Tax Breaks for Education Draw the Line

What should be first in line for tax breaks: education, capital gains or estates?

As the debate on tax relief comes down to the crunch, the Clinton administration is sticking to the late-spring deal it struck with Congress: $35 billion earmarked for incentives linked to education and job training. The administration’s proposal features hefty tax credits for the first two years of postsecondary education, a smaller but still substantial 20% credit for further education--including, crucially, part-time continuing education for working adults--incentives to save for future schooling and a permanent extension (plus improvements) of on-again, off-again tax benefits for employers who sponsor their workers’ postsecondary education.

Critics from academia and progressive interest groups have raised objections to the plan. While they reflect noble motives, these objections are mostly overblown or beside the point. And they provide cover for cynical efforts by others to break the deal and divert tax relief away from the middle class.

One objection is that many families who stand to benefit would have invested in education anyway. Of course. With the rising returns to education and training and the brutal penalties the modern economy imposes on the unskilled, they would be fools not to.

But tax incentives always are blunt instruments: Most deductions for charitable contributions reward giving that would have happened in any event, most research and development tax credits underwrite investments that firms would have undertaken on their economic merits and liberal estate tax limits don’t materially increase the number of people who die rich. The real issue concerns how much economic change a tax break inspires and the value of that change.

By this measure, education tax incentives beat the competitors for tax cut dollars--preferences for capital gains over earned income and other kinds of investment returns, or raising the amount that can be bequeathed tax-free. While there’s no consensus on the effects of preferential tax rates for capital gains, for example, the best prediction is little (maybe no) net increase in saving and investment, a lot of maneuvering by accountants and lawyers to relabel income as capital gains and a sharp rise in the after-tax income of a tiny, wealthy slice of the population.

Nobody can say with confidence just how much education tax incentives will boost human capital investment. A few careless critics imply no impact, which is implausible. Wherever such tax breaks do affect behavior, they move resources toward an investment with the surest, strongest link to shared prosperity. Almost as important, even where they “miss” the target of altering decisions, they concentrate tax cuts on families at the time when budgets tend to be tightest and tax relief matters most.

A second complaint concerns distribution. Tax incentives, critics say, can’t reach those too poor to owe any taxes. Instead of tax credits for the middle class, they suggest direct transfers targeted to low-income students. Wouldn’t it be better to just bump up the budget for education grants? We’re all for devoting more resources to helping the poorest get access to skills. But the issue is how to divide the tax breaks, and ironclad budget rules bar substituting grant increases for tax incentives. Watering down the education provisions won’t mean a dime more for grants; it just means more for capital gains and estate tax breaks.

The benefits of education tax incentives are focused on working families and phase out entirely at the upper reaches of the middle class, in dramatic contrast to the other options on the table. But even if they are targeted on the middle class and can inspire extra investment, the critics continue, won’t tax incentives merely invite colleges and other training institutions to boost tuition? This objection is vastly overblown. Most students still will be paying the majority of their tuition bills with their own money and will resist tuition increases. Private schools raising fees or cutting aid will lose students; legislators who try to cut appropriations for state schools will face voters’ wrath.

The real choice is between middle-class tax relief that rewards and encourages investments in America’s broad-based earning power, and economically sterile tax breaks that will deepen the divide between the very wealthy and the rest of us. Pushing for perfection risks squandering the chance to tilt tax cuts toward working families.