As he did in last year’s budget, President Obama has called for a cap on retirement accounts, even though the personal savings rate in America hovers in the low single digits. Obama has added a provision to encourage employers to auto-enroll employees in IRAs, which may boost saving among low-income earners but won’t fully offset the damage to the overall savings rate from the cap on retirement accounts. That’s because there is much more money at stake in the existing retirement accounts. This is what I wrote about the retirement account cap last year, which still applies:
Apparently, the $3 million cap would affect about 1 percent of retirement accounts, directly. But it would affect a much larger percentage of dollars invested, directly, and it would essentially affect all investors indirectly through lower asset prices. As after-taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. investment returns go down, we can expect lower investment, lower saving, and through that, lower economic growth.
The Heritage Foundation and many others also criticized the idea:
IRAs, 401(k)s, and other tax-advantaged savings vehicles are major improvements over the tax code’s basic treatment of savings, but they maintain much of the savings bias in the tax code, because annual contributions to them are capped. And savers may only withdraw the money after turning 59 ½ or face penalties. Taxpayers wanting to save above these limits (or those who wish to withdraw for purposes other than retirement, such as buying a home) face the tremendous bias imposed by taxes for doing so.
Congress should allow taxpayers to save as much as they can every year tax-free for any purpose with no cap on the total value of their savings. They would pay tax only when they withdraw their savings to spend for whatever purpose they choose.
As an intermediate step, rather than institute President Obama’s misguided cap, Congress should raise—or, better yet, eliminate entirely—the annual caps on contributions to retirement savings plans.
As a result, the cap went nowhere in Congress. This year, however, the idea of putting further limits on retirement accounts has become bipartisan. Chairman Dave Camp’s (R-MI) tax plan limits annual contributions to 401(k)s to half the existing limit, reducing it from $17,500 to $8,875. The remaining half may be put into a Roth retirement account, which means it is taxed up front but the returns are tax free. While this is equivalent treatment for those who are indifferent between the two types of retirement accounts, many savers are not indifferent, say because they are in a high tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. now and don’t expect to be at retirement.
Also, Camp takes away the inflation indexingInflation indexing refers to automatic cost-of-living adjustments built into tax provisions to keep pace with inflation. Absent these adjustments, income taxes are subject to “bracket creep” and stealth increases on taxpayers, while excise taxes are vulnerable to erosion as taxes expressed in marginal dollars, rather than rates, slowly lose value. of these limits for 10 years, resulting in a real decline in the caps. So with inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. picking up over 10 years, as is expected, these limits could affect millions of savers and do real harm to the nation’s already low saving rate.
These are dangerous policy proposals which undermine past efforts to reduce the double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. of saving and investment inherent in the tax code, i.e. the taxation of wages first and then the taxation of the returns to savings from those wages. Camp would worsen this double taxation to reduce tax rates on wages, essentially shifting the tax burden from labor to capital – not good for long-run growth. Obama would worsen double taxation to increase spending on questionable new programs, which is clearly bad for growth.
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