Measures do not increase rate of savings as intended

December 14, 2003

WASHINGTON -- If you save money, the government will reward you with tax breaks. That's such a popular idea that Congress keeps finding more and more reasons to offer it.

First, lawmakers offered tax benefits for retirement saving. Then came more breaks for people who save money for health costs, dependent care and college.

But an escalation of tax-advantaged savings accounts in the new Medicare bill, plus the Bush administration's plan to create a new variety next year, are raising questions about their fairness to low-income people and the potential of such tax breaks to expand the federal deficit.

Supporters say tax incentives encourage saving, which creates the pools of capital that businesses need to buy equipment and hire workers.

But critics say they represent one more tax break for the wealthy, pointing to signs that many households can't afford to put aside significant sums.

For example, about two-thirds of households have savings of less than $10,000. And while the country has more than 70 million children under the age of 18, fewer than 3 million "529" savings accounts for college tuition have been opened, according to Cerulli Associates, a Boston-based research firm.

Studies also show that most of the benefits of tax-advantaged retirement accounts go to the highest wage earners. The poorest 40 percent of households have only about 5 percent of all the assets in these accounts, while the richest 10 percent have more than half, according to a Harvard University study.

And while the tax breaks help relatively few Americans, they reduce revenues that could shrink the federal deficit or fund programs that help average- and lower-income households, the critics argue.

As the accounts proliferate, "We're digging a deeper and deeper hole in the deficit -- one shovelful at a time," said William Gale, an economist at the Brookings Institution, a liberal-leaning research group in Washington.

The White House estimated in President Bush's latest budget that tax breaks for retirement would cost the Treasury more than $415 billion between 2004 and 2008.

The expansion of tax breaks for savers also reduces revenues for states, which typically base their income taxes on federal taxable income.

Gale also disputes the basic assumption that the tax breaks encourage savings. Real savings, he said, come when people decide to temporarily reduce their standard of living to put money away for the future. Instead, tax-advantaged savings accounts simply encourage affluent people to move cash into tax shelters, he said.

The accounts "reward people for placing assets in certain investments, but do they serve to raise the level of savings? No, largely they don't," he said. "The money just gets shifted."

Indeed, despite the proliferation of tax-advantaged accounts, Americans have been saving less. In 1982, when Congress created individual retirement accounts, or IRAs, which allowed wage-earners to shelter up to $2,000 annually, the personal savings rate was 10.9 percent. By 2002, the rate was down to 2.3 percent, according to the Commerce Department.

In a review of the subject, the Congressional Budget Office concluded that "empirical studies have not been able to resolve the uncertainty about how IRAs affect saving."

But conservatives say the accounts do boost savings.

"When you tax something, you get less of it," said Stephen Moore, president of the Club for Growth, an influential group that lobbies for tax cuts. If Congress reduces taxes on saving, "then you'll get more of it," he said.