Paul L. Caron
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Friday, December 18, 2020

Weekly SSRN Tax Article Review And Roundup: Eyal-Cohen Reviews Tax Benefits, Higher Education and Race By Crawford & Gerzog

This week, Mirit Eyal-Cohen (Alabama) reviews Bridget J. Crawford (Pace) and Wendy C. Gerzog (Baltimore), Tax Benefits, Higher Education and Race: A Gift Tax Proposal for Direct Tuition Payments (Dec. 2020):

Mirit-Cohen (2018)

Amid recent nationwide protests and public condemnation of systemic racism, Americans are divided on whether this focus on the race and inequality gap will actually lead to major policy change. This product of collaboration between renowned tax crit Bridget Crawford and gift and estate tax expert Wendy Gerzog yields not only an admirable scholarly inquiry into the correlation between tax, race, and higher education, but also a practical proposal for policy reform to reduce race-based economic inequality. Using the case study of gift tax exemption for direct tuition payments, the Authors illustrate the ways tax rules can aggravate the racial wealth gap and put together a primer to fix the advantage most affluent taxpayers in the U.S. receive through educational tax benefits.  

Students and families who do not receive scholarships typically work and take out loans to finance their futures. In 2019, the Institute for College Access & Success estimated 62% of senior graduates had student debt; 85% of Black, compared to 69% of whites, 66% of Hispanic/Latinxs and 45% of Asians.  As to the ability to repay the loans, the Federal Reserve reports mean family net worth for Blacks is $142,500, $165,500 for Hispanic or Latinx families, compared to $983,400 for white non-Hispanics. Given that Black college graduates have the lowest net worth, the highest average debt load, the highest rates of unemployment and the lowest average wages, it is not surprising that—facing greatest financial challenges—they also have the highest student loan default rates – 40% of Black borrowers, compared to 29% of Hispanic/Latinx borrowers, 22% of white borrowers, and 19% of Asian borrowers.

Congress realizes the immense social welfare from the pursuit of postsecondary education: higher average of income, better health, lower levels of poverty, etc.. Accordingly, it utilizes various tax benefits to offset the high price of tuition, student debt, and loan repayment. Indeed, millions of Americans are claiming credits, deductions, exclusions, and other higher education tax benefits. Some of the most well-known benefits include the American Opportunity Tax Credit and Lifetime Learning Credit, a limited deduction for interest on education loans, an exclusion from gross income for gain on contributions to an education individual retirement account (aka “Coverdell education savings account”), and an exclusion for gain on contributions to qualified tuition programs (“529 plans”). For the 2020 fiscal year, the Tax Policy Center estimated total income tax expenditures for education as approximately $32.7 billion. Alas, these tax benefits for higher education are nonrefundable and fail to assist students and families with low taxable income. The latter are also unable to afford to contribute to 529 plans and utilize that federal (and state) tax benefit.

Critical Tax Theory calls for a wider consideration of “Fairness” and “Equity” in our tax system. As Professor Anthony Infanti has explained in his most recent book, it involves embracing the notion that tax laws are part of political choices that represent a collective national “self”. Tax crits such as Professor Dorothy Brown—through her most notable journey—and many others, have been calling to embrace a different type of tax scholarship: a more responsible inquiry that adheres not only to taxation in accordance with the level of taxpayers’ income but that also accounts for race, gender, class, disability, sexuality and other identity axes. Respectively, this Article focuses on the race-related biases of tax benefits in the realm of higher education. While the IRS’s official colorblind policy prevents it from collecting such data, other agencies use surveys that may provide some of the missing picture on disparities in education by race. Using U.S. Census reports, Federal Reserve and other credible sources from the higher education sector, the Article demonstrates that primarily wealthy White taxpayers capture the most generous educational tax benefits for higher education while Black taxpayers appear to benefit the least from these tax provisions. As such, this Article not only portrays the role educational tax benefits play in exacerbating racial inequalities but also their contribution to expanding the wealth gap.

After outlining the cost of higher education and the amount of debt students incur, the Authors describe income and wealth transfer tax benefits for higher education. They focus on section 2503(e) that provides an exclusion of direct tuition payments from gift tax. This section allows wealthy individuals to make tax-free lifetime transfers that, over time, can both reduce the size of their taxable estate and substantially enrich younger generation family members or other individuals. For most Americans, wealth transfer taxes are irrelevant in light of the lifetime exemptions from federal gift or estate tax (for a married couple is $11.7 million in 2021) and unlimited number of annual tax-free gift transfers of up to $15,000 per donee. Yet, for wealthiest Americans these benefits are extremely advantageous. These taxpayers and their savvy tax lawyers can plan a series of annual excludable gifts to their children and grandchildren (or their trusts) while substantially reduce the size of their gross estate for estate tax purposes.  Another benefit under section 2503 is the gift tax exclusion for “qualified transfers,” such as tuition costs and medical care (e.g., orthodontists’ bills). Grandparents can essentially pay pre-college private school tuition, college, and professional school expenses for all grandchildren—free of gift-tax—resulting in unwarranted depletion of their transfer tax base.  

Combining the lifetime exclusion, qualified transfers, and annual excludable gifts, wealthy grandparents can both substantially increase the wealth of the younger generations and reduce the size of their own taxable estate. These tax benefits essentially allow children and grandchildren of wealthy individuals to avoid incurring any debt while obtaining many years of schooling. Such tuition-gifted donees are already on their way at graduation to accumulating their own wealth. Paradoxically, educational tax benefits for higher education accrue disproportionately to those who can already afford it. Enacted in 1981, these benefits are inconsistent with the overall purpose of the wealth transfer tax (which underwent dramatic changes since 1981) and exacerbate the racial wealth gap by creating lifetime benefits for donees while diminishing donors’ tax base.  They are part of a system that contributes to, and sustains, white financial well-being to the near total (but not complete) exclusion of other races, and if I may add, on their and our expense.  

The Authors then propose an innovative litmus paper for evaluating the fairness of tax benefits and exclusions in the wealth transfer realm. Educational benefits are inequitable if they satisfy a two- factor test. First, they have unequal impacts on taxpayers the basis of race. Second, they create substantial wealth for transferees while depleting the transferor’s estate. In the case study of gift tax exemption for direct tuition payments, authors call for its repeal because it fails both parts of the test, as well as advocating to dramatically lower the lifetime gift tax exemption from its current $11 million level.

The investigation of the tax laws through critical lens is a foundational part of tax scholarship. It would be interesting to see whether the Authors’ proposed test, applied here only to the case of gratuitous wealth transfer and race, can be useful for other tax expenditures and different notions of fairness and equality. To name a few, how are tax benefits impacted by disability, gender, sexuality, and veteran status provide a benefit to one taxpayer on the expense of another? At the risk of throwing down the gauntlet, maybe this Article should be a series of papers, perhaps a book?

Here's the rest of this week's SSRN Tax Roundup:

https://taxprof.typepad.com/taxprof_blog/2020/12/weekly-ssrn-tax-article-review-and-roundup-eyal-cohen-reviews-tax-benefits-higher-education-and-race.html

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