Obama's college savings tax crashes to earth

President Barack Obama. Image copyright Getty Images

Gather around, children, as we tell the story of what happens when a US president tries to take away a cherished middle-class tax break - even one that doesn't really benefit much of the middle class.

Our tale begins two weeks ago, when President Barack Obama unveiled, as part of his programme to expand an education tax credit and provide two years of free community college for all Americans, a proposal to start taxing earnings of college savings accounts called 529 plans.

The plans have been popular with many Americans - including the Obamas, who put $240,000 (£158,000) into a 529 plan for their daughters in 2007 - as a preferred way to set aside money for the rapidly growing cost of higher education in the US.

The programme has existed since the 1980s - first allowing contributors to deduct college savings from their state income taxes and then, starting in 2001, to avoid federal taxes on the growth of funds in the accounts.

Mr Obama's change was unveiled with relatively little fanfare, as administration officials argued that the 529 programme disproportionately benefitted the wealthy, who could direct more money into the accounts and therefore reap greater tax savings.

According to the Government Accountability Office, in 2010 only 3% of families used 529 or similar tax-preferred savings plans, and they had 25 times the median financial assets of those who didn't participate.

If Mr Obama was counting on there to be little uproar over the change, however, he was quite mistaken. Many critics disputed the assertion that the savings plan solely benefitted the wealthy.

Mary Morris of the College Savings Foundation said that a recent study found that in 2014 10% of 529 accounts belonged to families with income below $50,000 (£33,000) and 70% were from families that made less than $150,000.

"Why target a tax benefit that goes to a lot of your supporters (and donors), that tickles one of the sweetest spots in American politics (subsidising higher education), and that will hit a lot of people who make less than the $250,000 a year that has become the administration's de facto definition of 'rich'? " asked Bloomberg's Megan McArdle.

Her theory was that, with taxes on the wealthy about has high as they could go, the government was running out of places to find revenue to pay for new programmes. Next in the crosshairs, she warned, could be the tax preferences of retirement savings plans.

Image copyright Getty Images
Image caption Education reform is part of President Barack Obama's "middle-class economics" programme

Others on the right were more pointed in their criticisms.

"This doesn't hurt the very rich - who just pay for college out of pocket - or the poor, who get financial aid, but it's pretty rough on the middle- and upper-middle class," writes University of Tennessee Prof Glenn Harlan Reynolds for USA Today. "In a double-whammy, those withdrawals will show up as income on parents' income tax forms, which are used to calculate financial aid, making them look richer, and hence reducing grants."

Reason's Shikha Dalmia attacked the fairness of the proposal, which he said took money from parents who are responsibly saving for education and gave it to those who are not.

Even the liberal-leaning Slate, while defending the White House's motivation, said scrapping the 529 plans was a bad idea.

"The evidence doesn't suggest that everyone will save enough to pay for college outright, but that saving and a sense of ownership give parents and kids a boost in confidence that helps them perceive college attendance as an attainable goal," Justin King writes.

And so on Tuesday afternoon - after the proposal was denounced by Speaker of the House John Boehner and criticised behind the scenes by congressional Democrats - the Obama administration quietly threw in the towel.

"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," an administration official told reporters.

The White House's quick cave was met with a predictable chorus of approval from the right, which heralded the move as a blow to Mr Obama's "contempt for the middle class," in the words of the Federalist's Robert Tracinski.

But perhaps of greater concern to those on both the right and the left is the fact that this recent episode shows once again how difficult it is to enact any kind of tax reform that adversely affects middle-class interests (or even, in this case, a tiny fraction of the interests of the middle class).

There's no question the White House (once again) botched the rollout of a policy proposal, but even more deftly handled reform of 529 plans likely would have met a similar fate.

"Tax reform is very popular in principle and very difficult in practice," writes the Brookings Institution's David Wessel in the Wall Street Journal. "Tax reform creates winners and losers - and the losers often shout louder. The losers know what they're losing; the winners first have to do the math."

Then add in the fact that the losing group in this particular reform came from an income bracket in which many of Washington's media elite reside, and it's a recipe for failure.

"Most of Obama's capital gains hikes would affect those earning $2+ million," tweets MSNBC's Suzy Khimm. "Most of his 529 change would hit those earning $150,000+."

"For DC intellectuals (journalists, policy wonks, etc.), $150k household income isn't 'the wealthy', $2 million is," shecontinues. "For lots of folks (including journalists), that's the difference between the very wealthy and the upper-middle class. Thus the outrage."

Mr Obama's proposal was a test to see if Washington policymakers could make "meaningful changes to the tax code that will come at the expense of high-income Americans", writes the New Republic's Danny Vinik. "They failed that test."

It likely goes beyond just that, however. One of the quandaries on the left is why many Americans in lesser income brackets object to policy changes that benefit the wealthy much more than they do them - a question asked by Thomas Frank in his 2004 book What's the Matter With Kansas?

One possible explanation is that even Americans who aren't in the upper income brackets are "aspirationally wealthy". They may not be rich now, but they hope to be - and when they finally make it, they don't want the privileges and benefits that await them taken away.

So sure, only 3% of Americans use 529 plans. But many more could see themselves using them once they have a little more money to sock away. The fact that, for many, the day may never come is not a concern.

If meaningful tax reform is opposed not only by those who are on the losing end of the changes but also by those who think they might someday be on the losing end ... well, turn out the lights on that idea.

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