Investor’s Business Daily: The war on 401(k)s

Investor's Business Daily
opines against a new proposal that would eliminate tax incentives for 401(k) plans and force all workers to save in new government-sponsored retirement accounts. Here's their basic argument:

The so-called "tax subsidy" of 401(k) plans comes to $80 billion a year, and its biggest beneficiaries are employees in higher tax brackets. A worker making $35,000 and paying income tax in the 15% bracket gets a $525 break by setting aside 10% of pay in a 401(k). A worker making $150,000 and paying in the 28% bracket gets $4,200 from the same 10% deferral.

You can see why this irks the spread-the-wealth party. So it's no surprise that Democrats are intrigued by an alternative plan that would replace 401(k)s with a flat tax credit at all income levels.

Teresa Ghilarducci, an economist teaching at the New School for Social Research in New York, explained the plan at an Oct. 7 hearing before the House Education and Labor Committee, chaired by Rep. George Miller, D-Calif. Miller invited Ghilarducci in his quest to find a replacement for 401(k)s, which he has called "a big failure in terms of providing an adequate retirement for middle-class Americans."

Her proposal has also caught the eye of Rep. Jim McDermott, D-Wash., who chairs the House Ways and Means Committee's subcommittee on income security and child support. A McDermott spokesman calls the plan "intriguing."

Under Ghilarducci's plan, all workers would get a credit of $600 if they invest 5% of their pay into a retirement account run by the Social Security Administration and invested solely in special government bonds paying 3% plus inflation. Existing 401(k)s would be allowed to remain, but contributions and employer matches would no longer be tax-deductible. For want of an incentive, they would wither away.

I have a somewhat different take, both pro and con.

On the pro side, critics are correct that current tax subsidies to 401(k) accounts are regressive and, more importantly, not optimal in terms of inducing saving. They're regressive because the size of the subsidy is tied to your income tax liability and most low-earners pay little income tax. (This regressivity at the margin doesn't particularly bother me because the overall incidence of the income tax is quite progressive.) But this set-up implies that high earners – who are most likely to save in any case – receive large subsidies while low earners, who aren't nearly as likely to save, receive none. My problem with the Ghilarducci proposal is that it would simply redistribute the current 401(k) successful toward low earners, making the net tax even more progressive than it already is. It should be possible to restructure saving subsidies so that average tax progressivity remains the same but that saving incentives at the margin are improved.

But here's my real beef with the Ghilarducci proposal: a requirement to save with the government creates a captive pool of revenue that, like current Social Security surpluses, can be used to cover deficits elsewhere in the budget. It is highly unlikely, in my view, that Congress would put the new pseudo-bonds in the mandatory savings accounts "on the books," counting them as part of the publicly held national debt. As a result, I suspect these new accounts could serve to mask deficits and encourage increased spending in the non-Social Security budget, much as Social Security surpluses have done over the past 25 years.