Retirement and Social Security Reform
Billing In Any Tax Reform Plan Must Go To Saving And Investment
Investor's Business Daily
March 1, 2005
By Ernest S. Christian
Let's hope President Bush's Tax Reform Advisory
Panel recommends the historic step of pairing up the dynamic
duo of tax reform - tax relief for personal savings and first-year
expensing for business investment in capital equipment.
Here are the reasons: First, taking the double tax off savings
gives people a fair chance to save for investment as well
as retirement. Next, they have a greater reason to save because
first-year expensing stimulates businesses to install more
productive capital equipment and, when they do, rates of return
on investment improve. And these dynamic tax reforms can be
self-financing within the 10-year budget window, even under
the restrictive "static economy" way that Congress
measures the revenue cost of tax relief for saving and investment.
To start, everyone would have the option of setting up a tax-free
universal savings and investment account (USIA). It would
function like a combination brokerage and savings account
into which the owner could deposit a portion of each year's
after-tax income. No tax deduction would be allowed for savings
deposited into the account, but because the account would
be funded solely with after-tax money, all earnings on investments
inside the account and all withdrawals from the account would
be free of additional federal income tax.
Basically, that's all there is to it. For illustrative purposes,
let's assume that in the beginning annual deposits are limited
to a fixed percentage of the saver's taxable compensation
income for the year, must remain in the account for at least
one year, and can be made only in money, not in stocks or
securities already owned outside the account.
Because no upfront deduction is allowed, the static revenue
cost of USIAs for future savings starts off quite small but
builds up over time as interest, dividends and other gains
on after-tax principal are received in the accounts.
Conversely, because first-year expensing is front-loaded compared
to depreciation, the static revenue cost starts out large
but declines over time.
As an estimate, the revenue cost of firstyear expensing for
capital equipment should be less than $600 billion over 10
years and "starter kit" USIAs for future savings
might add as much as another $50 billion to $100 billion,
depending on how strictly deposits were limited at the outset.
Even limited USIAs would be a great boon to future savers,
especially young Americans just starting out on the road to
acquiring assets. These accounts would fall far short of eliminating
double taxation of all personal savings and investment. Fortunately,
there is a salutary way to pay for firstyear expensing and
for full-fledged USIAs that include all future savings as
well as a big chunk of existing savings.
The revenues will come from a voluntary one-time toll charge
on people who already own stocks and securities, who want
their portfolios to be free of double tax in the future, and
who are willing to pay for it.
Right now, Americans have $5 trillion to $6 trillion invested
in 401(k) and other similar tax-deferred accounts over which
they have substantial control. When they withdraw money from
these accounts in the future, they will have to pay income
taxes on the accumulated earnings inside the account and on
the previously untaxed principal.
Substantial tax revenues can be raised by letting those savers
pay tax now in exchange for shifting savings into a USIA and
not having to pay a greater tax in the future.
Many individuals also own stocks and other financial assets
that are outside any tax-deferred account. People would be
willing to pay a voluntary toll-charge tax as the price of
shifting investments into a USIA for the future.
Extrapolating from Federal Reserve data, the amount of financial
assets potentially involved is huge - starting off with $16
trillion in market-traded securities, savings accounts and
money market deposits.
In addition to accelerating the payment of taxes that would
otherwise be payable in the future, the option of putting
existing financial assets in a USIA might trigger the payment
of toll-charge taxes on some substantial portion of the "locked
in" gains on highly appreciated stocks that are not likely
to be sold in the foreseeable future. Toll charges on these
assets would be "new revenues," and the amount could
be large during a multiyear transition to the USIA system.
Longer term, additional revenues could come from a decision
to phase out the tax deduction for the interest paid by businesses
to USIAs and other similar tax-free recipients. Overall, even
on a static basis, there will be plenty of revenue to pay
for the transition to first-year expensing and a fullfledged
The key to making any savings initiative work (whether it
be USIA or "personal accounts" under Social Security)
is to increase the rate of return on the investment of those
savings in productive assets in the U.S.
The cheapest, most immediate and powerful way of doing that
is first-year expensing. It makes U.S. investments attractive
to U.S.-origin savings and to foreign-origin savings. That
is good, but given the choice, U.S. capital is preferable.
When a capital investment is made in the U.S. and produces
$100 of U.S.-source net income, our economy gets the return
to labor ($81) because the resulting new jobs are in the U.S.
If the investment is paid for by U.S-origin savings, our economy
also gets the return to capital ($19).
The dynamic combination of higher rates of return, more investment
in the U.S. and more U.S.-origin savings with which to pay
for it ought to produce long-term GDP growth rates substantially
in excess of the historical average of 3%.
Insofar as the Treasury Department's tax collections are concerned
- and just as the marker outside the Treasury Building reads
- tax reform would truly have "struck the rock of the
public fisc and caused great fountains of revenue to spew
More important, standards of living in America would increase
enormously - and many more people than ever would experience
that special kind of freedom that comes from being an owner.
Ernest Christian is a former Treasury tax official who
is director of the Center For Strategic Tax Reform in Washington,
D.C. His e-mail address is: email@example.com.