The Good and the Bad for Higher Ed in the Republican Tax Proposal

On November 2, House Republican leaders unveiled their tax reform plan. A number of its provisions affect higher education. While this is only a proposal, it’s worth looking into those provisions. Several of them eliminate tax preferences for college-related activities and two impose new taxes.

Those that take away tax preferences are beneficial, but the new taxes are not. I say that because tax preferences of all kinds distort people’s decisions, pushing them to do things they might not otherwise do by making them less costly. The government shouldn’t do that. As for the new taxes, they would raise relatively small amounts of money but harmfully interfere with university operations.

Tax Preferences

Let’s first consider the change in deductibility of interest paid on student loans.

Under the current law, students can deduct the interest they pay on their loans, up to a maximum of $2,500. According to an analysis by Jason Delisle of the American Enterprise Institute, the average amount that those who claim this deduction is only $202 per year. Except for home mortgage interest, Americans don’t get to deduct the interest they pay on other loans, so this change is a move toward equal treatment of debtors and a move away from preferential treatment for those who go to college.

But losing that deduction might not harm most people who have college loans because another change in the plan increases the standard deduction for all Americans who don’t itemize on their income tax returns from $6,350 to $12,000 per year. Writing for Forbes, Michael Durkheimer argues that this move toward tax neutrality wouldn’t have much impact because “Student debtors would not likely be disadvantaged by trading one for the other.”

Another tax preference that would be eliminated is the deductibility of tuition payments. That also lowers the actual cost of college—it’s a hidden subsidy. Like the interest deduction on loans, it distorts behavior by making college relatively less costly than other choices. I have long argued that the U.S. has oversold higher education because of a host of subsidies and this is one of them.

A third change would tax “tuition waivers.” That concerns the widespread policy at research universities of not requiring graduate students to pay tuition. They receive modest stipends that are subject to income tax, but the waived tuition is tax-free. But under the House proposal, the waived tuition would be treated as taxable income, even though no money actually changes hands.

This has led to heated attacks. In this Inside Higher Ed piece, a graduate student at the University of Illinois, Mary Grace Hebert, says that if she had to pay income tax on the tuition that the university waives, it would cost her around $5,000, a large proportion of her $17,000 annual stipend. She says that it would be like “taxing a coupon.”

But the tax-free implicit income of waived tuition is another of the ways the tax code helps to underwrite higher education. If this change were made, universities would have to adjust by paying graduate students enough cash to attract their services and that would force them to choose between paying them and paying for other things they spend money on.

Capital is limited and there is no reason to give colleges and universities a borrowing advantage.

These subsidies are part of the reason why we have such a surplus of people with Ph.Ds. The Wall Street Journal’s November 8 editorial “The College Tax Reform Tantrum” correctly argues that tuition waivers “effectively let colleges employ teaching assistants as indentured servants and have contributed to a surfeit of graduate degrees in fields for which there are few jobs beyond academia.”

And a fourth proposed change in the tax code would make private colleges ineligible for tax-exempt private activity bonds. Those bonds enable schools to lower their cost of capital because state and local governments are actually doing the borrowing. Therefore, explains bond expert Charles Samuels in Inside Higher Ed, “Any facility (universities) built would be more expensive, or would have to be lessened or delayed in some way as they find the revenue for it.”

College officials naturally decry any increase in their cost of borrowing, but this is, again, a measure that would neutralize the preferential treatment higher education has enjoyed. Capital is limited and there is no reason to give colleges and universities a borrowing advantage.

The changes above would cause colleges to make adjustments, but they would be adjustments toward a more efficient use of resources for the economy as a whole. Writing for Bloomberg, Megan McArdle nailed the key point: “Compared to the public at large, people getting college educations are the wealthiest, the best protected, the best respected. Why should any of it be tax-advantaged?”

New Taxes

Two ideas in the House plan are bad ones that impose new taxes on a rather small number of colleges and universities.

One is the proposal for a 20 percent excise tax on employee compensation over $1 million at non-profit colleges, applying to the five highest paid employees, including all forms of compensation. At many schools, the top sports coaches make well into seven figures (Duke’s basketball coach Mike Krzyzewski pulls in more than $7 million per year), and 39 university presidents now top $1 million and eight top $2 million, according to U.S News and World Report.

The trouble with this idea is that it puts the nose of the federal camel under the tent of the college labor market. The million-dollar figure is arbitrary and symbolic. Those highly paid employees already pay hefty income taxes on their earnings. Congress should refrain from interfering in the market for top talent

Finally (and saving the worst for last) is the proposal for a 1.4 percent excise tax on the investment income of private college endowments. This new tax would apply to private institutions with endowment values of $100,000 per student or more. Presently, that (again arbitrary and symbolic) figure would snare about 150 schools including Harvard, Yale, Princeton, Stanford, and MIT, and some of their funds would be gobbled up by the government.

True, the deep-pockets universities make a lot of dubious if not ridiculous decisions regarding the use of the funds generated by their endowments, but the federal government is no better in its use of money. Throwing the proceeds of this new tax into the maw of the federal government will do precious little to balance the budget, but it crosses an important line by letting the government tax money that people give for educational purposes.

Having crossed that line, there is no logical stopping point.

In National Review, George Will spoke an essential truth: “Its appetite whetted by 1.4 percent, the political class will not stop there. Once the understanding that until now has protected endowments is shredded, there will be no limiting principle to constrain governments—those of the states, too—in their unsleeping search for revenues to expand their power.”

Diverting some endowment earnings from what college officials deem appropriate into the federal treasury, where the money will be used as federal officials choose, is nothing to applaud. It is no better than if the law made church collections taxable. This idea should be jettisoned.

To sum up, the tax code ought to be as neutral as possible, which is to say that it doesn’t alter people’s rational behavior. For that reason, the proposed elimination of various tax preferences is good. On the other hand, the clumsy tax on top-earning college personnel and the tax on endowment earnings are bad ideas that should be opposed.