Why Expanding Student Loan Interest Deductions is Unwise

The United States Congress has rarely met a change to the tax code that it doesn’t like. Since 2011, Congress has made nearly 5,000 changes to the tax code, making the tax code even more Byzantine and causing many Americans headaches each spring. While the exact levels and types of taxes preferred by the public tend to differ by political and economic ideologies, a general consensus exists among economists that a stable, predictable, relatively simple tax code achieves revenue goals at a reasonable cost.

Yet Congress is constantly faced with pressure to change the tax code to allow more credits and deductions to incentivize certain activities. We have certainly seen incentives in the tax code to increase educational attainment through the use of credits and deductions. These incentives have a difficult time being effective in inducing students to obtain more education because students and their families do not receive a financial benefit until well after the enrollment decision has been made, and awareness of these programs is uneven at best.

The deduction for student loan interest payments is designed to help student be able to repay their educational debt; currently, students can receive a $2,500 deduction on their taxes (if they itemize) in a given year and their income is less than $75,000 per year if single or $150,000 per year if married filing jointly. It is hard to imagine that such a program, which does not provide a financial benefit to students until after they have left college, will help increase educational attainment.

Yet Congressman Charles Rangel (D-NY), who is well-known for his 2012 censure over failing to pay taxes, has introduced the Student Loan Interest Deduction Act, which would double the tax deduction for student loan interest and get rid of the income cap for receiving the deduction. This bill has picked up the support of many higher education associations, including the American Council on Education and the National Association of Student Financial Aid Administrators, but it is an example of inefficient and misguided public policy.

Here are a few reasons why the proposed bill is poor public policy:

(1)    Students get the tax deduction years after beginning college. Yes, students with perfect information about the deduction (and who believe the policy will remain in place) will adjust their total cost of college down. But that requires a large amount of information and a low discount rate, neither of which can be assumed.

(2)    Increasing the deduction cap allows students to benefit more if they took out more debt. This can provide an additional incentive for colleges to raise their price and capture additional revenue if they think students will pay.

(3)    Getting rid of the income cap shifts the benefits more toward higher-income families, who are more likely to itemize deductions and be able to use the deduction. Advocates on the left should be particularly steamed by this point.

(4)    This acts as an additional tax on saving for college relative to borrowing, and can place families who chose not to borrow at a disadvantage.

I would prefer to see all interest deductions removed from the tax code and replaced with more efficient upfront payments. Instead of forgoing billions of dollars in revenue through tax credits and deductions, I would rather see the money used in grant programs, lowering the interest rates for federal loans, or used toward other educational improvements. Rangel’s bill just complicates the status quo and does little to actually help students afford college.