• Heritage Action
  • Heritage Libertad
  • More
WebMemo #704 on Taxes

March 29, 2005

The President's Savings Plans: Good for Retirees? and Everyone Else

By

Previous attempts to solve Social Security's problems have relied on a mix of benefit cuts and tax increases, but this approach is not a long-term solution. A more lasting solution to Social Security's problems involves a two-pronged approach that allows workers to invest part of their payroll taxes in their own accounts while also removing barriers to saving outside of the system. Although legislation has not yet been introduced to address the first part of this strategy, bills dealing with the second portion have been introduced in both chambers of Congress.

 

On March 8, Treasury Secretary John Snow, Senator Craig Thomas (R-WY), and Representative Sam Johnson (R-TX) announced the Save Initiative, a legislative effort that includes three new savings proposals. These savings plans were part of President Bush's 2006 budget proposals and are likely to be included in any tax reform package developed later in the year.[1] The bills would encourage people to save money and would greatly simplify the regulations governing retirement accounts.

 

Increase Saving, Reduce Complexity

By eliminating multiple layers of taxation, the Save Initiative would give taxpayers added incentives to save money and build their own wealth. Unlike current law, which taxes the money put into regular savings accounts as well as the money earned in those accounts, the new plans would ensure that savings are taxed only once. Just as important, the Save Initiative would consolidate the various types of tax-advantaged savings accounts and simplify their regulations. The proposed savings plans include:

 

  • Lifetime Savings Accounts. LSAs can be used to save for any purpose, not just retirement. There is no tax advantage on the money going into the account (up to $5,000), but the earnings on the money will not be taxed. Unlike typical retirement accounts, there will be no "early withdrawal" penalty, ensuring that savings can be used for whatever purpose individuals choose and that they are taxed only once.
           
  • Retirement Savings Accounts. The RSA is similar to the Roth IRA in that money goes into the account after taxes (up to $5,000) and the account is not taxed again. Investors are allowed to accumulate earnings in the RSA tax-free and then to use the money at retirement without paying additional taxes. Unlike the Roth IRA, there are no income limits preventing people with higher incomes from contributing. Like the Roth IRA, there are no additional age requirements mandating withdrawals after retirement.
               
  • Employer Retirement Savings Accounts. ERSAs would consolidate the plethora of employer-based saving plans, such as 401(k), Simple 401(k), and 403(b) plans, and simplify the qualifying rules. The ERSA rules would be similar to the current-law 401(k) rules, and contributions would be pre-tax. Existing plans could be maintained in their previous form, but new contributions would be disallowed after December 31, 2006.

Help Retirees…and Everyone Else

Allowing individuals to build their own wealth is an integral part of a market economy, and removing excess layers of taxation on saving can only help to increase private wealth. The Save Initiative would be a boon both to younger workers who currently hold out little hope of receiving their future Social Security benefits and to baby boomers who are on the verge of retiring.

 

Economists believe that Social Security provides a disincentive to save. As noted in the Economic Report of the President, the current multitude of special-purpose tax advantage accounts encourages people to create several smaller pools of saving that can be used only for specific purposes.[2] There is also evidence that taxing consumption rather than income would be more efficient and would boost economic activity.[3] The Save Initiative would help in all three cases.

 

The new proposals remove a layer of taxation on saving, thus providing a greater incentive to save for any reason, including retirement. Furthermore, the new savings plans move the income tax system toward a consumption tax because not taxing savings is the equivalent of taxing only consumption. For all individuals, whether young or old, rich or poor, the Save Initiative translates into easier saving through lower costs and less complexity.

 

Minimal Impact on the Federal Budget

Advocates of tax reform can also take comfort from the fact that the Save Initiative would have a minuscule impact on the federal budget. According to the Joint Committee on Taxation, consolidating the plethora of retirement accounts and creating the new LSA plans would reduce federal revenue by $5.4 billion between 2005 and 2015.[4] This figure represents less than one-fifth of 1 percent of the $3 trillion federal budget.

 

Conclusion
Allowing individuals to build their own wealth is an integral part of a market economy, and the policies embodied in the Save Initiative can only help to increase private wealth. The Save Initiative should be part of any tax reform package because it provides the proper incentives for individuals to save and reduces complexity in the tax code. These savings plans could also be an important first step toward meaningful Social Security reform because they would encourage people to save for their own retirement. Congress should consider going even further than the current proposals and removing all contribution limits from the new savings plans.

 

Norbert J. Michel, Ph.D., is a Policy Analyst in the Center for Data Analysis at The Heritage Foundation.



[1]These proposals have been in each of President George W. Bush's budget proposals starting in fiscal year 2004. The Senate bill numbers are S. 545, S. 546, and S. 547; the House bill numbers are H.R. 1161, H.R. 1162, and H.R. 1163.

[2]Economic Report of the President, February 2005, p. 88.

[3]See David Altig, Alan J. Auerbach, Laurence J. Kotlikoff, Kent A. Smetters, and Jan Wallise, "Simulating Fundamental Tax Reform in the United States," American Economic Review, Vol. 91, No. 3 (June 2001), pp. 574-595, and Alan J. Auerbach, Laurence J. Kotlikoff, and Jonathan Skinner, "The Efficiency Gains from Dynamic Tax Reform," International Economic Review, Vol. 24, No. 1 (February 1983), pp. 81-100.

[4]Joint Committee on Taxation, Description of Revenue Provisions Contained in the President's Fiscal Year 2006 Budget Proposal, JCS-3-05, March 2005, at /static/reportimages/566D239570CAE817B5370081D9E94E0D.pdf.

Heritage's daily Morning Bell e-mail keeps you updated on the ongoing policy battles in Washington and around the country.


The subscription is free and delivers you the latest conservative policy perspectives on the news each weekday--straight from Heritage experts.


The Morning Bell is your daily wake-up call offering a fresh, conservative analysis of the news.


More than 450,000 Americans rely on Heritage's Morning Bell to stay up to date on the policy battles that affect them.


Rush Limbaugh says "The Heritage Foundation's Morning Bell is just terrific!"


Rep. Peter Roskam (R-IL) says it's "a great way to start the day for any conservative who wants to get America back on track."


Sign up to start your free subscription today!