Proposed Savings Accounts: Economic and Budgetary Effects

Proposed Savings Accounts: Economic and Budgetary Effects

Order Code RL32228
Proposed Savings Accounts:
Economic and Budgetary Effects
Updated March 7, 2007
Jane G. Gravelle
Senior Specialist in Economic Policy
Government and Finance Division
Maxim Shvedov
Analyst in Public Sector Economics
Government and Finance Division

Proposed Savings Accounts:
Economic and Budgetary Effects
Summary
In various budget proposals, the President proposed to substitute for the current
system of tax-favored individual retirement accounts (IRAs) two new accounts: life-
time savings accounts (LSAs) and retirement savings accounts (RSAs). Senator
Craig Thomas of the Finance Committee and Representative Sam Johnson of the
Ways and Means Committee have introduced identical bills (S. 545/H.R. 1163 and
S. 546/H.R. 1162) to create LSAs and RSAs. Expanded savings accounts also were
a part of the final recommendations of the President’s Advisory Panel on Federal Tax
Reform.
These proposals differ from the current system of IRAs in several important
ways, including the required use of a back-loaded method now used for Roth but not
traditional IRAs (in back-loaded accounts contributions are not deductible but
withdrawals are not taxable), higher contribution limits in some cases, introduction
of LSAs with no penalties for withdrawal, and elimination of income phaseouts.
Shifting to a mandatory back-loaded method, including the ability to roll over
current deductible IRAs into the new system, along with some other features, has
important consequences for the path of revenue loss. The Treasury projects the plans
to either raise revenue or have little revenue effect in the first 10 years. CRS
projections of long-run revenue costs (in the steady state beyond 2015) suggest a 10-
year loss in the neighborhood of $300 to $500 billion. While it is difficult to estimate
the cost precisely, the large limits and lack of strings attached suggest that a very
large fraction of interest, dividends, and capital gains could be tax exempt.
Neither theory nor empirical evidence seems to present much of a case for a
significant (or even positive) effect on private savings resulting from these provisions
— particularly the back-loaded form. The change would tend to redistribute after-
tax income on both a relative and absolute basis from lower- to higher-income groups
in part because lower- and moderate-income individuals tend to have little or no
savings — although benefits to the highest-income individuals would be constrained
by the contributions limit.
The provision of tax favored savings accounts with high limits could have some
consequences for certain activities and sectors of the economy. It could reduce the
fraction of small businesses with pension plans, as owners elect to save in their
private accounts rather than through accounts set up in their businesses. The
provisions would also make a variety of currently favored investments less attractive,
including tax exempt state and local bonds, life insurance products such as deferred
annuities, and direct investments in owner-occupied housing. Some of these effects
should increase economic efficiency. The change would discourage equity
investment in unincorporated businesses and rental housing and favor investment in
debt. It would have uncertain effects on the most heavily taxed investment, corporate
equity. This report will not be updated.

Contents
Long Run Revenue Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Long Run Cost Projected From Short Run Official Estimates:
An Illustration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Direct Estimates of the Steady State Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Projections from Current Costs of IRAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Summing Up the Evidence for Long-Run Costs . . . . . . . . . . . . . . . . . . . . . . 9
Economic Effects: Savings, Distributional Effects and Interaction
with Other Tax Favored Savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Effects on Savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Distributional Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Effects on Other Types of Tax Favored Savings . . . . . . . . . . . . . . . . . . . . . 17
Employer Pension Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Individual Retirement Accounts and Life Insurance Products . . . . . . . 19
Education Savings Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Tax Exempt Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Owner Occupied Housing, Debt and Business Equity . . . . . . . . . . . . . 20
Simplification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Appendix A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
List of Tables
Table 1. Accrued Earnings on Investments of $5,000 per Year . . . . . . . . . . . . . . 6
Table 2. Accrued Earnings on Investments of $7,500 Per Year . . . . . . . . . . . . . . 7
Table 3. Revenue Impact Under Assumed Thresholds in a Steady State . . . . . . . 8
Table 4. Revenue Impact and Contributions Limits in a Steady State,
Excluding Sales of Capital Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Table 5. Revenue Impact and Contribution Limits in a Steady State,
Including Sales of Capital Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Table 6. Illustrative Distributional Effects of the Proposal Under
Assumed Thresholds in a Steady State, Excluding Gains on Sales
of Capital Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Table 7. Illustrative Distributional Effects of the Proposal
Under Assumed Thresholds in a Steady State With Capital Gains . . . . . . . 16
Table 8. Number of Returns by Income Class . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Proposed Savings Accounts:
Economic and Budgetary Effects
In several recent budget proposals, the President proposed to substitute for the
current system of individual retirement accounts (IRAs) two new arrangements: life-
time savings accounts (LSAs) and retirement savings accounts (RSAs).1 The
contribution limit for each of the new accounts was $5,000 in FY2005 — FY2007,
down from $7,500 in FY2004. In FY2008 the LSA accounts were restricted to
$2,000. In 2005 Senator Craig Thomas of the Finance Committee and
Representative Sam Johnson of the Ways and Means Committee introduced
identical bills to create LSAs (S. 545 / H.R. 1163) and RSAs (S. 546/H.R. 1162). A
year earlier the same legislators sponsored similar bills (S. 2263/H.R. 4078, and H.R.
4714). The President’s Advisory Panel on Federal Tax Reform proposed similar
accounts, called Save for Family and Save for Retirement accounts, with $10,000
annual limits, as a part of its final recommendations.
These proposals differ from the current system of individual retirement accounts
in several important ways. First, unlike the current system, no choice is allowed
between a traditional or front-loaded account (where individuals deduct
contributions, pay no tax on earnings, but pay tax on withdrawals, much like a
pension plan) and Roth or back-loaded accounts adopted in 1997 (where no
contributions are deducted and no earnings or withdrawals are taxed, as with a tax
exempt bond). The new system requires all accounts to be in the back-loaded form.
While both back-loaded and front-loaded accounts effectively result in a tax rate on
earnings of zero (assuming constant tax rates in the case of front-loaded accounts) the
revenue paths of front-loaded and back-loaded accounts are quite different — the
costs of front-loaded accounts occur much more quickly than the costs of a back-
loaded account.2 Moreover, the projected revenue effect would also reflect both the
involuntary substitution of back-loaded for front-loaded accounts (because the latter
would no longer be allowed) and voluntary shifts of present asset balances or
contributions to employer plans with discretion, such as 401(k) plans. The form of
the account also has some important implications for private savings responses.
1 There are other specialized tax-favored forms, such as medical savings accounts and
educational savings accounts; the proposal allows a rollover of education accounts into
LSAs. The President’s proposal also includes a tax credit to sponsors of savings plans for
lower income individuals, a much smaller and temporary provision, which is not considered
in this analysis. The analysis also does not address proposals for simplifying and
coordinating employer pension plans.
2 The two approaches differ in several other ways. For a more complete discussion see CRS
Report RL30255, Individual Retirement Accounts (IRAs): Issues and Proposed Expansion,
by Thomas L. Hungerford and Jane G. Gravelle.

CRS-2
Secondly, the limits of the new accounts are higher than current accounts,
amounting to contributions of $10,000 ($5,000 for each account) for the FY2007
proposal and Advisory Panel Proposal, and $7,000 for the FY2008 proposal. Married
couples filing jointly would have twice the limits. The 2004 proposals supported by
Senator Thomas and Representative Johnson were $15,000 ($7,500 for each
account). The contribution levels of IRAs were $2,000 before the recent tax cuts and
would have reverted back to this cap after 2010, but the benefits were made
permanent and the new amounts were set at $5,000.3 These higher limits also have
important economic implications.
Thirdly, the LSA account is to be allowed with no penalties for withdrawal
before retirement age. This feature makes this type of account, unlike the current
IRA, a virtually perfect substitute for ordinary savings — and one would expect
financial institutions to quickly set up simple types of accounts that would be eligible
for the tax benefit. RSAs have penalties for withdrawing before age 58 (slightly
below the current 59½ age) but like current Roth IRAs have no required minimum
distribution after age 70½ (as do traditional, or front-loaded, IRAs).
Finally, the proposal eliminates all income limits on the accounts; very-high-
income individuals are not currently eligible for the benefit, but would become so
under the proposal.
Long Run Revenue Cost
The projected revenue effects of these proposals show either a small revenue
gain or a small loss. The magnitude of these effects is no more than a few billion
dollars over 10 years for the budget horizon, but these intermediate-term revenue
effects greatly understate the eventual cost of the program beyond the budget
window. This section explores a variety of approaches to estimating the long run
cost that would occur after the cost has settled into a steady state, which would
probably be in the tens of billions per year, and several hundred billion over a 10-year
period (within the steady state, perhaps after the second or third decade). Even
though the annual contribution caps differed from proposal to proposal, the revenue
loss pattern is similar in every case and many conclusions remain unaffected by the
difference.
The Long Run Cost Projected From
Short Run Official Estimates: An Illustration
The near term revenue effects of the FY2004 LSA/RSA proposal (with the
$7,500 ceiling) as projected by either the Treasury or the Joint Committee on
Taxation (JCT), were very small. The President’s 2004 budget proposal showed a
gain of $14.8 billion in the first five years and a gain of $2 billion in the first 10
3 The Economic Growth and Recovery Act of 2001 increased the IRA limit to $3,000 in
2002-2004, $4,000 from 2005-2007, and $5,000 in 2008 (with indexation for inflation
thereafter; the provisions sunset after 2010.

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years.4 The JCT found a similar pattern (gains, then losses), but projected quite
different numbers, with a loss of $4.9 billion in 2013, an overall gain of $12 billion
in the first five years, and a loss of $5 billion over the 10-year period.5 For the
FY2007 proposals, with the lower $5,000 ceiling, both Treasury and JCT project
small 10-year losses of $122 million (Treasury) to $275 million (JCT).6
The comparable Treasury 10-year estimates for FY2006 and FY2005 proposals
were $1.5 billion and $5.6 billion gains, respectively.7 JCT’s estimates of the
measures were $2.4 billion and $0.9 billion losses over the 10-year period,
respectively.8 Both sets of estimates show a similar pattern of revenue gains in the
first years reversing into the losses in the remainder of the period.9
These near-term estimates (for the next 10 years) show positive or small
negative effects for three reasons. First, for any new normally taxable savings that
are now funneled into these tax free accounts, the cost rises very rapidly over time
compared to most tax reductions (which tend to rise at the nominal growth rate of the
economy, perhaps around 5%). For example, suppose $7,500 were put into an
account in each year and the interest rate is 10%. In the first year the reduction in
taxable income is $750 (10% of $7,500). In the next year, the previous year’s
4 Beginning with FY2003, the proposal had an annual gain in revenue in the first four years:
$1.4 billion, $10.6 billion, $4.8 billion, $1.9 billion. Revenue losses then occurred through
FY2013: $0.6 billion, $1.8 billion, $1.9 billion, $2.45 billion, $2.7 billion, $2.9 billion, and
$2.9 billion, according to the Treasury Department, General Explanation of the
Administration’s 2004 Revenue Proposals, Feb. 2003.
5 See Joint Committee on Taxation, Estimated Budget Effects of the Revenue Provisions
Contained in the President’s Fiscal Year 2004 Budget Proposal, Fiscal Years 2003-2013,
JCX-15-03, March 4, 2003. The estimate showed revenue gains from FY2003-FY2007 of
$1.7 billion, $3.2 billion, $3.1 billion, $2.8 billion, and $1.4 billion. Losses occurred from
FY2008-FY2013 in the amount of $0.2 billion, $1.6 billion, $2.6 billion, $3.5 billion, $4.4
billion, and $4.9 billion.
6 Department of the Treasury, General Explanations of the Administration’s Fiscal Year
2007 Revenue Proposals, Feb. 2006, pp. 10; Joint Committee on Taxation, Estimated
Budget Effects of the Revenue Provisions Contained in the President’s Fiscal Year 2007
Budget Proposal, Fiscal Years 2006-2016 in Description Of Revenue Provisions Contained
In The President’s Fiscal Year 2007 Budget Proposal, JCS-1-06, March 2006, p. 314.
7 Department of the Treasury, General Explanations of the Administration’s Fiscal Year
2006 Revenue Proposals, Feb. 2005, pp. 10, 159; Department of the Treasury, General
Explanation of the Administration’s 2005 Revenue Proposals, Feb. 2004, pp. 12, 191.
8 Joint Committee on Taxation, Estimated Budget Effects of the Revenue Provisions
Contained in the President’s Fiscal Year 2005 Budget Proposal, Fiscal Years 2004-2014,
JCX-14-04 R, March 3, 2004, p. 1; Joint Committee on Taxation, Estimated Budget Effects
of the Revenue Provisions Contained in the President’s Fiscal Year 2006 Budget Proposal,
Fiscal Years 2005-2015, JCX-10-05, March 9, 2005, p. 1.
9 For example, beginning with FY2005, the proposal had an annual gain in revenue in the
first five years: $3.9 billion, $8.2 billion, $5.5 billion, $2.8 billion and $0.7 billion (there
were no effects in FY2004). Revenue losses then occurred through FY2014: $0.7 billion,
$2.1 billion, $3.8 billion, $4.3 billion, and $4.7 billion, according to the Treasury
Department.

CRS-4
investment is now worth $8,250 ($7,500X1.10) and adding a current investment, the
total in the account is now $15,750. The second year’s reduction in taxable income
is $1,575, or 2.1 times the first year — a growth rate of 110%. In the third year the
cost is 3.31 times the first year. Based on the model shown in the appendix which
allows for contributions and withdrawals which relates each year to its eventual long-
term steady state, the first year’s cost (expressed in current income levels) is about
3% of the steady state cost, the fifth year’s cost is about 18% and the tenth year’s cost
is about 41%. Overall, the first five years’ cost is about 11% of a steady-state five-
year cost, and the first 10 years’ cost is about 20%. Thus, these losses are only a
fraction of their long run losses.
Secondly, there would be a temporary revenue gain because repeal of traditional
IRA provisions would reduce the cost of up-front deductions. In order to determine
the loss from the expanded limits, we need to eliminate this revenue, to measure the
loss, and then use the revenue pattern discussed above to project from the short term
to the long term. Using this approach, we project the cost with the $7,500 limit to
be at least $18 billion per year ($180 billion over 10 years with constant income
levels) using the Treasury estimates. The annual cost would be slightly over $20
billion with the JCT estimates. The cost with the $5,000 limit (Treasury estimates)
is about $17 billion.10 Again, these are conservative measures.
Thirdly, individuals are allowed to roll over existing accounts into back-loaded
accounts and pay for the cost over four years. Since these effects are in the first four
years, we can extrapolate from a single year past that point where the cost is expected
to be about 18% of the steady state. Those calculations suggest an annual cost of
closer to $40 billion with relatively little difference between the $5,000 and $7,500
ceiling.11 The projections from the Joint Tax Committee’s estimates would,
10 In the short run, this offsetting gain would include the tax benefit of traditional IRA
contributions, which were about $7 billion in 2000; at a 20% tax rate, worth $1.4 billion.
Over 10 years, therefore, the current limits would be at least $14 billion even without
accounting for growth, and would probably be considerably larger because of the rapid
growth of the income limits. While the dollar limit of contributions is fixed at $2,000,
temporary provisions in the 2001 tax cut allow increases in the dollar amounts to be
contributed to IRAs, and the income limit will increase substantially over the period. The
temporary provisions have been estimated to increase revenues by about $25 billion over
10 years. If we use the conservative $14 billion number and add the $25 billion, there are
temporary 10-year gains of $39 billion embedded in the estimates and without those
temporary gains, the gain of $2 billion for the $7,500 limit would be a loss of $37 billion.
Based on the projections discussed above, the long-run steady-state cost would be five times
as large or $185 billion, leading to an annual loss of about $18.5 billion. With the higher
revenues reported for the FY2005 estimates (with the lower ceiling) the $39 billion would
be offset by about $6 billion, for a loss of $33 billion — suggesting a total of $177 billion
over 10 years, or an annual about $17 billion. Note that this analysis assumes that additional
accounts would be diverted from existing accounts, and not associated with additional
private savings. See the section on savings effects for a justification of this assumption.
11 For the FY2004 Administration estimates, the appropriate year would be 2008, where the
revenue cost is estimated at $1.8 billion. However, this $1.8 billion is the net of a positive
gain from substitutions for front-loaded IRAs and the loss from additional back-loaded
(continued...)

CRS-5
however, have been smaller (about $28 billion, for the $7,500 cap). These estimates
would be affected by recent legislation that allows a one-time rollover of IRAs into
Roth IRAs with no income limit in 2010.
Fourthly, the revenue estimates may also include some gain from the possibility
of shifting some of the amounts currently contributed to 401(k) and similar plans to
individual accounts (at least for amounts without an employer match), given there are
no strings attached. These choices have the same types of effects as prospective
future IRAs and further expand the scope for additional revenue loss.
Finally, the long run revenue cost will be slightly larger (although the effect will
probably be small12) by the replacement of front-loaded by back-loaded accounts.
The implication from this extrapolation exercise is that the long-run steady-state
revenue cost of the plans will be in the tens of billions of dollars per year, and even
without accounting for all of the contributions to cost, could amount to as much $40
billion per year or $400 billion over 10 years, while the short run effect, at least
according to the administration estimates, is a gain of several billion over 10 years
— a dramatic contrast.
Direct Estimates of the Steady State Cost
The previous numbers extrapolated from the presumed use of these savings
accounts by the Treasury and JCT revenue estimators. Another approach is to
examine the total revenue collected from passive forms of investment and to estimate
what fraction of that revenue will become tax exempt under the proposed plan. Since
the LSA accounts have no strings attached, individuals should prefer to place all of
their savings up to the limit in these accounts, including non-retirement savings. The
$5,000 or $7,000 limit (and even the $2,000 limit) for each of these plans is so great
that the plans could allow all savings of moderate income individuals to be contained
in the account over a period of time, particularly for married couples whose LSA
annual amounts would be twice as large and combined LSA and RSA amounts would
11 (...continued)
IRAs. The cost for the 2001 increases for that year was projected at $3.4 billion, and if we
use a $1.4 billion cost for current IRAs, the results imply a loss of $6.6 billion — which
would translate into an annual loss of $37 billion ($6.6 billion divided by 0.18) per year
($370 billion over 10 years). This estimate fixes the existing loss of front loaded IRAs at
only $1.4 billion; if it were raised to $2 billion, the cost would $40 billion
(($2+$3.4+$1.8)X0.1/0.18. Applying the same methods to the new 2005 estimates with the
lower limit results but using 2010 (the 2005 proposal is made a year later and delays the
effective date by another year), the proposal loses $0.7 billion. However, the gain from the
temporary limit increase is $4.4 billion, implying a loss after backing out the temporary
revenue gain of $6.5 billion, which would lead to a cost of $36 billion, also close to $40
billion if the value of current IRAs was increased.
12 In the steady state the loss from back-loaded accounts is the interest rate times the asset
balance. The loss for a front-loaded account includes this forgone interest but it is reduced
by the gain from tax on withdrawals less the loss from the tax benefit of the deductions. See
Jane G. Gravelle, “Estimating the Long-Run Revenue Effects of Tax Law Changes,”
Eastern Economics Journal, vol. 19, fall 1993, pp. 481-494.

CRS-6
be $20,000 or $30,000. Over 10 years, savings could cumulate to as much as
$300,000, an amount much greater than the typical liquid savings of most families.
Thus, these families would not be expected to be constrained by the limit.
In 2000, according to the Internal Revenue Service Statistics of Income
(Individual returns) dividends and interest on taxable returns were $186 billion and
$140 billion, respectively. There were also capital gains distributions of $61 billion,
and net gain from sales of capital assets of $623 billion. The $623 billion would
include non-passive investments such as real estate and would be highly concentrated
among high income individuals. Just considering interest, dividends, and capital
gains distributions, the total is $387 billion, which, at a 20% marginal tax rate, would
yield $77 billion in revenue, implying a potential loss from the LSA/RSA plan in that
vicinity (or greater, since it excludes sales of capital assets) if virtually all assets were
eventually to be placed in these plans.
The actual revenue loss would be smaller than this amount for two reasons.
First, the amount already excluded from individual retirement accounts under
permanent rules could change because of rising income limits (although comparisons
of tax expenditure projections suggest this effect is only a few billion dollars). More
importantly, some share of this amount is in high income brackets where a substantial
portion of individuals might exceed the limit ($133 billion of the $387 billion is in
the $100,000 and over income class). And even among more moderate income
classes, some individuals will exceed the dollar limits.
To explore how much this revenue cost might be reduced by individuals saving
more than the maximum amount, we first determine how much would be earned
from accounts assuming the maximum had been saved and reinvested every year.
The formulas for calculating these effects are shown in the appendix; in Tables 1
and 2, we show the dollar amount of earnings, depending on the real interest rate and
the period of time that the asset is accumulating, for limits of $5,000 and $7,500,
respectively. Note that these are the amounts accrued by a single taxpayer; a married
couple would be able to save twice as much. They are also the amounts for the LSA
rather than the combined IRA/LSA accounts.
Table 1. Accrued Earnings on Investments of $5,000 per Year
Real rate of return on asset
Years held
3%
4%
5%
6%
10
$2,915
$3,688
$4,451
$5,480
20
$6,850
$9,191
$12,027 $15,467
30
$12,163
$17,400
$36,557
$50,496
40
$19,334
$29,647
$44,723
$66,822
Source: CRS calculations; see text. The inflation rate is assumed to be 2%.

CRS-7
Table 2. Accrued Earnings on Investments of $7,500 Per Year
Real rate of return on asset
Years held
3%
4%
5%
6%
10
$4,373
$5,533
$6,811
$8,221
20
$10,276
$13,787
$18,041
$23,201
30
$18,254
$26,101
$36,557
$50,496
40
$29,001
$44,471
$67,085
$100,231
Source: CRS calculations; see text. The inflation rate is assumed to be 2%.
The exact amount of exempt relevant passive income would vary for every
taxpayer depending on such factors as the amount of individual annual contributions
and withdrawals, years of participation in the program, and the rate of return on a
person’s investments. Modeling each of these parameters is not possible without
detailed data, particularly data that reflect age (which is not provided on tax returns).
In order to estimate the magnitude of the impact, we consider several scenarios and
combine them with the historic tax return data.
Sources of the relevant passive income were limited to taxable interest,
dividends, and capital gains distributions in one scenario. There are several other
sources of income, in particular capital gains on sales of capital assets, and much of
these gains (largely representing capital gains on stock sales) is also passive income.
We provide a second scenario that includes these gains as well. The 1999 income
amounts were not adjusted for inflation, although that is unlikely to have a significant
influence on the results.
We ignore expansions in the regular individual retirement accounts, which
would increase the maximum amount that could be sheltered in the savings plans, but
whose use is more difficult to predict. Ignoring RSAs would also understate the cost,
particularly keeping in mind a higher contribution limit of $5,000 under the proposal.
We also ignore the offsetting effect of interest earned on checking accounts, where
LSA treatment would not be feasible.
As shown in Table 3, three illustrative annual tax-exempt LSA income
threshold values of $5,000, $15,000 and $35,000 per person are selected. Thus,
married filers would effectively face caps of $10,000, $30,000, and $70,000
correspondingly. The estimation process applies these assumed thresholds to a
sample of historic 1999 individual income tax returns supplied by the IRS.13
13 Internal Revenue Service, Statistics of Income Division, Individual Statistics Branch, 1999
Public Use Tax File, Jan. 28, 2003. The data in this file are blurred (actual returns are
averaged and some other changes are made) in order to protect taxpayer confidentiality.
These data are the most recent available. We also use the tax rates in force in 1999, which
are different from the current rates, but consistent with permanent rates.

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Table 3. Revenue Impact Under Assumed Thresholds
in a Steady State
Revenue impact, without
Revenue impact,
Assumed threshold value,
sales of capital assets,
with sales of capital
$
$ billions
assets, $ billions
5,000
26.7
31.4
15,000
43.2
55
35,000
54.1
75.4
Source: CRS calculations; see text.
For example, consider two single taxpayers’ returns in the case of a $5,000
threshold: the first one with the sum of interest, dividends, and capital gains
distributions in 1999 of $3,000 and the second one with $11,000. Under the $5,000
assumption, the first taxpayer would be able to exempt all of the relevant passive
income, since it is less than $5,000. The second one would be able to exclude just
the first $5,000 of $11,000, and pay the tax on the remaining $6,000. Under $15,000
or $35,000 cap scenarios, both of them would be exempt on all of their relevant
passive income. Therefore, the sum of these taxpayers’ deductions in the first case
of $8,000 would increase to $14,000 in the second case, because of the higher income
taxpayer’s increased LSA deduction.
As the cap value increases, the impact grows larger, because higher income
taxpayers could exempt larger shares of their relevant passive income and each dollar
deducted by taxpayers in higher marginal tax brackets would be costlier than the one
deducted by taxpayers in lower marginal tax rate brackets. The revenue cost
increases much more slowly, proportionally, than does the cap. A tripling of the cap
increases costs by 60%; a seven-fold increase doubles the cost.
The results are sensitive to the limits chosen, but even the very modest $5,000
limit indicates a cost of $27 billion per year. Since close to half of all capital gains
is typically associated with sales of stock,14 if we take the intermediate limit of
$15,000 (associated with a savings period of around 25 years at a 4% to 5% return
with a $5,000 limit) and average the last two columns, the estimate is around $50
billion. The general magnitude of effects is consistent with a study last year by
Burman, Gale, and Orzag, who used a similar approach to estimate the FY2004
revenue loss, which they project to be in the neighborhood of $50 billion at current
(2003) income levels.15 (Given the modest increase in revenue cost with an increase
14 See Jane G. Gravelle, The Economic Effects of Taxing Capital Income, Cambridge, MIT
Press, 1994, p. 130; Leonard E. Burman, The Labyrinth of Capital Gains Tax Policy,
Washington, D.C., The Brookings Institution, 1999, p.25; Janette Wilson, “Sales of Capital
Assets Reported on Individual Income Tax Returns, 1999, Internal Revenue Service,
Statistics of Income Bulletin, summer 2003, pp. 132-154.
15 Leonard E. Burman, William G. Gale, and Peter Orszag, “The Administration’s Savings
(continued...)

CRS-9
in limits at this level, there is probably not a lot of difference between the $5,000 and
$7,500 limit).
One revenue cost that is not included in this analysis is the loss arising from
arbitrage. For example, individuals who actually have smaller savings than that
eligible for IRAs could potentially borrow from a home equity line of credit and
reinvest in IRAs creating an artificial tax saving. This artificial tax saving would be
constrained by the spread between the rate charged on loans and the rate earned on
investments, but it is possible that markets will develop to take account of such
arbitrage possibilities.
Projections from Current Costs of IRAs
A final way of gaining some notion of the magnitude of long run revenue cost
is to consider the tax expenditure estimate for the current IRA provision, which is
$20 billion, according to the tax expenditure compendium for 2008, the last year for
which estimates have been made.16 Some provisions have been in the law a long
time, others since 1997, and the most recent changes were made in 2003 (and
reflecting a limit of $5,000), so the provision is below its steady-state level. If one
just recognized that the dollar limits will be tripled (in comparison to the $5,000 cap),
if everyone tripled the size of the assets in their accounts, the cost would be an
additional $40 billion. This estimate is overstated because all individuals will not be
at the ceiling, so that one could not simply add $40 billion to account for this effect.
However, the income limits will be completely removed, which would add to the
cost, and the cost is not at its steady-state level. The cost would also be larger if
compared to a $2,000 limit. But, in general, since current IRA provisions are
relatively costly (i.e. $20 billion), it should not be surprising that such a dramatic
expansion is also quite costly and could, again, easily be in the tens of billions of
dollars.
Summing Up the Evidence for Long-Run Costs
While it is not possible to place a precise price tag on the long run cost of these
proposals, they are clearly much more costly than is suggested by the near-term
revenue estimates. An estimate of $300 to $500 billion, or even more, over a 10-year
period does not seem unreasonable — a significant contrast to the $2 billion revenue
gain in the short run projected by the Treasury for its FY2004 proposal, the $4 billion
loss projected by the Joint Committee on Taxation for that same plan, or the $5.5
billion gain projected by the Treasury for the FY2005 proposal.17 This huge
15 (...continued)
Proposals: Preliminary Analysis,” Tax Notes, March 3, 2003, pp. 1423-1446.
16 Joint Committee on Taxation, “Estimates of Federal Tax Expenditures for Fiscal Years
2004-2008,” December 22, 2003.
17 A recent CBO working paper, “A Steady-state Analysis of Proposals to Reduce the Tax
on Saving,” by Paul Burnham, February 2006, estimated a loss of $17 billion per year in a
steady state, well above the official annual cost estimates of the first ten years of the
(continued...)

CRS-10
discrepancy occurs for two reasons: the losses from additional savings in tax favored
forms are small in the short run relative to the long run, and the temporary short- run
revenue gains from the substitution of back-loaded for front-loaded plans and
rollovers is large enough to more or less offset these losses.
Economic Effects: Savings, Distributional Effects
and Interaction with Other Tax Favored Savings
Several important economic issues arise with respect to expanding savings
incentives. The focus of the Administration and perhaps of other supporters of the
plan is to increase savings and economic growth. Critics are often concerned about
distributional effects; savings incentives tend to favor higher income individuals.
The ceilings on contributions, however, limits the benefit available to high income
individuals. The expansion of tax preferred savings vehicles, particularly a general
one, will have consequences for other tax favored forms including pensions,
individual retirement accounts directed at pensions, tax favored educational savings
accounts, and other forms of tax preferred investment income including tax exempt
bonds and life insurance annuities. This section discusses these economic effects.
Effects on Savings
There has been extensive debate about the effect of individual retirement
accounts on savings.18 This debate has addressed both theoretical and empirical
17 (...continued)
program. The estimate appears to reflect an assumption that only 20% of corporate stocks
can be shifted into these accounts. The author gives no rationale behind this assumption,
and due to a very non-restrictive nature of the proposed accounts, it may be conservative.
18 For a more complete discussion of the savings literature, see Jane G. Gravelle, The
Economic Effects of Taxing Capital Income (Cambridge, MA., MIT Press, 1994), p. 27 for
a discussion of the general empirical literature on savings and pp. 193-197 for a discussion
of the empirical studies of IRAs. Subsequent to this survey, a paper by Orazio P. Attanasio
and Thomas C. DeLeire, “The Effect of Individual Retirement Accounts on Household
Consumption and National Savings,” Economic Journal, vol.112, July 2002, pp. 504-538,
was published. That study found little evidence that IRAs increased savings. For additional
surveys see the three articles published in the fall 1996 Journal of Economic Perspectives,
vol. 10: R. Glenn Hubbard and Jonathan Skinner, “Assessing the Effectiveness of Savings
Incentives,” (pp. 73-90); James M. Poterba, Steven F. Venti and David A. Wise, “How
Retirement Savings Programs Increase Saving,” (pp. 91-113); Eric M. Engen, William G.
Gale, and John Karl Scholz, “The Illusory Effects of Savings Incentives on Saving,” (pp.
113-138). An International Monetary Fund working paper by Alun Thomas and Christopher
Towe, “U.S. Private Saving and the Tax Treatment of IRA/401(k)s: A Re-examination
Using Household Saving Data,” Aug. 1996, found that IRAs did not increase private
household saving. A study by Eric M. Engen, Federal Reserve Board, and William G. Gale,
Brookings Institution, found that 401(k) plans, which are similar to IRAs in some ways, did
not have much effect on savings. See “Debt, Taxes, and the Effects of 401(k) Plans on
Household Wealth Accumulation,” May 1997. A recent simulation study in the American
Economic Review, while not based on direct empirical evidence, suggests only a small
(continued...)

CRS-11
evidence on savings incentives in general, and on the particular effects of individual
retirement accounts, which were made available to all individuals in the period 1981-
1986.
If one begins with overall evidence on savings with incentives without caps or
strings attached, even this evidence does not necessarily suggest private savings
would increase. The effect of a tax reduction on savings is theoretically ambiguous
because of offsetting income and substitution effects. The increased rate of return
may cause individuals to substitute future for current consumption and save more (a
substitution effect), but, at the same time, the higher rate of return will allow
individuals to save less and still obtain a larger target amount (an income effect).
The overall consequence for savings depends on the relative magnitude of these two
effects.
Empirical evidence on the relationship of the rate of return to the saving rate is
mixed, indicating mostly small effects of uncertain direction. Thus, individual
contributions to IRAs may have resulted from a shifting of existing assets into IRAs
or a diversion of savings that would otherwise have occurred into IRAs. A more
stark illustration of the uncertainty of increasing savings with a higher rate of return
is the juxtaposition of high returns in the stock market with a dramatic reduction in
the personal savings rate — suggesting that income or wealth effects dominated
behavior. This fall in the savings rate in the face of high returns provides some
additional evidence that expanded IRAs may not be successful in increasing savings
rates.
IRAs are even less likely to increase savings because they are subject to
contribution limits. For those who have saving in excess of the limit, there is no
marginal incentive. In this case, only the income effect dominates.
There is one caveat about this theoretical point — in the case of front-loaded (or
traditional) IRAs, there is some reason to expect that the tax cut itself would be saved
or largely saved. That is because the savings plan has a future tax liability attached
to it (when withdrawn) so that even if an individual were not affected by the savings
incentives in the normal way, he or she would wish to save the tax cut to pay the
future tax. (This choice would keep consumption fixed.) This analysis applies,
however, only to front-loaded IRAs, and not to the back-loaded forms in the
Administration proposal.
Note that despite this conventional analysis of IRAs and savings, some
economists have argued that IRA contributions were largely new savings. The
theoretical argument has been made that the IRAs increase savings because of
psychological, “mental account,” or advertising reasons. Individuals may need the
attraction of a large initial tax break; they may need to set aside funds in accounts that
18 (...continued)
fraction of IRA contributions represent net savings. See Ayse Imrohoroglu, Selahattin
Imrohoroglu, and Douglas H. Joines, “The Effect of Tax-Favored Accounts on Capital
Accumulation,” vol. 88, Sept. 1998, pp. 749-768.

CRS-12
are restricted to discipline themselves to maintain retirement funds; or they may need
the impetus of an advertising campaign to remind them to save.
There has also been some empirical evidence presented to suggest that IRAs
increase savings. This evidence includes both some simple observations that
individuals who invested in IRAs did not reduce their non-IRA assets and a variety
of statistical studies, especially estimates by Venti and Wise, that showed that IRA
contributions were primarily new savings.19
However, the fact that individuals with IRAs do not decrease their other assets
does not prove that IRA contributions were new savings; it may simply mean that
individuals who were planning to save in any case chose the tax-favored IRA
mechanism. The Venti and Wise estimate has been criticized on theoretical grounds
and another study by Gale and Scholz using similar data found no evidence of a
savings effect.20 A study by Manegold and Joines comparing savings behavior of
those newly eligible for IRAs and those already eligible for IRAs found no evidence
of an overall effect on savings, although increases were found for some individuals
and decreases for others; a study by Attanasio and DeLeire also using this approach
found little evidence of an overall savings effect.21 And, while one must be careful
in making observations from a single episode, there was no overall increase in the
savings rate during the period that IRAs were universally available, despite large
contributions to IRAs. Similarly, the household savings rate continued (and actually
accelerated) its decline after expansion of IRAs in 1997.22
An important issue for evaluating the Administration proposal is that, in any
case, the argument regarding private savings of the up front benefit and the debate
on the psychological effects of IRAs on savings concerned the effects of front-loaded,
or deductible, IRAs. These arguments do not apply to back-loaded IRAs. If the
objective of the plan were to encourage private savings, the front-loaded form would
have been more appropriate. Indeed, by repealing the front-loaded form and
requiring back-loaded approaches, there should be a direct reduction in savings from
this effect, even if savings incentives otherwise have no effect on savings.
Individuals who now effectively “prepay” their taxes (which gives the government
its revenue gain) should reduce their savings by an equal amount.
19 This material has been presented by Steve Venti and David Wise in several papers; see,
for example, “Have IRAs Increased U.S. Savings?,” Quarterly Journal of Economics, vol.
105, Aug. 1990, pp. 661-698.
20 See William G. Gale and John Karl Scholz, “IRAs and Household Savings,” American
Economic Review, Dec. 1994, pp. 1233-1260. A detailed explanation of the modeling
problem with the Venti and Wise study is presented in Jane G. Gravelle, “Do Individual
Retirement Accounts Increase Savings?,” Journal of Economic Perspectives, vol. 5, spring
1991, pp. 133-148.
21 See Douglas H. Joines and James G. Manegold, “IRAs and Savings: Evidence from a
Panel of Taxpayers,” University of Southern California; Orazio P. Attanasio and Thomas
C. DeLeire, “IRA’s and Household Saving Revisited: Some New Evidence,” National
Bureau of Economic Research Working Paper 4900, October 1994.
22 See CRS Report RS20224, The Collapse of Household Savings: Why Has It Happened
and What Are Its Implications?, By Brian Cashell and Gail Makinen.

CRS-13

Of course, the effectiveness of an expansion of IRAs is also affected by
contribution limits, since anyone contributing at the limit would not be affected at the
margin. For some individuals, there is currently no marginal effect but would now
be one which would tend to induce savings; for other new contributors who are still
at the limit, there would be no marginal effect and the income effects will reduce
savings. Higher contribution limits increase the fraction of revenue loss that is
associated with marginal investment. Nevertheless as shown in Tables 4 and 5,
under our simulations, a significant amount of revenue goes to individuals who are
at the maximum limit (excluding sales of capital assets, 56% at the lower limit and
24% at the higher limit).
This discussion relates only to private savings. If the deficit increases in the
long run, then national savings could fall even if private savings did rise.
Most of the evidence presented here suggests that the proposal is unlikely to
increase savings, or if it does increase savings, the effects would be small. However,
one point is clear: by choosing a form of subsidy that reduces short-run revenue
costs, the Administration is also choosing a form that is least likely to increase
private savings and most likely to reduce them.
Table 4. Revenue Impact and Contributions Limits in a Steady
State, Excluding Sales of Capital Assets
Revenue impact from returns with
Assumed
Total
threshold
revenue
Passive income below
Passive income over
value
impact
threshold
threshold
$
$ million
$ million
%
$ million
%
5,000
26,698
11,802
44.2
14,896
55.8
15,000
43,106
26,576
61.7
16,530
38.3
35,000
54,150
41,424
76.5
12,726
23.5
Source: CRS calculations.

CRS-14
Table 5. Revenue Impact and Contribution Limits in a Steady
State, Including Sales of Capital Assets
Revenue impact from returns with
Assumed
Total
threshold
revenue
Passive income below
Passive income over
value
impact
threshold
threshold
$
$ million
$ million
%
$ million
%
5,000
31,408
16,579
52.8%
14,829
47.2%
15,000
55,020
38,399
69.8%
16,620
30.2%
35,000
75,379
62,322
82.7%
13,056
17.3%
Source: CRS calculations.
Distributional Effects
Tax proposals vary in the extent to which they benefit high income versus low
income individuals. Savings subsidies typically benefit higher income individuals,
who are far more likely to have significant savings. The benefits of IRAs are
somewhat constrained for high income individuals compared to other savings
subsidies, however, because of the dollar ceilings and, in the case of current IRAs,
the income limits, which are particularly severe for traditional individual retirement
accounts. This proposal raises the contribution limits and ends the income limits.
To examine the distributional effects, we return to the assumptions used to
assess the general magnitude of the long run revenue estimates. Tables 6 and 7
show for every assumed threshold what share of the total tax savings is attributable
to every income class, average tax savings per return, and share of these savings in
adjusted gross income (AGI) of the income class. In Table 6, for example, in the
case of a $15,000 cap, taxpayers with AGI between $50,000 and $75,000 would
receive 15.77% of the total tax savings received by all filers in all income classes.
On average, each return in the group would see $394 in tax savings, which represents
0.65% of AGI.

CRS-15
Table 6. Illustrative Distributional Effects of the Proposal Under Assumed Thresholds in a Steady State, Excluding
Gains on Sales of Capital Assets
Assumed
threshold
$5,000
$15,000
$35,000
Share of
Average
Reduction
Share of
Average
Reduction
Share of
Average
Reduction as
AGI range
liability
reduction per
as a share
liability
reduction per
as a share of
liability
reduction per
a share of
($000s)
reduction
return, $
of AGI
reduction
return, $
AGI
reduction
return, $
AGI
0
10
1.22%
12
0.40%
0.78%
12
0.41%
0.62%
12
0.41%
10
20
4.96%
54
0.36%
3.71%
65
0.44%
2.94%
65
0.44%
20
30
6.10%
87
0.35%
5.06%
116
0.47%
4.10%
119
0.48%
30
40
6.41%
127
0.37%
5.56%
178
0.51%
4.73%
192
0.55%
40
50
6.81%
179
0.40%
6.37%
269
0.60%
5.79%
309
0.69%
50
75
16.93%
263
0.43%
15.77%
394
0.65%
14.44%
457
0.75%
75
100
14.92%
500
0.58%
14.21%
766
0.89%
13.33%
909
1.06%
100
200
22.88%
846
0.64%
23.01%
1,369
1.04%
22.85%
1,720
1.30%
200
500
13.34%
1,857
0.64%
15.84%
3,547
1.23%
17.80%
5,039
1.74%
500
1000
3.88%
2,904
0.43%
5.47%
6,593
0.97%
6.95%
10,587
1.56%
1000
NA
2.54%
3,234
0.10%
4.22%
8,664
0.28%
6.44%
16,717
0.53%
Total/Average
100.00%
206
0.45%
100.00%
331
0.72%
100.00%
418
0.91%
Source: CRS calculations.

CRS-16
Table 7. Illustrative Distributional Effects of the Proposal Under Assumed Thresholds in a Steady State With Capital
Gains
Assumed
threshold
$5,000
$15,000
$35,000
Share of
Average
Reduction
Share of
Average
Reduction
Share of
Average
Reduction
liability
reduction per
as a share of
liability
reduction per
as a share of
liability
reduction per
as a share of
AGI range ($000s)
reduction
return, $
AGI
reduction
return, $
AGI
reduction
return, $
AGI
0
10
1.59%
18
0.63%
0.98%
20
0.68%
0.71%
20
0.68%
10
20
4.60%
60
0.40%
3.37%
77
0.52%
2.49%
78
0.52%
20
30
5.68%
97
0.39%
4.52%
136
0.55%
3.47%
143
0.58%
30
40
6.12%
146
0.42%
5.10%
214
0.61%
4.13%
237
0.68%
40
50
6.58%
208
0.46%
5.97%
330
0.74%
5.14%
389
0.87%
50
75
16.99%
317
0.52%
15.39%
504
0.82%
13.52%
606
0.99%
75
100
15.45%
622
0.72%
14.58%
1,029
1.20%
13.28%
1,283
1.49%
100
200
24.27%
1,079
0.82%
25.46%
1,982
1.50%
26.01%
2,775
2.11%
200
500
13.08%
2,188
0.76%
16.16%
4,736
1.64%
19.26%
7,730
2.67%
500
1000
3.46%
3,111
0.46%
4.97%
7,834
1.16%
6.66%
14,386
2.13%
1000
NA
2.17%
3,327
0.11%
3.49%
9,360
0.30%
5.31%
19,544
0.62%
Total/Average
100.00%
247
0.54%
100.00%
433
0.94%
100.00%
593
1.29%
Source: CRS calculations.

CRS-17
Current IRA provisions are designed to limit the benefits to high income
individuals both through ceilings and income limits. However, a significant benefit
accrues to the highest income taxpayers for this proposal. Comparing Table 6 with
Table 8, which contains a distribution of the population, we see, for example, that
in the case of the $15,000/$30,000 assumed cap, the bottom 40% of the population
gets 4% of the tax cut, the top 15 % gets about 60%, and the top 2% gets a quarter.
The dollar benefit per return rises rapidly across the income classes because higher
income individuals save much more that lower income ones, and, to a lesser extent,
because of higher marginal tax rates.
Table 8. Number of Returns by Income Class
AGI Range
Returns
($000s)
Number
Share
0
10
27,456,833
21.6%
10
20
24,076,129
18.9%
20
30
18,335,165
14.4%
30
40
13,137,813
10.3%
40
50
9,955,658
7.8%
50
75
16,817,353
13.2%
75
100
7,798,113
6.1%
100
200
7,066,359
5.6%
200
500
1877722
1.5%
500
1,000
349,122
0.3%
1,000
NA
204,920
0.2%
Total
127,075,187
100.0%
Source: CRS calculations.
When examining absolute tax savings or the distribution of tax benefits, high
income individuals tend to have larger benefits (absent restrictions on availability
through caps or exclusions) because they have much higher incomes. Almost any
general tax cut would exhibit some degree of this pattern. There is a case for using,
instead, a relative measure of redistribution. A way to measure the relative
distribution is to examine the tax savings as a percent of income (ideally as a percent
of after-tax income). This relative distribution measure still indicates a shift in
relative income from lower incomes to higher incomes through most of the income
distribution. Where the peak is reached depends on the cap used and the inclusion of
full capital gains; however, in both Table 6 and Table 7, the peak generally is
reached in either the $100,000 to $200,000 income class or the $200,000 to $500,000
class, suggesting that the relative benefit rises through 90% to 95% of the income
distribution. Thus, except for the very wealthiest income classes (that is, the top 5%
or 10% of the population), the provision increases the relative share of disposable
income for higher income people — that is, redistributes income shares to the well-
off.
Effects on Other Types of Tax Favored Savings
The final economic consequence of a new savings account proposal, particularly
one with no strings attached, is that it would reduce participation in alternative tax

CRS-18
favored savings, as a new substitute becomes available. There are several types of
tax favored uses that might be reduced, including employer pensions, standard
individual retirement accounts, insurance plans, tax favored education savings
accounts, tax exempt bonds, owner occupied housing, and tax favored capital gains
and dividends. The displacement of tax favored accounts may be a desirable or an
undesirable outcome for purposes of efficiency gains. For example, the current tax
rules favor investment in owner-occupied housing, and diverting funds out of
housing and into other types of investments may be desirable. The shift into passive
forms of investment also favors debt finance, disfavors equity investments in
unincorporated businesses, and has mixed effects on corporate equity. Encouraging
employer pensions through tax benefits has some potential benefits but may also
involve some distortions.
Following the release of the FY2004 proposals, much attention was focused on
the effect of employer plans in discussion, and most attention will be devoted to that
issue. This possible effect is cited as one of the reasons for scaling down the limits
from $7,500 to $5,000.
Employer Pension Plans. Actually, the Administration proposal also
proposes to simplify employer plans, including substituting Employee Retirement
Savings Accounts for existing employer plans such as 401(k)s and allowing after tax
(back-loaded style) employee contributions. The objective is to simplify these plans
for employers (although the switch to back-loaded plans could reduce private savings
and affect revenue patterns just as in the case of LSAs and RSAs).
While it is possible that the simplifications in the proposal could increase
employer coverage, much more attention has been devoted to the possible effects of
the individual plans on employer pension plans, particularly in the case of LSAs.
Since LSAs have no strings attached, individuals might find it more attractive to
reduce their voluntary 401(k) or similar contributions not matched by employer
contributions and put such money instead into LSAs. Because these plans could be
easily tapped for non-retirement uses, the LSAs could actually reduce retirement
savings.
An even more serious issue arises with small business plans, and relates not only
to the LSAs but also to the linking of benefits of highly paid employees and rank-
and-file employees. Many small-business owners find setting up a plan complicated,
but may still do it to make their own retirement plans (and plans of their highly
compensated workers) more tax-favored. Qualification for tax purposes requires a
plan to cover rank and file employees as well as owners and top officers. The basic
argument made in many of these discussions is that small-business owners, finding
individual retirement plans with high ceilings and, in the case of LSAs, no strings
attached, will now prefer to save through individual accounts rather than by setting
up retirement plans within their firms for themselves and their employees. With a
$7,500 ceiling in each account (LSA and RSA), a married couple could save $30,000
per year (and save additional amounts in children’s accounts).
These views have been expressed by a number of different groups and
organizations. For example, the executive director of the American Society of
Pension Actuaries (ASPA) stated: “It is an understatement to suggest that the impact

CRS-19
of these proposals on small business retirement plan coverage will be anything less
than devastating.”23 Similarly, the president of the Profit-Sharing 401k Council of
America (PSCA) stated: “The proposed changes significantly erode the tax code
incentives that encourage employers to accept the fiduciary obligation and expense
that come with offering a retirement plan ... The current approach links the
availability of tax benefits for decision makers and better off workers with the
retirement savings of lower paid employees. This linkage requires that employers
incentivize lower paid workers to save for retirement by using expensive matching
contributions as well as conducting aggressive educational campaigns.”24 Jack
VanDerhei, a business professor associated with the Employee Benefit Research
Institute, when commenting on the benefits of LSAs and RSAs, stated, “That’s
probably enough for most small employers, who could jettison doing anything for
their employees and still get enough of a tax break.”25 Many other groups have made
similar arguments.26 There are also arguments that even larger employers might
abandon plans because of the availability of individual tax deferred savings for their
employees.
While there is no way to know for certain the effects of the proposal on
employer plans, it does seem possible — and, according to the groups quoted above,
likely — that the individual savings accounts, despite simplification for employer
plans, ultimately reduce the coverage of employer pensions.
Individual Retirement Accounts and Life Insurance Products.
Individual retirement accounts for individuals not at the limit of their combined
savings could be displaced by the LSAs, which have no penalties for early
withdrawal or other strings attached. Under the latest Administration proposal such
conversion becomes mandatory.
Any life insurance product that has a savings elements involves a tax subsidy
in the form of deferred taxes on earnings. Even term life policies if they have level
premiums involve an accumulation of earnings tax free, and whole life policies
explicitly provide inside buildup. Finally, life insurance companies offer plans that
are particularly aimed at achieving tax benefits in the form of annuities.
23 “ASPA Opposes Bush Administration Savings Initiative,” ASPA Press Release, February
2, 2003.
24 “President’s Proposals Will Reduce the Appeal of Employer Plans,” PSCA Press Release,
February 5, 2003.
25 This statement is quoted in Aaron Bernstein, “Bush’s Retirement Rx is Bad Medicine,”
Business Week Online, February 18, 2003,
[http://www.businessweek.com/careers/content/feb2003/ca20030218_8886_ca030.htm],
visited December 31, 2003.
26 Criticisms have also been made by the American Institute of Certified Public Accountants
(AICPA) Tax Section (whose letter was the subject of a September 2, 2003 response from
the Treasury Department). See also the comments reported in CRS Report RS21541,
Retirement Savings Accounts: The President’s Budget Proposal for 2004, by Patrick Purcell.

CRS-20
Since the tax exemption benefit for LSAs and RSAs is greater than the deferral
benefit, the attractiveness of these products, particularly in cases where tax reduction
is a principal objective, could fall substantially.
These shifts may not involve efficiency costs — and may involve gains — but
they would be disruptive for the life insurance industry.
Education Savings Accounts. Tax benefits are provided for a variety of
educational savings accounts, whose tax-favored benefits depend on using the funds
for educational purposes. Under the Administration’s FY2007 proposals, LSAs
would either displace these accounts or include them as a kind of sub-account.
Although certain types of education plans could be retained, for example due to state-
provided tax benefits, the attractiveness of a no-strings-attached LSA should lead to
the displacement of many of the educational accounts for those who are not saving
at the limit. Qualified tuition plans are more likely to remain concentrated among
high income individuals, where the incentive probably matters least, and less likely
to apply to moderate income individuals where the relative benefits may actually
influence decisions on how much to spend on education.
Tax Exempt Bonds. Tax exempt bonds carry lower interest rates than
equivalent taxable bonds. With favorable tax treatment for many other investments,
the demand for tax exempt bonds should contract which would raise financing costs
for state and local governments. Many analysts have criticized the tax subsidy for
state and local bond finance, which is largely an accident of history and of
constitutional interpretation, and might support this displacement. But it will place
an additional burden on the States and localities.
Owner Occupied Housing, Debt and Business Equity. The tax
exemption would shift investment into passive forms and out of equity investments
in owner occupied housing and unincorporated business including rental housing).
In general, the shift out of owner-occupied housing should increase economic
efficiency because this type of investment is favored. The shift out of unincorporated
business equity may decrease efficiency. The effects on corporate equity, the most
heavily taxed type of investment, is uncertain: while the changes favor corporate
equity relative to investments in other types of equity, the savings proposals also
favor interest more than dividends and capital gains (which are subject to lower rates)
— and thus shifts assets into debt.
Simplification
The Administration justifies its proposal on the grounds of simplification as
well as incentives to save. For most taxpayers, the current choice is either a back-
loaded or a front-loaded retirement, education, health, or other account, with
restrictions more limited on back-loaded plans and income limits differing.
(Individuals whose incomes exceed the ceilings can invest in a non-deductible tax-
deferred account.) The proposal would replace these choices with two plans that
individuals could invest in simultaneously, the RSA and the LSA. The proposal may
simplify rules by eliminating disparities among currently existing tax-preferred

CRS-21
accounts. It is important to keep in mind, though, that the substantial long-run costs
of the proposal may make this simplification effort a very costly one.
Although simplification may serve as an impetus for this change, it is unclear
how much simpler the resulting system would be. There would still remain a
disparity between RSAs and LSAs. The LSA rules are less restrictive than those of
RSA because they do not have age-based withdrawal penalties.
Furthermore, some disparities do not disappear under the FY2007 proposal but
rather become less conspicuous. For example, it retains some qualified tuition plans
as sub-accounts within LSAs. The funds within RSAs may be treated differently
depending on their origin: rollovers from some existing accounts may be subject to
various additional requirements compared to the new contributions. The FY2007
proposal would also retain limited traditional IRAs. Finally, at this point the
Administration’s proposal is just a conceptual framework, free of all the intricate
details that ultimately determine the complexity or simplicity of the whole system.
If simplification were the principal goal, it would be much easier to permit a
certain dollar amount of passive income to be excluded, without requiring the
complications of keeping accounts, at least for LSAs. This approach would,
however, cost more in the short run because the growth of the accounts limits the
initial revenue cost.

CRS-22
Appendix A
This appendix presents the method of estimating the growth pattern of a back-
loaded tax favored savings account for projecting revenue,27 and also for determining
the interest amounts in Table 1.
To estimate the pattern, we assumed that each year money is put into an account
where it grows for 15 years and then is withdrawn as a level annuity for the next 10
years. We assumed that contributions in each case are a constant share of output.
While variations in holding periods and withdrawal patterns will affect the results,
this example illustrates the general pattern.
Because of the time path of a Roth IRA, the cost is very small in the beginning
but grows rapidly.28 For example, in the first year, earnings from a Roth IRA that are
exempt from tax per dollar of contributions is r, where r is the interest rate, assuming
an annual interest payment. In the second year, the value is r(1+r) +r, or slightly
more than double (the first term is interest on the original first year contribution,
while the second is the interest on the second year contribution).
Based on calculations assuming a 7% interest rate and a 3% growth rate (g), and
keeping all measures constant relative to GDP, in the first year assets in the accounts
(and revenue costs) are 3% the size of their steady-state value. By the fifth year, they
are 18% of the value of the steady state size relative to GDP (which is reached in 25
years). By the 10th year, they are 41% of the size. On average, over the five-year
period, the cost is 11% of the steady state cost; over a 10-year period, the cost is only
one-fifth of the steady-state value relative to GDP.
A Roth-type IRA’s costs are directly related to the interest rate, since they
involve forgoing tax on interest. If interest rates are relatively low during the
estimating period, as there is some reason to believe to be the case, the revenue loss
will be even further below the steady-state values. This effect does not occur with
traditional deductible IRAs, whose costs in the short run are related only to
contribution levels.
Mathematically, to perform the calculations, designate the period the IRA grows
prior to withdrawal as T ′ and the entire period the IRA exists as T . To measure the
revenue cost for the Roth IRA, we estimate the cumulated value of assets in the fund.
For t years in the future, t less than T ′ , for each value of a dollar invested currently,
there are e-gt dollars invested that have grown at rate r, so the value of that vintage of
accounts is e(r-g)t. Integrating the value of assets yields a value at time t of:
27 The pattern of both forms is estimated in Jane G. Gravelle, “Estimating Long run Revenue
Effects of Tax Law Changes,” Eastern Economic Journal, vol. 19, Fall 1993, pp. 481-494.
28 This revenue cost assumes that Roth IRAs displace other investments, a finding consistent
with empirical evidence and with economic theory (which suggest that these provisions can
either decrease or increase savings). In any case, the relative pattern of costs should be
similar as long as some cost occurs.

CRS-23
(1) Cumulative value at time:

t (e(r−g)t
=
−1)/(r −g)
For t greater than T’ but less than T, one must take account of the value of funds
that have been partially withdrawn. An annuity for a dollar that grows at rate r for
T’ years and then is withdrawn over (T - T’) years is e (rT’) r/(1-e-r(T-T’)). The
remaining value in the asset account is:
rT ′
−r(T−t )
⎛ e (1− e
)⎞
⎜
⎟
(2) V (t) = ⎜
−r(T−T′)
⎝ 1−
⎟
e
⎠
when t reaches T, the numerator becomes zero.
To cumulate these amounts over time, recognize that the value in (2) is
−
multiplied by e gt , and integrate from T ′ to t, to obtain:
(3) Cumulative value of (2) at time t =
r(T t')
gT'
-gt
-rT
(r g)t
(r g)T'
[erT'/(1 − −
−
−
−
e
)]{e
- e
/ g - e
(e
−
−
e
) / (r − g)}
For period t, t greater than T ′ but less than T, the total asset value is (1) plus (3),
with t set at T ′ in (1). For t greater than T, substitute T for t in (3) and obtain the
steady state (relative to GDP) results by adding (1) and (3). If we set the second first
term in the curly brackets (the one divided by r-g) to zero and multiply the result by
the interest rate, the formula gives us the cumulative value of withdrawals at time t,
which are relevant to traditional IRA revenue losses.
For present value calculation each year’s revenue loss is discounted at rate r-g.
For a constant relative to GDP cost, the share of the cost allocable to the first t years
(
)t
is .
1 − − −
e r g
To determine the ceilings in Table 1, assuming that contributions are indexed
to inflation levels, note that a contribution made t years ago grows by the nominal
interest r and thus has grown to a value that is ert times the original contribution. At
the same time; each contribution t years ago is e−πt for each dollar today, where B is
the inflation rate. Integrating over all the investments, we obtain:
t
(r − p)
(4) Cumulative value at time t = (e
− 1) / (r − p)
and the current earnings are:
(r− p)t
(5) Current earnings at time t = r(e
1)
− / (r − p)
Earnings are therefore a function of the nominal interest rate, the inflation rate, and
the period of time the asset has been accumulating.