The Fiscal Cliff and Higher Education

We’re now well into December, and there is a pretty good chance that Congress and the Obama Administration will fail to agree on a set of policies designed to keep America from going over the “fiscal cliff,” or a series of tax increases and reductions in planned increases in domestic and military spending. Much of the attention during the fiscal cliff discussions has been about how to raise additional tax revenues from higher-income individuals. Democrats and the Obama Administration tend to favor raising the marginal tax rates while leaving deductions alone, while Republicans tend to favor keeping marginal tax rates at current levels while capping deductions at a specified amount.

These two proposals would affect higher education in different ways. The Democratic proposal has been better received than the Republican proposal in the higher education community because of the reliance of many colleges on charitable giving, which would be adversely affected by the cap on deductions. (President Obama has proposed similar limits in the past.) Capping deductions would substantially increase the real cost of a donation to higher education, as high-income taxpayers would be unable to receive a deduction equal to as much as 35% of the total gift.

The Democratic proposal would affect charitable donations in a different manner. Their proposal to raise capital gains tax rates (on the sale of stock and other securities) would reduce the payout that colleges would receive if gifts of stock are received. The strong likelihood of increased capital gains rates has led many companies, including those in the for-profit education sector, to issue special dividends before tax rates increase.

The net result of the uncertainty regarding tax rates is likely to be a positive for colleges in the short run. If previous tax increases are any indication, increasing income and capital gains taxes is likely to result in a short-term increase in charitable donations as individuals race to make decisions under more favorable circumstances. Regardless of whose revenue proposal is accepted, gifts to higher education (and government revenues) are going to be higher than they otherwise would in fiscal year 2013. This will also result in lower levels of donations for the following years since planned donations have been shifted forward.

Let’s also not forget the spending side of the fiscal cliff negotiations. Going over the fiscal cliff would result in sequestration of a substantial portion of the Department of Education’s expected budget. Most functions in the Department of Education would see an 8.2 percent cut in expected program funding, including the Institute for Education Sciences, although Pell Grant funds would not be affected. If the mandatory cuts are avoided (or more likely, pushed into the future where they will be ignored), expect a wave of federal spending as agencies spend the money that could have been sequestered.

I’m not optimistic that Congress and the Obama Administration can reach an agreement on the fiscal cliff, especially since the debt ceiling must also be addressed in the next few weeks. But since I hate to end a post on a sour note, I’ll leave you with former Senator (and co-chair of the Bowles-Simpson committee to reach a deficit solution) Alan Simpson (R-WY)’s dance moves. Enjoy!

Author: Robert

I am an a professor at the University of Tennessee, Knoxville who studies higher education finance, accountability policies and practices, and student financial aid. All opinions expressed here are my own.

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