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Brett Arends’s ROI: How our retirement system shortchanges the middle class


America has a vast and elaborate system of public policies supposedly designed to help us all save for retirement and avoid the catastrophe of a penurious and poverty-stricken old age.

But does this system end up shortchanging the middle class that is the backbone of the country and the economy? That’s the accusation of a new report from the National Institute for Retirement Security, a nonpartisan think-tank. It’s hard to argue they’re wrong.

Actually, they may not even go far enough — but more on that in a moment.

“The middle class is left behind by the retirement savings system in key ways,” report authors Tyler Bond, the NIRS research manager, and Dan Doonan, the executive director. “Social Security replacement rates are too low for middle-class families to maintain their standard of living in retirement, but many middle-class households don’t reach the level of income and savings needed to truly benefit from the tax incentives for individual savings. This means the middle class too often is missing out in terms of benefiting from various retirement savings programs.”
In other words we have a progressive Social Security system specifically designed to help the lowest earners and a tax break system designed to help the highest earners.

Spot the group that’s missing.

Social Security is essentially an insurance program designed to minimize absolute poverty in old age. So it is structured in a clearly progressive way. The less you earn, the higher the percentage of your income it will replace. As the NIRS points out, those earning low amounts may get benefits equal to two-thirds or more of their working-age income. Meanwhile those in higher income groups may get 30% or less.

Meanwhile the tax breaks for retirement savings, for example through deductions for contributions to 401(k) plans and IRAs, benefit high earners. A couple making several hundred thousand dollars a year is likely to be paying a top federal tax bracket of 32%, 35% or even 37%. So deducting contributions saves them some money. But according to the IRS more than 70% of households pay a top rate of 12% or less. So the deduction, while welcome, isn’t huge.

The tax breaks on all these plans are expected to average about $290 billion a year over the next decade, federal data report. Half the benefits go to families in the top 10% of incomes, NIRS estimates.

It’s not just about income levels and tax rates, either. Lower-paid workers, especially those who are working part time, are less likely to be offered participation in a 401(k) plan at all. 

Meanwhile the so-called “Saver’s Credit,” allegedly designed to help the working poor save for retirement, is so badly designed that if you were a conspiracy theorist you might think it was deliberate. 

Such as: You can’t claim it using the 1040-EZ tax form — which, as NIRS points out, is the form used by many of the people who qualify for it. It is nonrefundable, so if you don’t owe taxes you won’t get a benefit even if you saved for retirement during the year. The maximum value is $1,000. It is so obscure that less than half of people earning under $50,000 a year even know about it.

The Savers Credit seems designed for working poor people who nonetheless owe taxes and hire an accountant to do their taxes. 

But the NIRS indictment of our retirement system hardly goes far enough. For instance Social Security would be much better funded if it were invested in stocks, like every other pension fund on the planet, instead of U.S. government bonds.

And despite the repeated references to high earners, they miss the gigantic gaping hole in most discussions about the U.S. tax system. It’s the billionaires, stupid.

Complain all you like about tax breaks for people making $500,000 a year, they’re still paying 37% marginal federal taxes, plus state, city and so on. The real problem is the people making $500 million a year, or more, whose marginal tax rate is effectively 0%. A billionaire making their money through wealth — such as direct stock ownership, or by running a private equity or hedge funds — needs to pay little if any tax. They can borrow against their untaxed fortune, tax-free. Or they can use the “carried interest” loophole on their funds.

But mention the idea of a simple, flat tax on wealth or assets and you’ll be greeted with hysterical complaints that you want to tax “wealth creators.” What does that make the rest of us?

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