A bullet point on Page 18 of President Barack Obama’s 2014 budget sounds ominous: “Prohibit Individuals from Accumulating Over $3 Million in Tax-Preferred Retirement Accounts.” That it appears in a section titled “Strengthening the Middle Class” is odd since such a proposal would seem to undermine the goal.
Why, at a time when the government is looking to reform entitlement programs because it can’t keep the promises it has made to future generations, does Obama want to reduce the incentive to save? It makes no sense.
Suddenly, the political agenda becomes obvious. Mitt Romney’s $102 million individual retirement account became an issue during the 2012 presidential election. Instead of offering a solution to prevent wealthy individuals from putting deeply discounted stock in their IRAs and earning huge, tax-free profits, Obama is looking to score political points.
“He’s taking a cheap shot at Mitt Romney rather than helping lower- and middle-income Americans save for their retirement,” says Jason Fichtner, a senior research fellow at George Mason University’s Mercatus Center in Arlington, Virginia. “He’s going after a very small segment of the population that has in some way managed to save wealth in a tax-deferred vehicle.”
A very small segment -- for a very small return. Limiting an individual’s total retirement balances to about $3 million, enough to finance “an annuity of not more than $205,000 per year in retirement,” would raise $9 billion over 10 years, according to Obama’s budget proposal. Why, it makes it sound as if the danger is saving too much, not too little.
Fichtner has spent the last 15 years -- at the Joint Economic Committee of Congress and Social Security Administration before going to Mercatus -- looking for ways to help lower- and middle-income people save for retirement. And he has come up with some terrific solutions.
For starters, Fichtner would adopt a system of automatic enrollment. By forcing individuals to opt out rather than opt in, saving becomes a passive choice. Think of it as the default setting. You do nothing, which is the path of least resistance, and you receive the benefit. Research by Harvard University’s Raj Chetty has shown that nudging people to save in this manner is more effective than the existing tax break.
To his credit, Obama’s budget includes automatic IRA enrollment and payroll deductions for those who lack employer-based 401(k) plans, considered to be the best way to induce people to save.
Next, Fichtner would address the current deductibility limits, which he says are “upside-down”: The higher the marginal tax rate, the bigger the benefit from the deduction. The existing system gives incentives to those who don’t need any.
He suggests changing the deductibility of 401(k) and IRA accounts to a nonrefundable tax credit. Instead of giving an individual in the 10 percent income-tax bracket a 10 percent benefit, give a dollar-for-dollar credit on his income tax. For high-income savers, the credit would be capped.
Operationally, capping pretax savings would be a nightmare. The amount of money required to generate an annuity of $205,000 at today’s interest rates is greater than if they stood at, say, 5 percent. What happens then? Is the additional principal returned to the individual and taxed at his current rate? What happens when interest rates fall, requiring more savings to guarantee the maximum annuity payment?
You get the point. It should be obvious that the proposal to cap retirement accounts was designed to punish the rich rather than strengthen the middle class. The result is something that’s “unworkable, unmanageable and un-administrable,” Fichtner says, rather than good retirement policy.
There is a much simpler solution to Romney’s IRA. If the problem is ensuring that partners in private-equity firms don’t put low-cost-basis shares into their IRAs, the government could stipulate that only cash be invested.
Perhaps a more important question is whether the government should be subsidizing saving in the first place. In a recent working paper, Chetty and four co-authors found that the tax subsidy for retirement savings accounts cost the government $100 billion a year. That puts it among the top five tax expenditures, or loopholes that are really government spending by another name. And it’s much less effective than automatic saving.
The well-to-do don’t need a tax incentive to save. At some point, they have all the homes, cars, yachts and airplanes they could ever want. And while saving is certainly a worthier pursuit than many of the activities government subsidizes, studies suggest there are more effective ways to achieve that goal. So why pay people to do what they are already doing?
We shouldn’t, Fichtner says. “But we should make sure we help those who aren’t doing it, do it.”
That sounds like something out of the Obama playbook. Having just paid a lower effective tax rate (18.4 percent) than his secretary this year, the president may want to rethink his fairness doctrine. That might help him to differentiate between good ideas for retirement saving, such as automatic enrollment, and purely political ones. At least we can hope.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg View columnist. The opinions expressed are her own.)
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