The Mother of All Tax Shelters

Abstract

By its own account, the federal government spends more than $500 billion every year to subsidize retirement savings in 401(k) plans, IRAs and similar arrangements. That figure is larger than the annual budget of every government agency other than the four largest. The theory behind this massive subsidy is that it gives workers at all income levels an incentive to save money that they would otherwise spend, thereby enhancing retirement security, reducing old-age poverty and easing dependence on Social Security. But the theory is wrong. The retirement tax subsidy is anything but egalitarian. Less than five percent of the subsidy goes to households in the bottom 40 percent of the income distribution scale, and more than 60 percent goes to households in the top 20 percent. And among higher-income households, the subsidy generally does not encourage saving. Instead, the affluent respond to the subsidy primarily by moving assets from taxable investment accounts to tax-exempt retirement accounts. In short, the federal government spends more than half a trillion dollars every year to provide windfalls to higher-income households with little meaningful increase in retirement security for lower-income and middle-income households. It is time to acknowledge that the retirement tax subsidy is a tax shelter, nothing more and nothing less, and to reset tax policy accordingly.