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Why Is College Tuition Subsidized, While K-12 Is Not?

If you are a parent who’s trying to save for your kids’ college education, you should check out Jane Kim‘s article in the Wall Street Journal about 529 college-savings plans. If you don’t know what a 529 plan is, you should; and if you do, Kim’s article is helpful in assessing whether you’re optimizing your participation.

In a nutshell: a 529 is a tax-advantaged plan that helps parents save for college; each state offers its own plan but investors can choose whichever state’s plan they prefer.

The article is centered around a new Morningstar analysis of the various states’ plans and makes at least one really important point: while most investors choose the 529 plan from their own state — in large part because of a state tax deduction (and, I am guessing, because of more robust in-state marketing than out-of-state marketing) — many people would be better off choosing out-of-state plans with lower fees and better returns, which would more than make up for the state tax deduction.

Kim’s article also points out an important fact that I’d missed: “Congress in 2006 made the tax benefits [of 529 plans] permanent; they had been set to expire at the end of 2010.”

So if you are trying to save for college and have the means, there is no good reason I can think of to not participate in a 529, as long as it has low fees and a good menu of funds.

Several years ago, Austan Goolsbee warned us about bad 529’s, but I am guessing that even Goolsbee would now be happy with the transparency that’s been brought to the market by reports like Morningstar’s.

Reading about 529’s so soon after the April 15 tax deadline does reinforce for me just how random the U.S. tax code can be. Why, for instance, are there such significant tax breaks for college tuition (in the form of both a state deduction on a 529 contribution and tax-free appreciation) while there are no tax breaks at all for K-12 tuition?

The obvious answer is that you can get free K-12 schooling. College tuition, meanwhile, is rarely free. But think it through a little further.

If you live in New York, like I do, and choose to send your kids to a private school, you can easily pay $30,000 a year for tuition — more than many colleges. That’s a choice, of course: you could send your kids to public school for free. But the college tuition savings that accumulate tax-free in a 529 plan can be spent on a private or public college: there’s no distinction.

If, however, you choose to send your kids to private or parochial school, you are still paying school taxes for other people’s kids as well as the tuition for your own kids, with no tax break. (Here’s a primer on school vouchers.)

Our tax code also heavily subsidizes home ownership — a big driver in the subprime mess — while there are no tax breaks for renting your home.

And then there’s the tax-free status of religious institutions. In a country with such profound expressed respect for the separation of church and state, should this be the case? A small but pronounced example is the “parsonage” deduction, whereby members of the clergy can deduct from their taxes the amount they pay each year in living expenses — whether or not they actually lead any sort of religious congregation.

I have several friends who are clergy working at, e.g., academic or non-profit institutions, who still gain the parsonage deduction. To a person, they admit it is a ludicrous loophole; but, because they are not idiots, they take advantage of it.

These are but a few of the random tax wrinkles that make a lot of people, rational and otherwise, favor a flat tax.