Why Don’t Taxpayers Maximize their Tax-Based Student Aid? - Salience and Inertia in Program Selection

Sep 19, 2026

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Complexity in the federal tax code likely prevents some taxpayers from minimizing their tax liability. Tax-based federal student aid adds further complexity because taxpayers must choose a single program (per student) from a menu of tax incentives. Using a nationally representative panel of individual income tax returns, the study finds about 25% fail to pick the tax-minimizing option. The results suggest higher salience of federal tax effects improves minimization, while inertia reduces selection of the optimal choice among repeat claimants.

LanguageEnglish

CategoryGeneral

FormatPDF

Pages39

Reading Time14 min

AccessFree to download

Introduction

Research focus: Tuition Deduction vs. Lifetime Learning Tax Credit

Non-tax-minimizing selections and estimated revenue effects

Explaining non-minimizing behavior: opportunity costs, salience, and inertia

Why Don’t Taxpayers Maximize their Tax-Based Student Aid? Salience and Inertia in Program Selection PRELIMARY RESULTS PLEASE DO NOT CITE WITHOUT PERMISSION Nicholas Turner* University of California, San Diego, La Jolla, CA 92093 USA Abstract: Complexity in the federal tax code is likely to prevent some taxpayers from minimizing their tax liability. Tax-based federal student aid adds to this complexity by requiring that taxpayers select a single program (per student) from a menu of tax incentives. Analyzing a nationally representative panel dataset of individual income tax returns, I find that in roughly 25 percent of returns taxpayers fail to select the tax-minimizing program. While opportunity costs may be a barrier to tax-minimization, the estimated effects of opportunity costs are imprecise so that this implication is unclear. Instead, I find evidence that greater salience of federal tax effects causes some taxpayers to minimize federal tax liability rather than combined state and federal tax liability. For taxpayers claiming the programs in consecutive years, I find that inertia in program selection reduces the probability of selecting the tax-minimizing option, relative to first time users. JEL Codes: H26, H31, H71 Key words: salience; inertia, default behavior; tax-based student aid * This work was part of my doctoral thesis in economics at the University of California, San Diego. My current affiliation is the Office of Tax Analysis, United States Treasury, Washington D.C. 20220. 1. Introduction Complexity in the federal tax code is likely to prevent some taxpayers from minimizing their tax liability. The literature finds substantial confusion regarding basic attributes of the tax system such as tax rates (de Bartolome 1995) and also with key features of tax programs such as the Earned Income Tax Credit ( Saez 2010 ; Chetty and Saez 2009) . Tax-based federal student aid adds an additional layer of complexity for middle class taxpayers by offering a menu of tax credits and deductions to lower the cost of postsecondary education. Taxpayers are often eligible for more than one tax-based aid program, but are restricted to one program per student each year. Many states allow the programs to reduce state taxes, compounding the difficulty of selecting the single option that minimizes combined state and federal tax liability. To explore how taxpayers select a single program from a menu of tax options, I focus on the choice between two tax-based federal student aid programs, the Tuition Deduction and the Lifetime Learning Tax Credit. I focus on these two programs for several reasons. First, the programs have similar eligibility requirements. A taxpayer selecting the Lifetime Learning Tax Credit can always select the Tuition Deduction and a taxpayer selecting the Tuition Deduction can usually opt for the Lifetime Learning Tax Credit. In contrast, the enrollment requirements of these programs are incongruent with the enrollment requirements of other tax-based aid programs such as the Hope Tax Credit. Second, due to data limitations it is difficult to determine if taxpayers selecting the Hope Tax Credit make the tax minimizing selection.1 Third, the Lifetime Learning Tax Credit and the 1 The Hope Tax Credit is available only during the first two years of college, so that a student claiming the Tuition Deduction or the Lifetime Learning Tax Credit may not be eligible for the Hope Tax Credit. As a further complication, the qualified spending limit for the Hope Tax Credit is smaller compared to the other programs and its phase-in rate is larger, so that it is not possible to determine if taxpayers selecting the Hope Tax Credit are minimizing tax liability. Tuition Deduction represent a majority of tax-based aid use, roughly 70 percent, during the analysis period. 2 Analyzing a panel dataset of individual income tax returns from the Internal Revenue Service (IRS), I find that a substantial number of taxpayers

FAQs

What question does the paper investigate?

It examines why some taxpayers do not choose the tax-minimizing federal student aid program when selecting from available tax incentives.

What do the paper’s results show about non-tax-minimizing choices?

Across returns claiming the Tuition Deduction or Lifetime Learning Tax Credit, roughly one out of four is not tax-minimizing, and the study estimates substantial forgone tax benefits over 2002–2008.

How do salience and inertia relate to program selection?

Greater salience of federal tax effects is associated with selecting tax minimization, while inertia in program selection lowers the probability of choosing the tax-minimizing option for taxpayers claiming in consecutive years.

Sep 19, 2026

Upload by Patrick