Obama Drops Plan to Tax College Savings Plans

Only a week after proposing to hit the middle class with a tax on college savings plans, President Obama dropped the assault on so-called “529 plans.” These plans have been used by parents for two decades to save for their children’s college expenses.

The plans, named after a section of the Internal Revenue Code, are attractive because they allow participants to make contributions that both grow and are paid out for educational expenses on a tax-free basis. In his proposal, offered during his State of the Union, Obama wanted to tax earnings resulting from all new contributions under these plans. This would have meant that at the very point when funds are finally being used to pay educational expenses, the Tax Man would show up with his hand out.

So for now, the 529 plans will remain intact. That’s the good news. This episode illustrates, however, the ill-informed advice the president received from his staff on this issue.

The administration’s talking points on the attempted 529 tax grab claimed that these plans disproportionately benefit high-income households. Obama’s advisers were apparently relying on the criticisms of 529 plans provided by a Government Accountability Office (GAO) study completed in 2012 using 2010 data. The “Concluding Observations” of that report are:  “As currently designed, 529 college savings plans benefit a small percentage of U.S. families. In general these families tend to be wealthier than others.”  The president seems to have been advised that the 529 plans benefitted a small group of wealthy families, and since the rich are easy political targets, why not tax their college-savings plans?

Let’s first consider the GAO claim that 529 plans had become a tax dodge for the wealthy: The report maintained that a large percentage of families (47 percent) who used 529 plans had total annual incomes above $150,000; in other words, the wealthy. Using the GAO’s own statistics, that still leaves over half of the families under $150,000—solidly middle class—a point the GAO seemed to ignore.

Obama advisors failed to discover recent figures that paint a significantly different picture. Strategic Insight, a research organization that provides data to the mutual funds industry, found that in 2014, 70 percent of households with 529 accounts had incomes below $150,000, many more than the roughly half set out in the GAO report. If one uses President Obama’s cutoff for the middle class at $200,000, then nearly three of four families saving for college by using 529 plans are in the middle-income category!

The Obama proposal generated responses from those who really know who benefits from 529s. Betty Lochner, who runs the state of Washington’s 529 programs, says: “If you’re really wealthy, you’ve got complicated trusts for your kids or you’re paying as you go. … These plans are not plans that are designed for the wealthy; they’re designed for the middle class.”

President Obama’s advisors uncritically embraced the GAO report’s impression that 529s are scantily used. In truth, by any measure, the 529 plans have been extremely popular. Even the rather negative GAO points out that 529 assets invested in 2001, which totaled $19.4 billion, had risen to $167 billion by 2011, an almost nine-fold increase in 10 years. Today, the asset totals are an astonishing $244 billion and the number of families with 529s has grown from around two million in 2001 to seven million. Mary Morris, chair of the College Savings Foundation, sums up the frustration with Obama’s now-abandoned taxing proposal: “529 college savings plans are now helping millions to attend college, and reducing the amount of student loan debt students must incur. The last thing that students struggling to meet the rising costs of attending college need is higher taxes.”

By making the 529 plans less attractive to Americans investing their own funds in their children’s educational futures, the Obama proposal would have driven parents into other governmental plans and loan programs. This, coupled with Obama’s advocacy of “free” community college education, would have turned the financing of post-secondary education into a largely governmental undertaking.

Finally, an influential member of the president’s own party, minority House leader Nancy Pelosi, reportedly urged the White House to drop the taxing plan. One can only wonder how Obama’s advisers had failed to consult key Democrats on a change that would affect millions of American families.

I give President Obama credit for withdrawing his proposal. What he eventually learned from the public’s reaction is that the 529 plans are popular, are beneficial to the middle class, and that leaders of his own political party favor their continuation. Penalizing middle-income families, while claiming he wants to help them during his State of the Union, would have been the worst demagoguery, especially since Obama himself contributed liberally to his own 529s for his daughters. President Obama got the message.

John A. Sparks

John A. Sparks

Dr. John A. Sparks is the retired dean of Arts & Letters at Grove City College and a fellow for The Center for Vision & Values. He is a graduate of the University of Michigan Law School and a member of the State Bar of Pennsylvania. He is a frequent contributor of articles based upon U.S. Supreme Court developments.

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