Update On 529 Plans

So on Sunday, with respect to the Obama administration’s proposal to tax 529 plan earnings (effectively destroying the plans), I said, “I don’t see another way to read the administration’s proposal other than an abandonment of the idea that families should save for their children’s college, rather than relying on government giveaways, loans, and loan forgiveness afterwards.”

It’s now been reported in multiple spots that the administration has dropped this proposal. Here’s the AP, via abcnews.com: “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.”

But here’s what’s useful to notice:

the original justification for taxing 529-plan earnings was that, if you do the math, the “rich” benefit disproportionately and are disproportionately likely to have a 529-plan in the first place. But now the AP article is reporting a new rationale even as they abandon the idea:

It was part of Obama’s plan to consolidate and simplify a sometimes confusing array of tax breaks for college students.
. . .
“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.
. . .
The administration said all the additional tax revenue would have been used to help expand and make permanent a $2,500 tax credit that families can use for education expenses.

Notice something?

The administration planned to swap a program that encouraged parents to save for college, for one that simply provided cash benefits (in the form of tax credits – though the article doesn’t say, and I don’t have time to look up, whether this is intended to be refundable) at the time of attendance, and treated these two as if they were of equal benefit, in broad principle, with the latter to be favored because it would provide a flat amount for each family/student regardless of income level.

Which pretty much proves my point, even though on Sunday I hadn’t seen this rationale.

The concept of the 529-plan tax break, like the parallel Roth IRA, is to provide the sort of benefits that encourage Americans to make wise financial decisions, like saving for college or retirement, thus providing a payoff for the tax break far in excess of the money “spent” by the forgone taxes — either in terms of reduced outlay on financial aid later, or the economic and social benefits of an increase in Americans with a healthy amount of savings at retirement.

Spending the money gained from taxing 529-plan earnings (which, let’s face it, won’t exist, because 529-plans would disappear) on a different set of benefits is a mindset that simply doesn’t recognize the value in saving, because, after all, the government can provide for you in your time of need anyway.

Update on 529 plans