529s and Prepaid Tuition

If you want to read a strong, well-documented argument for the Obama administration’s aborted effort to get rid of the so-called “529” tax deduction for college savings, our former colleague Ryan Cooper’s got the goods over at The Week:

President Obama suffered a minor political setback this week, when a proposal to end the 529 college savings tax credit, unveiled during the recent State of the Union address, sparked a backlash. He has now dropped the proposal.

On one level, it’s no big deal, since it’s only a small policy, letting people build college savings accounts without being taxed. It’s also vanishingly unlikely he could have gotten anything through Congress. But on another, it’s an extremely frustrating example of the limitations of American political discourse.

So, let’s be clear: the 529 tax credit is a piece of utter trash policy. Few people use it, those who do are mostly wealthy and don’t even save very much, its effectiveness varies wildly based on when you start investing, and tax breaks on savings are a lousy way to subsidize higher education in the first place. The fact that we can’t even consider getting rid of this steaming garbage pile — and there are dozens like it in the tax code — does not bode well for the American system.

Ryan goes on to cite some useful research from Ed Sector about the inadequacy and riskiness of 529 Plan savings, and the regressive nature of the distribution of this tax benefit.

My only demurral to his argument is that in significant parts of the country (19 states, plus private colleges all over), 529 plans are used in tandem with prepaid college tuition guarantees that lock in current tuition rates and also certify pre-payment whatever the market happens to be doing. So one prong of Ryan’s argument against 529s does not really apply to their use in such programs. Yes, the benefit is still regressive, as is the case with any tax deduction (rather than credit). But the practical effect of 529s, and thus the constituency for maintaining this tax subsidy, really do vary depending on whether they are linked to prepaid tuition.

Ed Kilgore

Ed Kilgore, a Monthly contributing editor, is a columnist for the Daily Intelligencer, New York magazine’s politics blog, and the managing editor for the Democratic Strategist.