One small attempt at tax reform illustrates the challenges ahead

Rep. Chris Van Hollen (D-Md.) was among those lobbying Obama to back off one of his tax proposals.
Rep. Chris Van Hollen (D-Md.) was among those lobbying Obama to back off one of his tax proposals.
(Adalberto Roque / AFP-Getty Images)

Both the White House and new Republican leaders have mentioned tax reform as an area of possible progress in the new Congress, but the short life and unhappy fate of one small provision the Obama administration proposed shows why that talk is unlikely to translate into action.

President Obama’s policy wonks took months to craft tax reform proposals that the president unveiled ahead of his State of the Union speech last week and plans to detail in his budget on Monday. It took just over a week for the White House to back away from one part of the plan, which would have taxed so-called Section 529 college savings plans.

White House officials contend that the wealthy benefit most from the tax-free accounts, which their proposal would have replaced with an expanded tax break for parents paying for college. The replacement arguably would have helped a considerably larger number of people. But the idea was blasted by both Democrats and Republicans, and the White House was not willing to fight for it.


It was a distraction that threatened to jeopardize the overall tax package, White House spokesman Eric Schultz said Wednesday.

The dust-up underscored the difficulty of any move to overhaul the tax code: Those who have an existing benefit tend to value it more — and be more vocal — than the future beneficiaries of a political promise. For elected officials, the mechanics of winning support for a package that would be riddled with easily dissected, base-angering, politically unpalatable compromises have been too daunting.

“Tax reform is really hard. What we have now is this really complicated system. Nobody thinks it does what it should,” said Elaine Maag, a senior research associate at the nonpartisan Tax Policy Center.

“We know we need to reform it and any serious plan will have winners and losers. But there’s a real attitude that there shouldn’t be any losers,” said Maag, who called the president’s idea “good tax policy.”

“It was realistic tax policy,” she said.

That view was not shared by Republicans on Capitol Hill, who called the proposal bafflingly bad and anti-middle class. But even its opponents agreed there were lessons for tax reform in the proposal’s demise.

“Tax reform is easier done comprehensively, all at once, where you have the opportunity to get the good lower rates and the less fun stuff at the same time,” said Brendan Buck, a spokesman for the House Ways and Means Committee chairman, Republican Rep. Paul D. Ryan of Wisconsin. “You don’t want to get into a situation where you’re picking and choosing here and there for different types of credits and deductions.”


Of course, the comprehensive approach has its own problems. Last year, Rep. Dave Camp (R-Mich.), the previous chairman of the committee, released a detailed tax plan he and his staff had worked on for more than a year. Republican House members took one look at the details and headed for the hills.

Asked about the plan, House Speaker John A. Boehner of Ohio memorably replied, “Blah, blah, blah.” It never came up for a vote.

The 529 investment accounts date back to 2001. Families can make withdrawals free of capital gains taxes as long the money is used for college tuition and expenses. The president’s proposal would have eliminated those tax benefits going forward, while consolidating a half-dozen tax and savings programs into two, including an expanded American Opportunity Tax Credit, which it called a “better-targeted” tax incentive. A new such credit of up to $2,500 a year would be available to a broader pool of people. More than 8 million parents and students would see their taxes cut, the White House said.

The 529s and the similar but smaller Coverdell Education Savings Account have drawn fire before. A 2005 paper by researchers affiliated with the Tax Policy Center named the two programs “the most regressive” among the many available education tax incentives. Users of the plans are likely to earn more, save more and be better educated than other families, the report found.

“These are high-income families that tend to save their money and tend to send their kids to college anyway,” said Susan Dynarski, an education and public policy professor at the University of Michigan who has researched the impact of the plans.

With its proposal, the White House backed that view — pointing to a survey conducted in 2010 for the Government Accountability Office that showed less than 3% of families in the U.S. saved in a 529 plan or Coverdell account. Of the total invested in the accounts, 70% belonged to households making more than $200,000 a year.


Advocates for the 529s and Coverdells argued that the report is out of date and doesn’t reflect the steady increase in savings, particularly in the wake of the recession. They noted the data cited by the White House only described what might be considered obvious — the wealthiest families save more money and reap more in tax benefits.

But another data point in the survey illustrated what would be the proposal’s downfall. Roughly 47% of families with 529 plans or Coverdells had incomes of more than $150,000, meaning 53% fell below that bar.

Rather than a group of mega-rich tax dodgers, the account holders look more like people who consider themselves middle class, even if they don’t fit economists’ definition. Democrats worried that the White House was muddling its middle-class economic message and pushed the administration to preserve the tax credits, said one Democratic aide, who asked not to be identified describing private conversations.

House Minority Leader Nancy Pelosi (D-San Francisco) and Rep. Chris Van Hollen (D-Md.) were among those lobbying Obama to back off.

“The Republicans are going to attack it no matter what,” but the issue was also getting rank-and-file Democrats riled up, the aide said. “It was an unnecessary distraction.”

On Wednesday, the White House downplayed the importance of its disowned proposal. Obama’s education tax overhaul would raise $50 billion in revenue, and the 529 plan proposal was “a very small component of that,” Schultz said.


But, Schultz said, it was too late to remove it from the budget, which had already been sent to the printers.