The GOP Tax Plan

In case you haven’t heard, Republicans want to pass a “tax reform” measure.  Of course, being Republicans, when they say, “tax reform” they mean “tax cuts” primarily for the rich (because cutting taxes for the poor doesn’t accomplish very much).  Since this would dramatically increase the federal deficit, and because a lot of Republicans don’t like that idea, they have to look for ways to raise tax revenues without increasing tax rates, which can be tricky.

 One idea that was reported by respectable news sources is a plan to cap employee contributions to 401(k) plans, which are used by employees to save money for retirement.  The current cap limits tax deductible contributions from $18,000 to $24,000 a year; Republicans want to lower that amount to an amount possibly as low as $2,400 per year.

 Before I discuss the implications of this proposal, a little history of 401(k) plans is in order.  When 401(k)s were created in the 1970’s, they were a way to give highly paid executives a higher retirement income without raising benefits for everyone in a company’s pension plan.  Contributions to a 401(k) were treated as non-taxable income; taxes were paid when the money was withdrawn during retirement, at which point most company executives would be in a lower tax bracket, thus creating an incentive for the executive to squirrel away money.

 However, the tax code has changed a lot since the 1970’s.  Upper brackets were eliminated by the Reagan tax reforms, and companies found ways to compensate executives with stock options and the like which reduced the incentive for highly paid executives to use 401(k)s.  As private pension plans were eliminated during the late 20^th century (for reasons that I will leave to be explained another day), most private companies made 401(k)s the principal method of retirement saving for rank and file employees.

 One consequence of this is that the tax-deferred advantage of investing in a 401(k) has largely gone away.  It used to be said that retirees could live on 70% of their final income, mainly because presumably their house was paid off, but now many people refinance their housing instead of paying it off.  Also, medical expenditures are increasing for people of retirement age, so now people are expected to need about 90% of their final income in retirement.  This means that people who retire are in the same tax bracket as when they were working.

 So, the tax-deferral aspect of 401(k)s is just that—deferral, not avoidance.  What that means is that the Republican plan to cap 401(k) contributions won’t raise more tax revenue; it merely shifts when the taxes are paid from the future to the present.  So, the Republican plan mortgages the future in order to write down the deficit-enhancing aspects of the tax cuts.

 Shifting the tax payments means that the economy will be stimulated now, creating more jobs and, as I said, reducing the deficit now.  But there is no free lunch—the economy will be depressed in 10, 20, 30, or 40 years in the future when retirees retire and find they don’t have enough income to live on.  So not only will tax revenues be lower in the future, but there will be an increase in demand for government services as an increasing number of older citizen find they need government assistance to make ends meet.

 Taking public sector employees off pensions and putting them into 401(k) plans has been a Republican mantra for decades.  Now Republicans essentially want to take 401(k)s away (a cap of $2,400 per year would not allow people to save enough to live on when an employee reaches retirement age).  This means that the Republican plan would essentially mean that most workers couldn’t afford to retire, they would have to keep working until they die.  This may not be an issue for people in white collar jobs (California Senator Dianne Feinstein, who is 84, announced she is running for re-election, meaning she plans on working until she is 90), but people in blue-collar trades often can’t physically continue to work when they get older and can’t meet the physical demands of their job.

The concept of “retirement” is a relatively new one; before the Great Depression (the one in the 1930’s, not the one in the 2010’s) pretty much everyone expected to work until they keeled over at their work station.  Thanks to the 20^th century development of pensions, enough could be set aside for future costs so that people might enjoy a few years of rest between work and the grave.  Then businesses decided that pensions were too expensive, so switched to 401(k)s, and now Republicans think that 401(k)s defer too much spending. 

 In a perfect world, everyone would save enough for their golden years.  In case you haven’t noticed, the world is less than perfect.  According to the Federal Reserve, Americans have a credit card debt of a little over $5,000 per person with a credit card, or $9,600 per household with credit card debt.  In our consumer culture, saving for the future is not as exciting as buying a really neat boat (or renting a one-bedroom home in the San Francisco Bay Area).  401(k)s are one of the few resources that people have to make wise decisions about savings, but the Republicans want to take away people’s futures in order to give the wealthy a tax cut.