The 401(k) Is a $240 Billion Waste
http://www.theatlantic.com/business/archive/2012/11/the-401-k-is-a-240-billion-waste/265593/
Imagine there were no 401(k)s. You wouldn't stop saving for retirement, right? Right? Don't worry, I won't tell Suze Orman. Not that CNBC's personal finance guru would get mad at you -- according to a new paper, most households wouldn't sock away any less for their golden years if we eliminated 401(k)s. Which raises a $100 billion question...
Why subsidize retirement saving if the subsidies don't work?
As far as tax expenditures go, the one for retirement savings is a biggie. Remember, "tax expenditure" is just econospeak for the various deductions, exclusions, and preferential rates -- in other words, subsidies -- that litter the tax code. According to the Congressional Budget Office (CBO), excluding pension contributions and earnings from taxes will cost us about 1.2 percent of GDP over the next decade, or an average of $240 billion a year. That's a lot of spending -- that's what tax expenditures are, just disguised spending -- without much bang for the buck. Maybe just a penny's worth.
In fact, one penny's worth is exactly how much extra saving a dollar's worth of retirement subsidies produced in Denmark, according to the recent paper by Raj Chetty and John N. Friedman of Harvard, Soren Leth-Petersen and Tore Olsen of the University of Copenhagen, and Torben Heien Nielsen of the Danish National Centre for Social Research. In other words, we might be spending $240 billion to get people to save $2.4 billion more.
But don't the trillions of dollars in 401(k) accounts tell a different story? Not necessarily. There isn't enough data for the U.S., but Chetty et. al. looked at the numbers for Denmark, which has accounts similar to our 401(k)s, to examine how much more incentives to save get us to save. The first chart shows how much households contributed to tax-preferred accounts after subsidies increased and the second chart shows how much they contributed to non-tax-preferred accounts, again after subsidies increased. It's a bit hard to see, but the decrease in the latter almost completely offsets the increase in the former -- households saved an average of 1 cent more.
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because it raises a legitimate issue that is undoubtedly being discussed as part of the fiscal cliff negotiations (or at least should be discussed).
This article, however, is atrocious. Whatever the merits of the author's proposal, his conclusion is not substantiated very well:
(1) In contrast to the quantitative academic studies cited, his argument for taxing 401k contributions as normal income is, literally reduced to: Imagine there were no 401(k)s. You wouldn't stop saving for retirement, right? Right. For a middle-income family, imposing a federal tax rate of 35% and additional state and local taxes means that the same savings would be worth about 1/3 to 1/2 less when they retire. This is a big deal. How many people would heavy up their savings for increased taxes? One can only guess, but it's probably not a whole lot.
(2) The author says that 401k tax breaks are 'wasted'. This comparison made only when comparing voluntary tax-free contributions to greater forced savings. I am all for better retirement planning, but Mr. O'Brien really, really needs to get out and experience how people who make less than the median income would be affected by the reduction in paychecks that would result from additional forced withdrawals from paychecks.
(3) The article invokes Suze Orman when she has absolutely nothing to do with this proposal. Furthermore, it leads with a large unflattering picture of her. Where it lacks an argument, it relies on a rhetorical question ("you wouldn't stop saving for retirement, right?"
This is what propagandists do.
(4) The author assumes a misinformed reader. If this sounds familiar, it's because that's how the payroll tax works -- except it's how you think the payroll tax works now. There's a misconception that the money the government withholds from you every month ends up in an account with your name on it that eventually becomes your Social Security benefits. It doesn't. This is especially puzzling since readers of The Atlantic probably do not share this particular belief.
(5) The graphs are extraordinarily hard to interpret and lack some basic information in order to make sense of them, such as the "top tax cutoff" rate, the years involved, the exchange rate, average financial readiness for retirement in Denmark. They appear to be included not to shed light but to give the impression that the author's thesis has been confirmed by an academic study even if the reader cannot grasp the proof.
To get the context, it is necessary to pull up the original academic study (http://obs.rc.fas.harvard.edu/chetty/crowdout.pdf). Even that is not sufficient, and a number of other factors have to be researched independently. After poring over those charts and looking up some background material for an hour or so, all I can conclude is that when Denmark began offering tax breaks for retirement savings accounts, people above the "top tax cutoff" invested more in those accounts, a trend which was strongly correlated with income. (In other words, the wealthy invested more than those just above average.) Maybe this supports the author's proposal to eliminate 401k accounts in the US, but to put it kindly, it seems like a stretch.
Maybe taxing retirement savings is a good idea. But this article makes me more wary of it rather than less.