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Federal Tax ExpendituresFor Higher Education

by Mark J. Warshawsky

Reprinted from Tax Notes, October 20, 2014, p. 327

tax notesVolume 145, Number 3 October 20, 2014

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Federal Tax ExpendituresFor Higher Education

By Mark J. Warshawsky

As millions of students begin a new school yearat colleges and universities around the country, it isworth pausing for a moment to consider the largesize of this mainly tax-exempt sector, its poor priceperformance, and the significant federal tax expen-ditures associated with it. Although we will notclaim to have proved causal relationships, in thelast decade: (1) the sector has grown rapidly and ismassive, with $479 billion in revenues in 2011-2012;(2) tuition prices have significantly outstrippedgeneral price inflation; and (3) even ignoring directexpenditures and subsidized student loans from thefederal government, as well as state and localgovernment support, the value of governmentfunding through various federal tax expenditureshas grown rapidly and is substantial. It is reason-able to ask how much of this government spendingis unnecessary, misdirected, or even harmful topublic policy goals at a time of fiscal constraint.

A. Size of the Higher Education Sector

As shown in Figure 1, student enrollment incolleges and universities has increased rapidly inthe postwar years. Some of that expansion may beattributed to the baby boom and general populationgrowth, but there has also been greater motivationto enroll as higher levels of education have becomethe norm in both the job market and social life. Thebiggest spurts occurred in the late 1950s through the1960s, the late 1980s, and the 2000s, likely reflectingdemographics, the competing attractions, or lack ofthem, of the job market and military service, andthe costs, net of all sorts of government and private

support, of tuition. There are now more than 21million students enrolled in some form of highereducation.

Another measure of size is the total revenue ofthe sector, broadly defined to include all levels ofpostsecondary institutions, both public and private,as well as affiliated hospitals, endowments, sportsactivities, and research. According to data from theNational Center for Education Statistics, total rev-enue in higher education grew from $399 billion in2005-2006 to $479 billion in 2011-2012, despite fluc-tuations in investments, grants, appropriations, andgifts, and steadily increasing tuition.

Finally, statistics from the Delta Cost Projectindicate the number of both public and privateemployees in the sector, at all levels, from commu-nity colleges to research institutions, including fac-ulty as well as professional, support, andadministrative staff. In 2000 there were 2.5 millionemployees; by 2012 that number had grown to 3.2million.

These indicators — students, revenue, and em-ployees — consistently show robust growth in thehigher education sector in the last decade, despiteoverall weaknesses during the same period in theeconomy, personal income, and the labor and finan-cial markets.

B. Tuition IncreasesAlthough only between a quarter and a third of

the tax-exempt higher education sector’s revenuecomes from tuition (net of scholarships), the postedtuition rate is still a relevant indicator of the cost tothe consumer of the service provided by the sector’sinstitutions — the education of students. Therefore,we will briefly review the recent history of increasesin tuition and fees compared with the generalincrease in consumer prices.

In Figure 2, statistics from the Bureau of LaborStatistics are plotted, comparing the overall level oftuition and fees with the consumer price index from1978 through 2012. Tuition and fees have increasedabout eightfold over this period, compared with athreefold increase in general consumer prices. Ap-parently, there was a particularly large spike intuition in the early 2000s.

A more detailed view of tuition and general priceincreases appears in Figure 3. It shows the monthlyyear-over-year price changes in tuition and fees andgeneral consumer prices, in percentage terms, dur-ing the period from January 1979 to February 2013.

Mark J. Warshawsky was formerly Treasuryassistant secretary for economic policy and is now avisiting scholar at the Mercatus Center at GeorgeMason University.

The tax-exempt higher education sector is hugeand growing, as government policies encouragedemand and tuition prices continue to rise. Thereare many higher education tax benefits, on both thesupply and demand sides, and estimated tax ex-penditures for the sector reached $50 billion, orabout $2,400 per student, in 2012.

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The source is again the Bureau of Labor Statistics.The message in the two charts is clearly the same —with the exception of the late 1970s, when generalprice inflation was fueled by the Federal Reserve,

college tuition and fees have risen at a faster pacethan general prices. The early 1990s and early 2000ssaw particularly high rates of tuition inflation (10

Figure 1. Total Fall Enrollment by Year, Postsecondary Institutions, 1947-2010

20011998

1986

25 million

20 million

15 million

10 million

5 million

0

19471950

19531956

19591962

19651968

19711974

19771980

1983

19891992

19952004

2007

Source: U.S. Department of Education.

Nu

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Figure 2. Higher Education Tuition and Fees vs. CPI, 1978-2012

Source: Bureau of Labor Statistics.

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Rel

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Tuition and Fees

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percent in 2004, for example). More recently, con-sumer price inflation has moderated, at less than 2percent, but tuition has increased at 4 percent and 5percent annual rates. In fact, over the last five years(2008-2009 to 2013-2014), tuition and fees increased,in real terms, 14 percent at private nonprofit four-year colleges and 27 percent at public four-year col-leges.

There are many possible reasons for this rapidrise in tuition, that is, the base cost of a collegeeducation. In any economic model, the increases inrelative price and in the number of students andemployees can be explained largely by robust de-mand. A lack of innovation (that is, few productiv-ity enhancements and poor efficiency) on theproduction side and rent-seeking behavior amongtenured faculty, senior administrators, coaches, andathletic directors, as well as a lack of competitionamong the trendsetting elite institutions, could befactors as well.

C. Federal Tax Expenditures

In this section, we catalogue the numerous taxpreferences, benefits, and exemptions that the fed-eral government provides to the higher educationsector, on both the producer/supply side (collegesand universities) and the consumer/demand side(for example, parents of college students). We alsoreport the tax expenditures in nominal dollars asestimated by the Joint Committee on Taxation. Weadd our own rough estimate of the tax expendituresarising from the exemption of the income (revenuesless expenditures) of colleges and universities fromthe corporate income tax.

The most obvious tax benefits and expenditureson the producer side are the exemption for intereston bonds issued by tax-exempt colleges and univer-sities (for example, to build dormitories, parkingstructures, or hospital buildings) and the exemptionfor charitable giving to colleges and universities.

Figure 3. College Tuition and Fees vs. Overall Consumer Prices, Percent Change From Previous Year(Jan. 1979-Feb. 2013)

Source: Bureau of Labor Statistics (bls.gov series CUSR00000SEEB01 and CUSR0000SA0).

Note: Seasonally adjusted; recessions shaded (Mar. 23, 2013).

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

17%

16%

15%

14%

13%

12%

11%

10%

9%

8%

7%

6%

5%

4%

3%

2%

1%

0%

-1%

-2%

-3%

-4%

-5%

1979

College Tuition and Fees

Overall Consumer Prices



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According to the JCT, the value of these exemptionshas grown from $4.8 billion in 1999 to $9 billion in2013, as shown above.

Next, we provide a rough estimate of the value ofthe exemption of the sector from the federal corpo-rate income tax. Although nearly the entire sector istax exempt, there are some educational organiza-tions, like the University of Phoenix and DeVry Uni-versity, that are for-profit and taxable. In 2013 theeffective tax rate for these and other publicly tradedhigher education companies averaged 35 percent.Applying this tax rate to the income of the tax-exempt higher education sector, with income de-fined as revenues (including investment income andgains) less expenditures, we estimate that the ex-emption from corporate income taxes at the federallevel was worth about $4.9 billion in 2011-2012. Thisis a rough estimate — probably underestimated —because the definitions of income in the for-profitand nonprofit sectors are quite different, and theinclusion of investment income and gains (whichwere relatively low in 2011-2012) will make the es-timated annual tax expenditures volatile.1

Now we provide a list of the various tax benefits— exemptions and deductions on the consumer/demand side — with brief nontechnical explana-tions.

1. Qualified tuition programs. Investment incomeon the assets in these programs (also known assection 529 plans), established by states and educa-tional institutions, is exempt from personal incometaxes, and distributions to pay expenses for highereducation, including tuition and fees and room andboard, are not taxed. There are no income restric-tions on contributions to these plans, unlike section401(k) and other retirement plans, and the contri-bution limits, set by the program sponsors so that acontributor can fully finance the cost of a collegeeducation, are quite high.2. Coverdell plans. These are another type of tax-advantaged education savings plan, more limitedthan section 529 plans in terms of annual contribu-tion caps and income restrictions but broader interms of investment possibilities.3. Tax credits (HOPE, American opportunity, andlifetime learning). The American opportunity tax

1According to a 2012 study from the Tellus Institute, thevalue of the federal income tax exemption for NortheasternUniversity for fiscal 2011 was $33 million. State and localgovernment exemptions were worth $23 million and $39 mil-lion, respectively. See Ann Solomon and Joshua Humphreys,‘‘Public Investment in Private Higher Education: Estimating theValue of Nonprofit College and University Tax Exemptions,’’

Tellus Institute (Sept. 2012). See also the interesting paper by theCongressional Budget Office focusing on collegiate sports,which makes the case that athletics at Division I-A schools in theNCAA are fairly obviously commercial activities under currentlaw, even if subjecting them to the unrelated business incometax would be technically challenging. CBO, ‘‘Tax Preferences forCollegiate Sports,’’ May 2009.

Figure 4. Federal Tax Exemption Value, Excluding Income, for Higher Education Institutions, 1999-2013(billions of nominal dollars)

Source: Based on JCT data.

Bil

lion

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Charitable Giving Exemption

Bond Interest Exemption

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1 0.7 1 0.8 1 1.1 1.1 1.5 1.5 2.8 3.1 2.6 3.1 3.1 3.4

4.8 5.1 6.5 7.2 6.3 5.7 6 6.6 6.4 5.4 5.5 5.3 5.2 5.6

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20132000 2012


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credit is a credit of up to $2,500 per year per eligiblecollege student (usually a dependent) — 40 percentof which is refundable — for four years, coveringtuition and fees paid toward earning an under-graduate degree through at least half-time study.The income limit on claiming the credit is $180,000for married households. This credit, which wasauthorized by the 2009 stimulus legislation, re-placed and significantly expanded the HOPE credit.The lifetime learning tax credit is a nonrefundablecredit of up to $2,000 per return per year, for anycourse of postsecondary education, having no timelimitation and covering tuition and fees. The in-come limit is $127,000 for married households. TheAmerican opportunity tax credit and the lifetimelearning tax credit cannot be claimed simultane-ously; the latter is particularly well-suited to gradu-ate or part-time study, and often, the students claimthe credit themselves.

4. Deduction for tuition and fees. Taxpayers areallowed to deduct up to $4,000 in tuition expensesas an above-the-line exclusion from income. Formarried couples, income must be less than $160,000.The deduction cannot be taken if education taxcredits or other specified education tax benefits areclaimed.5. Parental personal exclusion. Taxpayers withqualifying children who are students (up to age 24)may be able to claim dependent exemptions and theearned income tax credit.6. Employer-provided assistance exclusion. Up to$5,250 of education assistance benefits may be ex-cluded from taxable income each year. Any courseof study that improves capabilities is eligible.7. Student loan cancellations and repayment assis-tance. These are not included in taxable income ifthe cancellation or repayment is conditioned onwork for a specific period and in specified profes-sions, such as healthcare in underserved areas.

Figure 5. Nominal Growth in Tax Expenditures for Students, 1995-2012(in billions of dollars)

Source: Based on JCT data.

QTP

Coverdell

HOPE (AOTC) and LLTC

Deduction for Higher Education Expenses

Parental Personal Exclusion

Debt/Repayment Income Exclusion

Scholarship/Fellowship Income Exclusion

Deduction for Student Loan Interest

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

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8. Scholarships and fellowships. These are ex-cluded from taxable income if granted as aid in thepursuit of study or research, if the individual is acandidate for a degree at an eligible educationalinstitution and no services, such as teaching, areprovided by the individual to the institution.9. Deduction for student loan interest. This is anabove-the-line exclusion of up to $2,500. For mar-ried couples, income must be less than $155,000.

Other tax benefits for education include the edu-cation savings bond program and the educationexception to additional tax on early IRA distribu-tions.

Figure 5 shows the tax expenditures on thedemand side for higher education, as estimated bythe JCT, from 1995 through 2012. By the end of thatperiod, they were more than $35 billion.

All tax expenditures, on both the producer andconsumer sides, totaled about $50 billion in 2012.

D. ConclusionGovernment support for higher education is

rarely questioned, and there seems to be a continualpolitical impetus to expand that aid, despite fiscalconstraints. Yet it is fair to ask whether the intendedpublic policy goals — an educated workforce, trans-mission of past cultural and scientific knowledge,and innovative research — are most efficiently andfairly achieved through the benefits bestowed onthis tax-exempt sector, or whether there are betteralternatives. A comprehensive answer to that ques-tion is beyond the scope of this article. However,consideration of the size of this sector, the pricescharged, and the tax expenditures provided, as wellas their rapid growth, is a good starting place.

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