Tax Analysts Blog

What Obama’s 529 Flip-Flop Says About Your Roth IRA

Posted on Jan 29, 2015

Well, that was quick. According to news reports, the White House has abandoned its brand-new proposal to tax withdrawals from 529 college savings plans. Administration officials are now calling the plan a “distraction,” which is a nice way of saying “albatross.”

I guess if you’re going to cut and run, you might as well do it fast.

On the level of policy, the demise of Obama’s 529 proposal is unfortunate -- it would have been a step in the right direction for higher education aid, which has long been inefficient, poorly targeted, and politically driven. Section 529 plans are great for families rich enough to send their kids to college under any circumstances. They are less great for anyone struggling to make college even vaguely plausible. As Kim Rueben and Sandy Baum have noted:

      Because low-income households pay little or no federal income tax, the tax exemption doesn’t help them at all. Higher-income families are saving anyway, and their children are already the most likely to go to college. According to estimates based on the 2013 Survey of Current Finance data, only about 3 percent of families participate in 529-type plans and over 70 percent of accounts comprising 87 percent of the balances are held by taxpayers earning over $100,000; almost 70 percent of balances are held by the 6.4 percent of households earning over $200,000.
Politically, however, it’s hard to see how the White House ever thought this idea would fly. Talking up the importance of higher education while dialing back a popular savings vehicle is awkward, to say the least. In some ways, however, it’s vintage Obama. The president takes policy seriously but treats politics as an afterthought. In some abstract way, that’s admirable. But it also points up (yet again) his inconsistent and often mediocre political skills.

The bursting of the 529 trial balloon should serve as an object lesson for anyone hoping to rein in other tax preferences. In particular, proposals to scale back Roth IRAs – popular among liberal analysts – seem hopeless in the extreme.

Again, there are good reasons for limiting the largess. As analysts from the Center on Budget and Policy Priorities have pointed out, “Current tax incentives for retirement saving are expensive, inequitable, and economically inefficient, giving the largest subsidies to the people who least need help in saving adequately for retirement and are most able to shift assets to capture the subsidies.”

True enough. But if you think the blowback on 529 reform was bad, just try floating a meaningful Roth reform. It won’t be pretty.

Obama’s 529 debacle also tells us something about the perils of using tax preferences to pursue social goals. Once given, preferences are hard to eliminate or even scale back significantly. Efforts to improve targeting are a particularly heavy lift, since Americans like their social programs to be universal (in the model of Social Security and Medicare), even if that means giving benefits to rich people.

When it comes to spending programs, universality is expensive, showering benefits on people who don’t need them. But when applied to tax preferences, universality is both expensive and ineffective, since the benefits still flow to the rich but also fail to reach the truly needy. Badly designed tax preferences aren’t just poorly targeted – they often miss the target entirely.

Read Comments (4)

robert goulderJan 28, 2015

"... the perils of using tax preferences to pursue social goals." Amen to that,
brother.

edmund dantesJan 28, 2015

"When it comes to spending programs, universality is expensive, showering
benefits on people who don’t need them."

Bunk. Whatever happened to equality before the law? Why does "need," as
subjectively defined by liberals, ever come into it? Even Warren Buffett
"needs" tax breaks, as evidenced by his widespread utilization of them.

We've already adopted "one size fits all" health insurance, how about sticking
to "one size fits all" tax policy? The rampant use of "phase-outs" of tax
breaks for "the rich" is a big part of what makes the tax code so unnecessarily
complex.

The reversal on 529 plans is welcome, especially because it was so poorly
communicated that many people did not understand it would have applied only
prospectively. And what a bookkeeping nightmare that would have been, now
thankfully avoided.

Last year Harvard garnered $1 billion for its massive endowment, even as it
earned $4+ billion on those investments. What does it tell us when Obama
proposes to impose taxation on middle class savings for college, and never
mentions imposing any taxation at all on these massive endowments for educating
the children of the 1%?

jrJan 29, 2015

"The president takes policy seriously but treats politics as an afterthought."

Almost as ridiculous as the claim that the President is not interested in photo
ops.

Chris EdwardsFeb 1, 2015

Joe
Your readers would have benefited from your first revealing your Haig-Simons
starting point, then discussing your views about savings and 529s. In other
words, for the many readers of TN that have a different view about the tax base
than yours, it appears you are just trying to pull the wool over some peoples'
eyes.
Cheers
Chris

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