Wednesday, September 16, 2009

Let's Truly Become Flexible

During the presidential campaign last year, a good deal of time and energy was spent talking about what could be done to help America's "struggling" middle class. Now, with all the hubbub over health care reform, cap n' trade, and skyrocketing deficits most of that talk seems to have been pushed to the back burner. Other than the oddly titled Making Work Pay Tax Credit (which amounts to $400 a year for singles/$800 for marrieds--or $20/$40 on your bi-weekly paycheck), it's hard to point to concrete steps that the Obama administration has taken to help middle class Americans and their families. It's time for some new ideas.

Like many others, the company I work for offers Flexible Spending Accounts:

A flexible spending arrangement (FSA), or Flexible Spending Account, as they are commonly called, is one of a number of tax-advantaged financial accounts that can be set up through a cafeteria plan of an employer in the United States. An FSA allows an employee to set aside a portion of his or her earnings to pay for qualified expenses as established in the cafeteria plan, most commonly for medical expenses but often for dependent care or other expenses. Money deducted from an employee's pay into an FSA is not subject to payroll taxes, resulting in a substantial payroll tax savings.

We have both medical expense and dependent care FSAs available. The medical FSA is a good way to cover any medical expenses not picked up your insurance coverage. It also encourages you to monitor your health care spending more closely than you might otherwise. Having a little skin in the game motivates you to compare costs and plan for elective care procedures (like Lasik). The one downside is that you can't roll over money in the account from one year to the next, but that's a minor complaint. While there are some restrictions on what medical FSAs will pay for and limits on how much you can set aside in any given year, in general they provide a good deal of freedom for individuals to decide how their health care dollars are spent.

Dependent care FSAs meanwhile are more restrictive. Mainly they are used to cover day care costs for your children (also for older parents who live with you) up to a limit of $5000 a year. They are also only available for single parent families or families where both spouses work. If you're in a family where both of you work it's a good way to help save money on your day care costs (for some--others would be better off taking a child tax credit instead). So in effect, the government is subsidizing part of a family's annual day care costs thereby making it easier for both parents to choose to work. You might even say the government is encouraging such a choice.

Granted, it's not a huge encouragement from a financial perspective and probably is not a factor in most people's decisions whether they should both work or not. But it is a benefit that the government is only making available to working parents and it's not necessarily based on any actual need. Consider the following:

A two parent working family that makes $200K a year and sends their kids to day care could utilize the dependent care FSA to avoid payroll taxes on $5K of income.

A two parent family where only one works that makes $50K a year and pays tuition to send their kid to pre-kindergarten could not utilize the dependent care FSA at all.

Seems fair, right? Now, I'm not going to get into a debate about whether the government should be helping parents pay for their kids day care. Let's allow dependent care FSAs to cover day care as they currently do. But why not expand the scope? Instead of just day care, dependent care FSAs should be available for two parent families where only one parent works and they should cover educational care for dependent children. That could be school supplies, tuition, and any other educational expenses your children incur up to the age of eighteen.

And yes, that would include tuition for private schools. Again as with medical expenses, it would encourage parents to plan for their educational costs and shop around. If you decide to send your kids to public schools you could still use the FSA for expenses like fees, outside tutoring, supplies, etc. (I know there are some tax deductions for these already but they seem overly limited). If you send your kids to private school, you get some savings from being able to use tax free money for tuition (at least up to $5K). It's a start.

One of the reasons that the middle class is reportedly so stressed and struggling is that we're worried about our children's education. Expanding the dependent care FSA to cover educational expenses would at least begin to help alleviate some of that stress. And it would allow people at least a little more freedom in making educational choices.

How to make up for the lost tax revenue you ask? The glib answer would be "who cares?" as we're already so far under fiscal water that whatever revenue shortfall this created would be like a drop in the ocean. But if you insist on pay-as-you-go planning, I'd take it straight outta the Department of Education's budget. Who knows better than parents how to spend money on their children's education?

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