Saturday, October 02, 2004

The FairTax and Education Spending

The FairTax replaces all income, payroll, capital gains, dividend, interest, and business taxs with a 23% national retail sales tax on all new goods and services. It does not in general tax investment. If you invest $100 in stocks or bonds or your business and at the end of the year that investment has earned $10 you get to keep all $10. In keeping with this spirit of not taxing investment the FairTax does not tax educational spending. The rationale for this is that education is investment in human capital and should not be discouraged.

So if you have to pay a $10,000 tuition bill for your childs education, you only need to earn $10,000 under the FairTax.

Please note, HR25 Title II SubTitle A Section 2 Subsection a Paragraph 4 defines education spending as:

The term `education and training' means tuition for primary, secondary, or postsecondary level education, and job-related training courses. Such term does not include room, board, sports activities, recreational activities, hobbies, games, arts or crafts or cultural activities.

By not taxing spending on education the FairTax dramatically increases the affordability of college education. Today a family wanting to send their child to college has basically three choices:

Coverdale IRAs

Coverdale IRAs allow parents to put aside up to $2,000 dollars a year for their childs education. The money put aside may grow with no taxes, and if used for qualifying educational expenses is not taxed on withdrawl. The money put into the Coverdale is not tax deductible however. The IRS has more information on Coverdale Accounts. Suffice it to say the rules are a little complicated.

529 Plans

Each state has a 529 college savings plan that you can invest money in for your childs college tuition. You get no tax deduction for money contributed. The money put aside grows tax free and isn't taxed on withdrawl if spent on qualifying educational expenses. Unfortunately you have to be a pretty savy shopper to not get ripped off as administration fees from the state, and management fees from the institutions managing the fund can greatly reduce returns. Additionally these plans are usually marketed through brokers who charge hefty commisions to move your money into them. You also have very limited control over how the money is invested.

Just Save

In this senario you pay taxes on the money you save, and then you pay taxes on the earnings on the money you save. Ick

With a Coverdale Plan or a 529 plan at least 25.3% of each dollar you save is taxed away by income tax(minimum 10% bracket) or payroll tax (%15.3) before you even put it in the accounts. If you save outside these accounts then you're earnings get eroded each year by taxes on capital gains, dividends, and interest. Additionally the ins and outs of Coverdale and 529 plans can be quite involved.

With the FairTax you pay no taxes on dollars you save for your child college tuition (or any other purpose) at all. When you go to spend those dollars on educational costs you are once again not taxed on them. Thus the FairTax makes it not only much easier to save for your childrens educational expenses, but also much more effective.

Update: An article on Yahoo news about how broken 529 plans are.


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