The Administration’s New Tax-Free Saving Proposals: A Preliminary Analysis

Leonard E. Burman,
Leonard E. Burman Institute Fellow - The Urban Institute, Co-founder - Urban-Brookings Tax Policy Center
Peter R. Orszag, and
Peter R. Orszag Vice Chairman of Investment Banking, Managing Director, and Global Co-Head of Healthcare - Lazard
William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

February 23, 2003

In its fiscal year 2004 budget, the Bush Administration proposes to create a new set of tax-preferred accounts that would expand opportunities and consolidate rules for tax-advantaged saving. The initial reaction to the proposal was not particularly positive. Less than a week after the budget was released, Congressional Republicans dismissed the plan. The White House reportedly reacted by blaming the idea on recently departed Treasury Secretary Paul O?Neill (Van der Hei 2003). Congressional leaders, however, later softened their initial remarks and indicated that some elements of the proposal might be included in legislation aimed at expanding access to pensions (Rojas 2003).

Despite its uncertain prospects, the proposal is worth considering in detail because it would dramatically alter the tax treatment of saving, via the creation of Lifetime Saving Accounts (LSAs), individual Retirement Saving Accounts (RSAs) and Employer Retirement Saving Accounts (ERSAs). Some elements of the proposal?in particular, some of the simplifications?might form the basis of a useful pension reform package. Other elements are troubling because they would be regressive, could reduce saving among the most vulnerable populations, and would exacerbate the already bleak long-term budget outlook. In this paper, we provide a preliminary analysis of selected aspects of the proposal, with the following principal conclusions: (included in attached paper.)

Section II describes the proposed changes. Section III examines the potential for tax simplification. Section IV briefly describes what we view as the major structural changes in saving rules and the likely set of relevant behavioral effects to consider. The following three sections examine the effects on revenue, the distribution of benefits from the tax cut, and private and national saving. Section VIII discusses some broader aspects of the plan, including its interaction with the President?s proposal to cut dividend and capital gains taxes and with proposals for fundamental tax reform. Section IX closes with comments on reform of tax rules for pensions and other saving.