Government's Costs for Retirement Accounts

Abstract

Americans are considering major reforms to income tax, both personal and corporate. In order to fund the desired reduction in tax rates it is necessary to broaden the tax base. All tax deductions, credits and exempt incomes (tax expenditures) are under review. On that list are the tax sheltered treatments of retirement accounts. This paper analyzes the government’s costs for both Traditional and Roth retirement accounts. It shows that the cost to government is not equal to the benefit for savers. Both accounts have the cost of permanently sheltering profits from tax. Traditional accounts have an added cost when withdrawals are taxed at lower rates than at contribution. They also have a third factor; a benefit from leveraged investing. Essentially the government borrows at low Treasury debt rates and gives it to savers to invest (on the government’s behalf) earning higher portfolio rates. Policy changes are considered in light of the accounts’ different costs and benefits. In many likely scenarios Traditional accounts are cheaper. But the opposite is also true. It depends on the relationship between the Traditional account’s second and third factors. Policy change should protect the third factor’s benefit and delete the second factor’s cost.