President George W. Bush is expected to push for new tax-free savings accounts during the upcoming presidential race by promoting a bill by a fellow Texas Republican, Representative Sam Johnson. Under the Lifetime Savings Accounts Act of 2004, H.R. 4078, Americans would be able to contribute up to $5,000 a year to two types of savings accounts and withdraw money at any time without penalty.
The contributions would not be tax-deductible (that is, they would be made with after-tax dollars), but earnings would accumulate tax-free and withdrawals would not be taxed. Persons with existing education accounts would be permitted to convert them into the new lifetime savings accounts. Sandra Fabry of Americans for Tax Reform recently interviewed Daniel Clifton, executive director of the American Shareholders Association in Washington, DC, on this subject.
Fabry: How do Lifetime and Retirement Savings Accounts work?
Clifton: Under Rep. Sam Johnson’s legislation [HR 4078, introduced in May 2004], LSAs can be used for any type of saving and will allow an individual to contribute up to $5,000 a year and make penalty-free withdrawals at any time–with no holding period. Hence, participants will be able to save in one tax-favored account for any purpose, including their children’s education, home purchasing, health care needs, or to start their own business.
RSAs [HR 4714, introduced in June 2004] will allow individuals to contribute up to $5,000 a year (in addition to the amounts contributed to an LSA) and work like a Roth IRA. The proposal greatly simplifies existing IRA rules, encouraging more savings and supplementing Social Security and labor earnings in retirements.
Fabry: Why are these new savings vehicles needed?
Clifton: With Social Security facing a looming insolvency, younger workers will need to improve their personal savings to a greater degree. To supplement Social Security’s modest benefits, a healthy retiree individual or couple will need, in today’s dollars, at least $20,000 per year–an income that could be reasonably expected from a retirement annuity of $250,000. If we use those assumptions for a retirement annuity of less than $50,000, that household can expect an annuity income of around $4,000 per year, one-fifth [of what will be] needed for a comfortable retirement. This difference becomes more exacerbated if either spouse requires extended nursing home care or assisted living.
Fabry: What is causing this low savings?
Clifton: While many demographic factors come into play, both double taxation of savings and current saving incentives’ complexities have significantly hindered American savings. Under the current income tax system, income is taxed when earned. If income is used for consumption, no additional federal tax is generally paid for goods and services. If that income is saved, there is another layer of tax on the earnings of the savings. Taxing dividends of a stock and capital gains on assets that have increased in value over time, when the assets are sold, are two examples. LSAs and RSAs would remove the bias between consumption and savings, taxing income once and only once.
Furthermore, complexity resulting from restrictive rules on eligibility, contribution amounts, and withdrawals also contributes to lower personal savings. According to former Assistant Secretary of the Treasury Pam Olsen, contributions to IRAs rose nearly tenfold between 1980 and 1986, from $4 billion to $38 billion. When Congress restricted IRA contributions’ deductibility in 1986, the IRA contributions level fell sharply and never really recovered.
Previous contributors were excluded from participation, [which accounted for] a portion of this decline, but savings also dropped among families retaining full eligibility. Even though the change in law did not affect them, eligible family participation declined by 40 percent between 1986 and 1987. The number of IRA contributors with income of less than $25,000 dropped by 30 percent in that one year.
Fabry: Will the Bush proposal generate new savings or just shift existing savings to tax-advantaged accounts?
Clifton: The new LSAs will clearly generate new savings, especially among individuals who are currently not saving. Younger and lower-income workers are less focused on saving for retirement than saving for a house, their children’s educations, or catastrophic expenses. As such, individuals will have the ability to save for expenses they cannot currently consider without a double tax or withdrawal penalty [if they use the savings] for near-term expenses. This adds new savings.
More savings for all Americans will result from simplification. As explained above, the existing programs’ complexity and contribution limits led to a declining number of people and amounts saved. This decline even occurred among people who remained completely eligible with no program changes. A more simplified approach, as in the proposed LSAs and RSAs, will add more contributors and savings amounts.
Fabry: When you speak of simplification, does that also mean tax simplification?
Clifton: Without question. Today, there are six different savings accounts with confusing and seemingly endless rules. The IRS publication explaining individual retirement accounts is now 104 pages long. In 1982, the publication was 12 pages. LSAs and RSAs are a sure way to significantly simplify the tax code.
Fabry: And with tax simplification follows tax reform, right?
Clifton: Exactly. People talk of a flat tax or a national sales tax. LSAs and RSAs do all the heavy lifting needed for major tax code changes. With the Death Tax being phased out, the removal of the double taxes on savings and investment sets you up with the domestic end of fundamental tax reform being completed. Once completed, move on to fundamental changes to the international portion of the code and removal of the special-interest tax deductions, and “Bang!” You have the Armey/Forbes Flat Tax.
Fabry: What are the prospects for passage?
Clifton: It all depends on presidential leadership. If Bush comes out strongly for it in his convention address and wins, you can bet this will be the 2005 Bush tax cut. He cuts taxes once a year. This will be it, while moving toward major Social Security system reform. If the issue is more obscure in the campaign, though, then we will have to build grassroots support, which we are set to do.
Sandra Fabry ([email protected]) is an associate with Americans for Tax Reform.