Monday, March 3, 2014

Some Good, Much Questionable in Camp’s Tax Reform Proposal

Much of the country may be oblivious to the tax reform proposal that House Ways and Means Committee Chairman David Camp released on February 27th.  But for some in the financial, tax and retirement sectors, reading this legislative draft was like making contact with a cattle prod.  Despite advance warning of what Camp’s tax reform might look like, it was still a jolt to actually see in print the proposed dismantling of key elements of the retirement saving infrastructure as we know it.

Disappointing, too, that while billed as pursuing the noble aim of putting the nation’s budget house in order, at the same time making taxation simpler for us all, this tax reform proposal takes advantage of a too frequent congressional practice that offers “solutions” that look good in the short term but often come at the expense of budgetary solvency in the long run.

First, I might point out that the tax reform proposal offers a few positive things.  The SIMPLE 401(k) plan, which the tax reform proposes ending, has seen very little adoption from its beginning in 1997, offering greater complexity and less generous benefits than the  more popular SIMPLE  IRA plan.  Medical Savings Accounts, or MSAs, really serve no purpose now that we have Health Savings Accounts, and most would not mourn their disappearance, either.   Some simplification of options is a good thing.

Allowing an extended time period to roll over an outstanding plan loan that is offset when a participant retires would help preserve retirement assets; a win-win, from my perspective.  Permitting a plan participant to continue making elective deferrals after they have taken a hardship distribution is another positive.  The current law’s requirement to suspend deferrals for six months penalizes the participant who wants to save and eliminating this requirement is a step in the right direction. 

There are some reasonable arguments, pro and con, about limiting the length of retirement plan and IRA payouts to nonspouse beneficiaries, or whether to retain the early distribution penalty exceptions for first-time home buyers and for higher education expenses.  Retirement assets are, after all, for retirement, some might say, while others would say that the ability to access funds for these purposes encourages savings and that providing beneficiaries with extended payout options is a useful planning tool.  Reasonable minds may differ.

Other elements of Rep. Camp’s proposal are, I believe, neither positive  nor open to conjecture.  Eliminating Traditional IRA contributions, and forcing IRA, 401(k), 403(b) and 457(b) savers to make more Roth contributions, is a gimmick intended to capture more tax revenue in the short term, in order to pay for Rep. Camp’s other reforms within the 10-year period in which this proposal will be measured.  I’m not saying that Roth contributions are not a good thing, as they clearly are in the right circumstances.  Rather, I contend that eliminating tax deferrals and Traditional IRA contributions is not. 

Understandably omitted from this committee’s summary is the fact that guiding so many contributions into Roth IRAs and Roth accounts in employer plans will result in less tax revenue in the future.  For when these accounts later disgorge qualified distributions, all earnings will be tax-free.  The Roth features in IRAs and employer plans are valuable, but I doubt that the previous Congresses that created them contemplated that tax-free earnings would ever become the rule rather than the exception.  Pre-tax contributions do not result in lost revenue, but simply federal tax revenue collected at a later time, something that too many congressmen and senators either do not understand, or refuse to admit.  Chairman Camp’s tax reform proposal is leading us toward the possibility of revenue shortfalls in the future, leaving it to a later Congress to raise taxes, or cut other expenditures, to correct such shortfalls.

Apart from this Roth-centric proposal’s negative effects on future federal tax revenues, eliminating pre-tax IRA contributions and restricting employer plan pre-tax saving would be detrimental to many taxpayers, who would no longer be able to make reasonable tax planning decisions with the options available to them today.  Contrary to what Rep. Camp may believe, many people would save less, if at all, if they did not receive a current-year tax deduction or exclusion for those savings. 

Though there are numerous other questionable provisions I might cite, I will limit myself to one more.  Perhaps the most indefensible of Rep. Camp’s tax reform elements would lock down IRA and employer plan contribution and testing limits, without cost-of-living adjustments, for a full decade.  How, at a time when Americans are being told they are not saving enough for retirement, when we are seeing presidential orders issued to broaden retirement saving options even further, can we propose to hold contribution limits to present levels for 10 years?  How many workers would be willing to agree to no wage or salary increases for 10 years?  How many senators and congressmen?  Can we count on a 10-year period with no inflation?  It is another example of sleight-of-hand to make the federal budget appear balanced for that period of time.

I admire Rep. Camp for taking on the daunting task of tax reform and balancing the federal budget.  I also know that many Americans will have to make some sacrifices toward that end.  But I’m confident that there are special interests and more dubious tax expenditures – actual tax expenditures – that are more worthy of targeting than American workers trying to accumulate a nest egg for a reasonably secure retirement.