That 401(k) Tax Break Shouldn’t Be Sacred

But if the idea is to actually reduce the tax deductions for retirement savings, not just shift them across time, it's maybe not so crazy. That's because the use-tax-deductions-to-get-Americans-to-save-for-retirement approach doesn't seem to be doing a good job of getting Americans to save for retirement. Why not? Here are some of the problems:

• The tax incentives don't have much effect. A 2013 study by Harvard's Raj Chetty and a bunch of other economists, most of them Danish, found that a 1999 reduction in the tax subsidy for retirement savings in Denmark had almost no impact on overall retirement savings. People who were saving before still saved afterwards, just not necessarily in a tax-sheltered account.
• They're expensive. The estimated "tax expenditure" on 401(k)s and other workplace defined contribution accounts adds up to $102 billion this year, according to Congress's Joint Committee on Taxation. By contrast, the earned income tax credit, the biggest benefit for the poor in the tax code, costs $73.4 billion.
• Most American workers don't have them. A recent Census Bureau survey based on tax data found that only 32% of American workers are saving anything in a workplace retirement savings account. In many cases, that's because their employers don't offer one — most private-sector employers don't.
• The benefits are skewed toward those with higher incomes. This is true of any tax deduction (as opposed to tax credits, such as the earned-income credit) because the higher your tax rate, the higher the savings from a deduction. Also, of course, people with higher incomes tend to have more spare money to put in retirement accounts.
• They're inefficient and often poorly managed. Investment returns have generally been lower for defined contribution plans such as 401(k)s than for traditional defined benefit pension plans, and administrative costs are higher. There are lots of other problems with pensions and how they're funded, but as professionally managed pooled investments, they have lots of advantages over individual accounts loaded up with mutual funds.
• They individualize risks that are better shared. Because some people die earlier than others, it costs a lot less per person to guarantee an adequate retirement income for 1,000 people than to do it for just yourself. There are ways around this, such as buying an annuity with one's retirement savings. But few people do that, and at present the 401(k) system isn't really set up to encourage it.

So what would be better than giving people a tax deduction for putting money in a 401(k)? Chetty and his co-authors argue that automatic contributions by employers are a much more effective way of encouraging savings. Maybe we should put in a tax subsidy for that. Or there's the bold plan unveiled last year by New School economics professor Teresa Ghilarducci and Blackstone President Tony James to replace the 401(k) with mandatory, professionally managed retirement savings accounts that are automatically converted to annuities at retirement.

Now that is definitely not going to be in this year's tax bill. Let us not dismiss the idea of shrinking that 401(k) deduction just yet, though. I'll admit that, as a heavy user of said deduction, the thought makes me cringe— and the fact that there are millions like me is why, in the end, I bet Congress will leave be. But there are far more millions of Americans who aren't getting any benefit from the current setup at all. Making it untouchable seems like a bad move.

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