A proposal floated by the Center for Retirement Research at Boston College to bolster Social Security by eliminating the tax deferrals that individuals receive for contributing to their 401(k) retirement savings accounts has drawn sharp industry criticism, with some lashing out on social media.
"I personally cannot think of a more preposterous idea," said Brian Graff, chief executive officer at the American Retirement Association, in a LinkedIn post shortly after the report was released on Jan. 16.
The proposal urges the industry to eliminate or reduce the tax deferrals, saying they are expensive, benefit the wealthy who are at no risk of poverty in retirement, and do little, if anything, to increase savings or expand coverage to workers without access to plans.
The authors of the report — Alicia Munnell, the 25-year director and founder of Boston College's Center for Retirement Research; and Andrew Biggs, a senior fellow at the American Enterprise Institute — note that in 2020 tax preferences for employer-sponsored retirement plans – both defined contribution and defined benefit plans – and individual retirement accounts cost the government $185 billion to $189 billion.
"This is a lot of money," Biggs said in an interview. "You can fix three-quarters of the Social Security funding gap using that money."
One of the biggest arguments the authors make in the report is that tax deferrals don't make much of a difference in getting people to save for retirement. They would have saved regardless of the incentive, the authors contend, citing various studies.
"The tax deferral doesn't necessarily cause people to save more. It affects more where they save," Biggs said, explaining that people who would have saved in a taxable investment account simply shift their savings over to a tax-advantaged retirement account.
"You're bribing them to do what they'd do anyway," Biggs said.
Critics were dumbfounded, saying that reducing or eliminating the tax incentive would in fact deter people from saving.
"I think it would be a very large social experiment to try this on the American public," said Rob Reiskytl, a partner and actuarial retirement consultant at Aon. "What Aon would likely be afraid of with this proposal is that changing the tax advantage associated with retirement savings will likely not work in favor of incenting additional savings, which is, in our opinion, what's needed."
David Blanchett, managing director, portfolio manager and head of retirement research at PGIM, also expressed grave concerns about the proposal's impact on savings.
"We need to be doing more to actively encourage participants to save in retirement, not enact any kind of legislation that would in any way dissuade individuals from saving inside 401(k) plans," Blanchett said. "I don't want any negative signals when it comes to how individuals are encouraged to save."
The American Retirement Association's Graff is also worried about a potential negative impact on savings. "Social Security alone is insufficient for most people in retirement. If you eliminate the tax incentives for private savings to 'pay for' Social Security, you are making the situation only worse for most Americans," he said in a statement.
Academics also snubbed the proposal. In a blog post on Feb. 1, Adam Michel, director of tax policy studies at the Cato Institute, refuted the argument that tax-advantaged retirement accounts do little to increase retirement saving, calling the assertion "an overconfident misinterpretation of the academic literature."
"The overwhelming evidence is that tax-advantaged accounts significantly increase private savings," he said in the blog post.
While aware of the concerns, Munnell and Biggs nevertheless contend that the removal of the incentive is unlikely to stop people from saving, particularly wealthy individuals who must replace a much greater portion of their current income in retirement to maintain their lifestyle.
"People have to save for retirement," Munnell said. "Social Security was never intended to be the sole source of support. People above the lowest earners really need to save some additional amount, and it would be foolhardy not to do so."
Critics also argued that eliminating tax deferrals would deter employers from offering plans, a fear that Munnell and Biggs contend is not supported by the facts.
The authors point to a preliminary study Biggs conducted that showed no statistically significant difference in retirement plan coverage between states with low-income taxes and those with high-income taxes, where greater plan coverage would be expected given the higher value of the tax preference.
If the tax deferral mattered, states with high-income taxes, such as New York and California, would have higher retirement plan coverage than states with low or no taxes, such as Texas or Florida, but there was no statistically significant correlation, Biggs said of the study he expects to expand.
Nevertheless, to offset any potential decreased interest in offering retirement plans or potential decreased interest in saving, the authors recommend pairing the removal of the deferrals with a mandatory retirement savings program that employers must offer their employees if they don't offer one themselves.
The authors point to the success of the U.K.'s National Employment Savings Trust, a retirement savings plan that all employees are automatically enrolled in if their employers don't offer a plan.
Since NEST's creation in 2018, retirement plan coverage in the U.K. jumped to about 80% from about 40%, Biggs said.
"If you can get to 80% at much, much lower cost, why not get to 80% at (a) much lower cost?" he asked, noting that plan coverage in the U.S. has remained stuck at about 50% since 1989.
Critics also challenged the idea that tax deferrals are a government expenditure in the way that tax deductions are.
"401(k) deferrals are a loan, and it's a function of government accounting that it's viewed as an expenditure because the government will eventually make the money back when those monies come out of the plan," PGIM's Blanchett said.
The authors immediately squashed the criticism, saying that deferrals lose the government money.
"On the simplest level, they don't get the money for 20, 30 years," Munnell said. "Money today is worth more than money in the future."
Munnell explained that the $185 billion cost attached to tax deferrals represents the difference between how much the government would get in tax revenue from individuals saving in taxable investment accounts and how much it would get in tax revenue from individuals saving in a tax-preferred retirement accounts.
"That's a permanent loss in money. That's not money that's recouped later," she said. "That's taking the difference between two present values."
Critics, however, wholeheartedly supported the need to fix Social Security, with some suggesting tax increases to fix Social Security's funding problem. Currently, the combined Social Security trust funds face depletion in 2034.
"If you want to target ways to improve Social Security funding, you can just make the taxation more progressive," Blanchett said. "I would tax wealthy Americans more so that it's more of a blanket increase to fund this social assistance program vs. kind of trying to pull it away from — in any form or fashion — retirement savings."
Biggs disagreed, saying the removal of tax deferrals is a less painful way to get at the problem.
An increase in the payroll tax rate, he said, is "a disincentive to work," and lifting the payroll tax ceiling means "a 12-percentage point increase in the top marginal tax rate" that almost all economists say will be a problem.
"Rolling back the tax preference strikes me as a less problematic way to get money," Biggs said.