Proposed Savings Tax Breaks Part of an Equation for Change

For three years, President Bush has been giving Americans part of their money back in tax cuts. On Monday, he proposed giving back still more, and throwing in a series of sweeping new savings tax breaks to boot.

Bush’s election-year budget calls for permanently extending most of the tax cuts of 2001 and 2003, a move that would cost the government $1.24 trillion in lost revenue during the next decade, according to the Treasury Department -- and critics say that might understate the revenue shortfall by half a trillion dollars.

Bush coupled the tax cut extension with proposals for new savings tax breaks that the administration hoped would replace such icons of American investment as IRAs and 401(k)s and begin nudging the nation away from the New Deal legacy of Social Security and toward the more privatized, market-oriented world of individual accounts.

The Treasury Department estimates that the new breaks would produce almost $20 billion in new tax revenue in the first five years as people stopped using old accounts and paid extra taxes when they rolled savings into the new tax-favored accounts. But analysts warned that the new proposals would prove frightfully expensive in the decades that follow.

“They would lock into place breaks at the very point when government revenues are going to be falling far short of government promises to help pay for the baby boomers’ retirement,” said C. Eugene Steuerle, a former Reagan administration Treasury official and tax economist with the Urban Institute, a nonpartisan economics and social policy organization based in Washington.

The president has struggled for months with how far to push his tax-cutting agenda in the face of rising federal deficits and the prospect of election-year criticism.

Under the administration’s proposal, the government would establish three new kinds of tax-favored accounts -- retirement savings accounts, lifetime savings accounts and employer retirement savings accounts -- that would largely replace IRAs, 401(k)s and the like.

The three accounts would be somewhat less generous than similar accounts proposed last year but quickly dropped. For example, a taxpayer could only contribute $5,000 annually to a retirement savings account (RSA) or to a lifetime savings account (LSA), instead of the $7,500 that the administration sought last year for the accounts.

Analysts said that change was intended to keep the new accounts from being so appealing that business owners would lose interest in employer-provided retirement savings plans in favor of the new accounts. Currently, one of the chief motivations for owners and executives to offer a 401(k) plan is that they can get the tax benefits themselves only if they also provide them to employees.

But at least one congressional Republican hinted Monday that he didn’t think the administration had gone far enough in limiting lifetime savings accounts. “LSAs promote short-term savings. I believe there is a greater need to promote long-term savings,” said Rep. Rob Portman (R-Ohio), a Bush supporter and member of the tax-writing House Ways and Means Committee.

Democrats were considerably harsher in their criticism of both types of accounts.

“Buried in the president’s budget are a patchwork of private accounts that undermine the retirement and health security of all Americans,” said Rep. Pete Stark (D-Hayward), the ranking Democrat on the Joint Economic Committee. The accounts “are like an army of termites that have been let loose on the foundations of our health and retirement system.”

Under the administration’s proposal, people would not get a tax break as they do now with 401(k)s and some IRAs at the time they contribute. They would also have to pay taxes on money they rolled over from most existing IRAs into the new accounts. But they would pay no taxes on any of the interest, dividends and capital gains that they earned on the money in the new accounts.

People could set up separate lifetime savings accounts for themselves, their spouses and their children, but could only set up retirement savings accounts if they earned the money they contribute. That means a family of four in which both the husband and wife work could save up to $30,000 a year in the accounts, according to Pamela F. Olsen, the assistant Treasury secretary for tax policy whose office devised the savings breaks.

Olsen portrayed the accounts as a streamlining move intended to encourage new savings by making it simpler. But critics said that, coupled with recent cuts in the dividend and capital gains taxes, the new savings breaks would effectively shelter most investment income from taxation. They charged that the tax breaks would favor the wealthy.

“These are not just simplifying, clarifying tax proposals. The combination of these with the 2001 and 2003 tax cuts would radically shift the progressive nature of our tax system,” said William Gale, a tax economist with the Brookings Institution.

The cost of the tax-cut extensions was challenged Monday by some analysts who said it would almost certainly be even more costly than the $1.24 trillion cited by the administration if the current alternative minimum tax is eliminated.

For now, Bush is proposing only one year of relief from that tax, which has been raising the taxes of millions of Americans. The alternative minimum tax was set up in the late 1960s to catch a handful of millionaires who had escaped paying taxes, but its provisions could soon cover more than one-third of all taxpayers.

The president has ordered the Treasury to study how to remedy the problem. The analysts said that permanently eliminating the tax would boost the price of the tax cut extension by at least half a trillion dollars.