President’s Plan to Tax 529s Was Not a Distraction

January 28, 2015

The Obama Administration yesterday backed down from its plan to tax the earnings on 529 savings accounts, a kind of saving account for higher education under section 529 of the tax code. At Bloomberg, Richard Rubin and Mike Dorning report: "A White House official, speaking on condition of anonymity, said the issue had become a distraction from the president’s broader plan to expand and simplify tax breaks for education."

While the issue was, perhaps, a distraction from the administration's priorities on community college, it was not at all a distraction from the administration's priorities on tax policy. It is deeply philosophically consistent with virtually every tax policy proposal, proposed or enacted, from the administration.

The administration's proposals all tend to follow a particular blueprint for tax policy: simply put, that when Americans save by investing in some kind of asset, that they should be taxed at ordinary income rates on both the initial value of the asset and all the future returns on the asset. (For example, with 529 plans, the initial investment is taxed, and the Obama Administration's proposal is to tax the returns as well.) This view is mistaken, in that a financial asset's value is precisely in its future returns. The value of the financial asset, then, is taxed twice.

During the his administration, the President has succeeded in enacting a 3.8% surtax on investment income through the Affordable Care Act, and further increasing capital gains and dividend taxes by an additional 5% in the fiscal cliff deal of 2012. He has also (as yet, unsuccessfully) proposed an additional increase in capital gains and dividend taxes, a limit on individual retirement accounts, and the tax on 529 plans.

In other words, the President has a consistent record of attempting to capture additional tax money from savers. This is at odds with, among other things, the theoretical work of Christophe Chamley and Kenneth Judd, the (correct) tax treatment of IRAs, 529s, and 401(k)s, and the Tax Foundation's Taxes and Growth model.

Given the decline of saving and investment in the U.S. overall, the president would be wise to abandon the idea of double-taxing saving more generally, rather than just in this one instance.

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