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A public policy blog from AEI
Shortly before Christmas, my friend and colleague Nat Malkus offered a hard-hitting critique of Congress’ move to expand the use of 529 college savings plans as part of tax reform. The inclusion of the “Student Opportunity Amendment,” offered by Senator Ted Cruz, means that families can now use funds stashed in 529 plans to pay for private K-12 schooling as well as for college.
Because a number of states allow taxpayers to deduct 529 contributions from state income taxes, Nat took to the New York Times op-ed pages to point out that this would reduce income tax revenue in those states. He noted, for instance, that additional 529 contributions are projected to reduce taxable income in New York by three billion dollars, reducing state income tax collection by a couple hundred million dollars.
Nat slams this development as an attack on federalism. While I’m a big fan of Nat’s work, and while we frequently agree on a host of questions, that’s simply not the case here. I’m afraid I just don’t follow his logic. States are free to make 529 contributions deductible if they choose. They are also free not to do so, or to rescind or modify the credit as they like. None of this is affected one whit by the Cruz amendment. Whatever state legislatures opt to do, no federal inducements are being offered and no federal funds are at risk of being lost. That stands in stark contrast to Medicaid expansion under the Affordable Care Act, for instance, in which massive federal subsidies were wielded as a cudgel to compel even reluctant states to expand their plans.
It is true that the Student Opportunity Amendment will change the politics around 529 deductibility. Many affluent parents who reside in high-tax states and use private K-12 schools may suddenly find 529 plans more appealing than ever. Since a lot of these families are residents of urban areas in high-cost blue states and are politically engaged, it might have some intriguing consequences. But none of this constitutes an assault on federalism. Rather, it’s just a reminder that federal policy has ripple effects, even when it’s restrained and designed with due regard for the federal system.
As to whether expanding 529s in this way is good policy, that’s a separate question. On that, I tend to agree with Nat’s earlier observations noting the modesty of the amendment’s practical impact. He and Preston Cooper pointed out that the power of 529s is mostly in the tax-free compounding of interest — and that using these funds for elementary school (which is when most families use private schools) leaves little time for compounding to work its magic. This could be counterproductive if families wind up pulling out funds to use for elementary school, and are thus unable to take advantage of out-year compounding to pay for college — undermining the original purpose of 529s.
In other words, this is a modest win with some risks if used recklessly. But that doesn’t make it bad policy and it surely doesn’t make it an attack on federalism. Rather, the Student Opportunity Amendment is a constructive but quite limited change that could well cultivate an influential new constituency for the deductibility of private K-12 education.
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