A Brookings Institution report released Feb. 26 recommends curtailing the benefits for top earners to boost tax revenues.
Defined contribution plans reward higher earners who would save anyway while not providing enough incentive for low and middle-income earners, according to Karen Dynan, co-director of the economic studies program at Washington-based Brookings and author of the proposal, “Better Ways to Promote Saving through the Tax System.”
The current incentives encourage wealthy households to shift money into tax-deferred accounts rather than taxable ones, generally without increasing their savings rate, Dynan told Bloomberg Businessweek. Low-income households most at risk of outliving their savings don’t receive as much of a benefit because they’re taxed at lower rates, she said.
“We really need to think hard about whether the dollars we are spending are effective at achieving the goals,” Dynan said. “Our existing programs are falling short.” Her solution: the federal government should expand tax breaks so more small businesses set up retirement plans for their workers, revamp savings credits for low-income workers, expand access by establishing an automatic IRA program and cap the value of tax deferral in retirement accounts at the 28% bracket.
A 28% limit on the tax benefit for high earners would reduce the budget deficit by about $7.5 billion in the first year, while all of the proposed changes would mean a net reduction of about $4 billion, according to the Brookings proposal.
The proposed 28% limit drew immediate fire from the retirement plan industry, starting with Brian Graff, Executive Director/CEO of NAPA and ASPPA. “Brookings has proposed placing a 28% cap on the ‘rate at which deductions and exclusions related to retirement saving reduce a taxpayer’s income tax liability,’” Graff noted in a statement.
But because the tax incentive for retirement savings is a deferral, not a permanent exclusion, Graff notes, “the proposal would more accurately be described as double taxation of contributions to retirement savings plans for anyone with a marginal tax rate of over 28%. Retirees already pay ordinary income tax on distributions from retirement savings plans; if this proposal went through, a small business owner in the 39.6% bracket would pay an 11.6% tax on contributions made to the 401(k) plan today, and pay tax again at the full rate when they retire."
The Brookings proposal acknowledges that individuals subject to this double taxation may decide to put their savings somewhere other than in the 401(k) plan. “What it fails to acknowledge is when that double-taxed person is a small business owner and it no longer makes sense for the owner to have a 401(k) plan,” says Graff, “that owner probably won’t offer a 401(k) plan to the employees, either. You won’t expand coverage by penalizing small business owners for offering a 401(k) plan.”
While ASPPA strongly supports expanding coverage through proposals such as automatic enrollment IRAs, Graff notes, “we think those proposals should be a step up for workers who have no access to workplace retirement savings — not a step down for workers who had a 401(k) plan before their employer got hit with a double tax on their own 401(k) contributions.”
