With all the economic pain and consternation — surging unemployment, enormous corporate bankruptcy, trillions becoming the new billions — it's easy to overlook the fact that tens of thousands of families have suddenly lost a great deal of the money they socked away to pay for college. They lost it because public officials told them to risk their children's educational future in a casino run by idiots and thieves. Those officials did that because it was a way for them to score easy political points, avoid hard choices, and generally feel good about themselves. I know — for a little while, I was one of them.
I refer to "529 plans," the tax-deferred savings vehicles named for the section of the tax code that defines them. The plans were created by Congress in 1996. But their origins lie further back in time, in the 1970s and 80s, when the price of higher education began to rise at historically unprecedented rates, settling into a steep upward trajectory that continues to this day.
That upward trend in tuition happened for many reasons. State spending on prisons and health care surged, leaving less money for universities, while antitax zealotry shut off sources of new public funds. Students became more consumer-oriented as the higher-education market nationalized, spurring competition and spending to match. Demand for postsecondary education surged while regulatory barriers kept new competitors at bay. U.S. News & World Report gave colleges the means to spend their way to rankings glory. As independent, status-seeking institutions, colleges had both opportunity and motive to jack up tuition every year — which is exactly what they did.
That put public officials in a bind. Tuition sticker shock created a lot of anxiety among voters who realized with horror that sending their kids to college for four years cost more than their first house. But none of the standard solutions were attractive. Restraining tuition growth would involve either: (a) engaging in an annual series of tedious, difficult fights with college administrators about efficiency and spending, or (b) ponying up a lot more money to subsidize higher education, which in turn would require tax increases and/or cuts in other public services, and thus more tedious, difficult fights.
So legislators hit upon a third option, a solution beloved by politicians of all ideological stripes: free money. Specifically, magical free stock-market money. Parents would be encouraged — heck, practically bribed — to put little Janie's college fund in tax-deferred savings accounts. The money would be invested in the stock market, which, as we all knew back in 1996, because everyone up to and including the guy who asked if you'd like fries with that would tell you, had returned an average of 11 percent since 1920. Eleven percent! Even colleges, with their unquenchable thirst for higher tuition, were unlikely to beat that. Tuition increases would be swallowed up by the miracle of compound interest. Problem solved.
The first version of the 529 plans simply deferred taxes on capital gains, allowing savers to accumulate interest on a larger base of capital, in much the same way taxes are deferred on 401(k) plans. That was, it should be said, never a very good idea. College affordability is a problem for middle-class and poor people. Capital-gains taxes are largely paid by rich people. In other words, 529 plans mostly benefit the people who need them the least.
The plans undoubtedly caused some people to save more for college than they would have. But much of the cost to the taxpayer — billions of dollars over the years — simply went to creating a lucrative new tax shelter for people who would have invested that money anyway. Two-thirds of 529-plan assets ended up being held by people with median income of nearly $200,000 per year, according to calculations by the Minnesota House of Representatives..
But none of that mattered to the public officials. Washington operates on a set of widely held convictions that defy all manner of logic and sense. One is the idea that if the government gives you a dollar to spend for a specific purpose, it is a "government program" that requires an annual budget and is subject to intense suspicion from those who oppose government on general principle. If, however, the government tells you to keep a dollar that you owe in taxes, so you can spend that dollar for exactly the same purpose, it is a "tax cut" that is intensely supported by the very same antigovernment folks. Once enacted, the cost of tax cuts disappears into a black hole of lost revenue, never to be worried about again. In other words, 529 plans were supported by free government money to produce free stock-market money. A more perfect political object is hard to imagine.
Unsurprisingly, public officials made a sport of adding ever-more lucrative features to the standard 529 model. Room and board were added as qualified expenses in 1997, and more family members were allowed to contribute. In 2001 the deal got even sweeter — instead of deferring taxes on capital gains, participants never had to pay them at all. State policy makers added income-tax deductions of their own. Free money all around.
Rather than sensibly creating a standard national savings plan, Congress let each state create its own. Indiana was among those that jumped at the opportunity, creating the Indiana Education Savings Authority, governed by an oversight board that includes the state budget director. The budget director sits on many such boards and doesn't have time to attend all of the meetings. So she sent the assistant state budget director for education in her stead. From 1999 to 2001, that was me.
The meetings were very pleasant, as I recall. Rather than analyze spreadsheets and have tedious, difficult arguments about money — my normal duties — I got to sit around a nice conference table and talk about college savings. The private bankers whom the state had hired to run the program wore well-cut suits and gave reports about fund performance — 11 percent or better! Just like they said! — along with bar graphs showing the number of new families that had signed up. I felt good about the whole thing and put it on my résumé.
At no point during those meetings did anyone use phrases like "stock-market crash" or "asset bubble" or "global recession." It was beyond imagining that using free government money to induce and subsidize college savings was anything other than a fantastic idea. We were all so comfortable with the conventional wisdom of investing for retirement — "buy and hold," "save for the long term" — that nobody bothered to note a couple of things that are obvious in retrospect. First, saving for college isn't like saving for retirement. The run-up is much shorter, 18 years at most instead of 30 or 40, so most of the miraculous gains of compound interest are lost. Second, the payout is far more immediate and inflexible. People can choose when to retire, delay if they have to, and ride out ups and down in the market over decades. For most students, college happens three months after graduation, ready or not, and the check is due on Day 1.
Now our mistakes are all too clear. Parents had to be aggressive in their investing — otherwise, you can't get the 11 percent, and there's not much time to earn — leaving them exposed to market gyrations. Some opted for "life cycle" funds that shift dollars into more conservative investments as college approaches. But "conservative" is in the eye of the beholder — in North Carolina, it meant "half the money in stocks and real estate," with disastrous consequences.
In some states, parents who went with prepaid-tuition plans (another type of 529) are discovering that the promise — pay tuition at current rates now and avoid increases in the future — is no guarantee. Having lost nearly half its money in the market, Alabama's plan sent parents a letter noting that it has no "legal or moral obligation to ensure the ultimate payout," i.e., pay for college. All across the country, parents are facing the prospect of paying for college with hollowed-out college-savings accounts at the very moment when their jobs are at risk — or already gone.
In truth, there is no free money and never was. Everyone likes college, and everyone likes savings, so everyone just assumes that saving for college is an unalloyed virtue. But why should people in a still very wealthy society like ours — despite the downturn — have to scrimp and save for decades just to have access to what should be considered a basic public service in this information age? College affordability is not a technically complicated problem to solve. The state and federal governments should regulate and subsidize public universities to keep tuition affordable for middle-income students, and provide additional need-based financial aid for low-income students. Two subsidies: one for colleges, one for students.
But that costs more time, money, and political capital than policy makers have been willing to spend. So we end up with a witches' brew of uncoordinated and inefficient grants, subsidies, and tax breaks — to which new ingredients are added by the year. Instead of raising enough tax revenue and holding institutions accountable for spending money effectively, policy makers are constantly searching for the next free dollar and sound-bite affordability plan.
And when the bill comes due, as it always does, those who should have known better will be long gone.
Kevin Carey is policy director of Education Sector, an independent think tank in Washington.
http://chronicle.com Section: Commentary Volume 55, Issue 35, Page A56
