Social Security: Could Cutting 401(k) Tax Exemption Fund Program’s Shortfall? Here’s the Proposal

One of the biggest concerns about Social Security involves a trust fund that is expected to run out money in about a decade, leaving the program able to pay for only 77% of current benefits. A new paper from the Center for Retirement Research at Boston College proposes to fix that problem by eliminating tax preferences included in 401(k)s and other employer-sponsored retirement plans.

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The paper, released last month, cited U.S. Treasury Department estimates showing that the tax preference for employer-sponsored retirement plans and IRAs reduced federal income taxes, and thus revenue, by about $185 billion to $189 billion in 2020. Even so, evidence suggests that the federal tax preferences do little to increase retirement saving, according to a Jan. 16 brief from co-authors Andrew Biggs and Alicia Munnell.

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Their idea? Repeal the retirement saving tax preferences on these plans and use the ensuing revenue to address a large chunk of Social Security’s long-term funding gap.   

“Ultimately, reducing tax expenditures for retirement plans could be an effective way to help address other pressing demands on the federal budget, such as Social Security’s financing shortfall,” the authors wrote.

The shortfall they cited refers to Social Security’s Old Age and Survivors Insurance (OASI) Trust Fund, which is expected to become insolvent around 2033 or 2034. When that happens, Social Security will be solely reliant on payroll taxes to fund benefits, reducing current funding by nearly one-quarter.

Plenty of ideas have been batted around on how to deal with the shortfall. Most focus on some combination of increasing Social Security payroll taxes, cutting benefits and raising the full retirement age.

The proposal by Biggs and Munnell covers new ground by eyeing employer-sponsored retirement plans to bolster Social Security’s finances.

“The current tax preferences primarily benefit high earners, and the tax expenditure has failed at its broader policy goals of increasing national saving or expanding plan coverage,” the authors wrote. “Therefore, the case is strong for curtailing these tax breaks.”

Not everyone agrees. As the 401(k) Specialist website noted in a blog last week, the proposal by Biggs and Munnell has already gotten pushback on a couple of fronts.

One of the critics is Adam Michel, director of tax policy studies at the Cato Institute. In a brief filed on Feb. 1, Michel took issue with the claim by Biggs and Munnell that tax-advantaged retirement plans do little to increase retirement savings.

“The overwhelming evidence is that tax‐​advantaged accounts significantly increase private savings,” Michel wrote. “Over time, even small increases in private savings can contribute to a larger capital stock, additional labor supply and a bigger economy. The private benefits to additional saving, combined with the broader economic benefits, outweigh any temporary government losses, even if the lower revenue does not induce a one‐​for‐​one increase in private savings.”

A separate paper from current and former officials at George Mason University’s Mercantus Center criticized the Biggs-Munnell proposal because of its tax implications and potential impact on Social Security.

“Instead of ending an inequitable tax preference, the Biggs-Munnell proposal would raise taxes massively by effectively double-taxing retirement savings,” the Mercantus Center authors wrote. “In addition, bailing out Social Security with this huge infusion of general revenues would bear substantial adverse ramifications for the Social Security program as a whole as well as for its individual participants.”

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This article originally appeared on GOBankingRates.com: Social Security: Could Cutting 401(k) Tax Exemption Fund Program’s Shortfall? Here’s the Proposal

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