficiencies. For one, the system is highly progressive with a top marginal tax rate of 55 percent, the third highest in the OECD. The total tax burden on labor, often also called the tax wedge, is the fifth highest. For single workers, the tax wedge is 47.4 percent compared to 35.9 percent in the OECD on average. This means that the average worker in Austria only takes home half of his income. A large portion of the tax burden is payroll taxes, which fund pensions and social insurance programs. 

On corporations, Austria boasts a higher tax rate than any neighboring country other than Germany and Italy. Though the 25 percent corporate tax rate is significantly lower than the 34 percent Austria was boasting before a reform in 2005, it still is above-average in global comparison. The Austrian system also does not allow the full costs of capital assets to be deducted from a company’s net income. Thus, taxes are levied on both business profits as well as partially on business costs. While businesses can indefinitely carry forward net operating losses to offset future profits, they cannot carry unused losses backwards to help offset tax liabilities. Finally, a minimum tax on companies, regardless of their income, is in place, which can prevent smaller enterprises from achieving economic success. All of this nonetheless only comprises for 5.9 percent of Austria’s tax revenue.  

To be sure, there are reasons why Austria’s tax system is internationally recognized as relatively pro-growth. There are no damaging wealth or inheritance taxes, its property taxes are efficient and much less distortive than those in other developed countries, and Austria’s consumption taxes, including value-added taxes, are simple, comprehensive, and well-designed. 

A reform of the Austrian tax system then has to focus on corporate and individual income taxes. On corporate taxes, eliminating taxes on retained earnings—as countries like Estonia have done–a reduction of the corporate tax rate to 20 percent, improving the treatment of capital investment and net operating losses, and eliminating the minimum tax, would lead to Austria becoming more competitive and more attractive for companies interested in settling in the country. 

As for individual income, reducing the progressive tax system to a flatter, broader tax base with a lower rate is of the utmost importance. For instance, Austria could include a 20 percent flat tax on income which could be revenue neutral when applied to a broad tax base. In addition, indexing tax brackets for inflation and eliminating special tax treatments for the 13th and 14th salaries could be beneficial, too. Austria should also move toward a system that does not punish savings and investment. After the important reform of the social insurance system in 2018, there is now also an opportunity to lower social security contributions. These measures would reduce the cost of labor significantly. 

Instead of focusing on the introduction of distortionary measures like a digital services tax, the Austrian government should use its unique opportunity and implement a comprehensive tax reform. By lowering taxes and simplifying the tax code, Austria would become more competitive internationally, and be a place companies as well as individuals want to do business and live in. 

 A Menu of Tax Reform Solutions

The history of tax reform in Austria is a long one. Unfortunately, reforms of the past either increased the burden on taxpayers or were much less ambitious than they needed to be. Nonetheless, many of these changes were sold as the “biggest tax reform of all time.” Overall, the effects of these attempts were disappointing. Many more comprehensive reforms would have been necessary to have a significant impact. 

The last reform of Austria’s tax system, which occurred in 2015 and 2016, is a good example. This reform was also labeled the “biggest tax reform of all time” by its proponents, but consisted mostly of changes to income tax brackets. Most experts agreed that it lacked crucial elements, like provisions to limit bracket creep, and ignored the urgent need for structural reforms. Without these important changes, it was just another attempt at turning some small cogs and selling it as a great success. As expected, the last “biggest tax reform of all time” failed to have a significant impact. 

Now, with the new government in Austria, there might be a chance to deliver tax reform that deserves to be called significant. One thing is for sure: if Austria wants to remain competitive in the future, there are several reforms it must undertake.

Tax systems should be neutral towards consumption and investment while minimizing economic distortions. High marginal tax rates and multiple layers of taxation for the same income can impact the growth outlook for a country. Each of the following options would move Austria closer to an optimally designed tax system.

Corporate Taxes

Eliminating Taxes on Retained Earnings. Some countries, including Latvia, Estonia, and Georgia, have adopted tax systems that are completely neutral toward business investment and only tax business earnings when profits are distributed to shareholders. Austria could change its corporate tax base from net earnings less costs and allowable deductions to one that only includes distributed earnings. This could be paired with eliminating shareholder taxes on dividends, resulting in a single layer of tax for corporate earnings levied when those earnings are distributed.

Lowering the Corporate Tax Rate. The Austrian corporate tax rate is above the OECD average and higher than all but two of its neighbors. Lowering the corporate tax rate to 20 percent or below would allow Austrian businesses to be more competitive with their international counterparts. 

Improving Treatment of Capital Investment. Capital investment is vital to long-term economic growth, but Austria lags its peers in capital productivity. Providing the ability to fully deduct the cost of acquiring new machinery and equipment in the year it is acquired will minimize the distortions of the current straight-line depreciation system. Shortening the asset lives for buildings and structures will also improve the system. Importantly, changes to depreciation schedules take into account the time value of money and the way the current system inflates taxable profits.

Eliminating Minimum Taxes on Business. The current policy of applying minimum taxes on businesses has very little revenue impact as those taxes can be credited against future tax liability. These taxes can be a squeeze on small or growing businesses that may have negative earnings in a difficult year. Removing this barrier to business growth could have immediate impacts for some sectors.

Improving Treatment of Net Operating Losses. The current limit on net operating loss carryforwards results in some businesses not being taxed on their average profitability. Allowing businesses to offset taxable earnings with the full value of their operating losses would result in a more neutral tax system. 

The above options would result in the following changes to Austria’s overall and corporate tax ranking in the International Tax Competitiveness Index.

Note: a: This assumes immediate write-offs for machinery and equipment, 25-year asset lives and straight-line depreciation for building and structures, and 12-year asset lives and straight-line depreciation for intangible assets. b: The ITCI does not include a category for minimum taxes on businesses.

  Overall Rank Corporate Rank
Current System 10th 15th
 Eliminate Taxes on Retained Earnings 7th 5th
 Lower the Corporate Tax Rate to 20 percent 9th 9th
 Improve Treatment of Capital Investment (a) 9th 10th
 Eliminate Minimum Taxes on Businesses (b) (b)
 Improve Treatment of Net Operating Losses 9th 12th
Both Eliminate Taxes on Retained Earnings and Lower the Corporate Tax Rate to 20 percent 5th 3rd

Individual Income Tax

Flattening the Tax Structure. The progressive income tax system of Austria is particularly steep. If tax systems are too progressive, they can disincentivize workers to earn more, since they may lose out in the end by having to pay an even larger share in taxes. Flattening the system is one option to prevent this. A 20 percent flat tax, for instance, could even be revenue neutral when applied to a broad tax base.

Reducing the Top Marginal Tax Rate. At 55 percent, Austria’s top marginal income tax rate is the third highest among OECD countries, behind Sweden at 61.8 and Denmark at 55.8 percent. Austria’s rate kicks in for those earning more than one million euros annually. Having such a high marginal tax rate creates serious economic distortions and can incentivize tax avoidance. It can also lead to higher-income individuals seeking to move away to other countries instead of living and investing in business and financial operations domestically.

Indexing Tax Brackets for Inflation. When inflation occurs, but the tax brackets in a progressive income tax system are not adjusted, this can cause so-called “bracket creep.” Since prices rise, but the tax brackets stay the same, taxpayers potentially pay more over time. In Austria, the “bracket creep” problem could be solved by indexing tax brackets to inflation, so that tax brackets adjust from year to year.

Eliminating Special Tax Treatment of 13th and 14th Salaries. The 13th and 14th month salaries for holidays in the summer and for Christmas in winter are taxed differently than the twelve other monthly payments. The system for the 13th and 14th salaries is hard to fully grasp; it’s an added layer to an already complicated tax structure. Eliminating these special tax treatments and lowering taxes overall would make the system more transparent.

Adopting a Universal Savings Account. Broad-based income taxes are not neutral between saving and consumption. A system that is neutral between choices of savings and consumption taxes income one time and allows returns to savings to be tax-exempt. A universal savings account would allow individuals to save their after-tax earnings without facing an extra layer of tax on the gains to those savings.

Lowering Social Security Contributions. Payroll taxes, which finance pensions and social insurance programs, are a major contributor to the cost of labor, making up 36.2 percent of pre-tax labor costs. After important reforms to the social insurance system by the current government, including simplifications and spending cuts, a reduction in contribution levels is also in order. This would reduce the cost of labor, making Austria more competitive internationally, and let workers keep more of their income.

The above options would result in the following changes to Austria’s overall and individual tax ranking in the International Tax Competitiveness Index.

Note: a: The ITCI does not include a categories for these policy changes.

  Overall Rank Individual Rank
Current System 10th 21st
Implement Flat Income Tax of 20 Percent on a Broad Tax Base 7th 8th
Eliminate the 55 Percent Tax Bracket 9th 18th
Index Tax Brackets for Inflation (a) (a)
Eliminate Special Tax Treatment of 13th and 14th Salaries (a) (a)
Adopt a Universal Savings Account 9th 17th
Lower Social Security Contributions Rates by 5 Percentage Points 10th 21st
Both Implement a Flat Income Tax of 20 Percent and Adopt a Universal Savings Account 7th 3rd

Consumption Taxes

Simplifying and Broadening the VAT Base. A well-designed VAT can be one of the more efficient ways for a government to raise revenue, but exemptions or special rates create distortions. Austria should continue to adopt reforms to its VAT that subject more categories of goods and services to the standard VAT rate rather than special rates. A broader tax base could allow for a lower standard rate.

Avoiding Burdensome New Taxes

Rejecting a Digital Services Tax. The current debate at the global level regarding the taxation of profits generated from intangible assets has led some countries to propose narrow taxes on revenues of certain businesses. Digital services taxes are inherently distortive and discriminatory, representing a significant departure from the principles of sound tax policy: simplicity, transparency, neutrality, and stability.


Source: Tax Policy – Opportunities for Pro-Growth Tax Reform in Austria

Governor Cuomo’s Aggressive Theory of Tax Flight—And Why He’s Wrong About How to Stop It

Tax Policy – Governor Cuomo’s Aggressive Theory of Tax Flight—And Why He’s Wrong About How to Stop It

In New York, Governor Andrew Cuomo (D) is staring down a $2.3 billion shortfall, and he thinks he’s identified the culprit: the state and local tax (SALT) deduction cap. It’s a politically convenient scapegoat, but it misses the point—and more importantly, it misses an opportunity to improve the state’s uncompetitive tax code.

Once a skeptic on tax migration, the idea that people or businesses would move in response to high state tax burdens, Gov. Cuomo has emerged as one of the idea’s most fervent evangelists. “Tax the rich, tax the rich, tax the rich and now what do you? The rich leave,” the governor declared, in the sort of lament not typically associated with Democratic governors of progressive states. Absent a generous federal subsidy for the state’s high taxes, he says, New York is at a “long-term competitive disadvantage” on tax burdens.

Prior to the enactment of the Tax Cuts and Jobs Act of 2017, taxpayers who itemized (about 30 percent of all taxpayers at the time) were able to take an uncapped deduction for their state and local tax payments. Although this benefit was limited or even eliminated for some taxpayers by the Pease limitation and the alternative minimum tax, it represented a particularly attractive benefit to residents of high-tax states and localities, as a significant portion of their state and local tax burden was subsidized by other taxpayers across the country.

That deduction is now capped at $10,000, a change that Gov. Cuomo likens to an “economic civil war” that “literally restructured the economy to help red states at the cost of blue states” in a “diabolical, political maneuver.” In reality, the dividing line cuts much closer to home: the majority of taxpayers in New York itself do not itemize, and non-itemizers tend to have significantly lower income than itemizers. These taxpayers—along with others across the country—are subsidizing the tax burdens of higher earners.

Let’s put a number on that. Imagine two taxpayers living in New York City, one with $50,000 in taxable income and the other $500,000, under the old law (uncapped SALT deduction and a federal top marginal rate of 39.6 percent). For every additional dollar our $50,000 filer earns, she faces a 6.33 percent state marginal rate and a 3.876 percent city marginal rate, for a combined rate of about 10.21 percent. For every additional dollar our $500,000 filer makes, she faces the state’s top marginal rate of 8.82 percent plus the city’s top 3.876 percent rate, for a combined rate of about 12.7 percent.

But wait! Our high earner is an itemizer and gets the benefit of the SALT deduction. (We’ll assume she isn’t subject to the AMT. Some in her income range would be, but not all—and the higher her income, the less likely the AMT is to apply.) She’s getting a reduction of 39.6 cents in her federal tax liability for every additional dollar she owes New York. Functionally, her marginal rate isn’t 12.7 percent, it’s 7.67 percent. That’s way lower than what far less well-off New Yorkers are paying.

That diabolical political maneuver of which Cuomo speaks? It’s no longer making that lower-income New Yorker (or resident of another state) subsidize some of the nation’s top earners. You’d think that would be something a progressive governor would favor.

Of course, we know why Gov. Cuomo and others oppose the SALT deduction cap, even if ideologically they ought to favor it: as Cuomo is quite willing to admit, he’s afraid of tax flight. He’s concerned that wealthy, highly mobile residents aren’t actually willing to face a combined top marginal rate of 12.7 percent, on top of their high property taxes and high cost of living. Yet instead of doing something about it in the statehouse, the governor is doubling down on policies that would actually increase tax burdens for individuals and businesses alike.

In other words, Gov. Cuomo is suddenly highly attuned to the downside of high, uncompetitive taxes, but instead of finding ways to make New York more competitive, he wants an even more aggressive tax regime that makes it harder to do business in the state. His only solution is to call for the federal government to subsidize New York’s high earners again, to soften the blow of the state’s uncompetitive tax code.

Tax flight cannot explain a $2.3 billion budget shortfall. The bottom line is that New York’s estimate was off, while other states, like Connecticut, hit or even exceeded targets with similar demographics and national impacts. Stock market volatility in 2018 undoubtedly led many of New York’s high earners—to say nothing of its professional investor class—to take capital losses at the end of the year, reducing overall collections. Because New York is home to so many high earners, who tend to generate more income from investment, the state is unusually sensitive to stock market fluctuations. If the state underestimated how many high earners would take investment losses in 2018, that could produce a sizable forecasting error.

That said, tax migration is part of it. A few years ago, progressive governors insisted that tax flight was not a real phenomenon. Now, with less of a federal subsidy to ease the burden of their own uncompetitive tax regimes, some regard it as a crisis. The reality has always been somewhere in between, but there can be little doubt that New York’s high taxes are influencing domiciliary choices.

Here, in a nutshell, is the entire theory of tax migration, articulated by Gov. Cuomo: “People are mobile. They will go to a better tax environment. That is not a hypothesis. That is a fact.”

The solution to that problem is a local one. It involves New York getting its own house in order. There’s something particularly ironic about Gov. Cuomo’s preferred solution, which would provide a $670 billion tax cut (over a ten-year budget window) that flows almost exclusively to the top 5 percent of earners—most of whom already received a tax cut under the Tax Cuts and Jobs Act due to lower rates, a higher AMT threshold, and the repeal of the Pease limitation, among other reforms.

Ultimately, the governor is blaming everything but the real culprit: New York’s own tax code. The governor is to be commended for corporate tax reforms undertaken in 2014, but overall, New York still imposes high and poorly-structured taxes, ranking 49th on overall tax structure in our State Business Tax Climate Index. Capping the SALT deduction righted a longstanding wrong in the federal tax code. Instead of railing against a change that increased tax equity, it might be time for New York policymakers to look inward.  


Source: Tax Policy – Governor Cuomo’s Aggressive Theory of Tax Flight—And Why He’s Wrong About How to Stop It