Capping Deferral Limit Wouldn’t Do Much to Fix Budget Deficit

A paper suggests that lowering deferral limits to 401(k)-type plans wouldn’t make much dent in the U.S. budget deficit and could result in workers not saving.

Researchers with the National Tax Association estimated the long-term effect on tax expenditures of limiting the maximum total deferrals to 401(k)-type plans to $10,000 and found that even at high rates of return, doing so would only decrease the cost of the tax expenditure by at most $33 billion, or 2%, of the current $1.5 trillion deficit.

“Hence, if policymakers hope to raise substantial revenue from reforming 401(k)-type plans, a much deeper reduction in the contributions limit or other reforms would be needed,” the paper authors wrote.  

The report, “Long-run Changes in Tax Expenditures on 401(k)-type Retirement Plans,” noted that substantially lowering the limit seems to be at odds with policymakers’ concern that taxpayers may not be saving enough for retirement, and if tax benefits of saving for retirement were reduced, lower-income workers could reduce their retirement savings, which could increase government costs in other areas.  

Lawmakers have made proposals to reduce retirement plan tax expenditures as a way to increase revenue; however, industry groups have battled against those proposals (see Industry Groups Urge no Changes to Retirement Savings Tax Advantages).  

The report authors contended that because retirement plan tax expenditures are generated by deferral of tax, its cost should be considered over a time horizon that extends beyond the five years of the tax expenditure cost estimation window.