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UPDATE Feb. 26, 2015: The House voted Wednesday to expand the benefits of the 529 college savings plan, which President Obama previously attempted to scale back. According to the Associated Press, the bill would allow students to use money from the savings accounts to buy computers and other technology, something not currently permitted.
After a confident and sweeping State of the Union address focused on “middle-class economics,” President Barack Obama found himself pivoting away from part of it Tuesday.
After an uproar over Obama’s proposal to dismantle the college savings plan known as the 529, the President walked it back and abandoned the plan.
How did one little program suddenly become so important? Here’s what you need to know:
What’s a 529 anyway?
Named for the relevant section in the tax code, a 529 college savings plan is similar to a 401k or IRA. It’s a a state-offered investment plan, often a mutual fund, set aside to cover college expenses for a set beneficiary.
The account grows tax-deferred, and 529 funds used for tuition, fees, books, supplies and in some cases room and board are tax-free. Some states also let the account holder write off contributions to 529s, so there are tax breaks going in both directions. Nearly every state offers them.
Who uses 529s?
The Obamas, for one, but they’re part of a small group. A 2012 Government Accountability Office study found less than 3 percent of families have 529s. Even among households expecting education expenses or prioritizing college saving, 529s were rare. As of last summer, there were fewer than 12 million accounts nationwide, according to the College Savings Plans Network.
The families who use the plan are wealthier than those who don’t. The GAO study found median income among families with 529s or the similar Coverdell plan had a median annual income of $142,400, and nearly half of them made more than $150,000 per year. That group was likely to see a median tax savings of $3,132, while families making less than $100,000 saved $561.
Why did Obama want to get rid of it?
It’s part of his broader tax proposal laid out in the days leading up to the State of the Union and focused on the middle class. Obama’s 2016 budget would get rid of the tax breaks from 529s and use the money to expand the American Opportunity Tax Credit.
That program applies only to households making less than $180,000 per year, and it can cut taxes by up to $2,500 per year or give households that don’t make enough to owe taxes up to $1,000 in refunds. Obama’s plan would up the refund and make the credit available to part-time and fifth-year college students.
So what’s the problem?
Prominent lawmakers on both sides of the aisle spoke out against the change in public and private. Speaker of the House John Boehner said the president was scuttling a plan that already helped middle-class families, and a Republican representative reintroduced bipartisan legislation to expand 529s.
House Minority Leader Nancy Pelosi also urged the White House to drop the 529 proposal, which it did Tuesday, calling the furor a “distraction.” An administration official told the New York Times other changes to the tax code would be able to fund the plan instead.
Why does it matter?
The proposal’s undoing was, in part, that the definition of “middle class” is fluid. Any benefits to consolidating 529s into other tax credits aren’t nearly as clear-cut as, say, as raising taxes on the super-rich and giving everyone else a break.
“The soaring cost of a college education makes even a six-figure income seem small,” Russell Berman wrote in the Atlantic, adding that the small group benefiting from 529s might be doing well financially, but they’re not all 1-percenters.
That’s true for a lot of the little breaks in our complicated tax code, and cutting any of them can easily feel like a blow to the middle class — whoever that is.
None of this bodes well for bipartisan tax reform. Writing for the Brookings Institution, David Wessel said it best: “It turns out that a lot of people prefer complexity to simplicity if simplicity means doing away with a tax break they get.”
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