[PEN-L:34293] taxes/savings

["Ian Murray" <seamus2001@xxxxxxxxx>]

New Tax-Free Savings Plans Proposed
Retirement, Non-Retirement Accounts Would Shelter Earnings

By Jonathan Weisman
Washington Post Staff Writer
Saturday, February 1, 2003; Page A01


The Treasury Department formally unveiled a proposal yesterday to radically
reshape the way Americans save money, consolidating an array of tax-preferred
savings plans into three new accounts that would allow families to shelter the
earnings on tens of thousands of dollars a year from federal taxes.

In effect, the proposal -- combined with President Bush's plan to slash
taxation on investment dividends -- would make capital gains, interest and
dividends income tax-free for most Americans. That has been a goal of many tax
reformers for decades but has been dismissed politically as far too costly to
the Treasury and far too beneficial to the wealthy -- criticisms Democrats
raised again yesterday.

Under the plan, the Treasury would establish two new types of account,
lifetime savings accounts and retirement savings accounts, each of which would
have an annual contribution limit of $7,500 per person. Income limitations
that currently prevent many individuals from contributing to tax-free savings
plans would be eliminated.

In both types of account, after-tax contributions would be allowed to
accumulate interest, capital gains and dividends tax-free, and withdrawals
would also go untaxed. Lifetime savings accounts would work like existing
special-purpose tax-preferred savings accounts, except that the funds could be
withdrawn for any purpose. Existing medical saving accounts and education
accounts would not be eliminated, but savers would be encouraged to convert
them into lifetime savings accounts.

Contributors to the new retirement savings accounts would have to have earned
income, and they could begin withdrawing funds at age 58. Traditional IRAs, in
which contributions are tax-deductible for lower- and middle-income workers,
could be converted to the new retirement savings accounts or left in place.
But contributions could no longer be made to those accounts.

The Treasury also proposed setting up a new employment retirement savings
account, which would work like existing 401(k) plans that take pretax
contributions and like the retirement savings accounts that take after-tax
contributions but allow earnings to accumulate tax-free. Contributions would
be capped at $12,000 per person, but the cap would rise to $15,000 by 2006.

In effect, a family of four could shield up to $45,000 a year from investment
and interest taxation in the lifetime and retirement savings plans, plus
$30,000 in the employer accounts by 2006 for a total of $75,000 a year. A
couple contributing $30,000 a year and earning a 7 percent return would
shelter $716,000 in investment earnings over 20 years, according to a
Democratic Ways and Means Committee analysis.

Treasury officials refused to say how much the proposal would cost the
government. In the short run, it would probably bring in more tax dollars as
people shifted money from traditional IRAs into the new accounts and would
have to pay taxes on the withdrawals.

For the Bush administration, that could prove useful. The 2004 budget, which
will be released on Monday, will only project the cost of new initiatives for
five years, rather than the customary 10. That means the new savings proposal
could appear to cost nothing in the budget, or even could be a revenue
booster.

In the long run, the cost could be enormous, congressional Republican and
Democratic aides said. Taxes from capital gains, dividends and interest total
roughly $160 billion a year, according to calculations by Citizens for Tax
Justice, a labor-funded group. The loss of much of that revenue would begin
showing up just when the baby boom generation is straining Social Security and
Medicare.

Democrats said the proposal is transparently aimed at the rich, who will
simply shift existing savings into the new tax-free accounts.

"The president accuses us of engaging in class warfare. Then, at the same time
he asks thousands of mid- to lower-income reservists and National Guardsmen to
sacrifice by being away from their families and jobs for extended periods of
time, he proposes yet another big tax break for the wealthy," said Rep.
Charles B. Rangel (N.Y.), the ranking Democrat on the House Ways and Means
Committee.

"It's breathtaking," said Sen. Kent Conrad (N.D.), the ranking Democrat on the
Senate Budget Committee. "These guys really don't care about the future at
all."

Pamela Olson, assistant Treasury secretary for tax policy, defended the
proposal. "You know what we can't afford? We can't afford having people not
saving for the future," she said.

Olson said the plan would encourage middle- and lower-income workers to save,
by removing guesswork and complexity from existing plans. Such workers have
resisted putting savings into accounts limited to medical expenses, education
costs and retirement funding because of fears that they would need the money
for other purposes, she said. By removing withdrawal restrictions, the savings
plan will boost savings.

"There's still some distance to go" to a tax system that taxes consumption but
leaves investment income untouched, she added. But in moving toward that end,
the stated goal of many administration economists in their academic writings
before joining the White House, administration officials are clearly moving to
tax reforms once considered radical.

"One of the fundamental elements of tax reform is to reduce or eliminate taxes
on savings," said Mark Bloomfield, president of the business-backed American
Council for Capital Formation. "This is fundamental tax reform."

Democrats scoffed at the administration notion that middle-income workers
would have the savings to contribute. Recent research suggests that only
between 2.5 and 5 percent of Americans currently are constrained by the $3,000
limit on existing individual retirement accounts and the $12,000 limit on
401(k) plans, said Peter Orzsag, a Brookings Institution economist.

The General Accounting Office recently concluded that raising contribution
limits on 401(k) plans directly benefits only 3 percent of participants, and
that 84 percent of those benefiting are earning more than $75,000.

Senate Budget Committee Chairman Don Nickles (R-Okla.) signaled some
skepticism when he said he favors tax reform measures that tax all kinds of
income once and only once. He acknowledged that the new savings plans could
exempt large amounts of income from any taxation at all.