The 529 Microcosm: A Revealing Political Train Wreck with Regard to an Inefficient Tax Break

This little train wreck over the White House's proposal and then retraction of a plan to cut back on a wasteful yet beloved tax benefit is highly instructive. It's a clear example of how much hot air there is in these fiscal debates.
01/28/2015 05:03 pm ET Updated Mar 30, 2015

This little train wreck over the White House's proposal and then retraction of a plan to cut back on a wasteful yet beloved tax benefit is highly instructive. It's a clear example of how much hot air there is in these fiscal debates, where policy makers and pundits scold everyone within earshot of the need for "fiscal responsibility," then punt when they've got a chance to actually... you know... do something responsible.

The benefit in question is the 529 college savings plan, a tax break that allows people to save as much as they want without paying tax on either accruals or withdrawals (the accounts must be used to pay for college). It turns out that 70 percent of the benefits of 529s go to the top five percent of households -- those with incomes above $200,000. The problem with that, as higher education scholar Sandy Baum recently noted, is that "[529s] primarily provide a subsidy to people who would save in other forms anyway."

So the WH, to their credit, proposed to tax withdrawals from the plans (accruals would remain untaxed) while significantly boosting better targeted measures to help lower-income households afford college (the 529 change was to be grandfathered in, i.e., applied solely to new plans).

For their efforts, they were quickly and roundly attacked by defenders of the 529s from both sides of the aisle. That's not too surprising, given that pretty much everybody thinks of themselves as middle class, worries about college tuition, and doesn't think much at all about the fiscal waste engendered by subsidizing savings that they'd (i.e., "we'd" -- I've got a couple of these accounts myself!) likely undertake anyway.

But the next step did surprise and take me aback. The White House punted. An official said:

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, as well as the president's broader package of tax relief for child care and working families.

One can understand their lurch. The proposal wasn't going to be legislated anyway, so why get smacked around for nothing?

But I still think they made a mistake. There is no tax break that nobody likes... one you can cut back and everyone says, "good choice, WH... well played!" Meanwhile, if all our politics allows is to introduce new tax breaks while none of the old ones can ever be revoked, we're in deeper fiscal doo-doo than even I thought. Given this train wreck over a 529 rollback that was going to raise a mere $1 billion over 10 years, it's awfully hard to take seriously the notion that we're somehow poised for a big push on tax reform.

At least the WH might have said, "OK, we hear you. Families below $300,000 (or something) can still make tax free withdrawals." Granted, you won't have raised much for the Treasury, but at least it's a hat-tip toward better policy.

There's a sweet spot in this work where good policy is good politics. It's easy to advocate for that sort of thing (I'd put work/family balance ideas in that space, e.g.). What separates the wheat from the chaff is when you stand up for good policy that's tough politics.

This post originally appeared at Jared Bernstein's On The Economy blog.