Helping more Americans save: why the Senate should restore IRAs
AMERICAN society is criticized for spending too much and saving too little. European society for too many holidays from work. Japanese society for exporting too much and spending too little at home. Each criticism is a generalization. But, as the world tries to balance its trading system, some revisions of incentives make sense in each of the three leading branches of the Western industrial world.
In this context, the effort now underway to get the US Senate to save the Individual Retirement Account (IRA) makes a lot of sense. Senators are hearing pro-IRA pleas from a lot of their constituents. The constituents are right.
A national economy is a Rube Goldberg kind of contraption. It is fueled by millions of individual workers providing goods and services, buying some of those goods and services, exporting some of them, and saving part of their share of the profit to invest for the future. The machine is so complex that even the economic model builders can't keep track of all the variables.
But one factor is not complex. Societies need to raise productivity if they are to prosper. And productivity can increase only so far through Gorbachevian calls for heroic Stakhanovite performance by workers. More productive equipment is needed -- now more than ever. Industries that introduce highly automated equipment see quantity and quality of output increase and rejection rates for defective products decline.
To buy the computers and automatic controls needed for such plant modernization requires investment capital. Such capital comes from corporate and individual savings.
But is the IRA really such a good savings vehicle?
Since IRAs were introduced, the American savings rate has wavered, but generally declined from its already low average in the 1970s. And, because IRAs defer taxation until retirement, they have cut government tax revenue. So they have added to the deficit in recent years. Critics say that IRAs have not added that much to total savings anyway. Much of the $2,000 that working Americans are annually allowed to save free of tax appears to have been shifted from already-saved funds. Ergo, it is only the affluent and relatively affluent who are saving through IRAs.
There is some justification to these criticisms. But there are, nonetheless, strong reasons for the Senate and the eventual Senate-House conference committee to restore the full IRA tax credit in tax reform legislation.
The chief reasons:
1. America needs to save more. As already noted, savings create investment capital, which buys plant modernization, which increases productivity, which means a higher standard of living in future.
2. Americans need to be wooed into recovering the saving habit. IRAs are a widely publicized vehicle for reminding a new generation of this virtue practiced by many of their ancestors.
3. IRAs need not be the preserve of the upper-income and upper- middle-income groups. President Reagan, leaders in his administration, and leaders in large and small business can stimulate more blue-collar participation. One way to do so is to encourage more payroll withholding IRA plans.
The biggest deterrent to IRA saving is the feeling of many wage earners between January and April each year that they don't have $2,000 to save. That could be reversed if small regular paycheck deposits were made. The total at year-end could range from a small amount (perhaps $500) to the limit ($2,000).
Take-home pay would be only slightly dented (since tax withholding would also be lower). And employees would likely be converted to the saving habit as soon as they began to see the magic of tax-free compounding begin to take effect. (House and Senate cuts in the amount which firms can withhold under the more generous 401-K retirement plans should not impede moves to get smaller, less-wealthy firms to adopt an IRA withholding program.)
Overall, the Senate Finance Committee's tax reform bill moves in the right direction. But it does not improve fairness between generations. It tends to lead to gratification for the present generation at the expense of the next generation. It also sells some snake-oil in claiming that reduction of tax brackets from 14 to just two (15 and 27 percent) is ``simplification.'' There's nothing simpler about two brackets, since taxpayers have only to look up their tax in a table anyway. What the two-bracket proposal does is load middle-income taxpayers with the same rate as upper income payers. Without this loading upon the great mass of citizens in the middle the program would not pay for itself (be ``revenue neutral'').
And that raises the last question about restoring IRAs to the Senate bill: How could compensating tax revenue be found?
The problem is likely to solve itself in an eventual Senate-House compromise on the top tax rate. But if that anticipation is not enough, the Senators might raise excise taxes, lower the personal exemption, and/or look again at the formula for taxing social security paid to upper-income retirees.
Earl W. Foell is editor in chief of The Christian Science Monitor.