Personal saving, the setting aside of resources today to get benefits in the future, is taxed in a variety of ways in the United States. Ordinary income tax treatment taxes income when first earned, and, if saved, taxes the returns on the saving (the reward one “buys” by saving). By contrast, income used for immediate consumption is taxed only once by the income tax; the income tax does not fall again on what one buys with the after-tax income. This second layer of tax on the rewards for saving favors immediate consumption over delayed consumption.
The tax treatment of retirement accounts, however, removes this bias for a limited amount of personal saving. Neutrality is achieved in one of two ways: defer tax on the saving and tax all returns of principal and earnings, or tax the amount saved up front and exempt all returns from additional tax. Either way, saving in retirement systems and consumption face the same lifetime tax burden, in present value. This neutrality is limited, though, by numerous rules and restrictions that govern retirement accounts, making the tax structure of long-term savings complex and biased.
Congress should consider reforms to the complicated structure of long-term saving vehicles. Discriminatory taxes on capital income discourage saving and slow capital formation, lowering the growth of employment, wages, and GDP. Removing contribution and age limitations and eliminating withdrawal penalties for tax-neutral savings accounts would make the tax code more conducive to personal saving and would improve long-term growth.View Article