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Obama's College-Savings Tax Plan Made Sense. Why Did Even Democrats Oppose It?

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On Tuesday afternoon, the Obama administration dropped its plan to make a change to a widely used tax break for college tuition after facing a feverish backlash from both sides of the aisle. That’s a shame. The White House’s proposal was eminently reasonable. The rapid abandonment of it underscores just how hard it is to make major—or, in this case, minor—policy changes in Washington.

As part of its new tax proposal, Obama proposed making changes to so-called 529 college savings accounts. Families could accrue savings in 529 accounts tax-free and then withdraw the funds to pay for their kids’ college tuition, tax-free as well. The White House wanted to tweak the plans so that families would have to pay taxes when they withdrew the funds. The changes would not apply to current plans.

Your immediate reaction may be confusion. Why is Obama seemingly making it harder for kids to go to college? But that’s not the case. To understand that, you have to look at who actually benefits from the plan. First, its families who have kids that go to college (obviously), ruling out a large percentage of the population who are predominantly poor. Second, families must have high enough incomes to actually have savings. That narrows down the beneficiaries of the plan as well. In the end, it’s largely not middle-class families who benefit from the 529 accounts. It’s the rich. In 2012, the Government Accountability Office found that the median income of a 529-account holder was $142,400, more than three times the median income for all other families. More than 70 percent of account holders had incomes above $70,000.

There’s no clear definition of “middle-class.” But I think most people would agree that an income of $142,400 is well above middle-class, no matter where the family lives. (If you don’t think that’s the case, read Jeff Spross’s analysis of Obama’s 529 plan at The Week.) In that case, Obama is not making it harder for middle-class families to send their kids to college. He’s eliminating a tax break for high-income families.

That’s not how opponents of the plan have described it though. “It’s a tax increase to middle-class families that are using 529 plans to save for their kids’ education,” said Representative Lynn Jenkins, who has created her own plan to expand 529 accounts. House Minority Leader Nancy Pelosi expressed her disapproval of the plan to the president. So did House Speaker John Boehner. “529 plans help middle-class families save for college, but now the president wants to tax those plans,” he said. “It’s another example of his outdated, top-down approach.”

The White House’s decision to give up on this part of its plan is not a big deal by itself. It was a minor part of the president’s proposal, expected to bring it about $1 billion in revenue over the next 10 years, according to Jason Furman, the chair of Obama’s Council of Economic Advisors. Replacing that revenue won’t be difficult, especially because the education tax breaks in Obama’s plan are worth roughly $50 billion.

But the bipartisan opposition to Obama’s plan has worrisome implications for future policymaking, especially tax reform. Whenever Democrats or especially Republicans talk about tax reform, they talk about simplifying the tax code—i.e. closing tax breaks. But it’s easy to vaguely talk about closing tax breaks. It’s much harder to actually lay out which ones you want to close because that means taking money away from a certain group of people—and those beneficiaries, like the beneficiaries of the 529-accounts, are largely above-average in income. The Congressional Budget Office reports that more than half of benefits of tax expenditures, as they are also known, accrue to the top quintile of earners. Nearly 70 percent accrue to the top 40 percent.

So you can think of Obama’s proposal to tweak 529-accounts as a small test to see if legislators have the courage to make meaningful changes to the tax code that will come at the expense of high-income Americans. They failed that test.

This post has been updated.