Trusting in Tax Free Promises Won’t Work Much Longer

The government gives tax free promises and the government takes away.


The good news is that President Obama’s threats against the dwindling middle class resources will probably not get carried out due to the Republican control of the House and Senate. But we can’t be sure of that since the Republicans are already making noise about raising taxes.

But when I wrote that Obama’s free college comes with strings, I did not know the half of it. Obama is not only jacking up taxes on the middle class in order to pay for the free college, but is deliberately breaking a promise that parents were counting on as they calculated the cost (and the savings necessary) to send their child to school.

An editorial at USA Today explains the situation: “Middle-class savings like blood in the water.”

Though millions of Americans have been putting money into “tax free” 529 plans to save for their children’s increasingly expensive college educations, President Obama would change the law so that withdrawals from the plans to fund college would be taxed as ordinary income. So while you used to be able to get a nice tax benefit by saving for college, now you’ll be shelling out to Uncle Sam every time you withdraw to pay for Junior’s dorm fees.

This doesn’t hurt the very rich — who just pay for college out of pocket — or the poor, who get financial aid, but it’s pretty rough on the middle– and upper–middle class. In a double-whammy, those withdrawals will show up as income on parents’ income tax forms, which are used to calculate financial aid, making them look richer, and hence reducing grants.

Likewise, Obama proposes to tax the appreciation on inherited homes. When you sell property at a profit, you pay capital gains on the difference between the basis (what you paid) and what you sell it for. (Obama also proposes to increase the capital gains rate). That’s not a big issue for most middle class people, because right now if your parents leave you their house, you get what’s called a “step-up” in basis.

That means that the basis isn’t what your parents paid for the house decades ago, but rather what it was worth when you inherited it. Thus, the appreciation your property experienced while your parents owned it comes to you tax-free. For many families, that appreciation is their biggest inheritance. Now, subject to some exemptions Obama plans to tax those gains, and other gains via inheritance.

Just analyzing this as a tax is bad enough. All that talk about “the one percent” was never really aimed at plundering them some more. Obama’s piggy bank is the Middle Class.

But there is more, the whole reason this money exists is because people made decisions based on the government’s promise that it would be untaxed for college tuition. People made decisions relying on the law as a fixed and stable guide to the future.

But the law was never stable. Congress created the law and congress can change the law.

Likewise parents planning on leaving an inheritance to their children, were relying upon certain stable tax practices. But that was a mistake.

What we are seeing here is somewhat similar to unions realizing that governments might declare bankruptcy and default on their pension promises. As the economy breaks down governments will become more desperate for cash and will break long-standing promises.

So what’s next?

When a government is desperate for cash, it goes after the middle class, because that’s where the money is. Yes, the rich are rich, but the middle class is far more numerous. And this has raised other fears. As [Megan] McArdle also notes, if 529 plans aren’t sacrosanct, what about Roth IRAs? People have worried for a while that the government might go after retirement accounts as another source of income — to the point that there have even been calls for Congress to make such grabs explicitly off limits. But, ultimately, no one is safe, as what is enacted by one Congress can be repealed by another.

The truth is, in our redistributionist system politicians make their careers mostly by taking money from one group of citizens that won’t vote for them and giving it to another that will. If they run short of money from traditional sources, they’ll look for new revenue wherever they can find it. And if that’s the homes and savings of the middle class, then that’s what they’ll target.

I strongly suspect this might be the term when we see the Republicans explicitly join Democrats in this behavior.  Perhaps it will take longer but probably not much longer.