This piece originally ran in The Greenville News –
Sen. Max Baucus, Democratic Chairman of the Senate Finance Committee and Sen. Orrin Hatch, the committee’s ranking Republican have announced a “blank slate” strategy to reform the federal tax code. They want to eliminate all special provisions, such as deductions, exemptions and loopholes. Other Senators have been given until July 26th to speak up if they think any personal deductions are worth keeping.
Among the items on the chopping block are popular deductions such as interest paid on mortgages, donations to charities and contributions made to IRA and 401(k) accounts. These deductions present a catch-22 to reform minded politicians. They are targeted because they reduce tax revenue, but targeting them prevents tax reform because of their broad appeal. Needless to say, most Senators have responded to the deadline with a blank look.
When it comes to personal income tax deductions, Americans understand what politicians cannot seem to grasp. While we may debate whether the mortgage interest deduction actually promotes home ownership or if the charitable donation deduction substantially increases the amount of funds given to charities, we understand that taking away these deductions will raise our tax bill.
IRA and 401(k) deductions are not as easily understood. These deductions only lower our tax bill for the present. They were designed to be taxed at a later date – preferably as they are withdrawn during retirement when most of us are in a lower tax bracket. We also overlook that these deductions are tax deferrals, not tax exclusions. The money deducted is saved not spent.
The difference can be seen in how much has accumulated in IRA and 401(k) accounts. Currently, they hold over $9 trillion – collectively larger than the GDP of China. Over 88 million of us have 401(k) accounts. When we become eligible to participate in a 401(k) plan, over 85% of us choose to do so.
On a broader scale, IRA and 401(k) deductions have injected significant investment capital into our economy. Through payroll deductions and automatic drafts, these deductions pump into the stock market on a weekly basis. They provide our economy with an immediate benefit, unlike mortgage interest, which can only be recovered if our homes appreciate in value.
Outside of these accounts, many of us face a different “blank slate” when we look at our retirement savings. According to the U.S. Bureau of Economic Analysis, our average personal savings rate has fallen to 3.2% as compared to over 10% in the 1970’s. We simply do not save for retirement, except in our IRA and 401(k) accounts. By any measure, these deductions have become a necessary part of our retirement planning. Yet our Senators want to punish savers under the cover of tax reform.
Tax reform has turned into the Siren’s song of American politics. Almost all of the proposals present a terrible end for the taxpayer due to the massive national debt hidden just beneath the surface. If Baucus and Hatch were serious about revenue-neutral tax reform, they would define the tax base and establish rates before targeting deductions. Right now, they are playing a game with us. They are offering us a blank slate in one hand while hiding a tax increase behind their backs.