Association for Public Policy Analysis & Management

This paper uses the Nakamura-Steinsson (2014) open economy relative multiplier framework to examine how the use of 529 plans may affect the fiscal multiplier related to government expenditures and taxes.  529 plans are state-sponsored college savings accounts named after section 529 of the Internal Revenue Code, which established the federal rules for these plans.  However, the tax benefits of using these plans vary by state.  If the federal government increases expenditure in a state, the income of its residents usually increases.  The extent to which this income is used to consume goods depends on marginal propensities to consume and save, which depends on returns.  Assuming the substitution effects of saving returns exceeds the income effect, generous 529 plans increase savings, and thus decrease the fiscal multiplies.  As plans may invest savings outside their state, the effect of the increase in military expenditure on demand is reduced.

The past decade has simultaneously witnessed a substantial increase in enrollment at post-secondary institutions and a marked increase in college tuition.  Not surprisingly, this trend overlapped with an increased demand for student loans and tax-advantaged educational savings—529 college savings plans.  Contributions to these plans are made from after-tax income; earnings on contributions grow tax-deferred and, as long as plan distributions are used for higher-education expenses, earnings remain tax-exempt.

In this paper, we combine a unique 529-plan dataset from College Savings Plans Network (CSPN), Savingforcollege.com, and Morningstar, with military expenditure information from the Department of Defense, state-level income and GDP information from BEA, state-level population information from the Census bureau, and tax information from NBER, to explore regional variation and analyze how the use of these college savings plans impacts the fiscal multiplier related to government expenditures and taxes.  

We test three hypotheses: First, if the fiscal multiplier decreases with the generosity of tax benefits in 529 plans.  Second, if the multiplier effect of state income tax rates is reduced by the existence of 529 plans.  Third, if the multiplier effect of federal income tax rates is decreased by the existence of 529 plans, but is increased by such plans when their usage is high.