[This Commentary originally appeared in the April 5, 1990 issue of The Mendon-Honeoye Falls-Lima Sentinel.]
From our nation’s capital we hear many discouraging words on the American economy. A plethora of ideas have sprouted from the mouths of elected officials. Some have been good, some have been bad. All have been aimed more at solving personal political problems than at curing any one economic ill.
All parties clearly point to the nation’s low savings rate as one of the primary causes of our weakened economy. They suggest if individuals would save more and consume less, more money could be used to reinvest in American industry. This, in turn, would permit us to avoid relying on foreign (primarily Japanese) investors to fund our growing deficit which would then improve our balance of trade.
Numerous proposals have bounced to and fro on Capitol Hill. These plans intend to improve our national savings rate (which seems to be getting a little better all by itself). Most notable, Senator Llyod Bensten’s offer to provide $5,000 IRA-type savings accounts induces people to save more via a direct tax break. President Bush has echoed this concept with a separate formula of his own.
People began complaining the moment the 1986 Tax Reform Act effectively scuttled the IRA savings incentives. Though the data is inconclusive, one can intuitively agree that IRA-type savings accounts only encourage people to save. We simply hope the president and Congress fully explore this plan.
Lurking beyond the issue of the national savings rate lies an even greater impediment to improving the American economy. This mountain represents no new challenge, and it has received much attention from both sides of the political aisle (although neither seems able to develop a workable proposal).
We’ll leave aside any judgments regarding secondary school – or even collegiate – curriculum. Instead, we will focus only on incentives to pursue higher education. Even the best laid course does no good if too few students attend the class.
Any parent realizes the extreme cost of higher education presents an imposing dilemma. With the combined costs of tuition and living expenses of four years at the elite institutions approaching six figures, nearly every family wishes for some sort of financial assistance. A few universities possess the endowment to grant scholarship aid. Unfortunately, even the government seems unable to provide for all but the most extreme cases.
We may now be in a position to tackle two tough social issues in one fell swoop. We can at once encourage savings as well as prepare families to send their children to college. To do this, we must allow all families to deduct – tax free – up to $1,000 per child (under 18 years) per year for the purpose of establishing a Family Education Trust Account (FETA). The maximum deduction would increase by the inflation rate each year.
Like IRAs, FETAs would be established through financial institutions like banks and mutual funds. Not only can the family deduct directly each year, but, again like IRAs, the income earned in FETAs would be sheltered. All money in FETAs, as in IRAs, would be taxed only upon withdrawal.
Withdrawal can occur at any time for any reason. The family, however, would pay only three quarters of the normal tax rate if they withdraw the money for the direct payment of a child’s educational expenses. Should the money be withdrawn for any other reason, it would be taxed at the family’s ordinary tax rate.
FETAs would allow families to save for their children’s education in a manner which encourages national investment without cutting back significantly on government revenue. Let’s look at an example for a family which begins savings the maximum allowable deduction for a child born today.
At an inflation rate of 4%, over the course of the next 18 years this family will contribute a total of $25,645 to the FETA. At an annual return of 9%, the FETA will be worth $58,670 by the time the child enters college. We’ll say the family’s nominal tax rate is 28%, so the FETA, when withdrawn for the child’s education, will be taxed at a rate of 21% (i.e., three-quarters of their normal rate). The after tax value of the FETA would be worth $46,349.
How does this compare with the four year cost of the child’s education? A student entering the University of Buffalo today would expect to pay about $20,000 over the course of four years. In 18 years, assuming costs rise at 5% a year (which is greater than inflation), it will cost $45,840 to undertake a four year program at the University of Buffalo. This is roughly equivalent to the after-tax value of the FETA.
While the FETA might not be as helpful for students going to the Ivy League (where four year costs can be about $90,000), it can be most helpful to the average middle class family. If most families utilize FETAs, the government can continue to allocate a greater percentage of direct educational assistance money to families who do not earn enough to take full advantage of FETAs.
A comprehensive FETA program ultimately allows all families to encourage their children to pursue higher education. By inviting increased savings, FETAs further permit the nation to invest in our businesses for today and our children for tomorrow.
Last Week #53: What is the County Legislature? (originally intended to be published March 29, 1990)
Next Week #55: Some Silly Thoughts… (originally published on April 12, 1990)
[What is this and why is here? See Interested in Discovering My Time Machine? for more details.]
Author’s Comment: Sometimes I even surprise myself. I wrote this Commentary a full six years before Congress passed legislation approving what we can call “529 plans.” These 529 plans unfortunately do not have the flexibility I envisioned in 1990 as investors must operate them under individual state rules. I’ll let you talk to your financial planner about the advantages and disadvantages of 529 plans, but suffice it to say my wife and I have never utilized them for any of our children.
My guess is I wrote this to expand people’s thinking about economics and savings by using an existing structure and applying it to a different problem. As I recall, a lot of readers responded favorably to this idea. The fact Congress passed a similar concept in 1996 shows others were thinking along the same lines.