The Bush Tax Cuts: How did they affect retirement saving?
The Bush tax cuts did little to change saving incentives for low- and middle-income households, focusing instead on providing tax cuts to wealthier households by increasing annual maximum contribution limits to Individual Retirement Accounts (IRAs) and 401(k)s. This reform benefited only the small proportion of households with sufficient wealth to contribute more than the pre-tax cut maximum. Since many of the provisions to encourage retirement saving applied primarily to high-income households whose pension contributions are likely to represent little new saving, the Bush tax cuts were more effective at shifting assets from taxable to tax-preferred accounts than at raising saving. They thus cost the Treasury revenue while doing little to achieve the intended objective.
- The changes in maximum contribution limits to 401(k)s and IRAs were aimed at high-income taxpayers. In 2001 workers were allowed to deposit a maximum of $10,500 in a 401(k) account. The 2001 tax legislation (known by its legislative acronym EGTRRA) raised the maximum gradually to $15,000 by 2006. These higher limits benefit only those who would have saved the maximum anyway under pre-EGTRRA law and wished to save more. Similarly, EGTRRA more than doubled the amount that a taxpayer and spouse may contribute each year to an IRA. The vast majority of Americans did not make the maximum contributions to their 401(k)s or IRAs even under the older limits, and therefore they benefit little if at all from the raised limits.
- A 2000 study by an economist at the Department of the Treasury found that only 4 percent of all taxpayers who were eligible to deduct their contribution to traditional IRAs in 1995 made what was then the maximum allowable contribution of $2,000. The percentage of the population affected by the 401(k) changes was likewise very small. The General Accounting Office (now called the Government Accountability Office) concluded that the increase in the contribution limit for 401(k)s directly benefits fewer than 3 percent of participants. Other recent studies have reached similar conclusions.
- The households who were constrained by the previous limits are disproportionately high-income households, and a variety of empirical evidence shows that these households are likely to respond to the higher limits by shifting other saving into 401(k)s and IRAs to benefit from the tax advantage. In other words, the change is likely to represent an expensive tax subsidy for saving that high-income households would have done in any case. Contributions to tax-advantaged retirement accounts that are financed by shifting other assets into the accounts do not increase private saving. Little new saving is thus likely to result from these retirement saving provisions.