President Obama’s plan to provide two “free” years of community college to “everyone who’s willing to work for it” has gotten a lot of criticism from the right. Republicans in Congress certainly don’t like it. Critics point out the obvious: that there’s no such thing as “free.” Somebody has to pay for it. Community colleges haven’t been a good investment anyway, with low graduation rates in spite of the already wide availability of 100% tuition support. Students tend to treat the offer of community college with the same respect humans accord anything they didn’t have to work or sacrifice for.
But, again, somebody does have to pay to subsidize that twilight world of educational non-commitment. Obama’s got it covered. “Free” community college isn’t the only thing Obama wants to fund with the tax hikes he’ll be proposing in his State of the Union address this week. But people who’ve been working hard to save for their kids’ college tuition by putting money into tax-free 529 plans will find one of those hikes particularly galling, given the “free community college for all” proposal.
Americans for Tax Reform summarizes it as follows:
Under current law, 529 plans work like Roth IRAs: you put money in, and the money grows tax-free for college. Distributions are tax-free provided they are to pay for college.
Under the Obama plan, earnings growth in a 529 plan would no longer be tax-free. Instead, earnings would face taxation upon withdrawal, even if the withdrawal is to pay for college. This was the law prior to 2001.
Eliminating the tax on 529-plan withdrawals for education costs was one of the better things done by George W. Bush and a Republican Congress in his first year of office. Tax-deferred or exempt education savings plans, originally pioneered by the states, had gained federal recognition in the mid-1990s, but Bill Clinton vetoed a proposal from Congress in 1997 to eliminate the federal tax on withdrawals (as long as the money was used for education costs). Bush did eliminate the tax, but now Obama wants to bring it back.
So, to be clear, if you work and save for college, you’ll be taxed when you withdraw the money to pay for college — as part of a scheme for your tax dollars to pay for “free” community college for people who didn’t work and save for college.
This was a little too much for Sean Davis (h/t: Weasel Zippers):
“How should we pay for my ‘free’ community college plan?” “Let’s steal from people who saved money for college!” http://t.co/7qmJqMqwd5
— Sean Davis (@seanmdav) January 18, 2015
We’re not talking peanuts here either. Withdrawals from a 529 plan would presumably be taxed by the IRS at a standard rate, depending on the taxpayer’s status and deductions. In 2011, Matt Krantz ran a comparison for USA Today of the difference in taxed versus non-taxed withdrawals for a notional investment of $50,000 over 10 years. After an annual return averaging 7%, the non-taxed plan leaves the investor with $100,000 to pay for college. The taxed-withdrawal plan — taxed at 15% — takes $7,500 out of the $50,000 earned, leaving the investor with $92,500.
The investor does still have the relative advantage of not seeing his earnings on this investment taxed annually. Taxation happens only when the money is withdrawn for use. But since it wasn’t the government’s money in the first place, the absolute reality is that the investor’s overall disadvantage has now increased again. Government didn’t give; it has no power to. But government inevitably taketh away. The poorer savers, to whom that $7,500 is a big deal, are always the hardest hit.