How Obama's 529 College Tax Plan Debacle Proves the Welfare State is Doomed

Someone has to pay for it-but no one wants to foot the bill.

To understand just how bad the politics of Obama's now-withdrawn plan to tax 529 college savings were, think about it this way: Obama, under heavy pressure from both Democrats and Republicans, made a public show of pulling a proposal that already had no chance of passing.

Even as an inert fantasy proposal, it was so widely disliked that the White House had to back down.

It's a minor but revealing political fiasco—one that shows how distant the White House is even from the interests of its own party while offering a preview of economic policy debates and welfare-state fiscal challenges for decades to come.

The political optics of the plan were flat-out terrible for Obama, who put forth the proposal in the context of a State of the Union address built around the theme of Middle Class Economics. The gist was that Obama proposed taxing the wealthy in order to pay for new middle class benefits, like free community college tuition.

But, somewhat awkwardly, given the president's chosen theme, 529 plans are tax-advantaged savings vehicles that currently benefit an awful lot of middle class people. In particular, they benefit middle and upper-middle class families in high-tax blue states.

So it is not exactly surprising to find that, in addition to the entirely predictable GOP pushback against the proposal, Rep. Nancy Pelosi, a Democrat from California, and Rep. Chris Van Hollen, a Democrat from Maryland, lead a seperate Democratic push for the White House to drop the plan. This is an administration that is now so isolated and out of touch that it does not grasp the obvious interests of its own party.

The plan was also tremendously awkward for Obama himself. As the folks at Americans for Tax Reform have noted, Obama was not only a public booster of 529s, someone who as a Senator voted to make them permanent and praised them as tools to help families with college expenses in his book, he was also someone who had relied on a 529 himself, contributing $240,000 to a 529 college fund for his own children back in 2007. Obama took advantage of the plan's tax benefits—then proposed closing the door behind him.

As political miscalculations go, this was a minor epic. This was a major component of Obama's slate of State of the Union proposals, previewed and highlighted in a white paper released several days earlier. And yet somehow the White House seems to have managed not to solicit input from members of its own party in Congress, and to ignore Obama's personal history on the issue. The backlash to this proposal was entirely predictable, and yet the White House seems to have been caught by surprise.

How does a political miscalculation like this happen?

One possible answer is that it's just an inevitable symptom of an isolated second-term administration that is openly bored with Congress and out of touch with everyone outside its inner circle of supporters.

But another possibility is that this is the sort of plan than inevitably follows from the long-term fiscal logic of the welfare state.

Yes, the budget wars have calmed recently as annual deficits have fallen and the economy has improved. But total national debt remains at historic highs, and medium to long-term budget prognosis is still rather grim.

The core of the problem is clear: the growing cost of the entitlement state. As the Congressional Budget Office warned earlier this week, over the next decade, "spending will grow faster than the economy for Social Security; the major health care programs, including Medicare, Medicaid, and subsidies offered through insurance exchanges; and net interest costs." Tax revenues will stay essentially flat at around 18 percent of GDP, while spending, driven by entitlements, will rise to more than 22 percent of GDP. Longer-term projections indicate the cost of entitlements and interest on the debt will continue to rise in the decades after that.

In the bigger picture, the existing welfare state is unaffordable. Either it will have to be cut, or reformed, or paid for—by someone, somehow. The administration and its allies would like to reassure you that the someones who will pay for all of this will be limited to the richest of the rich, but in practice there's only so much money that can be squeezed out of the extremely wealthy.

Which means that eventually, anyone looking for ways to keep the welfare state afloat will have to go after after the middle class—and, in particular, middle class savers. That's where the money is. Sure, you can imagine alternatives, like a Value Added Tax (VAT), which might raise enough tax revenue to keep the budget in the clear. But it's hard to imagine a popular political coalition forming around a regressive consumption tax that gives the government a major new revenue stream.

If anything, it's far easier to imagine a popular coalition forming in opposition to such a plan. That's more or less exactly what happened with Obama's 529 proposal.

And it's why this episode and the swift bipartisan opposition it generated is so revealing, not only about the short term political instincts of the Obama administration, but about the longer term political and policy dynamics of sustaining the welfare state. If this is the reaction to a policy that was never going to pass, and, indeed, never really designed to pass, imagine the backlash to a middle class tax hike that was actually intended to go into effect. The White House may not want to acknowledge this problem, but that's the reality of, well, middle class economics.