Congress is in need of a bright idea to fix Social Security’s cash flow problems — without one, beneficiaries could see a more than 20% reduction in benefits in the next decade.
Economists Andrew Biggs and Alicia Munnell laid out a perhaps surprising idea in a recent proposal. Biggs, a senior fellow from the right-leaning think tank American Enterprise Institute, and Munnell, director of the Center for Retirement Research at Boston College, argue that limiting current tax preferences for certain retirement plans could create enough revenue to fix Social Security’s finances.
When you contribute to a defined contribution plan like a 401(k), you do so with pre-tax dollars and usually don’t pay any taxes until you start making withdrawals in retirement. That means whatever you contribute lowers your taxable income for the year by the same amount. The contribution limit for workers in 2024 is $23,000, and employees 50 and older have the option to put away up to an extra $3,500 in “catch-up” contributions.
Tax preferences for retirement plans reduced federal income tax revenue by roughly $185 billion in 2020, with 401(k) tax benefits making up the majority of that lost revenue thanks to their widespread use and higher annual contribution limits.
The researchers say that money could be used as a subsidy to fill the Social Security funding gap (though it wouldn’t quite cover the entire shortfall). They also argue that repealing these tax benefits wouldn’t have much effect on average savers because they mainly benefit high earners and don't really incentivize Americans to contribute more.
But other economists aren’t too keen on the proposal from Briggs and Munnell. In an opposing analysis, researchers from the Mercatus Center at George Mason University say that the plan not only fails to address the root of Social Security’s funding issues, but that it also would effectively dry up taxpayers’ retirement savings.
“Taxing the returns on these savings again would amount to a second layer of taxation on the same income,” the Mercatus team said in their brief. “To say that it will be extremely disruptive of Americans’ savings is an understatement.”
You can find out more about Munnell and Biggs’ controversial funding solution from Money reporter Pete Grieve’s story. Drop me a line at mcags@money.com with your thoughts, retirement questions or any stories you’d like to share.
— Mary Ellen Cagnassola, Money reporter
