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Published in Print: June 6, 2001, as Education Breaks Folded Into Tax Bill's Fine Print

Education Breaks Folded Into Tax Bill's Fine Print

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Income taxes. The "marriage penalty." The estate tax. Rebates. When Congress recently approved final legislation to reduce taxes, those items dominated the news.

But delving more deeply reveals a cache of education provisions within the plan, including one that helped prompt a veto under President Bush's predecessor because it provides a tax break for private school tuition costs.

Mr. Bush this week is expected to sign the legislation, which reduces federal taxes by $1.35 trillion over 10 years. About $30 billion of that is for education. Most of those benefits are geared toward college costs, but a few also affect K-12 education.

During Senate debate on the tax plan last month, some Democrats sought to modify a measure for "education savings accounts," or ESAs, by stripping out language allowing tax-free earnings from the accounts to be used for private school costs.

"Using ESA accounts for private school tuition is simply vouchers by another name," said Sen. Blanche Lincoln, D- Ark. "I am concerned that providing a tax incentive to pay private school tuition will divert the critical resources needed to improve our public schools."

Sen. Tim Hutchinson, R-Ark., shot back that to remove private school costs "tears the very heart out" of the proposal. "This is by no means vouchers," he said. "These are education IRAs, and the rights of parents should be preserved to have the maximum flexibility in their use."

The Democratic amendment was defeated 58-41, largely along party lines.

Before now, federal law allowed families to place up to $500 annually in after-tax dollars into education savings accounts to help with higher education costs, with no tax on the interest. The new law will raise the ceiling to $2,000 and allow families for the first time to use the money for K-12 expenses, including tuition, after- school tutoring, books, and computers. It will also allow third parties, such as relatives or employers, to participate.

A Brick in the Wall?

"This is a major breakthrough," said Joe McTighe, the executive director of the Council for American Private Education. He said it represents the first time the federal government will provide tax relief to help families expand their options for precollegiate education, including private and religious school costs.

"A brick has been removed from the wall that separates parents from the freedom to choose their children's schools," he said.

But even many supporters concede that the actual financial benefits of the measure will be relatively modest, since it applies only to interest. The tax savings would typically be less than $30 for a $2,000 contribution with a full year's interest, according to the nonpartisan Congressional Research Service. The cost to the U.S. Treasury over 10 years is estimated at $5.3 billion.

Controversy has swirled around the idea for several years because of the assistance for private school costs.

"Bill Clinton actually stopped a major piece of tax legislation because it contained education savings accounts," Mr. McTighe said. But not all Democrats oppose it. And with a Republican in the White House, observers said enactment had become a virtual certainty. ("Education Savings Accounts Are Getting Another Look," April 4, 2001.)

That said, the plan does not go as far as Mr. Bush's proposal to raise the ESA ceiling to $5,000.

Beyond ESAs, the tax package contains two modest measures to assist with school construction. First, it modifies existing provisions on "arbitrage," revenue a school district or other bond issuer gets when it invests bond proceeds and makes a profit. The plan will increase the amount of government bonds for public schools that small governmental units may issue without being subject to the requirement to return arbitrage to the Treasury.

Joel Packer, a lobbyist for the National Education Association, said the provision is narrow in scope, affecting only school districts that issue between $10 million and $15 million in bonds.

Another measure is aimed at encouraging public-private partnerships to build public schools. States and localities under current federal law are allowed to issue tax-exempt bonds for private contractors to build certain types of public facilities, such as airports, but not schools. The new provision will allow tax-free bonds to finance the building of a school, which would be owned by a private entity but leased to a school district or locality.

"We feel these are useful tools that will help some schools with their construction problems," said Dan Fuller, a lobbyist for the National School Boards Association.

But Mr. Fuller and others see a bipartisan plan in the House, which would provide tax credits to pay the interest on $25 billion in school construction bonds, as a much more far-reaching approach. That measure, opposed by the president and many congressional Republicans, was excluded from the tax package.

No Teacher Tax Breaks

Meanwhile, a tax break for teachers added to the Senate bill on a 98-2 vote was stripped out during negotiations with the House. It would have allowed K-12 educators to deduct up to $500 of their professional- development expenses. It also would have granted educators a tax credit of up to $250 for books and supplies they purchase for students.

On the higher education front, the tax plan contains a series of measures. For one, it will allow tax-free distributions from so-called Section 529 plans. Those plans, which some states have recently established, allow parents or grandparents of a child to set up a college-savings fund in which earnings would be tax-free. Previously, those earnings were taxed at the student's, typically lower, tax rate at the time of withdrawal from the account.

The tax package makes permanent a provision in the income-tax code that allows employees to exclude from their taxable income the cost of employer-provided educational aid, and it includes graduate school costs for the first time. It also creates a new deduction for $4,000 in higher education expenses by 2004.

Meanwhile, the plan provides some new benefits directly aimed at children. For example, the $500 child tax credit will gradually be raised to $1,000, and the credit will now be refundable for parents earning more than $10,000 who owe no taxes.

At the same time, roughly $90 billion in tax breaks for charitable contributions that Mr. Bush had supported were excluded from the final package.

Vol. 20, Issue 39, Page 28

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