Tax Reform Should Encourage More Saving, Not Less

Reducing the 401(k) tax deduction is a bad way to reform taxes.



Republicans want tax reform, but their refusal to cut spending forces them to look into all sorts of revenue raisers. Some are good, such as eliminating the deductions for state and local taxes. Others are counterproductive, such as the threat to significantly decrease the tax deduction on 401(k) accounts, potentially reducing the overall levels of savings for the millions of Americans using them.

Instead, they should keep the deduction intact, hence encouraging savings—and in addition create universal savings accounts. There are rumors that they are considering such a move.

First, let me complain about the no-good proposal to reduce the 401(k) tax deduction from $18,500 to $2,400 and expand Roth individual retirement accounts in their place.

I like Roth IRAs; don't get me wrong. Like 401(k) accounts, they are a good way to avoid double taxation of income that is saved. A Roth IRA allows you to save after-tax income and withdraw the income from that savings tax-free in retirement. A 401(k) allows you to save tax-free today but will tax you tomorrow when you consume the income from your savings.

Because there are no upfront tax savings with a Roth IRA, people tend to save and consume in a fairly neutral manner.

By contrast, 401(k) plans tilt people toward saving for retirement by allowing them to reduce their tax bills now. To experts who worry that Americans don't save enough, these accounts are important because they increase savings for 62 million users. Reducing the deduction, they fear, could lead to a reduction in savings.

And yes, 401(k) plans mostly benefit middle- and upper-middle-class savers. But these taxpayers will also bear much of the burden from inevitable policy changes to address the insolvency of Social Security when the trust funds eventually dry out.

This potential move is annoying for another reason: It has nothing to do with improving retirement savings and everything to do with Republicans' search for revenue. That's what happens when you give up entirely on spending cuts as a way to pay for tax reform.

In this case, the tax writers are resorting to a budget gimmick that would not raise overall revenue but instead shift the tax collection from tomorrow to today. In other words, revenue collection might increase today but would shrink tomorrow—as would our retirement security.

Instead, they should leave 401(k) deductions untouched and go a step further to supercharge savings with the creation of universal savings accounts. The good news is that House Ways and Means Committee Chairman Kevin Brady recently suggested to Politico that his committee could do just that.

Chris Edwards of the Cato Institute has been calling for the creation of USAs since 2002, and for good reason. Their hugely successful implementation in Britain and Canada has increased financial security and flexibility for millions of average families.

USAs are similar to Roth IRAs in that people contribute after-tax income. After that, all earnings and withdrawals are completely tax-free.

But the beauty of USAs is that they are for all types of savings, not just retirement savings. Savers are taxed once, and then they can put money away without arbitrary restrictions based on what it's for and when they may use it.

No more having to wait until retirement to use your money, so if you had an emergency, you could take out money without a penalty. No more having multiple accounts for multiple purposes and multiple filing requirements. No more having to justify every single dollar you spend from your kid's 529 account to show the IRS that those college books are indeed a legitimate use of the money you saved. The privacy benefit alone is huge.

USAs, in addition to 401(k) accounts, would add to personal financial security. And more savings would help the economy, because when people save, they expand the amount of credit available for companies and innovators to start or expand businesses. Thus, savings are a powerful source of economic growth.

There is one potential risk with Roth IRAs and USAs: Future governments may change the rules on us down the road when they are even more desperate for revenue than they are now. They could, for example, renege on their promises of tax-free withdrawals and start double-taxing Roth IRAs and USAs. This is another reason to preserve 401(k) accounts.

Apart from that, here is to hoping that Kevin Brady will listen to Chris Edwards.

NEXT: Rapid-Fire News Cycle Leaves Bump Stocks Behind

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  1. Tax Reform Should Encourage More Saving

    “Libertarians think the government should distort save/consume preferences with tax policy”

    1. It’s worse than that. Reason thinks the government should force you into a few select managed funds so that you get to keep a little bit more of your money today. In other words, Reason is promoting crony capitalism.

      1. The fake libertarians here at Reason 1) Can’t get their stories straight, and 2) Are obviously going to criticize Trump and the republicans no matter what it is that they do. If two hours from now, Trump and Ryan and company came out and announced that they changed their mind about reducing the 401(k) tax deduction, I promise you a couple of hours later another Reason fugazi would put out another piece here complaining about how they’re distorting the market through tax policy.

        They’re just reacting to the latest news on a minute-by-minute basis based on their Trump Derangement Syndrome just like all the rest of their fellow left-liberals in the so-called “mainstream” media.

        1. Well those cocktail party invitations don’t send them selves now do they?

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        2. So you would rather have no savings accounts that avoid taxes?

          I would rather have no taxes on interest and dividends, no contribution limits, and no withdrawal rules, like we had before the income tax was enacted 104 years ago. But that’s not likely to happen, so 401k’s and IRAs are the best we can do now to avoid or postpone paying taxes.

      2. Can we PLEASE just call it ‘cronyism’? When you add ‘capitalism’ to the term a lot of people think that’s how capitalism works, and helps encourage socialism.

    2. Re: buybuydandavis,

      Libertarians think the government should distort save/consume preferences with tax policy

      Trumpistas believe the government should distort save/consume preferences with tax policy, except that the Trumpista tax plan is much worse.

    3. Americans are carefree children. They need rewards from their overlords to encourage more saving. My dog needs less rewards than my step-kids.

  2. Since when is it a libertarian position to use tax policy to “encourage” anything?

    1. A tax policy that taxes me LESS encourages ME to keep more of MY GAWD-DAMNED MONEY and to use it as I SEE FIT.

      So STFU, Trumpista.

      1. Sure.

        But that’s not what a 401(k), or the theoretical “Universal Savings Account” does.

        They incentivize saving for the future over letting you use it as you “SEE FIT”.

        1. I prefer “Unlimited Savings Accounts”:

          1. Contribute untaxed income
          2. No tax on earnings
          3. No tax on withdrawals
          4. No contribution limits
          5. No forced withdrawal rules

          Sound crazy? That’s the accounts we had before the income tax was enacted.

    2. Perhaps libertarians have gained the requisite primal sensory ability to understand that any tax policy, even if it’s the status quo or a blank page, will motivate people to behave a certain way. That there is no pristine laissez-faire ideal that turns people into omnipotent beings. Thus, no escape from moral responsibility for your choices, even if your choice is maximum laziness.

      1. Tony|11.2.17 @ 10:36AM|#
        “Perhaps libertarians have gained the requisite primal sensory ability to understand that any tax policy, …”

        Perhaps they know full well that taxation is theft.

      2. When will Democrats learn that any tax policy which subsidizes or encourages a certain behavior is crony-capitalism… the thing which they claim to abhor the mostest?

      3. Tony, libertarians understand things you never can with that progtarded little tumor inside your cranium that passes for a brain. All of it is clearly beyond you.

        Now go drink your fucking Drano.

      4. Unless the government just stops taking people’s money. Let the political parties run their own governments. If people sign up to pay for them, good for them.

  3. It’s not really a question of encouraging savings; it’s rather a question of NOT discouraging them. Busting people in the chops for using savings to help get through retirement is just plain fucked up.

    Look, there aren’t but so many tricks you can pull. Sooner or later you’re either going to have to cut spending, or else it will get cut for you by economic collapse.

    1. You’re wrong about saving. deRugy is just repeating economic mantras from the early 1980’s trickle-down era. It ain’t the tax code that is obliterating saving. It is banks and Wall St and the Federal Reserve.

      If there was actually a shortage of savings and a free market; then banks would actually be paying depositors to SAVE. They not only aren’t doing that – they keep raising trial balloons about ‘negative interest rates’ and arbitrary deposit confiscation and other such destruction. Channeling those savings into the stock market (via insignificant tax-advantages) is nothing more than the usual crap by Wall Street and their dingleberry munchers to herd the ignorant into keeping asset prices at historically high prices so insiders/CEO’s/wealthy can sell to them and leave them holding the bag for a long-overdue ‘asset repricing’.

      De Rugy is just the usual useful idiot of (mostly Rand-quoting) wealthy elites – who want to pretend that a free market can be made to exist – even with absolutely no attention paid to fixing the cronyist control of the monetary system. As if a free market and a pricing system has nothing to do with freedom of the unit of account that determines all prices in that system.

      1. It ain’t the tax code that is obliterating saving. It is banks and Wall St and the Federal Reserve.

        ^ This guy gets it

        Who is going to save money when the Federal Reserve has arbitrarily set the price of borrowing money to ~0? Who is going to save money when the value of said money is diminished on a nearly daily basis, and all prognostics are that it’s going to get worse in the future?

        1. That was Hillary’s plan, and what she said in that meeting with the Wall St. people that paid her $600k. They were going to set negative interest rates to support democrat spending then force people to put at least some of their money into negative interest bearing accounts. In return for their support, Wall St. would get a cut.

          Thank God that fucking hag lost.

      2. Taxes on interest and dividends discourage saving. Repeal those taxes.

        The government Social Security/Medicare safety net discourages saving. End those programs.

        1. Taxes on interest/dividends are irrelevant now. The conversation in those elite circles has now moved to how much of the PRINCIPAL can be destroyed and/or transferred to the crony system without people noticing.

          1. I agree. I would guess that half the country (and possibly even more than half) is now making basically no money at all in interest and dividends at all.

            I believe in capitalism, but I do think some of these pigs on Wall Street wouldn’t be happy unless 99% of us were destitute and fully dependent.

            1. Only about a third of returns report ANY interest – and only a sixth report any dividends. Which obviously includes people mostly reporting $5 here and $10 there.

              The total amount of reported taxable interest is – $91 billion. The total amount of dividends is $255 billion. Compared to W2 wages – $6.3 trillion. And the distribution of interest and dividends are massively more skewed than wages.

              So my guess is interest/dividends only matter to the top 10% or less – and even then pretty marginally since they can easily manipulate income taxes because wealth (the thing paying that interest/dividend) isn’t taxed at all.

              1. No matter how we slice it, the real problem isn’t where to tax and how much,. The real problem is the spending. Period.

  4. They could, for example, renege on their promises of tax-free withdrawals and start double-taxing Roth IRAs and USAs.

    Seeing as all money belongs to the government anyway, they can really do whatever they want whenever they want and there’s not much you can do about it. There is no way to hide money from the government.

    1. Bitcoin is money, hide-able and not US owned.

      1. Until the US bans it.

  5. For a magazine named Reason…

    …nothing. I just need a drink. It’s that kind of morning.

  6. How do USAs work in Canadia? Is there a maximum deposit amount each year? Are there restrictions on how the money is saved? (Money market? Brokerage account? .0005% interest bank account?)

    If USAs are a tax free brokerage account, I don’t see why people would use 401ks going forward. I already max out my 401k and HSA. My family’s income disallows us from using Roths. If I could get the same performance (tax deferred savings) without the restrictions on when/how to use it I would totally switch to USAs.

    1. This year you could put $18000 into your 401(k) and either $3,400 or $6,750 into an HSA (individual vs. family). If you’re maxing out both every year, then I’m going to guess your annual household income is, at the very least, in the low six-figures, putting your household income in the “top 20%”. If you’re making at least $113,000, you’re in the top 10% for household income.

      In comparison, *most* Americans already don’t use 401(k)s at all. Of those that *do* use them, the average annual contribution is around $4500, with the median being lower, around $2400, and the average annual income for 401(k) users is closer to $50,000 then $100,000.

      Anyway, my point is that you aren’t representative, in income or behavior, so you should be careful to not conflate how this would affect *you* with how it would affect *most* folks.

      Random side note: anyone else having their phone’s autocorrect keep trying to change “you” to “thou”? My phone wants me to seem even more pretentious then I already do.

    2. My family’s income disallows us from using Roths.

      You’re going to hate the Trump tax hike reform plan then.

  7. No more having to wait until retirement to use your money, so if you had an emergency, you could take out money without a penalty.

    You can already take your direct contributions out of a Roth IRA at any time without any penalty.

  8. Roth IRAs already have the features of a USA. You can withdraw your contributions without a penalty.

    This is an under appreciated feature. I had to talk to three people at Fidelity before I found one who understood I could do this.

    For me, this actually encourages saving because I don’t have to worry about needing the cash before I retire. I needed some to weather a period of unemployment. For example.

    With a 401k you have to be careful not to save too much because you might need that cash for other things.

    With a Roth, you can put every last dime in savings, secure in the knowledge that if you need the cash you can get it back out. (There are details but in general this holds).

  9. You tax people either before they invest or after they invest. It’s not as big a deal as it’s being presented. It’s not like the question is: do you tax retirement income or do you not tax retirement income? That would be a different debate.

    Yes it will have the effect of discouraging 401k contributions for people who don’t receive a match from their employer, but there are plenty of other vehicles for investment and saving out there. The bigger reason we’re upset, I think, is because it’s just reminding us that incomes are being taxed.

    1. There’s a big difference in taxing it before and during compared to taxing it after though: you can grow your balance at untaxed gains. A 7 percent untaxed annual return for 40 years multiplies your balance 15 times. A 5 percent annual return (after taxing the 7 percent) for 40 years multiplies your balance only 7 times. You won’t be taxed at 50 percent when you take it out (hopefully.)

      1. Oh I agree. But operationally it’s the same thing. Once you’ve acknowledged that income is to be taxed, there’s no inherent reason that one method is fairer than the other one.

  10. Government would and will most certainly renege on things like Roth and USAs and “double tax”, its what they do.

  11. I have to agree with the critics on this one. Tax deductible 401(k)’s are social engineering as much as myriad other tax preferences like the home mortgage interest deduction and the child tax credit.

    We should be aiming to get rid of ALL of these things and just raise the standard deduction to something like $30,000 a year for individuals. Pick whatever number makes it tax neutral for lower-to-middle income brackets, so Democrats can’t bitch about it raising taxes on the middle class.

    1. Yup. Eliminate every single deduction. Flat tax for everyone. Same percentage for any and all income above a certain “base living” threshold. The poverty line should work fine.

      And require that the tax be paid directly. none of this paycheck withholding BS. Everyone should clearly see the lump sum the government takes each year.

      1. oh the non-profits arn’t going to like that.

      2. Alternatively, structure the tax system to better reflect “usage fees” that libertarians have been advocating for decades. If we’re going to be saddled with a bloated government and an income tax, and if we can agree that “usage fees” are the fairest way to collect taxes, we should strive to emulate them in the income tax code. And a flat tax doesn’t do that.

      3. Well, being realistic, a flat tax isn’t going to pass. A massively higher standard deduction just might.

    2. I agree with you re taxes. More realistically, I think we (the federal govt) need to move away from an excessive dependence on income taxes. It is that dependence on one revenue source that requires marginal rates that distort behavior.

      Switzerland (federal level) does it right imo.

      A relatively nominal VAT/consumption tax – 3% on food/necessities, 8% on everything else. This ensures everyone has skin in the game

      An income tax with a 30k exemption and a 12% flat marginal rate. That low marginal rate eliminates both the tax games (from the top) and the poverty trap (from the bottom).

      An annual wealth tax of 50 basis points on everything over 500k. THAT – not marginal income tax crap or end-of-life death taxes – is the only means by which those who already OWN property can be made to pay the costs for govt/law to PROTECT that property.

      1. Yeah, this might actually be the first time I’ve ever agreed with “HazelMeade” about something.

        In addition to everything you mentioned, a simple and fair tax code with about 70,000 fewer pages in it will free up enormous resources. The absurd amount of time, money, and energy people and businesses have to spend complying with the current byzantine monstrosity could be spent on things that are far more productive and add far more value to the economy and society.

        Yes, the tax lawyers and CPAs would hate it, but I’m confident that most of them are smart enough that they could find something else useful to do if they had to.

      2. I was waiting to hear someone mention VAT. Probably a good idea if structured correctly, but politically very, very difficult in a crony capitalist environment. [sorry for the shorthand]

      3. No no a thousand times no.

        A direct consumption tax is one thing, but a VAT is the worst possible way to implement such a thing.

        A VAT is not transparent.

        A VAT is too easy to “tweak” at some subcommittees whim.

        A VAT is a paperwork nightmare. Add VAT compliance on top of corporate income tax compliance and the economy takes a big hit (currently costs about $2 in compliance for every $1 remitted in corporate income taxes).

        Even what you described “3% on food/necessities” will be a lobbyist scam, where everyone is trying to get their product line deemed a food or necessity. Are Cheetos a food or necessity? For that matter, one could argue “Why tax necessities at all?” We end up with things like NY bagel sales tax (In New York, the sale of whole bagels isn’t subject to sales tax but sliced bagels are taxed).

        Just do a straight x% on all sales, leases, rentals and keep lobbying out of it.

    3. I agree with you, except for the standard deduction thing. No standard deduction either. If people making some arbitrary amount of income aren’t contributing to the revenue of the government, then you end up with competing factions of providers and takers. I would be willing to agree with a minimum taxable income if and only if the welfare state were abolished.

      The flat tax is, by definition, progressive in the sense that it taxes higher incomes more on an absolute basis. Govt. services are used by the people more in absolute terms than they are as a percentage of income. Rich people don’t require more national defense, roads, etc.

    4. The plan unveiled today gives small cuts to people making under 100K, big cuts to people making over 500K, and a big tax hike to people making 100 to 500 K.

      1. Fortunately, with all the deductions I can still get, my income will probably still come in under 100K. 🙂

  12. USA! USA! USA!

  13. Fuck you, cut spending.

    You really have to be a fucking idiot to cut saving instead of cutting spending

    1. Yep. It really is that simple.

  14. Employers don’t match contributions to your Roth IRA, right? That’s still a huge incentive to use a 401(k) until you max your contributions.

    As far as USAs go, I’m assuming that it differs from a normal savings account in that you can invest in particular funds/stocks so that it grows with the market instead of whatever measly interest rate the bank gives you? And then it has the added advantage of avoiding capital gains on whatever money you withdraw?

    I like the idea, but it would be seen as another way for Wall Street to avoid paying taxes on their investment earnings.

  15. Some are good, such as eliminating the deductions for state and local taxes.

    Umm…is it though?

    1. Why should someone in a low tax state pay more federal tax than someone in a high tax state? Any deduction is shifting the burden to someone else. A deduction for mortgage interest is shifting the burden to renters and to people without a mortgage. Etc. If your state taxes a lot, that’s the collective choice of your fellow residents, so you should shoulder that burden, not people in other states that were more frugal.

      1. We have decided that we only tax net income. If the state steals my money before I get it, that certainly isn’t net income, is it? If that is taxable, then everyone should be taxed on gross income and there be zero deductions.

  16. Republicans want tax reform, but their refusal to cut spending forces them to look into all sorts of revenue raisers. Some are good, such as eliminating the deductions for state and local taxes.

    How is this is in any way good if it results in many people paying more federal taxes?

    The whole tax “reform” bill seems like punishment for California for voting against Trump:
    1. No state and local tax deductions, hurting high tax states the most.
    2. Mortgage interest deduction capped at 500K, hurting high price real estate states the most.
    3. Brackets designed to penalize high salary people (couples at 200K to 400K) with a 7 pct tax hike from the 28 to 35 pct bracket.

    How is this even going to pass? There should be a tax cut of some size for everyone, getting bigger as your income and previous tax bill go up. Instead it’s a paltry tax cut for low income people, a huge tax cut for the uber-rich over 500K a year, and a big tax hike for families making from 150 to 500 K.

    1. As someone stuck in California for another 18 months or so this bill as written is going to raise my taxes in every facet as I fall right in the middle of every group that is in the “just this small percentage will have to pay more” and it sucks hard.

  17. If taxes were just 3 or 4 % of GDP, as opposed to 20%, we would not be arguing much about the best way to raise them.

  18. Want people to save for retirement? Abolish government pensions. Abolish government health insurace. Faced with a future without government handouts during old age, people will save.

  19. I’m all for rich people keeping their money but can they stop leeching it from the economy and actually spend it, that’s how trickle down economics is supposed to work.

  20. Yes i agree main purpose of Tax Reform Should Encourage More Saving. So, we should work on it and make the reforms right which will be sound good for all of us. I would like to say hey guys write my essay please which also on Tax topic and while looking such person i came here.

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