The Rich Don't Need a College Subsidy
Given the escalating costs of a four-year college education in the U.S., it makes sense for the government to nudge families to save for it. Currently, however, tax breaks for college savings mostly benefit the wealthiest Americans, while doing little to make college more affordable for the middle class -- and congressional Republicans’ tax-reform plan would exacerbate this imbalance.
The federal government provides tax incentives for college savers through so-called 529 plans, which allow parents to put after-tax dollars into investment accounts whose earnings grow tax-free. More than 30 states and the District of Columbia offer income-tax deductions on 529 contributions. Withdrawals from 529 plans are not subject to capital-gains taxes, so long as funds are spent on undergraduate or graduate-school tuition, fees, books, room and board.
Despite these advantages, 529s remain a boutique product -- only 6 percent of taxpayers with dependent children have a 529 account. Because families with incomes below $75,000 don’t pay taxes on capital gains, the tax break on 529 withdrawals amounts to a targeted subsidy to upper-income families. The loss of tax revenue from 529 investment earnings costs the federal government more than $1.5 billion a year, and that amount will double by 2026.
Defenders of 529 plans argue that they help poor students, too: With more affluent students paying full tuition, there is more financial aid available for low-income families. But if this is the strategy, it has failed to increase the numbers of high-achieving, low-income students at elite schools. And if that is the goal, there are more straightforward ways of achieving it.
There are modest ways to improve 529s. Eliminating the capital-gains exclusion on college savings for the highest earners would save the government an estimated $17 billion over 10 years. Congress could also restrict the tax break on 529 withdrawals to expenses related to undergraduate study, rather than subsidizing graduate school for affluent students, too.
The Republican tax plan passed by the House does none of these things. Instead, it makes the 529 tax break an even bigger gift for the wealthy, by allowing families to withdraw money up to $10,000 a year from their accounts tax-free and use it to pay for any private school, from kindergarten to 12th grade. That would cost the government $600 million over 10 years, due to taxpayers shifting investment income into the tax-preferred accounts. Meanwhile, the bill eliminates, among other things, tax deductions for interest on student loans, which currently benefit more than 12 million Americans.
The rationale for maintaining the current system of college-savings plans is slim but defensible. It’s much harder to make the case, as Republicans do, for expanding it.
Editors: Romesh Ratnesar, Michael Newman
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