Retirement Savings—Let's Get the Revenue Effect Right

Retirement savings is the best federal tax expenditure because it is not tax expenditure. For fiscal years 2008 -- 2012, the Joint Committee on Taxation estimates that the Federal Government will forgo $626 billion in revenue as the result of contributions and accumulations in employer-provided retirement programs. However, unlike other tax-free benefits and tax credits, contributions and earnings in retirement plans are not tax-free. They will be taxed at normal income tax rates at some point in the future. This means the long-term costs to the government of these plans is but a fraction of the estimate using the current approach. It is important that we convince policymakers of the difference between tax deferred expenditures and tax-free exclusions.

The Congressional Budget and Impoundment Act of 1974 was introduced to bring discipline to the Federal budget process. Its implementation imposes nonpartisan scoring using cash flow accounting on both proposed outlays and income. Often, the success or failure of a legislative proposal for a tax provision depends upon its estimated effect on Federal revenue.

In general, the budget scorekeeping requires measuring outlays and revenues on a “cash flow” basis because it enables policymakers to understand how policy changes will affect actual receipts and outlays during the budget scorekeeping window. It also provides a consistent basis to facilitate comparisons between proposals.

Unfortunately, cash flow accounting does not account for the taxable withdrawals during the withdrawal phase of an individual’s retirement plan life cycle. As a result, the true revenue loss of the employer-sponsored retirement system relative to other revenue or outlay proposals is significantly overstated. Because of the sheer size of the dollars involved, this issue is particularly acute, especially at a time when deficit reduction is a high priority.

Historically, this scoring approach has damaged retirement savings. Beginning in 1983, to raise federal revenue Congress has used this inaccurate scoring to justify changes that reduce retirement savings. For example, in 1982 the maximum defined contribution limit was $45,000. Had this limit been appropriately inflation-adjusted it would be more than twice as high today.

The long-term beneficial effects of retirement savings tax incentives should be clarified using a present-value basis. This approach would take into account the fact that retirement accumulations are eventually taxed. This would allow policymakers to consider legislative changes that could increase retirement savings for millions of Americans or at least not reduce them.

David