A reader wrote in to ask:
Obama's comments about a tuition tax credit yesterday have me confused. Don't we already have that already, more or less? Is this an additional credit? Is it refundable so starving students can use it? Won't universities just at least eat up part of it with increased tuition above what they would do already?From the Obama website:
Obama will make college affordable for all Americans by creating a new American Opportunity Tax Credit. This universal and fully refundable credit will ensure that the first $4,000 of a college education is completely free for most Americans, and will cover two-thirds the cost of tuition at the average public college or university and make community college tuition completely free for most students. Obama will also ensure that the tax credit is available to families at the time of enrollment by using prior year's tax data to deliver the credit when tuition is due.How about existing tuition tax credits? According to this site from the National Association of Student Financial Aid Administrators, the existing Hope Scholarship Tax Credit paid a maximum of $1650 in 2007. Unlike Obama's proposed new credit, the existing Hope credit is not refundable. The existing credit also phases out at higher incomes. It's not clear if Obama's new credit would be additional to the Hope credit.
As for the last question--will the new credit cause tuition to increase, partially eating up the value of the credit?--I'm glad you asked! This is a question to which we can bring to bear the mighty power of Econ 1 reasoning. The extent to which tuition increases depends on the supply and demand elasticies for education, i.e. how steep the curves are. A good guess is that the demand for higher education is downward sloping while the supply curve is pretty flat. In the short-term, schools can always squeeze in a few extra students, while in the longer term there's plenty of scope to hire new teachers and establish new schools. (Note that his analysis applies to higher education in general, not to very specific goods, e.g. a law school education at Harvard, for which the supply is highly inelastic.)
Below I've drawn the supply and demand curves for the case of a totally flat (perfectly elastic) supply curve. In this case, the credit shifts up the demand curve vertically by the amount of the credit, there is no change in the price of tuition, and enrollment expands. If the supply curve is not quite entirely flat, the subsidy would increase tuition a bit, and enrollment would increase not quite as much. I think it's a good bet, however, that the supply curve is flat enough that the effect of the credit on tuition would be small.
For more details on Obama's higher education proposals, see this document.
Update: See a more recent post on this issue here.