Obama + tax reform = political firestorm

Harwood breaks down 529 plans

Without intending to, the Obama administration has just conducted a live-fire experiment in tax reform and deficit reduction.

The conclusion: very, very difficult.

President Barack Obama
Saul Loeb | AFP | Getty Images

Exhibit A was the White House plan to tax capital gains on new deposits in so-called 529 college savings plans. Just 3 percent of American families own such plans. But the amount of money in them has mushroomed to $9.9-billion in 2011, from $1.3 billion in 2001 after the Bush tax cuts made those gains tax free.

As it proposed some $320 billion in new spending as part of Obama's push for "middle-class economics," the White House called on Congress to raise $1 billion over 10 years by taxing those 529 gains. The administration reasoned that most assets in those plans are held by families with incomes over $200,000; the college tax credit Obama proposed to expand is available to families earning up to $180,000.

What happened? A political firestorm.

House Speaker John Boehner blasted the plan as a blow to middle class families trying to save for college. He had a point: A majority of families with 529 plans earn less than $150,000 per year.

Read More 529 plans: The real users and what they sock away

Some leading Democrats, who share Obama's broader goals, agreed with Boehner. Nancy Pelosi lobbied the president to drop the idea while flying to Saudi Arabia to pay respects to the late Saudi King Abdullah. In the higher cost, higher tax East and West Coast states many Democrats represents, families with incomes of $200,000 don't feel wealthy even though that income level places them in the top 5 percent of households.

As a result, Obama dropped the 529 plan, which a White House official called "a distraction" from the president's larger budget goals. The decision was reminiscent of Obama's decision to accept tax increases incomes of $450,000 or more, not $250,00 or more as he previously advocated, in the late 2012 "fiscal cliff" deal.

Read More Obama drops proposal to tax 529 college savings plans

The episode previews the difficulty of achieving tax reform, even though so many politicians say they favor it. The outcry against a plan to eliminate the mortgage interest deduction or the deduction for charitable giving would dwarf the reaction to 529 tax hikes.

It also shows the difficult of additional deficit reduction. While dropping the 529 plan, Obama has not dropped his planned middle- class spending increases. And though Boehner has ruled out any tax hikes, he hasn't ruled out the middle-class spending increases, either.