How might low- and middle-income households be encouraged to save?
Expanding access to savings vehicles and scaling back deductions to provide greater incentives to low- and middle-income households could make a difference.
Low- and middle-income families receive significant income support through tax breaks, notably through refundable credits such as the earned income tax credit and the child tax credit. When it comes to building wealth, however, the tax code’s more than $400 billion in subsidies—incentives for everything from homeownership to health insurance to higher education—go mainly to high-income households.
Roughly 70 percent of the mortgage interest deduction and deductions for state and local property taxes, along with about two-thirds of subsidies for employer-based and individual retirement accounts, go to the top 20 percent of earners. That’s because these tax subsidies are structured as deductions and exclusions, which provide bigger subsidies to households in higher tax brackets. Further, lower-income households are less likely to have enough deductions to make it worthwhile to itemize on their tax returns, and itemization is required for claiming major homeownership tax breaks. Lower-income workers, particularly those in part-time or temporary employment, have less access and are less likely to participate in employer-based retirement plans.
At the same time, many low- and middle-income taxpayers simply do not participate in the regular and automatic saving vehicles through which much wealth accumulation occurs, such as paying off a mortgage and making regular deposits to retirement accounts.
A variety of changes would reduce the bias toward higher-income households by replacing existing subsidies with better-targeted incentives. Almost all these proposals favor some movement toward tax credits and scaling back deductions, and many use insights from behavioral economics to get more bang for a tax buck forgone.
Credits to encourage homeownership can take different forms. They can provide an up-front credit for first-time homebuyers of primary residences, similar to a temporary credit employed as a stimulus measure from 2008 to 2009. (An early version of this credit served as an interest-free loan to be paid back to the IRS.) Alternatively, homeowners could receive smaller annual credits proportional to their home equity, up to a designated maximum. Another approach is to provide a credit against property taxes paid on a home to defray a significant cost of homeownership. Reforms that reward building equity instead of subsidizing mortgage interest (which a badly designed credit could also do) would encourage actual saving instead of the acquisition of debt.
A saver’s credit is available to moderate-income taxpayers who contribute to qualified retirement plans. However, the credit is nonrefundable and phases out quickly at higher levels of income, making few people eligible for the maximum amount. Some economists have proposed expanding the credit and making it refundable, so that workers with no net income tax liability could claim it. More expansive proposals include reshaping the complicated pension landscape to simplify plans and increase access to employer-based retirement accounts with automatic enrollment. Contribution limits to tax-favored accounts would be lowered, and low- and moderate-income workers would instead receive government matches on their contributions. Any credits or matching employer contributions could not be accessed until retirement. Pension antidiscrimination rules could be revised to favor plans that support a larger percentage of full- and part-time employees.
Encourage savings and account ownership at tax time
Many low- and middle-income workers receive large refunds at tax time from refundable tax credits. A “saver’s bonus” could be offered to encourage taxpayers to save a portion of their refunds in qualified savings accounts. Taxpayers are already able to contribute to individual retirement accounts until the tax filing deadline and apply any deductions or saver’s credits against their tax year’s liability. Some tax preparers and tax preparation software remind taxpayers that they are able to do this and make clear how much tax they can save if they do. Tax time could also be used to link taxpayers to savings vehicles, such as children’s savings accounts or prepaid cards with savings features for taxpayers without bank accounts.
Butrica, Barbara A., Benjamin H. Harris, Pamela Perun, and C. Eugene Steuerle. 2014. “Flattening Tax Incentives for Retirement Saving.” Washington, DC: Urban-Brookings Tax Policy Center.
Eng, Amanda, Benjamin H. Harris, and C. Eugene Steuerle. 2013. “New Perspectives on Homeownership Tax Incentives.” Tax Notes. Washington, DC: Urban-Brookings Tax Policy Center.
Harris, Benjamin H., C. Eugene Steuerle, Signe-Mary McKernan, Caleb Quakenbush, and Caroline Ratcliffe. 2014. “Tax Subsidies for Asset Development: An Overview and Distributional Analysis.” Washington, DC: Urban-Brookings Tax Policy Center.
McKernan, Signe-Mary, Caroline Ratcliffe, C. Eugene Steuerle, Emma Kalish, and Caleb Quakenbush. 2015. “Nine Charts about Wealth Inequality in America.” Washington, DC: Urban Institute.
Perun, Pamela, and C. Eugene Steuerle. 2008. Why Not a ‘Super Simple’ Saving Plan for the United States? Washington, DC: Urban Institute.
Ratcliffe, Caroline, William J. Congdon, and Signe-Mary McKernan. 2014. “Prepaid Cards at Tax Time Could Help Those without Bank Accounts.” Washington, DC: Urban Institute.
Steuerle, C. Eugene, Benjamin H. Harris, Signe-Mary McKernan, Caleb Quakenbush, and Caroline Ratcliffe. 2014, “Who Benefits from Asset-Building Tax Subsidies?” Washington, DC: Urban Institute.