Top Administration officials are considering taxing deposits into 401(k) savings plans up front. The short-term fiscal benefit to the tax collector would be significant. But the cost to the economy could be enormous.
According to realclearmarkets.com:
In the process, the 401(k) has turned savers into investors. For previous generations, ownership of securities was a privilege reserved for the affluent. In 1983, fewer than one in five U.S. households owned stocks. Now, about half of them do. Two-and-a-half times as many Americans now have skin in the game and a direct stake in the economy.
As a result, a huge new pool of capital has been created for entrepreneurs to utilize in order to create wealth. At year-end 2014, about two-thirds of 401(k) assets, roughly $3.35 trillion, was held in equity securities – equity funds, the equity portion of balanced funds, and company stock. Almost 80 percent of defined contribution plan holders say the tax treatment of their retirement plan is a major incentive to contribute, according to a survey conducted last year by the Investment Company Institute. Based on these figures, stripping the upfront tax advantage of investing in a 401(k) could cost the equities markets as much as $2.7 trillion – more than the combined market capitalization of Apple, Microsoft, Facebook and Alphabet, the holding company of Google. If you want to get a sense of the size of the 401(k) market and its potential importance to start-ups, consider that the 10 largest IPOs this year raised $54.5 billion in capital on their opening market day – equal to just a little over 2 percent of the market power of 401(k)s. The goal of taxing 401(k) deposits upfront is to raise sufficient capital to make up for a cut in corporate taxes. But many companies would no doubt prefer market liquidity to lower tax rates, especially since few are paying the maximum rates now.
Treasury and White House advisors may think they have discovered a potential windfall in tax revenue. But a Joint Economic Committee study determined there is a bigger pot of gold at the end of the rainbow than the beginning, concluding that deferring taxes on a mutual fund’s capital gain ultimately increases federal government revenue by producing larger account balances and higher tax revenues when sold. In other words, taxing 401(k)s at the front end will result in more short-term pain for the taxpayer, and less long-term gain for the tax collector.
The goal should be to increase the circle of investors, generating retirement security for investors, stock market democratization, larger pools of capital, and deeper liquidity, not a quick fix for budget-makers.
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