By JONATHAN WEISMAN
JAN. 28, 2015
WASHINGTON — President Obama, facing angry reprisals from parents and from lawmakers of both parties, will drop his proposal to effectively end the popular college savings accounts known as 529s, but will keep an expanded tuition tax credit at the center of his college access plan, White House officials said Tuesday.
The decision came just hours after Speaker John A. Boehner of Ohio demanded that the proposal be withdrawn from the president’s budget, due out Monday, “for the sake of middle-class families.” But the call for the White House to relent also came from top Democrats, including Representatives Nancy Pelosi of California, the minority leader, and Chris Van Hollen of Maryland, the ranking member of the Budget Committee.
Ms. Pelosi pressed the case to senior administration officials on Air Force One as she flew with the president from India to Saudi Arabia, according to Democratic aides familiar with the discussions.
The move was an abrupt turn for the president, who had made the proposal during his State of the Union address only a week ago, a proposal he called part of his pitch for “middle-class economics.”
“Given it has become such a distraction, 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, as well as the president’s broader package of tax relief for child care and working families,” a White House official said.
The official added that Mr. Obama’s proposed increase in the capital gains tax rate and change to the taxation of inherited wealth would provide more than enough money to fund the tax plan.
White House economists had thought that taking away the tax advantage of the 529 plan for better-off families was a simple matter of tax fairness. Instead, it proved to be politically toxic, highlighting the difficulty for politicians focusing their efforts on the shriveling middle class and trying to overhaul the tax code. The idea was to end one tax break tilted toward the wealthy and plow that billion-dollar savings over 10 years into a far larger expansion of another tuition tax credit aimed more squarely at the middle class.
But in the days since the plan was rolled out, the focus has clearly been on Mr. Obama’s proposal that would have essentially gutted 529 accounts. Affluent savers were angered, Wall Street and state governments that run the accounts balked, and Republicans were given an opening to say that they are the better guardians of the struggling middle class.
Mr. Boehner said Tuesday that “529 plans help middle-class families save for college, but now the president wants to tax those plans.”
The contretemps over college accounts held broader lessons. For one, tax reform and “simplification” have great appeal in the abstract, but many specific provisions of the tax code have large and vocal constituencies. In addition, Americans’ concept of the middle class is far more elastic than that of economists.
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“That’s as middle class as it gets,” Representative Marlin Stutzman, Republican of Indiana, said of 529 college accounts.
But there is a continuing debate over the definition of middle class. The median household income is $53,046. Some economists have put a band around that figure, placing the middle class incomes from $35,000 — 50 percent above the poverty line for a family of four — to $100,000, about double the median.
Of the roughly seven million existing 529 plans, about 80 percent of the tax benefits go to households above $150,000, supporters of the Obama proposal say; 70 percent go to households with incomes over $200,000. That is because those people have the most money invested and can contribute $14,000 a year or more without worrying about reaching federal gift tax limits. Investment gains can then be used for education expenses without a capital-gains tax.
“Many people who fall within the lower echelon of the middle class were among the people the president proposed to tax,” said David Lillard, the state treasurer of Tennessee and president of the National Association of State Treasurers, who added that many states had made college savings a focal point of policy making.
White House officials argued that the 529 proposal had to be considered in the broader context. The idea was to consolidate six tuition tax breaks into two, for a net tax cut of $50 billion over 10 years. The bulk of that expansion would go to the American Opportunity Tax Credit, a tuition credit created by the 2009 stimulus law and available even to families who earn too little to pay income tax. The plan would also make that tax credit available for a fifth year of college, because many students cannot graduate in four, and would offer it to part-time students.
A Government Accountability Office report in 2012 found that a family with income of $100,000 or less withdrawing from a 529 account could expect about $561 in benefits from investment gains that would go untaxed. For a family with income above $150,000, that benefit was $3,132.
In contrast, the president’s proposed tax credit expansion would mean $2,500 more for college, White House officials.
“It’s kind of baffling that people in the middle are convinced they are getting hit hard when virtually all of them are the winners,” said Robert Greenstein, the president of the liberal Center of Budget and Policy Priorities.
But that reaction was due in part to the White House’s flubbed launch, Democrats said Tuesday. The tax proposals were rolled out the weekend before the State of the Union address, with virtually all the emphasis on tax increases targeting the very wealthy to finance broad-based tax cuts for the middle class, including a $500 credit for families in which both spouses work, increased child care credits and incentives to save for retirement.
White House officials say they modeled their education tax-credit consolidation on a bipartisan education tax proposal by Representatives Diane Black, Republican of Tennessee, and Danny K. Davis, Democrat of Illinois. But Mr. Davis said lawmakers had looked at ending the 529 benefit and opted against it.
“We didn’t see any way that would be helpful,” Mr. Davis said Tuesday, adding, “I was not excited to see” the White House’s interpretation of his work.
Republicans have latched on to the issue of wage stagnation but have struggled for a policy response. On Tuesday, before the White House announcement, Representative Lynn Jenkins, Republican of Kansas, reintroduced bipartisan legislation to expand 529s.