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Last week, The New York Times published an article on the Coverdell savings account, calling it controversial because earnings in these accounts are tax-free if used to send students to private or religious K-12 schools. The article also pointed out that the K-12 component of the tax credit expires at the end of this year, making the issue ripe for further debate. We think they may have missed the bigger picture. Some education-related tax benefits have expired already, more will expire soon, and some (maybe all of them) will ultimately be extended at the last minute. So Coverdell accounts are the tip of the iceberg.
The Coverdell account allows families to contribute up to $2,000 annually (in after-tax income) to an investment account (the earnings of which are tax-free, as are any withdrawals) for a child’s K-12 or higher education expenses. There are no data available on what proportion of taxpayers use Coverdell accounts to pay for K-12 costs versus higher education, but in total 644,000 taxpayers contributed $718 million to Coverdell accounts in 2009, the most recent year for which data are available. According to the White House Office of Management and Budget, the tax credit was expected to cost the federal government $80 million in forgone revenue in fiscal year 2013.
Still, the Coverdell tax credit in fiscal year 2012 cost less than one-half of one percent (0.35 percent, to be exact) of the costs of all federal tax benefits set to expire, either in full or in part, at the end of this year. For a table describing the changes scheduled to take effect at the end of the year, click here.
The most expensive (and most generous) tax benefit set to expire is the American Opportunity Tax Credit (AOTC). Originally passed as a part of President Obama’s stimulus package in 2009, the AOTC replaced the Hope tax credit for a few years and allowed more taxpayers (incomes up to $80,000, or $160,000 if filing jointly) to receive larger credits. It cost taxpayers $14.3 billion in fiscal year 2012, and is expected to cost another $13.7 billion next year. The credit then reverts to the Hope Tax Credit, which is expected to cost about $5.8 billion annually.
Also set to expire this December are nearly a half-dozen other tax benefits. The exclusion from taxable income of employer-provided educational assistance will expire completely; that tax benefit cost $750 million in 2012. And several health care-related scholarships – the National Health Service Corps (250 of which were awarded between 2009 and 2011) and F. Edward Herbert Armed Services Health Professionals scholarships – that taxpayers have been able to exclude from their taxable income will no longer be tax-exempt. That provision is expected to cost nearly $3.3 billion in fiscal year 2013.
The parental personal exemption for students over the age of 18 – which allows parents to claim their children as dependents if they are students aged 19-23 – will automatically lower the amount of the exemptions that high-income taxpayers may claim. That would likely lower the cost of the program, though we don’t know by how much. In total, the benefit cost $3.1 billion in 2012. And the student loan interest rate deduction will revert to its previous levels of lower income-phase out levels and a 60-month interest payment limit. That program cost $850 million in 2012.
What that means is that of the $23.0 billion spent on those six tax benefits in 2012, the Coverdell credit – only a portion of which will expire anyway – comprised only $80 million. In spite of their large price tag, tax benefits are often lower-profile because they are not funded by the annual appropriations process that dominates Congressional debate for much of the year, and so they are able to fly below the radar.
This morning, the Senate Finance Committee gathered to mark up a bill that would extend a dozen individual tax benefits, almost all of which expired a year ago in December 2011. The bill would make the tax benefits available to taxpayers for the 2012 tax year. Two of those benefits, the $250 deduction for teachers’ classroom costs and an up-to-$4,000 deduction for tuition and fees payments, are education benefits. Collectively, they cost shy of $900 million in 2011 – still falling well short of the considerable $23.0 billion cost of the six expiring later this year.
The Senate bill to extend deductions that expired in 2011 through the end of the 2013 calendar year will likely not receive much more attention before the November elections. But before Americans file their taxes next year, Congress will be forced to decide – publicly – whether it plans to swallow the costs and extend the 2011- and 2012-expired credits, or whether it is prepared to cut those benefits in favor of fiscal restraint and other priorities.