Recent comments in Smart Money’s Encore blog—“How much do 401(k) Plans Cost the Government,” (1.25.12) incorrectly characterizes estimates of retirement savings tax expenditures made in “Retirement Savings and Tax Expenditure Estimates” a research paper prepared for the American Society of Pension Professionals & Actuaries (ASPPA). The Smart Money post focuses on the magnitude of the tax expenditure estimates and strays from the main arguments in the paper.
The primary purpose of the ASPPA research paper is to highlight the problems with cash flow accounting for retirement saving tax expenditures. Further, the paper discusses the appropriate measure of the tax expenditure benefit of defined contribution retirement plans. The empirical estimates demonstrate the variability in tax expenditure estimates, depending upon the underlying assumptions.
The author of the blog incorrectly characterizes certain assumptions about the empirical work supporting the ASPPA publication. It is important to note that the blog author did not contact the authors of the paper prior to posting the comments; therefore, it is difficult to determine the source for these assumptions.
That said, any tax expenditure estimate is just that – an estimate. Estimates are sensitive to a variety of assumptions (e.g. current and future tax rates for defined contribution participants, rates of return on those contributions, the deferral periods, and withdrawal patterns) and therefore, may vary widely even when starting with the same baseline deferrals. Thus, arguing in absolutes, when discussing tax expenditures estimates for pension benefits, is misguided.
Instead it is important to focus on the primary point of the paper – cash flow estimates for pension tax expenditures overstate these tax expenditures relative to other tax provisions:
• Problems with Cash Flow Accounting – Each year the staffs of the Congressional Joint Committee on Taxation (JCT) and the Treasury Department’s Office of Tax Analysis (OTA) publish estimates of Federal tax expenditures. Because people often consider tax expenditures (1) as representing the cost of loopholes in the Federal income tax system, these tax expenditure estimates generate considerable attention. Policymakers use tax expenditure estimates to identify possible sources of increased revenues, often targeting the largest tax expenditures as possible sources of revenue raising proposals.
In the case of retirement savings provisions, the current cash-flow method for calculating tax expenditures measures the sum of the taxes that would otherwise be paid on retirement savings contributions made during the year and the tax-exempt earnings on all existing retirement savings plans accrued during the year minus taxes paid on all withdrawals from retirement savings that occur during the year. This cash-flow measure overstates the value of retirement savings provisions in absolute terms. As the Administration states in its annual budget, “these [cash-based] estimates do not accurately reflect the true economic cost of” providing deferral of tax. This overstates the value of the tax expenditure relative to provisions that provide a current deduction, exclusion, or credit.(2)
• Appropriate Measure of Pension Tax Expenditures – The cash flow method fails to measure the actual tax benefits of retirement savings contributions and as a result, distorts the size of the retirement saving tax expenditures relative to other tax expenditures.
• Retirement savings provisions create two tax benefits – The primary benefit of tax-exempt earnings on retirement savings and a secondary benefit if taxpayers face lower marginal tax rates when they withdraw retirement savings than the tax rates they faced when contributing to retirement savings. Measuring the two tax benefits on a present value basis for contributions made during a year provides a fair comparison to other tax expenditure estimates.
Estimates of retirement saving tax expenditures are sensitive to a number of assumptions and these assumptions can result in a wide range of estimates. Nevertheless, the fundamental point is accurate – a cash flow estimate of the tax expenditure results in the material overstatement of retirement saving tax expenditures relative to other types of tax expenditures.
 The JCT submits a report containing these estimates to the House Committees on Ways and Means and Budget and the Senate Committees on Finance and Budget. The OTA includes estimates of tax expenditures in the President’s annual budget submission to the Congress.
 Theoretically, there is a question as to whether retirement savings provisions should be characterized as tax expenditures at all.
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