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Taming the Deficit? Hardly!

My colleagues and I have written repeatedly (for instance, here, here, and here) about the need for Congress to enact another round of stimulus legislation that would extend unemployment benefits and provide additional fiscal relief to states, both of which would help strengthen the fragile recovery.

Some lawmakers have balked at passing such legislation that increased the deficit – even though some of these same lawmakers have worked behind the scenes to weaken some key provisions that would offset the costs of the additional spending, such as provisions to force private equity managers to pay taxes like everybody else and to make it harder for doctors, lawyers, and others to avoid paying payroll taxes.

Now, though, Senator Scott Brown has gone a step further.

The senator has argued that “we need to stop borrowing against our children and grandchildren’s future and start paying for things.”  Nevertheless, in proposing his own stimulus legislation this week, he included a gimmick that, while offsetting some costs in the short term, would make the deficit worse over the long term.

Here’s how it would work:

Americans could roll over their 401(k) balances into “Roth” accounts.  Taxpayers would pay tax up front on the rollover funds but, in the future, all of the earnings on these funds would be completely tax-free.  Moreover, “Roth” accounts have very permissive distribution rules and, unlike regular IRA accounts, Roth account holders do not have to make withdrawals when they reach age 70½.  As a result, the rollover option would give affluent people a way to shelter years of investment earnings and then pass the accumulated funds to their heirs.

Because those who made this rollover would pay taxes on the funds up front, the Joint Tax Committee estimates that the proposal would raise $5 billion over the next 10 years.  The provision, however, would cost the federal government much more after that.  The Joint Tax Committee does not estimate the revenue effects of proposals beyond 10 years, but the nonpartisan Tax Policy Center has previously analyzed similar Roth IRA rollover gimmicks and found that, on a net present value basis, the federal government would lose $2 tomorrow for every $1 raised today.

Senator Brown’s proposal looks good in the short term.  But it does precisely what the Senator cautions against – adding to the nation’s deficit burden over the long term.

Congress should reject it and any other such fiscal gimmicks – whether attached to stimulus legislation or anything else.

Chuck Marr
Vice President for Federal Tax Policy