529 expansion proposal doesn't count as real school choice

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Nat Malkus and Preston Cooper

School choice has long been the centerpiece of President Trump’s education policy platform. On the campaign trail, Trump promised $20 billion in federal funds to expand school choice. He reiterated this promise in his address to Congress last winter, calling on the legislature to pass a bill “that funds school choice for disadvantaged youth.” Now, with tax reform on Congress’s calendar for the rest of the year, the president has the perfect opportunity to deliver on those promises: a big investment to help poor families by expanding school choice.

Unfortunately, the main provision in the GOP tax reform bill concerning K–12 education falls well short of the administration’s stated goals.

This provision would allow families to use tax-advantaged 529 college savings plans for K–12 educational expenses, such as private school tuition. Under a 529 plan, a family can deposit after-tax dollars into a savings account on behalf of a child or other designated beneficiary. The initial contributions accrue earnings over time, and families pay no taxes on those earnings so long as they are used for educational purposes. Republicans argue this would advance school choice at the K–12 level.

529 plans are well-suited to pay for college expenses, since earnings can accrue for decades and offer families a large tax benefit. But this same feature makes them ill-suited for K–12 expenses, which families face much sooner. A simple hypothetical illustrates how using 529 benefits for K–12 expenses results in a smaller net benefit from the government to students.

Consider a family who deposits $250 monthly into a child’s 529 account solely for college expenses. The parents start saving when their child is born and realize an annual return on their contributions of 5 percent. With such disciplined savers as parents, the student’s 529 would yield $20,000 for all four years of college, with nearly $35,000 left over for graduate school. The 529 plan provides an effective 6.9 percent college tuition subsidy. Adding in graduate school, the total present value of the 529 plan’s benefits is $8,030.

Now consider what happens if the student’s 529 is used for high school tuition beginning in ninth grade. At $10,000 per year for four years of high school, the 529 account still yields $20,000 for two years of college, with $18,279 remaining for a third year. Under this scenario, the benefit is worth $6,031, providing a total subsidy of 5.0 percent. By withdrawing the 529 funds early, this family has reduced its federal benefits by a quarter.

Withdrawing funds earlier yields even smaller benefits. If our family starts paying private school tuition in elementary school (again at $10,000 per year), the money would run out by fourth grade, yielding federal tax benefits of only $1,392. Increasing contributions won’t fix the problem, as another $100 a month would only stretch the money to sixth grade, yielding $2,363 in benefits.

To be sure, 529 plans may offer a larger windfall when factoring in benefits at the state level. Families residing in one of the 33 states allowing state tax deductions or credits for 529 contributions would get larger benefits. But since state income tax rates are much lower than federal rates, the savings from even the most generous state policies are limited. Moreover, the whole point of President Trump’s campaign promises was to increase financial support for school choice at the federal level.

The central problem with using 529 plans in elementary or high school is that the benefit stems from compound interest, which only accumulates appreciably over time. Under the ideal scenarios above, the moderate college subsidy is drastically reduced when funds are withdrawn for earlier schooling. Of course, average savers don’t start so early and are apt to get less than ideal amounts. For instance, families who start saving when their child turns three realize benefits of $5,278 if they use the funds for college. Using the funds for high school reduces that benefit to $3,621, while using them for elementary school makes it $542.

Delivering on the Trump administration’s school choice promises would require substantial investment from the federal government, targeting benefits to the disadvantaged, and expanding school choice. But Congress’ proposed expansion of 529 plans does none of this.

Under the GOP plan, most parents who use their 529 plans for K–12 education rather than college expenses would actually derive less of a benefit from the federal government. Even families who increase their contributions are unlikely to enjoy net significant additional savings. Expanding 529 plans would cost the federal government just $600 million over 10 years, according to the Joint Committee on Taxation. So much for a $20 billion federal investment in school choice.

The scenarios outlined above require families to chip in $3,000 per year—well beyond what most poor families’ are able to save. As currently structured, 529 plans are not designed to deliver significant benefits to poor families in college. Giving families flexibility to spend those funds sooner does nothing to address their capacity to save; it only minimizes the potential benefits.

Allowing families to use 529 plans for K–12 education won’t expand school choice. The benefits are too marginal to provide many families with new options. The parents who will benefit most from these changes are those who already send their children to private schools or have access to tax advisors to help them plan their savings. If Congress really wishes to advance the administration’s stated goals on school choice, it would do better to scrap these reforms to 529 plans and come up with a different proposal.

Nat Malkus is a resident scholar and the deputy director of education policy at the American Enterprise Institute (AEI), where Preston Cooper is an education data analyst.

The views expressed herein represent the opinions of the authors and not necessarily the Thomas B. Fordham Institute.

Editor’s note: This article was originally published by RealClearPolicy.