Politics of the 529 Plan

President Obama’s backpedaling this week on a provision in his tax plan that would have gutted benefits for college-savings plans highlights the challenges facing advocates for low-income students who want to overhaul higher education tax breaks.

The collapse of the White House’s 529 savings account proposal, just days after it was announced, suggests that simplifying and retooling college tax breaks so they benefit more low-income families — and fewer wealthier ones — is an idea that enjoys third-rail status in Washington.

Obama administration officials had argued that their plan, to eliminate the tax exemption for withdrawals from 529 savings plans, would have ended a tax break that was ineffective and not well targeted. They said that 70 percent of the tax benefits went to households with incomes over $200,000.

A 2012 Government Accountability Office study found that roughly half of families with 529 and similar plans had incomes above $150,000; the other half of families with the accounts earned less than that.

The 529 plan changes would have raised revenue for the government by a relatively small amount: about $1 billion over 10 years, Jason Furman, chairman of the White House Council of Economic Advisers, told Bloomberg last week. And only 3 percent of families currently use 529 plans or similar accounts.

The political backlash, though, was swift. Many Congressional Republicans and fiscal conservatives, predictably, came out swinging against the 529 plan changes. They criticized the administration for trying to hike taxes on families saving for college.

But the White House was forced to drop the plan on Tuesday after catching heat from its own party. House Democratic leader Nancy Pelosi, according to press reports, personally lobbied administration officials aboard Air Force One to drop the 529 tax proposal. 

Even though the provision was to be just one small part of an Obama budget proposal that stands virtually no chance of becoming law, Congressional Democrats were apparently unwilling to be remotely associated with scaling back college tax breaks for some families.

The episode underscores the political will behind existing college tax breaks, which many researchers and policy experts have said need to be overhauled.

“The politics are a lot of rich people really like these things for their kids and grandchildren, and they use it as an estate planning mechanism,” said Sandy Baum, a professor of higher education at George Washington University and senior fellow at the Urban Institute. “The political constituency for them is strong.”

It’s a recurring dynamic, too, Baum said.

For instance, as the number of Pell Grant recipients swelled during the recession, many policy makers were eyeing benefit cuts to keep the program afloat. The increase in education tax credits was also large, she said, but hardly anyone was talking about scaling that program back.

Advocates for low-income students say the money spent on tax breaks would be far better used to boost aid for students with higher financial need.

Kim Cook, the executive director of the National College Access Network, said she’s concerned that some existing tax breaks are largely helping students who would already go to college without needing aid. “Some of these tax benefits are extremely popular and will be difficult to dismantle,” she said. “We see those as lost opportunities to target aid to those students who need it most.”

Still, some of the other higher education tax changes in the Obama proposal do have bipartisan support.

Among those provisions are making permanent the American Opportunity Tax Credit and making it more refundable so that more low-income families who do not owe taxes can benefit.

David Socolow is director of the Center for Postsecondary and Economic Success at CLASP, which advocates for low-income students and has pushed for changes within existing higher education tax credits so that they are more targeted to low-income students.

“Congress is likely to continue to deliver student aid in the form of grants, in the form of loans, and in the form of tax benefits,” he said. “Our goal is to make the tax benefits program better, and having them be both refundable and advanceable is a major priority.”