New report highlights cost of retirement tax breaks

Retirement tax incentives are set to cost the Treasury nearly $700 billion over the next five years, second only to the cost of the exclusion for employer-provided health insurance. The latest cost estimates are jaw-dropping—even by Washington standards—and are likely to draw unwanted attention to the popular tax breaks as Congress considers options for extending expired tax credits and comprehensive tax reform.

Before Congress’ August recess, the Joint Committee on Taxation (JCT) provided the latest estimates for tax expenditures for fiscal years 2014–2018—including the cost of retirement tax incentives—in a report to the House Ways and Means Committee and Senate Finance Committee. The most costly retirement tax incentives are for the exclusion of employer-sponsored retirement plan contributions. However, the JCT report estimates that the exclusion for Traditional and Roth IRA contributions and earnings will cost the Treasury $99.7 billion over the next five years. In contrast, the cost of the credit union tax exemption is only $11.9 billion over the same five-year period.

Because of international events in the Ukraine, Iraq, and Syria, Congress’ focus has not been on comprehensive tax reform. The House has passed a number of appropriations bills to fund the various government agencies for the fiscal year that starts on October 1, but the Senate has not taken action on any appropriations bills. With the new fiscal year approaching and lawmakers anxious to campaign full time before the mid-term election, Congress will likely pass a continuing resolution to avoid another shutdown and keep the government open until after the election. Consequently, lawmakers may not address certain issues, including expired tax credits, until they return after the election. Or they may defer action on appropriation bills to the new Congress that will be seated early next year.

There is concern that once Congress begins grappling with funding the government for the new fiscal year, retirement tax incentives may be used to generate revenue and reduce the debt. Earlier this year, the Senate version of the bill intended to replenish the federal Highway Trust Fund contained a revenue-raising provision that would have required most nonspouse beneficiaries to distribute and be taxed on inherited qualified retirement plan assets within five years. The House Ways and Means Committee’s version of the bill did not contain the nonspouse beneficiary provision, which was ultimately dropped from the Senate bill due to strong opposition.

The inclusion of the nonspouse beneficiary limitation in the Highway Trust Fund bill came on the heels of several proposals that would restructure the current tax incentives for retirement savings with an eye to generating additional tax revenue and reducing the debt. These proposals include the following.

• The draft tax reform plan from House Ways and Means Committee Chairman Dave Camp (R-MI) that would end contributions to Traditional IRAs and require nonspouse beneficiaries to take distributions over a period of no more than five years.
• The Obama administration’s fiscal year 2015 budget proposals that would cap tax-advantaged retirement savings plan accumulations, limit the tax deductibility of retirement plan and IRA contributions, and limit payout options for nonspouse beneficiaries.
• The National Commission on Fiscal Responsibility and Reform’s alternative plan that would reduce the limits on contributions to employer-sponsored retirement plans and IRAs.

Few in Congress would argue that encouraging saving for retirement is not good public policy. But going forward, there will be a spirited debate on whether to extend expiring tax breaks, make them permanent, or eliminate them as part of a comprehensive tax reform package that would lower tax rates and reduce the deficit. This will add scrutiny on the cost to the Treasury of all tax expenditures, especially retirement tax incentives, given the latest JCT estimates.

It is unfortunate that the Congressional Budget and Impoundment Control Act of 1974 defines tax expenditures as “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income,” as retirement tax incentives may be treated as “expenditures” when, in fact, they are just deferrals of income, not a permanent loss of revenue to the Treasury. Taxes eventually will be paid on retirement plan assets when participants withdraw the funds in retirement, resulting in additional revenue for the Treasury. Millions of Americans saving for retirement can only hope that this important distinction is not lost in the wider policy debate.