Given the escalating costs of a four-year college education in the U.S., it makes sense for the government to nudge families to save for it. Currently, however, tax breaks for college savings mostly benefit the wealthiest Americans, while doing little to make college more affordable for the middle class -- and congressional Republicans’ tax-reform plan would exacerbate this imbalance.
The federal government provides tax incentives for college savers through so-called 529 plans, which allow parents to put after-tax dollars into investment accounts whose earnings grow tax-free. More than 30 states and the District of Columbia offer income-tax deductions on 529 contributions. Withdrawals from 529 plans are not subject to capital-gains taxes, so long as funds are spent on undergraduate or graduate-school tuition, fees, books, room and board.
Despite these advantages, 529s remain a boutique product -- only 6 percent of taxpayers with dependent children have a 529 account. Because families with incomes below $75,000 don’t pay taxes on capital gains, the tax break on 529 withdrawals amounts to a targeted subsidy to upper-income families. The loss of tax revenue from 529 investment earnings costs the federal government more than $1.5 billion a year, and that amount will double by 2026.
Defenders of 529 plans argue that they help poor students, too: With more affluent students paying full tuition, there is more financial aid available for low-income families. But if this is the strategy, it has failed to increase the numbers of high-achieving, low-income students at elite schools. And if that is the goal, there are more straightforward ways of achieving it.
