We live in an era given to rhetorical excess, but some of the reaction to a minor recommendation in the Obama administration’s 2014 budget proposal set records.
The proposal was to cap tax-subsidized retirement accounts at $3 million per person. The recommendation is entirely consistent with the approach we have taken for decades and, in its general objective, would not be controversial among economists across the political spectrum, although some would suggest other measures to reach the same outcome.
Much of the reaction in the financial press and conservative media was extreme: President Barack Obama wants to keep you from saving for retirement; Obama wants to confiscate your retirement savings; a $3 million cap would slash national saving at a time when it was needed most; capital formation would plummet; and unemployment would soar. This was yet more evidence that the president was a socialist — no, a communist. And on and on and on.
First, recognize that there is no proposal to limit people saving for retirement. It is rather a proposal to limit the amount of savings that is subsidized by other citizens, that is “tax-advantaged” in personal finance jargon.
Second, understand that this will have no effect on national savings rates. This sounds like a sweeping statement, but it is easy to defend. We have had sundry government-subsidized retirement savings schemes for nearly a half century and public-finance economists have been studying these plans for nearly as long. Again and again, their studies come to the conclusion that, despite their popularity with middle and upper classes, these plans, Keogh, IRA, SEP, 403(b), 401(k), 457 or whatever, simply don’t raise overall personal savings. Increases in money put into such plans is offset by decreases in ordinary nonsubsidized savings.
Indeed, in the past 30 years, just as 401(k) plans and IRAs have proliferated, the national savings rate plummeted. I’m not arguing cause and effect, but if there was any positive result of tax-advantaged plans, it was swept away by a much stronger trend in the other direction. Only six-one-hundredths of 1 percent of such accounts would be hit by a cap. So no, such a cap would not affect national savings or availability of capital to businesses.
Also recognize that from the very start, we have limited the amount of money that can be put into such a subsidized retirement account in a calendar year. That limit is pretty low, for 2013, $5,500 for an IRA or $17,500 for a 401(k)/403(b). These limits on the amount of savings we are going to subsidize in a given year go back for decades and have never been controversial. So why should a cap on total accumulations be?
And for most people, the $3 million cap is unachievable anyway. At current annual contribution limits, and earning 8 percent interest, someone could start putting the maximum amount in an IRA the year they got out of high school and still not hit the limit before retiring at age 67. And virtually no one does that except for young people from well-off households whose parents give them cash each year to max out their tax-advantaged savings options as part of a larger family estate plan.
Yes, people who max out the higher limits of a 401(k) plan, get a substantial employer match and achieve good investment returns would hit a $3 million limit much earlier. Some people do, and that is one reason that one in every 1,600 such accounts would hit a cap. If that seems particularly unjust, then go for a somewhat higher cap.
Or, support a sensible alternative to achieve a similar goal. Institute a requirement that any contribution to tax-advantaged retirement plans be made in cash, not stocks or other securities of speculative value that can be manipulated to make a mockery of the annual limits.
That is how Mitt Romney was able to accumulate a reported $102 million in an IRA. If you are a principal in a venture capital firm or investment bank that engages in the restructuring of businesses, you can acquire shares of stock or “warrants” or “debentures” or other financial instruments that may have little, if any, identifiable market value at the time you acquire them.
With no one at the IRS likely to challenge how these are appraised, you can assign a trifling value and move them into an IRA while staying below the $5,500 annual limit. When it turns out that these securities are worth more than the few cents originally assigned, voila — you have millions or tens of millions in your retirement account.
Yes, you were not able to exclude more than the stated annual limit from your taxable income in the year in question. So the direct tax-subsidy is limited. But there are other advantages, and other implicit subsidies, in having as much as possible in IRAs. These include tax-free compound growth until the money is withdrawn and additional flexibility in transferring wealth to your heirs.
This has nothing to do with increased savings or capital formation.
Like the “carried-interest” scam that lets hedge fund managers pay capital gains rates on what should be ordinary income, contributing hard-to-value nontraded securities to IRAs is simply a mechanism to lower the average effective tax rate paid by a small group of well-connected, high-income people. Requiring that contributions be made only in cash would end that.
The administration and its critics can be faulted more broadly. Why are we quibbling over a technical detail in a “tax-expenditure” program that, as demonstrated by years of research by conservatives and liberals alike, fails the test of either equity or efficiency?
Why not just dismantle the whole edifice of tax-subsidized savings, jerry-built over 50 years, as part of broader tax reform?
Numerous studies, including Simpson-Bowles and Rivlin-Domenici, point out that reforming tax expenditures like these must be an important part of simplifying our tax code, making it fairer and making it more efficient. Why doesn’t the administration call for such broad-based reform and why don’t the administration’s critics demand it?