Smoke and Mirrors in Education Savings

The House Republican tax plan introduced last week proposes sweeping changes to the American tax system—with the biggest benefits reserved for, unsurprisingly, high-income and wealthy Americans. And education savings policy is no different: The House GOP is proposing big changes, with big benefits for the wealthy. But that’s not all: To top it off, they’re cloaking the move behind claims that they’re “streamlining” programs and “ending” tax provisions.  

The public communications document provided by the Ways and Means Committee outlines the proposed education savings plan changes. Specifically, the plan calls for “combin[ing] savings vehicles for education into one set of simpler, enhanced ‘529 account’ rules. These rules would allow taxpayers to use 529 accounts to help afford rising school costs before college, provide more flexibility, and eliminate the need to save in two separate kinds of accounts.”

But what does this tax talk mean, really? Media coverage has frequently referred to this as a proposal to “end” Coverdell Education Savings Accounts, or Coverdells, which are infrequently used, tax-advantaged savings accounts for K-12 expenses, including private school tuition. Yet while true, at least technically, that the plan proposes phasing out Coverdells, this surface-level interpretation misses the real story—that rather than ending the tax subsidy for private school tuition, House Republicans are proposing to supercharge it.

Coverdells, like 529s and Roth IRAs, are a government-sponsored account designed to promote certain behavior, respectively—saving for K-12, college, and retirement expenses. All of those vehicles offer the same carrot: Investments in the accounts grow tax free. But they all suffer from the same problems as well: Almost all of their benefits go to high-income families with excess capital. Rather than creating new savers, they tend to subsidize the existing behavior of those high-income families. Coverdells are distinct in that K-12 expenses generally don’t have the same long time-horizons for growth that college and retirement accounts enjoy. There’s also an income cap on opening and using a Coverdell: $110,000 for an individual, or $220,000 for a couple, and annual deposits are capped at $2,000 per year.

Coverdells are also extremely rare—so rare, in fact, that they barely show up in survey data. According to the Federal Reserve’s Survey of Consumer Finances, only about 3 percent of American families own a Coverdell or a (far more common) 529.

It should be little wonder that Coverdells are so rare, given that they simply aren’t designed to meet the needs of American families. According to the Pew Charitable Trusts, one in three American households has no savings at all.  White Americans, on average, keep on hand just enough liquid savings to cover one month of lost income, compared to only 12 days for Latinx and five days for African Americans.

Beyond a general lack of savings, Coverdells are poorly designed to support ordinary families. To see why, look at this example: A $2,000 contribution growing at 7 percent would yield just $140 of gain in a year. Given five years, that same contribution would yield $805 in tax-free gains. Unless your family has time, means, and ready access to financial planners, Coverdells offer you nothing. The highest income families are currently excluded from using this public subsidy—but House Republicans have been working harder and harder to change that.

In the 111th Congress (2009-2010), just six pieces of legislation were introduced that proposed changes to Coverdells. As the Obama era marched on, interest in promoting Coverdells intensified, and 18 bills to reform Coverdells were introduced in the 114th Congress (2015-2016). The majority of that legislation was focused on increasing or eliminating the cap on annual Coverdell contributions, which would primarily aid wealthier, white families.

The House GOP’s recent proposal achieves this long-sought goal, quintupling the cap on contributions from $2,000 to $10,000. Under the same investment scenarios as above, a fully funded Coverdell could yield $700 in tax-free interest given one year to invest; in five years the gain becomes $4,025. A family that contributes $10,000 each year for the first five years of a child’s life will find itself with over $71,000, including $21,000 in tax-free investment gains.   

And remember how the proposal moves the tax subsidy from Coverdells to 529s?

Well, this would, in turn, deliver a number of other benefits—all targeted at high-income families. This matters for two reasons. First, unlike Coverdells, 529s have no income cap. By moving elementary and secondary school expenses into 529s, the proposal opens the door to additional tax sheltering for all families, including those with incomes above $220,000 per year. And second, some 30 states support saving in 529s through an above-the-line tax deduction on state income taxes. In effect, the proposal hooks the states into providing an additional subsidy for rich families who are, most likely, already planning to send their children to private school.

This isn’t to say, of course, that 529s aren’t in need of reform of their own. The US Government Accountability Office  estimates the median financial assets of families who own 529s at $415,000. Unless they’re reformed, 529s will remain a wealth-building tool for—that’s right—the wealthy.

Such reforms, however, are possible. Brookings scholar Richard Reeves, laid out a reform agenda earlier this year, and states and cities are trying to build more inclusive and equitable mechanisms for boosting college savings. In Maine, for instance, an innovative public-private partnership opens a 529 and deposits $500 for every child born in the state. In San Francisco, the Treasurer sponsors an innovative program that equips every public school kindergartner with a $50 college savings account. There’s good evidence that these investments build up children, families, communities, and our country in positive ways. Results from a random-control trial operating in Oklahoma by the Center for Social Development at Washington University in St. Louis find that inclusive investments in child savings accounts have positive effects for parents and children, including boosting the child’s social-emotional development and supporting parental expectations for children’s educational achievement.

But the House GOP tax plan isn’t an inclusive investment in the well-being of America’s children, with a focus on those in need of support. To the contrary, what’s being proposed is gasoline for increasing inequality—increased public subsidies for the private interests of the wealthy, and, as Danielle Douglas-Gabrielle writes in the Washington Post, “a clear nod to Education Secretary Betsy DeVos’s push to shift more federal dollars to private schools.”

Public policy should be built off of evidence to serve the public good. We can invest in our public schools and build on the success of inclusive child savings account initiatives in states and cities all around the country. We can pave the way for widespread success in college and life. But that’s not what our government is doing. Instead, it’s proposing an aggressive and surreptitious policy perfectly in keeping with its overall goal: upward wealth redistribution.