Whether it's shady politics or just bad math, proposals to curb retirement plan tax incentives are not only detrimental for low-income savers, they're based on inflated calculations, experts said this week.
Lawmakers are eying tax-deferred retirement savings as a way to tackle the deficit. They've labeled 401(k) incentives as regressive tax expenditures that need to be reduced (which sounds better than proposing tax increases). By stifling the tax breaks on these plans, Congressional leaders hope to recoup some of the $600 billion in lost tax revenue over the next five years.
As tax-deferred retirement savings are one of three top "tax expenditures" in the U.S., it's no wonder the feds are targeting it. But economists at ASPPA say the forecasted savings from scaling back 401(k) tax incentives is not just a little exaggerated, it's inflated by almost 75 percent due to faulty analysis.
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"ASPPA's analysis, which takes the same long-term view that economists employ in evaluating other forms of investment, shows that the short-term window used in Washington budget scoring overstates the cost of retirement savings incentives – and therefore the savings that would result from slashing these incentives," said Brian H. Graff, ASPPA's executive director and CEO.
So it has to be asked, how – and why – would federal number crunchers exaggerate their estimates? ASPPA notes it's because they're using current cash-flow analysis, which is used in proposals for reducing the federal deficit. And since workers withdraw money from 401(k)s only in retirement, the taxes paid show up outside the 10-year timeframe used in cash-flow analysis, and are considered lost revenue, rather than deferred revenue.
The IRS will collect its taxes eventually, but when we're facing a $14 trillion deficit, it's a matter of trimming where it's relatively innocuous – at least in the eyes of these "budget hawks."
And though it's a bit underhanded, the government probably prefers to harvest taxes now rather than later, since people tend to be in lower tax brackets when they retire.
While that explains how estimates are skewed, it doesn't account for why lawmakers would zero in on 401(k) tax incentives. One excuse might be because those with higher incomes are the ones most likely to reap the tax benefits. According to the Tax Policy Center, 80 percent of the tax benefits are claimed by the top 20 percent of income earners. The bottom three-fifths of Americans enjoy only 7 percent of the benefit. So why allow generous tax breaks that are worth more to the wealthy?
"As is the case with the mortgage interest deduction, high-income individuals receive the largest immediate benefit of the exclusion, even though they are the people most likely to save anyway in the absence of a government tax subsidy," Robert Greenstein, president of the Center on Budget and Policy Priorities recently said in testimony before the U.S. Senate Budget Committee. "Because higher earners would save much of their income even without tax incentives to do so, a substantial share of the revenue lost through the deduction for contributions to retirement plans does not result in a net increase in national saving."
Even so, with Social Security and traditional pensions fading faster than Gingrich's shot at the White House, I have to agree with Putnam's Chief Robert Reynolds, who says cutting tax incentives for retirement plans would be a "grotesque" policy mistake. Indeed, it will take some precision to ensure Americans' retirement security isn't whittled away along with national debt.
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