Stealth Tax Reform

Imagine that President Bush had a plan to dramatically reshape the federal tax system, eliminating taxes on investment income for most taxpayers, making the tax structure less progressive, and providing a boon to the wealthiest Americans. You might think he would mention it during his State of the Union address. You might think he would call it by its name: radical tax reform.

It turns out that Mr. Bush has such an audacious plan, but he has left it to his Treasury Department and to his 2004 budget proposal, which was released yesterday, to spell it all out. It's being wheeled into town inside a Trojan horse of private savings accounts. That doesn't make it any less radical. Indeed, if enacted, the plan could have effects far greater than the President's related move to eliminate dividend taxes. It would create new savings accounts that would allow almost anyone who pays slight attention to tax planning to avoid paying taxes on investment income: gains from stocks, interest on savings and dividends.

A couple with two children - and the income to do so - could put away $30,000 a year in Lifetime Savings Accounts; this money would grow tax-free and could be withdrawn at any point, for any reason. In addition, the couple could put $15,000 in tax-free Retirement Savings Accounts. (This would be on top of the $22,000 per year per child that families can already put aside to grow, tax-free, for college savings.) Meanwhile, this couple could continue to put $24,000 a year into employer-sponsored retirement plans. In other words, if you had the money, you could simply invest it and watch the tax-free earnings pile up. As a practical matter, the taxes that would remain would be on those chumps whose sole income is from their jobs.

The Treasury Department says the plan would encourage private savings and therefore stimulate economic growth. A number of economists who have studied savings behavior doubt this assertion. They suspect that the people most likely to take advantage of the new accounts would be higher-income types who would simply shift assets into the tax-free accounts; they are already investing in stocks and bonds, but under Bush's plan they would be free of capital gains taxes. Low- and moderate-income earners, these economists say, would have far less flexibility to take advantage of these savings vehicles, and, history shows, they are far less likely to do so. A Treasury Department study in 2000 found that only 4% of taxpayers eligible for conventional individual retirement accounts in 1995 made the maximum contribution of $2,000. Meanwhile, the new accounts would drain tax revenue - potentially huge amounts - from the government down the road, when the money was withdrawn and no taxes were paid.

The Lifetime Savings Accounts could also harm existing employer-sponsored retirement plans. Small-business owners have an incentive to set up such plans for their workers in order to provide for their own retirement as well. Under the administration's plan, that incentive might be reduced because those at the top would be able to set up their own separate retirement accounts. That could leave many employees without the convenient prod of a 401(k) plan, often with the great incentive of employer matching funds, to save for retirement. And whatever money workers did manage to save on their own would more likely go into a Lifetime Savings Account that could be raided at will, leaving them without a cushion later.

Congress has been careful when establishing such savings accounts to limit the income of those who can enjoy the tax breaks, the purposes for which the money can be used, or both. Lawmakers should think hard - about tax fairness, about the risk to workers and about the cost to the Treasury - before they rush to put Mr. Bush's plan in place. His latest proposal is one more indication of his administration's recklessness when it comes to the future fiscal health of the nation.