Bush Proposes New Tax-Free Savings Plans

WASHINGTON -- The Bush administration proposed dramatically increasing the tax breaks on savings Friday by creating three tax-protected accounts that Treasury officials expect will replace such mainstays of American investment as IRAs and 401(k)s.

Treasury officials portrayed the proposal as a streamlining move, but a wide range of analysts said it could represent a significant retreat from a central tenet of the nation’s tax system: that the rich should pay a greater share of their income in taxes than those who make less.

The accounts, which President Bush is to unveil Monday as part of his new budget, would replace the current hodgepodge of breaks that are designed to encourage savings for everything from school tuition to retirement.

Their creation could also have a happy side effect for an administration wrestling with widening budget deficits: It could spark a big jump in government revenue now, but at a cost of shrunken revenue later.

“No longer will individuals have to worry about the confusing alphabet soup of six different savings accounts ... [and] the endless maze of confusing rules,” said Pamela Olson, the assistant Treasury secretary for tax policy.

She and other administration officials acknowledged that the fiscal 2004 budget Bush releases Monday will count tax money from the rollover of IRAs into the new accounts in the revenue column.

Some analysts said that, together with Bush’s recent call for a dividend tax cut and the administration’s already enacted income tax rate cuts, the new proposal would undermine the progressiveness of the tax system by placing a substantial share of the money made on savings and investment -- the lion’s share of which goes to the top few million households -- off-limits to taxation.

“This would be a huge change in our tax system,” said Ronald A. Pearlman, who held Olson’s job in the Reagan administration and was later staff director for Congress’ Joint Committee on Taxation. “Leaving everything else the same, the progressivity of the system has got to decline,” said Pearlman, who cautioned he had not yet seen details of the proposal.

Under the proposal, Washington would create a new “lifetime savings account” to which individuals could contribute $7,500 a year and from which they could withdraw money at any time for any purpose.

Although people would not get tax breaks for contributing, as they do with traditional individual retirement accounts, all of the interest, dividends and capital gains that they earned on their contributions would be tax-free.

Under Treasury’s rules, people could roll over money they now have in tax-favored medical savings accounts and various education savings accounts, but would have to do it before next January. In doing so, they would have to pay the taxes they had put off by contributing to the original accounts.

The government would also establish a new “retirement savings account” to which individuals could contribute $7,500 a year and from which they could withdraw money tax-free after age 58.

As with the lifetime accounts, Treasury rules would encourage people to roll over what they now have saved in traditional accounts like IRAs. People would have to pay the taxes they had deferred by contributing to the traditional accounts, but could stretch those payments over four years if they act before next January. Meanwhile, Treasury would no longer permit contributions to the traditional accounts after January.

The new retirement accounts would have no income limit on who can participate, unlike so-called Roth IRAs, which are restricted to married couples with incomes up to $160,000 and singles with up to $110,000. The $7,500 limit on annual contributions would be indexed for inflation and rise over time.

Between the two new accounts, a couple could save up to $30,000 a year, tax-free, and more if they set up additional accounts for their children.

Finally, the administration wants to establish a new “employer retirement savings account,” consolidate a laundry list of existing tax-protected arrangements like 401(k)s and thrift plans, and simplify the rules governing them.

The contribution limits would be the same as for 401(k)s, with an employee able to put up to $12,000 a year in the accounts, a figure that will rise to $15,000 in 2006, and the employer able to match up to a total of $40,000.

Olson, the Treasury official, said that streamlining the employer accounts would encourage more companies to offer plans and thus ensure Americans are better prepared for retirement.

But critics said that, among other things, the proposal would loosen restrictions that now require tax breaks given high-paid workers generally be no more than 1 1/2 times those provided lower-paid workers.

Word of the new accounts had trickled out in recent days. But the full dimensions of what the administration has in mind were not clear until Treasury issued a seven-page statement Friday.

Reaction from advocates and critics was swift and strong.

“It’s a tax shelter for the wealthy. This is really an attempt to help the president’s friends,” said Rep. Robert T. Matsui, D-Sacramento. “It’s unbelievable.”

“These are the building blocks of a new tax system,” said Grover Norquist, president of the conservative Americans for Tax Reform.

While the accounts might prove a boon for many individuals, a variety of analysts warn they could produce a series of perverse consequences for savings and especially for government finances.

Because of the generous tax breaks in the new accounts, it wouldn’t make sense for most people to save or invest anywhere else. As a result, more and more money would pour into them, eventually shielding much, if not all, of the nation’s savings and investment income from taxation.

Because most of that income is held by the top tier of households, most benefits of the breaks would go to the richest Americans, leaving the rest to make up the lost tax revenue.

The president “wants to poison the income tax system so it will collapse under its own weight,” said Leonard Burman, the Treasury deputy assistant secretary for tax analysis in the Clinton administration. The proposed tax-free savings accounts would “dissolve the income tax piece-by-piece.”

Meanwhile, tax revenue would probably rise in the short term -- helping to offset today’s soaring federal deficits -- because they would encourage individuals to make big, up-front tax payments to roll over money from, for example, traditional IRAs.

But individuals would then avoid having to pay taxes on any future earnings -- money that Washington will desperately need in order to cope with baby boomers’ retirement.

The amounts involved could be staggering. Federal Reserve statistics suggest that Americans have about $2.5 trillion in IRAs alone.

If even $1 trillion was rolled over into the new accounts, that could produce $250 billion or more in immediate tax payments, then a sharp fall off in payments in the years to follow.

“From a political point of view, [the administration proposal] is clever because the current Congress and the current president get the revenue,” said USC law professor Edward J. McCaffery. “But you are planting a time bomb for the future because it’s going to cost you money in the out years.”’