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Tax Incentives for Retirement Savings Are Ripe for Reform

December 13, 2013 at 2:18 PM

12-13-13tax-f1-infocus.pngReforming the costly and poorly targeted tax incentives for retirement saving could not only raise revenue for deficit reduction and tax reform goals, but also do more to encourage low- and moderate-income households — the people who most need to boost their retirement assets — to save more, our new paper explains.

In all, tax incentives for retirement savings plans like 401(k)s, IRAs, and traditional pensions cost well over $100 billion a year.  Yet they appear to do little, relative to their high cost, to encourage new saving.

That’s because the bulk of their benefits go to higher-income households, who are the most likely to respond by shifting existing assets into tax-preferred accounts rather than by raising their total savings.

As the top part of the chart here shows, the highest-income 20 percent of households get 66 percent of the benefits of retirement tax incentives, while the bottom 20 percent of households receive just 2 percent of the benefits.  Meanwhile, as the bottom part of the chart shows, most of the households that haven’t saved enough for retirement have lower incomes.

While current retirement savings tax incentives do not seem to increase private saving, they certainly increase federal deficits.  So the current system may actually reduce national saving, a broader measure that consists of saving by households, businesses, and the government.

The distinction between tax incentives and spending programs is often artificial; both are designed to promote policy goals and both are a type of government spending.  As policymakers continue to apply intense scrutiny to traditional spending, they would be wise not to overlook inefficient tax subsidies for retirement savings.

Click here for the full paper.