The alarmist financial “News” voices are up in arms screaming that “the government is going to eliminate 401K accounts.” Aside from the fact that this is political suicide for anyone who pushes it, that is not what the uproar is really based on. This story line can be traced to Daniel de Vise at USA today who is using a new paper from Biggs and Munnell (2024) as source material to lay out the case for eliminating the tax shelter of 401K and similar accounts. (https://www.usatoday.com/story/money/2024/02/08/case-against-401k-ira-retirement-tax-breaks/72506433007/)
The argument stated a bit more calmly is this. The tax treatment of retirement account contributions goes largely to the relatively wealthy. Roughly 59% of the benefit goes to the top 20% of earners. This may sound like it is highly skewed, but I would beg to differ. The average income of the top quintile is about 4 times larger than the average earnings of all Americans. The mean income for the top quintile is about $270,000, while the mean for the middle quintile is about $70,000. It would be almost impossible for most of the tax benefit to NOT go to this group. In fact, the limits on how much can be added to retirement accounts is the main reason that this gap is not much higher. If top earners could save as much as they wanted in such accounts, it is easy to see how they would reap 90% of the benefit.
However, this discrepancy is not really Bigg’s and Munnell’s chief issue. Their larger point is that the top quintile receiving most of the benefit are precisely the people who need it the least. They argue that if this benefit were not there, this group would save for retirement anyway. They would simply do it in other accounts or by purchasing other assets. When your marginal tax rate is lower, the benefit from the tax deferral is also lower. Thus, the tax break provides very little incentive for lower wage earners to save at all. These earners would get a much larger benefit if the tax revenue lost from providing the benefit to the top quintile could be captured and then used to increase the social security trust fund. This would be a particularly effective use of finds because SSI benefits make up a much larger portion of income in retirement for the bottom quintile of earners.
This is a great idea on paper. However, it suffers from at least one fatal flaw. The paper argues that the government could drop the tax break on 401K contributions, take the increased revenue, and use it to shore up social security. I don’t know about you, but I am willing to bet all the money I have that if the tax break were eliminated, the government would use the extra revenue to justify cutting taxes on that same top quintile to “stimulate the economy.”
This idea reminds me very much of the way that states produce advertising to explain how new lottery revenue will be spent on education, when the fact of the matter is that the extra money almost NEVER increases spending on education at all. As the Washington Post reported recently,
“Instead of using the money as additional funding, legislatures have used the lottery money to pay for the education budget and spent the money that would have been used had there been no lottery cash on other things.”
Washington Post
Money is fungible – meaning that once I have control over it, I can put it into any account that I wish. When legislators get additional funds and the choice is between spending it on children or cutting their own taxes, its amazing how it always seems to end up going the same way.
However, I do feel that the paper raises an intriguing argument. Taxes will be raised to fund social security one way or another. This proposal is a clever way to raise taxes while claiming that it “taxes the rich” to fund the rest of us. Pardon my cynicism but I hold severe doubts about the idea that rich congressmen and senators will all get together to raise taxes on themselves to save the rest of us. It ain’t going to happen.
Financial Media’s Track Record
Before we get too far ahead of ourselves in our reaction to the doomsday scenario of the day, let me remind you of a classic article from Barry Ritholtz in 1979 in BusinessWeek – “The Death of Equities.” As this classic story explains,
“At least 7 million shareholders have defected from the stock market since 1970, leaving equities more than ever the province of giant institutional investors. And now the institutions have been given the go-ahead to shift more of their money from stocks – and bonds – into other investments. If the institutions who control the bulk of the nation’s wealth, now withdraw billions from both the stock and bond markets, the implications for the US economy could not be worse.”
(ritholz.com/1979/the-death-of-equities/)
Sound familiar? No one wants stocks. We all want “alternative” investments. No one will buy stocks and bonds in this “modern age.” Perhaps you thought all of the current noise about alternative investments and other speculations like crypto-currencies was something new.
Consider what the S&P 500 has done since the end of 1979. If you invested 100 in the S&P 500 at the beginning of 1980, you would have about $12,097.47 at the end of 2023, assuming you reinvested all dividends. This is a return on investment of 11,998.47%, or about 11.61% per year. This beats inflation over the same period by 8.32% per year.
The total message is this. Doom and gloom scenarios are created to generate clicks. One day it’s the “End of equities.” The next day its “The end of the 401K!” This pattern isn’t new. Yes, the vocabulary evolves a bit. No one used the phrase “alternative investments” in 1979, but the message is exactly the same as it ever was. And your response should be the same as well. I will invest as much as I can afford in equities, as early as possible, and leave it there as long as possible. The rest of the noise will take care of itself.
