Chairman Johnson, Ranking Member Andrews and members of the Subcommittee, I am submitting this written statement in response to the Subcommittee’s request for additional views following its June 4, 2003 hearing on defined benefit pension plans. Among other issues, I have been asked to submit my views as to how Congress might expand pension coverage by making better use of the saver’s credit under section 25B of the Internal Revenue Code. That is the subject of this statement.
I. The Saver’s Credit
In 2001, Congress established a nonrefundable income tax credit for voluntary retirement savings contributions to 401(k) and other employer-sponsored retirement plans, and to IRAs (the “saver’s credit”). The saver’s credit provides what is in effect a government matching contribution for individuals’ contributions to 401(k)s, SIMPLE plans, IRAs and other plans—in the form of a tax credit of up to 50% of an individual’s contributions up to $2,000 per year. It applies to individuals whose adjusted gross income (AGI) does not exceed $50,000 a year (for those filing their federal income tax return jointly; $25,000 for single filers).
The saver’s credit is one of the most significant targeted initiatives ever enacted to promote tax-qualified retirement savings for moderate- and lower-income workers. This is important not only as a matter of relative need and equity. It is also important as a matter of efficiency in promoting national saving. Tax expenditures that are of use mainly to the affluent tend to be inefficient to the extent that they induce higher-income people simply to shift their other savings to tax-favored accounts. But contributions and saving incentives targeted to moderate- and lower-income workers tend to increase net long-term saving, thereby enhancing retirement security for those who need it most and advancing the goals of our tax-favored pension system in a responsible, cost-effective manner.
The saver’s credit was long in the making. It emerged as the end product of much larger-scale efforts to expand pension coverage during the late 1990s and 2000. The proposal was developed chiefly within the Treasury Department, with substantial involvement of private-sector stakeholders, including representatives of plan sponsors, the financial services industry (as providers to plans and IRA trustees and custodians), participants, pension professionals, and others. Its design was substantially influenced by comments from these stakeholders, and the proposal was revised in the House and Senate, before it was enacted on a bipartisan basis in EGTRRA (under the leadership of Senator Max Baucus, Ranking Member, and Senator Bill Roth, then Chairman, of the Senate Finance Committee, as well as Congressman Earl Pomeroy in the House).
The credit was designed to address the fact that more than 75 million workers and their spouses have no employer plan coverage, to help correct the top-heavy distribution of benefits in our current pension system, and to counteract what might be the central defect of our pension tax incentive structure: that the incentives—whether exclusions from income of contributions and earnings or tax deductions—are based mainly on the individual’s marginal income tax rate or tax bracket. Therefore, those who most need the additional retirement security—those in the lower tax brackets, especially workers who are in the zero income tax bracket but who pay payroll taxes—have the least to gain from contributing or from demanding employer pensions. Accordingly, participation in tax-qualified plans is far lower among moderate- and lower-income individuals.
A tax credit, especially if refundable, as the savers credit was originally designed to be, puts individuals in different tax brackets on a more equal footing. The saver’s tax credit is provided in addition to any other tax benefits generated by the retirement contributions (such as a tax deduction for a contribution to a traditional IRA).
The saver’s credit was also carefully designed to support and enhance the employer plan system, instead of competing with it. By in effect matching lower-income workers’ contributions to 401(k) and other plans—in addition to any matching contributions the employer might make under the plan—the saver’s credit encourages contributions by workers who might not otherwise save. This makes it easier for plans to pass the 401(k) nondiscrimination tests, which in turn increases the amount of tax-favored 401(k) contributions highly paid employees can make.