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Overhauling the 401(k) System

During the week of October 6th, Theresa Ghilarducci, professor of economic-policy analysis at the New School for Social Research in New York testified before the House Education and Labor Committee chaired by Rep. George Miller, D-California and the House Ways and Means Committee’s Subcommittee on Income Security and Family Support chaired by Rep. Jim McDermott, D-Washington. Components of the plan include the following:

• All workers would receive a $600 annual inflation-adjusted subsidy from the U.S, government but would be required to invest 5 percent of their pay into a guaranteed retirement account administered by the Social Security Administration. This money would be invested in special government bonds that would accrue 3 percent per year. [PerotCharts question: Does this sound vaguely similar to the current Social Security Trust Fund?]
• The current system of providing tax breaks on 401(k) contributions and earnings would be eliminated.
• “I want to stop the federal subsidy of 401(k)s” Ghilarducci said in an interview. “401(k)s can continue to exist, but they won’t have the benefit of the subsidy of the tax break.” [PerotCharts note: We already have these types of accounts; they’re called brokerage accounts.]
• To make the plan more palatable, Ms. Ghilarducci offered an incentive, “Short term I propose…that Congress allow workers to swap out their 401(k) assets, perhaps at August level for a guaranteed retirement account.” [PerotCharts note: The idea here is to induce holders of 401(k) plans to turn over their plan assets to the government in exchange for restoring the balance in their 401(k) plans prior to the stock market collapse in September and October.]
• The plan would allow workers to pass on only half of their account balances to their heirs; presumably the government would keep the remaining half. [Currently, 401(k) balances are fully inheritable.]

Observations by PerotCharts.com:

• Many people contribute to their 401(k) plans because their employers match their contributions. Eliminating the tax break for 401(k)s would make the matching portion taxable to the recipient and subject to additional FICA taxes payable by both the employer and the employee.
• Eliminating tax breaks for 401(k) plans pushes individuals into higher tax brackets even though they have no additional disposable income.
• Apparently, there was no mention as to the rate at which the government would pay your money back to you when you reach retirement age.
• Although the chairman of the House Education and Labor Committee stopped short of endorsing the plan, it was reported that he was clearly against continuing tax breaks for 401(k)s as they currently exist.
• No mention was made of the fact that, under the proposed plan, the government would need to liquidate the stock portfolios of the former 401(k) holders. Neither was it explained how the market could absorb $3 trillion of securities currently held in 401(k) plans.
• There is no indication that the new administration favors this proposal. It is in discussion stages of the two committees mentioned above.

This chart combines the data from the Summary of Income Taxes Paid and the Summary of Income Reported charts to illustrate the progressive structure of the federal income tax system, as seen in the percentages shown in the center column. A relatively small proportion of the U.S. population pays a disproportionately large percentage of federal income taxes. For example, in 2005 the top 10% of taxpayers paid 69.7% of the total income taxes collected by the federal government.

This chart reformats the data from the Share of Income Taxes Paid chart to produce this summary of income taxes paid by individuals in 2005. For example, there were more than 33 million taxpayers who earned between $30,588 and $61,055, and they comprise the category of taxpayers who earned between 50% and 75% of income in 2005. This group paid $105 billion of income taxes, or 11.2% of the total income taxes paid in 2005.

The IRS determines the total amount of income tax paid by taxpayers within the various percentiles each year ($935 billion for 2005). The chart indicates, for example, that the top 50% of taxpayers paid almost 97% of federal income taxes for the year 2005.

This chart reformats the data from the Federal Income Tax Return Categories and Share of Income Earned charts to produce this summary of income reported by individuals in 2005. For example, there were more than 33 million taxpayers who earned between $30,588 and $61,055, and they comprise the category of taxpayers who earned between 50% and 75% of income in 2005. The income of this group totaled $1.4 trillion, or 18.8% of the total reported in 2005.

The IRS determines the total amount of income reported by taxpayers within the various percentiles each year ($7.7 trillion for 2005). The chart indicates, for example, that the top 50% of taxpayers reported over 87% of total income for the year.

For purposes of analyzing income tax data, the Internal Revenue Service uses the percentile categories shown in the chart (Top 1%, Top 5%…etc.) A total of 132, 730,734 tax returns were filed by individuals in 2005. The IRS analyzes the statistics to determine income categories. For example, the chart indicates that the top 25% of tax returns (33.2 million) filed in 2005 reported income of at least $61,055.

Taxation is a topic of never-ending debate in the United States. How the tax burden should be distributed goes to the core of domestic policy. The subject is explored in greater depth in the Taxation section of this web site.

Ultimately, the size of the economy, called Gross Domestic Product (or GDP) is an absolute limit on the amount of taxes that you can collect. Growth in tax collections cannot exceed growth in the economy for very long. In fact, this chart shows that tax collections, as a percentage of GDP, have remained relatively constant for many years.

In 1980 and 2007, the government collected $571 billion and $2.57 trillion in taxes and other receipts, respectively. Dividing these amounts by the GDPs for those years ($2.79 trillion and $13.67 trillion) yields percentages of 18.9% and 18.8%, respectively. For the past 28 years, tax collections by the federal government have fluctuated within a narrow 5% range, with a high of 20.9% in 2000 and a low of 16.3% in 2004. The average tax collection rate over the 28-year period has been 18.4% of GDP.

In Washington, D.C. the term is revenues; everywhere else, they’re known as taxes. In 2007, the government collected $2.568 trillion from taxpayers, or $162 billion less than it spent during the same year. Unlike spending, revenues have not risen every year for the past 40 years. There was a very small decrease in 1983 during a phase-in of tax rate cuts. Revenues dropped considerably as a result of tax rate cuts in 2001 and again in 2003. However, in the last four years total tax collections have risen at the fastest pace in the past 40 years—an average of 9.5% per year.