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Tax Policy and Education Policy: Collision or Coordination? A Case Study of the 529 and Coverdell Saving Incentives

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  • Susan M. Dynarski

Abstract

529 saving plans and Coverdell Educational Savings Accounts are marketed as attractive vehicles for college savings. The main finding of this paper is that college savings plans can actually harm some families. The joint treatment by the income tax code and financial aid system of college savings creates tax rates that exceed 100 percent for those families on the margin of receiving additional financial aid. Since even families with incomes above $100,000 receive need-based aid, the impact of these very high taxes is quite broad. I find that an aid-marginal family with funds in a Coverdell is worse off than if it did not save at all. Simulations show that $1,000 of pretax income placed in a Coverdell for a newborn and left to accumulate until college will face income and aid taxes that consume all of the principal, all of the earnings and an additional several hundred dollars. This perverse outcome is the product of poor coordination between the income tax code and the financial aid system.

Suggested Citation

  • Susan M. Dynarski, 2004. "Tax Policy and Education Policy: Collision or Coordination? A Case Study of the 529 and Coverdell Saving Incentives," NBER Working Papers 10357, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:10357
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    References listed on IDEAS

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    1. Aaron S. Edlin, 1993. "Is College Financial Aid Equitable and Efficient?," Journal of Economic Perspectives, American Economic Association, vol. 7(2), pages 143-158, Spring.
    2. Daniel Feenberg & Elisabeth Coutts, 1993. "An introduction to the TAXSIM model," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 12(1), pages 189-194.
    3. Feldstein, Martin, 1995. "College Scholarship Rules and Private Saving," American Economic Review, American Economic Association, vol. 85(3), pages 552-566, June.
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    Cited by:

    1. Vicki L. Bogan, 2014. "Savings Incentives And Investment Management Fees: A Study Of The 529 College Savings Plan Market," Contemporary Economic Policy, Western Economic Association International, vol. 32(4), pages 826-842, October.
    2. Dynarski, Susan, 2004. "Who Benefits From the Education Saving Incentives? Income, Educational Expectations and the Value of the 529 and Coverdell," National Tax Journal, National Tax Association;National Tax Journal, vol. 57(2), pages 359-383, June.
    3. Turner, Nick, 2010. "Why Don’t Taxpayers Maximize their Tax-Based Student Aid? Salience and Inertial in Program Selection," University of California at San Diego, Economics Working Paper Series qt0pb3f440, Department of Economics, UC San Diego.

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    More about this item

    JEL classification:

    • I22 - Health, Education, and Welfare - - Education - - - Educational Finance; Financial Aid
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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