One of the ways President Obama proposed to pay for his plan to provide two free years of community college and expand certain college tax benefits was to raise taxes a college savings plan that’s popular with state governments and the upper middle class. If that sounds politically unwise, that’s because it was.
The AP reports that the White House is dropping the idea:
The White House said Tuesday it is dropping a proposal to scale back the tax benefits of college savings plans amid a backlash from both Republicans and Democrats.
President Barack Obama made the proposal last week as part of his State of the Union address. It was part of Obama’s plan to consolidate and simplify a sometimes confusing array of tax breaks for college students.
Resistance from Congress was swift. Republicans publicly criticized the plan, and aides said House Democratic Leader Nancy Pelosi pushed senior administration officials to drop it as she flew with the president aboard Air Force One from India to Saudi Arabia.
Other Democrats also privately weighed in against the plan, including Rep. Chris Van Hollen of Maryland, the top Democrat on the House Budget Committee, and Sen. Charles Schumer, D-N.Y.
A White House official said Tuesday the proposal had become a distraction.
“We proposed it because we thought it was a sensible approach, part of consolidating six programs to two and expanding and better targeting education tax relief for the middle class,” said the White House official. “Given it has become such a distraction, we’re not going to ask Congress to pass the 529 provision so that they can instead focus on delivering a larger package of education tax relief that has bipartisan support.”
The officials spoke on condition of anonymity because they were not authorized to be quoted by name.
It’s a little rich for them to scrap the proposal as a “distraction” — ah, yes, finding a way to pay for new spending programs, a mere distraction.
How much the proposal was supposed to raise in revenue is unclear; that would have been laid out in the president’s upcoming budget. One of the most vocal opponents of this change has been Americans for Tax Reform and their policy director, Ryan Ellis — see his Forbes work on the 529 proposal here.
It was a middle-class tax hike, since about half of 529 accounts are held by Americans earning less than $150,000 a year and about one-third held by those earning less than $100,000.
But it is a much bigger tax hike on the coastal middle class and the wealthy than it is the Heartland middle class. The benefits of 529 plans skew much more heavily toward the upper-middle-class and wealthy than the account-holding numbers represent — higher-income earners pay much higher marginal tax rates than do the 529 holders earning less than $100,000 and sock away more for college. It’s people like President Obama and his wife, who put $240,000 into their 529 plan in 2007, who were going to see the biggest tax hikes by far: Seventy percent of the tax benefits in 529s go to families earning over $200,000, according to the liberal Center on Budget and Policy Priorities. Most tax-exemption programs are like this, more generous to the wealthy than the working class, but they tend to have caps on benefits — 529s only have a (very high) cap on the total size of the account.
529s are actually a bit of a crony-capitalist system, a closed system popular with state governments and the biggest players in the financial industry. States oversee the plans, charging a fee to account-holders, and hire outside financial managers from whom 529 holders have to pick, who then charge more fees of their own. States love handing out a privilege like being a 529 manager, and the privilege is big: There’s more than $200 billion in 529 plans across the country now. The 2012 GAO report noted that fees can range up to 2.78 percent a year, which is noticeably higher than similar investing vehicles.
But that doesn’t make it a good idea to make their earnings taxable. The idea of eliminating 529 benefits to pay for making other tuition tax credits more generous is, as Andrew Kelly of AEI pointed out, a return to the Obama 1.0 approach to higher-ed reform: Tinker with how we finance it in redistribution-friendly ways, rather than holding universities accountable and bringing down the actual costs.