The Tax Code Is a Terrible Place To Promote Policy

The current Congress has proposed 13 bills trying to encourage personal savings. Democratic Senator Max Baucus wants to create “Young Savers accounts” to allow parents to open Roth IRAs in their child’s name. Chuck Schumer and Jeff Sessions and John Murtha have similar plans. New York Democratic Senator Kirsten Gillibrand wants to increase the rate of the tax credit for retirement savings contributions and made the credits refundable. Ohio Republican Congressman John Boehner wants to, among other things, increase the dollar limit on IRA contributions.

None of these ideas will fundamentally affect the way Americans save, because they’re all trying to accomplish their goal through the tax code, a mechanism that’s horribly inefficient at accomplishing public policies.

To illustrate this issue, consider the table below, from my new Charts You Can Trust showing how 529 plans favor the fortunate. 529 plans were meant to help families afford the rising costs of higher education, but their benefits mostly go to families that are more able to afford it already. The data come from 2007 tax filers in Kansas, and it shows that 81 percent of the 529 deductions went to these higher income classes, even though they made up only 10 percent of the tax returns. Only 1 percent of Kansans earned more than $250,000, yet they claimed 37 percent of the total 529 tax benefits. The average deduction for wealthy Kansans was nearly five times larger than the ones claimed by Kansas residents earning less than $50,000.

Because 529 plans are administered through the tax code, and because the value of tax deductions correspond to tax rates, individuals paying higher taxes see greater benefits. For high-income households, the tax advantages of financing college expenses through 529 plans can amount to as much as a 39 percent advantage over traditional taxable savings accounts (High-income families can reap the tax benefits of 529 plans even if their child is currently in college. Instead of paying cash directly for their child’s college expenses, funneling money through a 529 would qualify the family for these high savings.). For middle-income families, the advantage is 35 percent, but for low-income families, it’s only 22 percent.

Besides being poorly targeted, many families who benefit from state and federal tax subsidies don’t even realize it. Nearly two-thirds of participants in tax-sheltered college savings accounts don’t believe they’ve received any financial support.

We spend $600 million each year giving high-income families tax benefits for saving for their child’s college education. Tax expenditures like 529 plans have the benefit of being hidden from the ordinary budgetary process, yet, like entitlement programs, Congress has little control over year-to-year spending. Judging by the list of pending legislation attempting to boost savings rates, Congress has not yet kicked the habit of attempting to solve policy problems through the tax code. But if congressional leaders want to root out wasteful spending and make government more efficient, it should think more carefully about tax expenditures like 529 plans.

Tagged as: 529 plans, College Affordability, Federal Budget, Tax Expenditures