This guest blog is part of a series on different perspectives related to the Financial Security Program’s event, Should They Stay or Should They Go? Reexamining Retirement Tax Incentives.
Monique Morrissey is an Economist with the Economic Policy Institute.
You authored a detailed report last year on the “state of American retirement.” What did you find?
We’re moving toward a retirement system that magnifies inequality rather than reducing or simply reflecting it. Social Security’s progressive benefit structure reduces inequality—this is not news to most people. What’s more surprising is that before the 401(k) revolution, black workers were almost as likely to participate in pensions as white workers, and high-school-educated workers were almost as likely to participate as college-educated workers. The charts in The State of American Retirement show that this isn’t true with 401(k)s. While 401(k)s have failed most Americans, at-risk groups have fared the worst. The typical lower-income, black, Hispanic, high-school-educated, or single household has no savings at all in a retirement account.
Why are the tax code and retirement system interrelated?
In the United States, government subsidies for employer pensions and retirement savings take the form of deferred income taxes on investment earnings. Meanwhile, Social Security is primarily funded through a dedicated payroll tax on workers, and these benefits are largely exempt from income tax. The government’s involvement is based on the assumption that people do not save enough on their own for retirement, and, in the case of traditional pensions and Social Security, that group plans are more efficient due to economies of scale and risk pooling.
However, there’s no rule that says government incentives to sponsor or participate in a voluntary plan must take the form of tax breaks on investment earnings, nor that mandatory social insurance must be funded through a tax on labor income. There are advantages and disadvantages to these approaches that are worth discussing, though personally I favor maintaining a strong link between worker contributions and social insurance benefits.
How do you see the prospects for the best ideas moving forward in our current political moment?
Reform of tax incentives pits narrow interests—in this case, the financial industry lobby, avid investors, and the wealthy—against diffuse interests. Meanwhile, Congress is controlled by a party that opposes tax increases, wants to shrink government, and doesn’t consistently equate tax expenditures with government spending. Given these political realities, probably the best that can be hoped for in the short run is mildly progressive base broadening—revenue-neutral tax reform that limits and better targets tax incentives in exchange for slightly lower tax rates.
Looking beyond the 115th Congress, advocates need to start building the case for reforming these and other tax incentives by educating voters about tradeoffs. While tax experts tend to be jaded about reform prospects, the issue is ripe for a populist campaign showing who benefits from our complicated tax code. People may like tax incentives for retirement saving yet still accept the need to lower contribution limits and cap the benefit for taxpayers in upper tax brackets, especially if the savings are used for something they like even more, such as strengthening Social Security.
While President Obama fell short in his attempt to limit and target tax expenditures, he and his allies in Congress did not make this a legislative priority and their efforts should be seen as laying the groundwork for reform rather than hitting a dead end. Tax reform is difficult, but so is cutting popular programs or raising tax rates, if these are the choices.
This is not the first time we’ve heard talk of comprehensive tax reform as a top priority for Congress – do you think this year we’ll actually see action?
You would think so, given that one party controls three branches of government and has said they will take up the challenge. Though I agree with conservative tax wonks on certain issues, such as the need to reform the home mortgage interest deduction, I’m guessing that anything the Congressional majority and President could agree on would make things worse, not better. For example, I don’t see them taking up President Obama’s proposal to cap deductions and exclusions at 28 percent, though I’d love to be proven wrong. Instead, I’m counting on internal disagreement and other distractions scuttling any deal.
The views and opinions of the author are their own and do not necessarily reflect the view of the Aspen Financial Security Program or our funders.