Tuesday is April 15, a day that once was only the deadline for filing income taxes but that in recent years has become the closing day of a new national ritual: funding the IRA. In the last half a dozen years, the individual retirement account and a related payroll deduction plan called the 401(k) have grown in the people’s affection.
IRAs this year will attract almost $50 billion, and the 401(k)s--which allow employees to put aside pretax income, usually with a matching contribution by employers--may take in another $7 billion. That would bring the total squirreled away in these tax-free retirement accounts to around $270 billion--four-fifths of the gross national product of Canada.
So why is official Washington so suspicious of the IRA? Why, as they work together on tax reform legislation, are the House Ways and Means Committee, the Senate Finance Committee and the Treasury Department in substantial agreement that tax incentives for retirement savings should be cut back?
Because Congress, which committed itself less than a decade ago to encouraging such savings, thinks the people are thwarting its intent. Congress looks at the evidence and sees that despite the growth of IRAs, the national savings rate has gone down, not up, in this decade. This indicates that people--at least so far--are not adding to savings but only transferring funds from taxable to tax-free accounts. Clearly, also, people are borrowing to fund IRAs, and in some cases they are simply withdrawing early, and paying the taxes, in order to use IRA money for other purposes.
So Congress is going to clamp down. If tax reform becomes law, there will be limits on the amounts that can be saved tax-free, as well as costlier penalties for early withdrawals from tax-free plans.
The attitude is understandable as the lawmakers try to reconcile a proposed reduction in tax rates with a pressing need to cut the government deficit. Limited tax incentives for true retirement saving are OK, they are saying, but the government just cannot afford incentives for more general saving.
But Congress is shortsighted. First of all, it is incredibly impatient. Expanded eligibility for IRAs is only 5 years old. At this point, you might get net new savings if you raised limits on contributions, say economics professors David Wise of Harvard and John Shoven of Stanford.
And the 401(k) has been extended widely to corporate employees for only four years. What’s significant is that its reception has been most enthusiastic among the lower-earning two-thirds of a typical company’s work force. No mystery there: Withholding of pretax pay, and matching contributions by employers, make the plans ideal for building a nest egg--the average wage earner’s tax shelter.
So what if occasionally somebody pleads hardship and withdraws the money to pay for a kid’s college tuition? The point is that the money was saved to begin with. In a country that makes installment interest tax-deductible and instant credit available everywhere, the people want a way to save. As their income growth has slowed in the last six years, they have gone heavily into debt.
The country doesn’t need more consumer debt, it needs more saving. It needs capital formation, a big term that was fashionable years ago before we started funding government deficits by borrowing from foreigners.
Capital formation basically means the sum of dinners done without; jam tomorrow instead of jam today. It means putting money by and investing it to increase productivity. Our country hasn’t been saving enough, or investing enough, in recent years, and our productivity--meaning the true increase in output that lifts our standard of living--has been lagging badly.
Yes, but can we afford to make saving tax-free, as the Japanese do? Sure we can. In the long term, tax-free capital formation would pay for itself. We could do it in small ways, by lowering the deductibility of installment interest, as Sen. Bob Packwood (R-Ore.) is proposing.
And we could do it in big ways. The real question for Congress is: Do we need to cut the tax rates just now? When President Reagan stumped the country for his tax plan last year, he met with no great enthusiasm from the people. They seem less interested in a lower tax rate than in the nest-egg building possibilities of tax-deferred compound interest.
The people are economically rational. They know how hard it is to save. They also know that as medical advances allow us to live longer, a little something to supplement Social Security is a necessity.
Instead of being suspicious of the people’s economic choices, official Washington might think of how better to accommodate them.