As many of you know, there has been talk of overhauling the current tax system and producing a “fairer, simpler, and more pro-growth” tax system than the current “complicated mess.” (See previous post here.) Thanks to the TaxProfBlog for the pointer to this blog which posts a document from Pam F. Olson to former Secretary Paul O’Neill (dated November 7, 2002) providing proposals for possible avenues of tax reform that might be utilized in trying to achieve a “fairer” system. The document provides some insight into how retirement plans and other benefits might be affected in such proposal. Here is a rundown of the different proposals and what the document says about the effect they would have on retirement plans and other benefits (you can read the document further for a detailed description of what each proposal would entail):
(1) Flat Consumption Tax:
Excerpts:
“Many of the special deductions, exemptions and credits allowed under the current tax system are intended to promote widely held social goals, e.g., health care, home ownership and charitable giving. The Flat Tax would eliminate these tax incentives without providing substitute programs.”
“To some extent existing pension plans and other tax favored savings plans increase retirement savings because of institutional factors – such as payroll deduction, withdrawal penalties, and persuasive advertising – rather than simply encouraging savings by increasing the after-tax rate of return. Because the proposal exempts all capital income from the individual level tax, it would remove the relative tax advantage currently enjoyed by qualified retirement saving plans, and it is likely that such plans would be less prevalent than under existing law. Compared to current law, this could reduce retirement saving by those for whom institutional factors had been a primary determinant of retirement saving.”
(2) Flat Income Tax:
Excerpts:
“Many of the special deductions, exemption and credits allowed under the current tax system are intended to promote widely held social goals, e.g., health care, home ownership and charitable giving. The Flat Tax would eliminate these tax incentives without providing substitute programs.”
“To some extent existing pension plans and other tax favored savings plans increase retirement savings because of institutional factors – such as payroll deduction, withdrawal penalties, and persuasive advertising – rather than simply encouraging savings by increasing the after-tax rate of return. Because the proposal exempts all capital income from the individual level tax, it would remove the relative tax advantage currently enjoyed by qualified retirement saving plans, and it is likely that such plans would be less prevalent than under existing law. Compared to current law, this could reduce retirement saving by those for whom institutional factors had been a primary determinant of retirement saving.”
(3) Add-On Value Added Tax and Reformed Income Tax
Excerpts:
“Some incentive for employer-provided pension and health fringe benefits would be retained, as both would be deducted from corporate income and excluded from compensation.”
“To some extent existing pension plans and other tax favored savings plans increase retirement savings because of institutional factors – such as payroll deduction, withdrawal penalties, and persuasive advertising – rather than simply encouraging savings by increasing the after-tax rate of return. Because most low- and moderate-income taxpayers would never face a tax on capital income at the individual level, for these taxpayers, the proposal removes the relative tax advantage currently enjoyed by qualified retirement saving plans. To the extent that the removal of the relative tax advantage leads to lower participation rates in qualified retirement savings plans, the proposal could reduce the provision for retirement by certain low- and moderate-income taxpayers for whom institutional factors had been a primary determinant of retirement saving.”
(4) Income Value Added Tax and Reformed Income Tax with Social Security Revenue Replacement
Excerpt:
“To some extent existing pension plans and other tax favored savings plans increase retirement savings because of institutional factors – such as payroll deduction, withdrawal penalties, and persuasive advertising – rather than simply encouraging savings by increasing the after-tax rate of return. Because most low- and moderate-income taxpayers would never face a tax on capital income at the individual level, for these taxpayers, the proposal removes the relative tax advantage currently enjoyed by qualified retirement saving plans. To the extent that the removal of the relative tax advantage leads to lower participation rates in qualified retirement savings plans, the proposal could reduce the provision for retirement by certain low- and moderate-income taxpayers for whom institutional factors had been a primary determinant of retirement saving.”
(5) Reform the Current Income Tax
Excerpts:
“The current menu of retirement, education, and medical savings accounts would be consolidated into two programs, LSAs and RSAs. Contributions to these accounts would be taxed, but earnings would accumulate tax-free and distributions would not be included in income. Withdrawals from LSAs would be allowed at any time for any reason. Withdrawals from RSAs would be penalty-free beginning at age 58. Neither account would have required minimum distributions. All individuals, regardless of income or earnings would be eligible to contribution 45,000 a year to an LSA and $5,000 (or earnings, if less) to an RSA.”
“Various employer-based defined contribution plans, such as 401(k), 403(b), and 457 plans, would be consolidated, qualification rules would be simplified, and required minimum distributions would be simplified.”