CORRECTED: Who benefits from student loans and educational tax benefits?

July 13, 2011

On Wednesday, we looked at mortgage debt and the home mortgage interest deduction, based on new data released in a Joint Committee on Taxation report. Today, we’ll look at student loans and their corresponding interest deduction.

The numbers here are far, far smaller, and therefore less likely to be a meaningful target in the ongoing budget discussions in Washington: The amount of student loans out, $33 billion $330 billion, represents a sliver of total household debt of $13.4 trillion, and is dwarfed by the $10.2 trillion in home mortgage debt. While the ever-rising cost of higher education is an enormous issue for anyone who’s facing those college costs, as a country we’re more indebted for our cars.

The reasons for providing tax benefits for education are clear: More education results in higher wages, higher productivity and, even, studies show, improved health. Academic studies show that an extra year of education increases wages by between six percent and 13 percent. Also, importantly, government intervention can help reduce the inequalities in access to education between low-income and high-income families.

Yet, it’s tougher to know precisely what the right policy should be. Over the past 25 years, the tax treatment of student loan interest has flip-flopped (at times allowing unlimited deductibility, at times prohibiting it, and at times limiting it for higher-income taxpayers). The tax code offers a variety of other educational tax benefits — including tax credits that are generally more valuable than deductions — that are extremely complicated to sift through.

Who gains from the student loan deduction? According to the JCT report, the total cost of the student loan interest tax deduction is $801 million, all of which goes to families earning under $200,000 a year. Nearly half of the benefit (47 percent) goes to families that earn $75,000 or less. The average amounts per return are relatively small: $180 for those who earn between $100,000 and $200,000 and $133 for those who earn between $50,000 and $75,000.

But the issue with the deductibility of student loan interest is more complicated than this data makes it seem because there are so many — overlapping and sometimes conflicting — tax benefits for education. The bigger issue is not this one tax break, but that morass.

As National Taxpayer Advocate Nina Olson testified before the Senate Finance Committee in late June: “The tax code contains at least 11 separate incentives to encourage taxpayers to save for and spend on education. The eligibility requirements, definitions of common terms, income-level thresholds, phase-out ranges, and inflation adjustments vary from provision to provision. The point of a tax incentive, almost by definition, is to encourage certain types of economic behavior. However, taxpayers will only respond to incentives if they know they exist and understand them. Few, if any, taxpayers are aware of each of the education tax incentives and familiar enough with the particulars to make wise choices. Moreover, some who try to make informed choices will be overwhelmed by this complexity.”

How have you sorted through the tax benefits for education? To what extent does the deductibility of student loan interest play into your thinking? Comment below.

(This post was corrected on July 14, 2011 to amend the amount of student loan debt in second paragraph)

One comment

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The $33 billion figure appears out of whack. It may be the volume of loans that take advantage of the student loan interest deduction, but it is nowhere near the amount outstanding. The volume of student loans outstanding recently hit the $1 trillion mark and recently surpassed outstanding credit card debt.

Many borrowers who qualify for this deduction simply itemize, but policymakers and experts have long lamented the low takeup rates on the student loan interest deduction.

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