In the first article of this series, we discussed the approach described by the Government Accountability Office (GAO) in evaluating tax expenditures and laid out the issues that impact treating the deduction, exclusion and deferral mechanisms for tax-qualified retirement plans the same as “spending” tax expenditures.  In the second article, we focused on two of the critical questions posited by the GAO in the GAO Report that are intended to assist Congress with its seeming effort to revise the Code.  In this last article in the series, we will focus on a few additional questions posited by the GAO in the GAO Report and draw some conclusions.

Does the Tax Expenditure Generate Net Benefits In the Form of Efficiency Gains for Society as a Whole?


The GAO Report states:  Resources are used most efficiently when they provide the greatest possible benefit or wellbeing.  The concept is to reflect “net benefits in efficiency gains for society.”  In a nutshell, this means that what is being given up should be less valuable than what is being provided for society as a whole in order to justify the expenditure.  In the case of retirement plan expenditures, net current tax revenue may be given up that could go to appropriate uses.  A gain results from a seemingly enhanced retirement structure for American workers that is greater than it would otherwise be if not for the tax expenditures.  It is reasonable to assume that enhanced savings for retirement is a benefit for society.  Therefore, the question is best answered by looking at the numerous independent studies of the Employee Benefits Research Institute (EBRI) that “measure” the benefit.  In general terms EBRI’s work would support the notion that there is an enhanced benefit that results from the tax expenditures.  Measuring that against whatever other use Congress and the Administration might make of tax dollars “saved” by reducing or eliminating the expenditures is pure political conjecture.  


It is broadly accepted that there is an enhancement in retirement savings as a result of the tax benefits Congress makes available to qualified plans, both with respect to the employer deduction and the employee income recognition deferral.  However, there are some who may be naysayers.  See Joe Lustig’s Bloomberg BNA Pension & Benefits Daily™ article of February 6, 2013 describing a different perspective contained in the report, Subsidies vs. Nudges: Which Policies Increase Savings the Most? This report, prepared by researchers from Harvard University and the University of Copenhagen, takes a look at the Danish system and concludes that a reduction in tax incentives has virtually no impact on increasing total savings.  The Lustig article describes the EBRI disagreement with this conclusion and refers to EBRI’s countervailing report:  Tax Preferences and Mandates: Is the Danish Savings Experience Applicable to the United States?  EBRI states that the Subsidies vs. Nudges report is flawed since the two countries have different savings incentive structures.  Believe what you will, we suppose.


Regardless, there seems to be ample evidence that, based on our employer-sponsored system, tax expenditures are a critical component.  They encourage plan adoption and retention by employers, plan contributions by both employers and employees and assist greatly in America’s overall savings for retirement.  The critical unknown based on the GAO question is a determination of “how much” expenditure is needed to make sure that there are net benefits in the form of efficiency gains for society as a whole.  If Congress were to reduce the 415 limits, for example, the reduction would arguably be based on a determination that the current limits either do not result in net benefits in the form of efficiency gains for society as a whole, or that the limits can be reduced somewhat to provide the same net benefits.  Finding that “sweet spot” would seem, at best, to be conjectural.  The last time Congress reduced the limits in 1986, as we pointed out in an earlier issue on this topic, savings rates plummeted.  One might suspect that the result was a dramatic loss in net benefits – probably a primary reason Congress has not repeated the error for almost 30 years.


Since tax expenditures for retirement are “recouped” by the federal treasury over time, the issue raised by the GAO question may be irrelevant except for a matter of degree.  Unfortunately, its relevance, to the extent there is some, comes from the budgeting process described in our first installment, a process that fails, for the most part, to draw a distinction between the tax expenditure impact for retirement plans and the tax expenditure impact for spending expenditures.  It should be demonstrable that retirement plan tax expenditures always result in net benefits in efficiency gains for society as a whole.   For statistical bases reflecting plan utilization, see these studies from the Bureau of Labor Statistics and this Department of Labor bulletin.  Putting a measuring stick on the size of the expenditures is a complex task.  However, as discussed above, Congress has proved in the past that a significant reduction does result in a deleterious consequence.


Subsumed within the net benefits question contained in the GAO Report is this question:


What is the Benefit to Society of the Activity the Tax Expenditure Encourages?


The activity is saving for retirement.  The conclusion here, assuming that the tax expenditure is effective, is the encouragement of saving that has led to an overall $19.4 trillion in retirement savings.  Not only does this sum portend that many Americans will be the beneficiaries of valuable retirement benefits, but it suggests that the system results in a significant net economic  benefit to society.  Although there may be arguments about the efficacy of the tax expenditures in being able to accumulate $19.4 trillion, it is illogical to suggest that the tax expenditures did not help grow this monumental pot of assets.  Ultimately, the benefits to society are numerous:  (1) retirees having sufficient funds on which to live, (2) less pressure on the social security system, (3) extensive investment in America’s corporations, and (4) support for, and creation of, jobs.  Of course, the list goes on, but the point is that tax expenditures for retirement savings do benefit society as a whole.


Some Conclusions


The American retirement system, for better or worse, is rooted in having employer-sponsored retirement plans.  Having the ability to save at the point of receipt of wages makes it easy and efficient for employees to save.  One might argue that employers need not be “big brothers” and go to the expense and fiduciary risk of providing plans since every individual should save on his or her own whether or not there is an employer plan.  Practicality and the statistics do not bear this out, however.  The percentage of those who save where there is an employer-based plan far exceed the percentage of savers where no plan is made available at work.  To what extent do the tax expenditures cause and/or enhance these results?  Congress demonstrated that the cause and effect is significant as a result of the reduction in limits that came about through 1986 legislation.  Employers are more likely to sponsor plans and fund them and employees are more likely to save where there is a tax benefit in doing so.


On the other side of the coin, one might contend that having a plan is part of a competitive hiring market, i.e., the best prospects will certainly want their employer to provide the best possible plan.  Therefore, employers will sponsor plans even without the tax incentive or with greatly reduced tax incentives in order to hire the best employees.  It is unlikely that Congress would dare to test this unproven hypothesis.  But even if it did, what would it do to the savings rate in today’s 401(k) universe?  Would as many employees participate, would they save as much, would employer matching contributions shrink?  The lesson of 1986 suggest that answers to all of these are not favorable.


In the final analysis, it would be best for Congress to appreciate that the tax incentives for retirement plans do not create a true expenditure since the federal fisc ultimately gets most, if not all or more of, its money back, a situation that does not exist with “spending” tax expenditures.  So when Congress looks to the retirement plan tax incentives, hopefully it will appreciate that the tax expenditures for retirement plans provide positive answers to the GAO questions and truly benefit society in a meaningful way.  Congress should recognize that ultimately the cost of providing these incentives is not harmful to the federal fisc.  This would suggest that societal efficiency gains result in a significant net benefit.


Related Link


InvestmentNews  – Survey Shows Americans Support Tax Incentives for Retirement Benefits