President Obama on Tuesday abandoned a proposal to end a major tax benefit of popular college savings accounts used by millions of American families after the White House faced mounting criticism from lawmakers and parents.
White House officials said the backlash against the president’s plan became “such a distraction” that it was best to drop the proposal, which would have removed the ability of families to withdraw money tax-free from the savings plans, known as 529s.
The administration had tried to frame the elimination of the tax break as a way to redirect more money to middle-class families, arguing that the savings plans were being used disproportionately by wealthy families.
But the proposal proved to be a serious political miscalculation. With more than $1 trillion of outstanding student debt in this country, the 529 plan has become one of the best tools for families to save for college. About 12 million American families rely on the accounts.
The administration’s proposal to roll back the benefits of 529 plans was like “kicking a ball in your own goal,” said Jared Bernstein, senior fellow at the Center on Budget and Policy Priorities and former economic adviser to Vice President Biden. “Yet I still thought it was smart fiscal policy because we shouldn’t subsidize spending that would occur anyway.”
Sen. Charles E. Schumer (D-N.Y.), who lobbied the White House to drop the plan, said, “The president’s plan has the puzzle pieces necessary to bring the middle class back, but this particular piece didn’t fit.”
Indeed, the 529 proposal had an extremely short life span of only a week. Critics pounced on the plan, saying it was tone deaf to the needs and aspirations of ordinary Americans looking for any help they can get saving money for college. House Speaker John A. Boehner (R-Ohio) jumped on the issue and insisted the proposal be stricken from the president’s budget.
Even liberal House Minority Leader Nancy Pelosi (D-Calif.) warned Obama that targeting college savings was a political misstep. Pelosi pressed the case to drop the 529 proposal with senior administration officials on board Air Force One as she flew with the president from India to Saudi Arabia, according to people familiar with the meeting who were not authorized to speak publicly.
Another lawmaker who raised objections to Obama’s proposal was Rep. Chris Van Hollen (Md.), ranking Democrat on the House Budget Committee. “This particular proposal undercut the message that they were focused on helping the middle class,” Van Hollen said in an interview.
“I understand the policy nuances,” Van Hollen added. But the way it was designed — with no regard, for instance, to income level or the size of the balance in a 529 account — “hit everybody indiscriminately,” Van Hollen said.
The White House originally defended its plan, saying that 70 percent of account balances are held by households making more than $200,000 a year.
But the administration quickly realized that the public backlash was jeopardizing the rest of the plan laid out by the president in his State of the Union speech last week.
“We’re not going to ask Congress to pass the 529 provision so that they can instead focus on delivering a larger package of education tax relief that has bipartisan support,” a White House official said Tuesday.
Critics of the proposal accused the administration of ignoring the fact that a growing number of Americans earning less than six figures are investing in 529 plans.
The College Savings Foundation, a nonprofit group that advocates for 529s, estimates that 70 percent of account holders earn less than $150,000 based on a 2014 survey conducted by Strategic Insight, a mutual fund research firm. Another 10 percent of account owners have income below $50,000. Families on average contribute $175 a month and amass about $19,774 in their accounts.
The Government Accountability Office, however, paints a different picture. Researchers found that nearly half of the families with 529 plans made more than $150,000 a year and had median assets of $413,000 — 25 times higher than the assets for families without the plans.
The use of 529 plans surged after George W. Bush rolled out a series of tax cuts in 2001. Before then, any money withdrawn from a 529 plan was treated as ordinary income subject to taxes — a rule that Obama wanted to revisit. Very few people used the plans in those days, but that started to change once the tax cuts took effect. Assets in 529 plans have risen from $19.4 billion at the end of 2001 to $245 billion in 2014, according to the Investment Company Institute.
Obama was not calling for the abolishment of 529 plans. Families could still defer paying taxes on the plans as the earnings grow, but that would end once they started drawing down their accounts, according to the White House.
The administration said its larger goal on college finance is to simplify the current jumble of education tax credits. The president wants to expand and make permanent the American Opportunity Tax Credit, which provides families up to $2,500 a year for tuition, books and supplies.
“The 529 provision is a very small component of the president’s overall plan,” a White House official said Tuesday. “We proposed it because we thought it was a sensible approach, part of consolidating six programs to two and expanding and better targeting education tax relief for the middle class.”
The administration has previously touted the benefits of 529 plans. In 2009, then Treasury Secretary Timothy F. Geithner said the plans “can be an immensely effective way for Americans to save for college.”
Geithner said that while the accounts weren’t being used broadly enough by middle-income families, the Treasury Department had a series of recommendations to “expand their use, lower investment fees and make them safer for Americans across a wide range of incomes.”
The Obama family itself has used the plans to save for Sasha’s and Malia’s college educations, based on financial disclosures. The Obamas made contributions of $240,000 in 2007, according to their 2008 tax returns.
Steven Mufson and Karen Tumulty contributed to this report.