May 29, 1997
Worried about paying for your child's college education? You should be.
Since 1980, average tuition costs at private universities have increased 218 percent, while family incomes have risen only 80 percent. If costs continue to climb at this pace, today's new parents will need more than $100,000 (in current dollars) by the time their child heads off to college.
But help is on the way -- maybe. The recent budget deal between Congress and the White House earmarks roughly $35 billion in tax relief to help families cope with skyrocketing college costs. The deal says nothing, however, about what kind of tax relief will finally emerge.
The danger is that Congress will embrace the tax-relief plan proposed by President Clinton, which has nothing to do with helping parents pay for college costs and everything to do with making the middle class even more dependent on government than it already is.
The centerpiece of the president's plan is a $1,500 tax credit that families can use to help pay for the first two years of college. It's simple: Send your child to college and you can knock $1,500 off your tax bill. The drawback is that colleges will respond by simply raising their tuition. So the president's plan won't make college any less expensive, and it won't do anything to help the parents of young children who will face even steeper college costs down the road.
If Congress and the president really want to give families tax relief to help with college costs, there's a better way -- one that would make families more self sufficient and less dependent on government. Simply put, Congress could eliminate the double taxation families face when saving for college.
One straightforward way to do this would be to create Education Savings Accounts (ESAs) -- an idea included in the Safe and Affordable Schools Act of 1997 introduced by Sen. Paul Coverdell of Georgia. While the IRAs many Americans use to save for retirement require contributions to be made in pre-tax dollars (with the accumulated earnings taxed upon withdrawal at retirement age), ESAs would allow families to make after-tax contributions and would impose no additional tax penalty when the money was withdrawn to pay for college.
How much could families benefit under such a plan? Assume the parents of a newborn deposited just $500 a year into an ESA earning 8 percent a year (three percentage points less than the stock-market average). By the time their child is ready to go to college they would have enough to pay for all four years at an average-priced public university and one full year at an average-priced private university. By contrast, the president's tax credit would cover only 1.3 years at an average-priced public university and less than a semester at an average-priced private university.
I use the figure of $500 saved per year because that's also the value of the per-child tax credit outlined in the budget deal. If both ESAs and the tax credit were approved, families could simply deposit the $500 child credit into the education account, which would enable them to save for college with no additional out-of-pocket expenses.
Barring a full-scale system of ESAs, the very least Congress could do is to make the interest earned on state-based and private college savings plans tax free. To date, 26 states have set up programs ranging from simple savings trusts to more complicated pre-paid tuition plans -- a way of locking in tomorrow's tuition at today's rates -- to help families handle the tuition at state colleges and universities. In addition, several private savings institutions and schools have expressed an interest in setting up similar plans for private colleges and universities. Congress should encourage the tax-free buildup of earnings in both kinds of plans.
Other options lawmakers could pursue include allowing parents to roll over existing savings into ESAs or letting them borrow from their IRAs to pay for their child's college education (which is currently illegal). The point is that any of these approaches would be superior to limiting families to a $1,500 tuition tax credit that will only give colleges an excuse to raise their prices.
Given a choice between a handout from Washington and help in building up their own savings, most families would favor the latter. The only question now is whether Congress and the White House will give them the option.
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Note: John S. Barry is a former economic policy analyst at The Heritage Foundation, a Washington-based public policy research institute.