The Case for Using Subsidies for Retirement Plans to Fix Social Security

Introduction 

The U.S. Treasury estimates that the tax preference for employer-sponsored retirement plans and IRAs reduced federal income taxes by about $185-$189 billion in 2020, equal to about 0.9 percent of gross domestic product. Other estimates of the costs are even larger. However, the best evidence suggests that the federal tax preferences do little to increase retirement saving. While this dismal assessment may sound like bad news, it actually offers policymakers an opportunity to strengthen the nation’s retirement income system. Revenues saved from repealing the retirement saving tax preferences could be reallocated to address the majority of Social Security’s long-term funding gap, strengthening a program that is crucial for the retirement security of older Americans while bypassing a decades-old debate about raising taxes or reducing Social Security benefits. 

This study reassesses the favorable tax treatment of retirement plans and explores an opportunity to use taxpayer resources more productively. The first section addresses the revenue loss, considering the impact not only on the personal income tax but also the payroll tax, concluding that the revenues forgone are significant no matter how they are measured. The second section examines who receives these tax expenditures, concluding that the bulk goes to high earners. The third section explores what taxpayers get for their money, finding that the favorable tax treatment has failed to significantly increase national saving. Given the enormous federal deficits and overwhelming demands on the federal budget, the fourth section explores ways to recoup all or some of the tax subsidies currently accorded retirement saving. The fifth section explores how the savings from eliminating or reducing the tax subsidies could be applied to Social Security. 

The final section concludes that it makes little sense to throw more and more taxpayer money at employer plans and IRAs. In fact, the case is strong for eliminating the current tax expenditures on retirement plans, and using the increase in tax revenues to address Social Security’s long-term financing shortfall.