Common Ground Reached
Recently, we both concluded that the subsidies provided for private-sector retirement plans have minimal impact on increasing private saving. Moreover, we share the belief that the revenue generated from repealing these “tax expenditures” could be better utilized to address the funding gap faced by Social Security.
Understanding Tax Expenditures
Tax expenditures, specifically under the personal income tax, arise due to the ability of employees to defer taxes on their compensation through retirement savings. This special tax treatment significantly reduces the amount of lifetime taxes paid by participating employees in comparison to saving through a regular investment account. In 2020 alone, this tax treatment cost the government a staggering $185 billion, amounting to approximately 0.9% of GDP.
Distribution of Tax Expenditures
When examining the distribution of these tax expenditures, studies reveal that 59% of the current benefits for retirement saving flow to the top quintile of income earners. This distribution pattern comes as no surprise, given that individuals with higher incomes are more likely to have access to employer-sponsored retirement plans. Additionally, they are more inclined to actively participate in such plans and contribute more substantial amounts towards their savings.
Recent Changes and Their Impact
Recent updates in retirement policies are expected to further increase the proportion of benefits received by the top quintile. The introduction of expanded “catch-up” contributions will only benefit individuals who are limited by existing contribution limits—representing approximately 16% of participants. Moreover, raising the age for mandatory minimum distributions to 75 grants participants an additional 4½ tax-free years of compound growth. However, it is important to note that this provision primarily favors wealthier individuals who have the means to take advantage of this extended period.
This collaboration between Andrew Biggs and myself highlights our shared concerns over the effectiveness of subsidies for private-sector retirement plans. By redirecting the revenue from these tax expenditures towards addressing the funding gap in Social Security, we can work towards a more sustainable and equitable retirement system for all Americans.
Tax Expenditures and their Impact on National Saving
As a professional copywriter, it is crucial to evaluate the effectiveness of tax expenditures, especially considering that they primarily benefit higher-income households who are already financially secure in their retirement years. The key question we must ask is whether these expenditures serve a broader social objective, such as stimulating national saving.
When examining this issue from a theoretical perspective, there is no strong evidence to suggest that federal tax preferences actually increase total saving. While tax preferences may make retirement saving more appealing and have indeed resulted in substantial accumulation of funds in retirement accounts, economists propose a lifecycle model that argues people could simply redirect their savings from taxable investment accounts to tax-advantaged retirement accounts.
In fact, empirical evidence supports the predictions of the lifecycle model. A definitive study conducted in 2014, based on Danish tax data, analyzed the response to a reduction in the subsidy for retirement contributions among individuals in the top tax bracket. The findings revealed that while some pension contributions declined, this decrease was largely offset by an increase in alternative forms of saving. In essence, the tax subsidy primarily encouraged individuals to shift their savings from taxable investment accounts to tax-advantaged retirement accounts without contributing to an overall increase in household saving.
Considering that tax expenditures for retirement plans are not advantageous for taxpayers, it seems logical to scale back these tax breaks and allocate the resulting revenue elsewhere. Over the next 75 years, Social Security faces an actuarial deficit of 1.3% of GDP. Eliminating the tax expenditure would address 70% of this deficit, and the actual gains could even exceed this estimate for two reasons. Firstly, the government would continue to collect income taxes on past tax-preferred contributions. Secondly, payroll tax revenues would increase as they are also influenced by the tax preferences.
In summary, it is imperative to reallocate government resources away from retirement plans where the incentives do little to enhance retirement security. Instead, we should redirect our focus to a program that undoubtedly safeguards individuals’ retirement: Social Security.