If President Obama thinks his proposal to place a $3 million cap on tax-deferred retirement plan contributions will help boost government coffers, he might want to review a Congressional Budget Office report that tells an altogether different story.
Obama's proposal – released just ahead of his recent State of the Union and a rehash of an idea the White House tossed into the mix last year – was lauded by some as a way to prevent the abuse of tax loopholes by the ultra-rich. Others said the idea could, in fact, create a host of potential unintended consequences that would harm middle-class investors.
Either way, the CBO report plainly says that any reduction or removal of tax-deferred incentives for retirement plans could actually lead to an eventual net loss in tax revenue for the government.
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The 2004 study, titled "Tax-Deferred Retirement Savings in Long-Term Revenue Projections" lays out some of the basics about how tax-deferred defined-contribution plans affect the economy.
It points out that allowing taxpayers to stash away money in tax-deferred accounts means they end up with more money at the time of withdrawal.
Better yet, doing so increases tax revenues as a percentage of the gross domestic product, it says.
"The Congressional Budget Office estimates that deferred taxes will modestly increase income tax receipts as a percentage of GDP," the report says. "At the end of 75 years, the effect is to make receipts about 0.5 percent of GDP higher than in 2003, with about one-half of the rise in the next 25 years."
That is, in fact, a "modest" amount but opponents to Obama's cap idea argue policymakers and Congress should be doing all they can to help Americans save more, not less.
Under Obama's proposal, the amount of money that anyone could accumulate in IRAs and other tax-deferred retirement savings plans would be capped at $3.4 million. With interest rates low, the cap would affect few Americans, perhaps less than 1 percent by some estimates. But higher interest rates could significantly increase the number of people affected, experts say.
The CBO opens its report with an observation fully understood by retirement professionals.
"As baby boomers retire and draw on their pensions and individual retirement accounts, increasing amounts of taxable income will be generated," it says. "Contributions to those retirement plans are largely untaxed, tending to reduce taxable income and tax receipts when the contributions are made. (But) … taxable distributions from the plans will become relatively more important with the aging of the population, tending to boost future taxable income and receipts, not only in nominal terms but also as a percentage of gross domestic product."
According to the CBO study, which was requested by the Senate Finance Committee, if a taxpayer places a sum of money into a taxed savings account and allows interest to accrue, the taxpayer will end up with less money upon withdrawal than if she or he were to place the same sum into a taxed-deferred account and pay taxes on the entire sum — principal plus interest — upon withdrawal. In other words, there's more income to tax through withdrawals, which means fatter government coffers.
This, of course, is a win for investors and a win for the government, the CBO wrote.
The Insured Retirement Institute, among others, says it is opposed to the president's proposed cap.
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