This content is provided by the Americans for Tax Reform Foundation.
A number of tax credits on the books today are deemed “refundable,” because they can reduce filers’ tax liabilities below zero (when this occurs, the IRS sends the filer a check, rather than the other way around).
One such refundable provision is the American Opportunity tax credit (AOTC), enacted as a temporary measure under the 2009 stimulus. The AOTC, modeled after the earlier Hope Scholarship and Lifetime Learning credits, is a four year, dollar-for-dollar tax reduction of up to $2,500 for the first $4,000 in eligible educational expenses (tuition, fees, course-related supplies, etc.). Up to 40% of the credit ($1,000) is refundable. The credit is reduced for taxpayers with AGI in excess of $80,000 ($160,000 for joint filers), so that it is fully phased out for filers with AGI $90,000 or above ($180,000, jointly).
The American Opportunity tax credit will expire on January 1, 2013 — Taxmageddon. Many of its recipients will receive in its place the Hope Scholarship credit, a nonrefundable credit with stricter income requirements that is worth up to $1,800 for two years of qualified educational expenses.
The American Opportunity tax credit is a tricky subject, due mostly to its status as a refundable tax credit. Refundable credits, when they result in negative tax liabilities, can rightly be viewed as increasing government spending — “spending in the tax code,” as it were.
According to reports by the Congressional Research Service (CRS) and Treasury Department, the AOTC doled out just shy of $4 billion in “refunds” (read, handouts) in 2009, for an average refund of $800. Of that amount, CRS found, an estimated 11.5% went to recipients with AGI over $50,000; $100 million went to recipients with incomes greater than $75,000.
Eligibility and reporting requirements for the AOTC are notoriously convoluted as well, which has shut out deserving applicants while providing benefits to ineligible filers. In 2011, the Treasury Inspector General of Tax Administration (TIGTA) found that 2.1 million AOTC recipients may have received $3.2 billion in “erroneous education credits.” Of those claimed, 84,754 students did not have a valid Social Security number, and 250 “students” were incarcerated.
These statistics illustrate just a few of the problems with “Santa Claus” provisions like the AOTC. Too often, refundable credits turn into welfare programs for the well-off. And because these programs do not technically count as spending, they often metastasize without the knowledge of those who foot the bill — real taxpayers.
Expiration of the AOTC will eliminate a fair bit of spending in the tax code, but it will also deny up to $5,000 in actual tax relief to many filers. “Refund” recipients make up just over a third of those who receive the AOTC, which means the other two thirds (eight million students and their families) may see higher tax burdens because of the credit’s expiration.
The AOTC, then, is a mixed bag, and its expiration will produce mixed results. The correct response to its expiration is to salvage its tax relieving components, while scrapping its spending components.
10 Year Revenue Effect
Department of the Treasury: $137.4 billion (of that amount, $62.3 billion are outlays, or “refunds”)