Leaders from both parties and both chambers of Congress have vowed to wipe the tax code clean and scrutinize every deduction, credit, and expenditure. They claim to be on the lookout for good ideas that can serve as pillars for meaningful – and fair – tax reform.
If they are serious about this endeavor, one central objective of tax reform should be to help close the ever-widening gap in wealth between the families at the top and at the bottom.
We know tax rules have been amended over the years to favor higher-income families, playing a substantial role in reinforcing economic inequalities. Current tax rules create costly tax shelters rather than well-crafted incentives. Each year the government allows more than $140 billion to go untaxed through preferred treatment of savings accounts like 401(Ks) and IRAs. Yet we know from a Congressional Budget Office study that two-thirds of these benefits get funneled to the top 20 percent of earners who make the bulk of the contributions to these tax-advantaged accounts. The lower 60 percent of income earners—the very families that could use the support—are allocated just 16 percent of the tax benefits.
This is not to say that we don’t need incentives to support savings. Our country would certainly benefit from making sure more families could build up their personal balance sheets. But allocation of benefits enshrined in the code today is regressive and ineffective, rewarding the wealthiest among us for the ability to move money around rather than helping more people do something beneficial.
Federal tax policy should be dedicated to closing these gaps, not reinforcing them. One way to do this is to consider creating a Financial Security Credit, a proposal advanced last week by Representative Jose Serrano (D-NY) and twenty of his colleagues in the House.
If passed into law, eligible families who save would have their money matched by the federal government at a 50% rate on contributions up to $1,000 a year. Families can qualify for a benefit by contributing to a range of saving products, including those traditionally associated with retirement as well as more flexible vehicles like short-term savings accounts. This gives them the choice as to whether they want to save for higher education, build up a financial cushion to handle unexpected emergencies, or plan ahead for retirement. By not limiting the benefit to long-term objectives, the policy would be flexible enough to align with the range of needs families have and their diverse circumstances, at the same time as it affirmed that increasing personal savings is a policy priority, supported by the tax code.
The credit also has the advantage of being real money and does not depend on having a positive tax liability.
In addition to providing greater savings incentives for lower and middle income families who otherwise aren’t getting the same tax benefits for savings that wealth Americans now enjoy, this proposal has the added benefit of encouraging more families to join the financial mainstream. Under the Serrano proposal, families who don’t own savings accounts would be able to open them at tax time and make direct deposits into those accounts from their tax refunds. New York City tested this approach with a program called $aveNYC, aimed at encouraging low-income taxpayers to save a portion of their tax refunds at tax time. From 2008 to 2010, more than 2,200 taxpayers opened an account and committed to save more than $1.7 million. The success of $aveNYC has since led to the expansion of the program to additional cities across the country in a broader effort now called Save USA.
These initiatives have built up an impressive evidence base for the Financial Security Credit proposal.
A first-rate country should have a tax code that is not a mess. A clear and effective tax code not only raises the revenues that fund government but is a building block for the activities critical to our nation’s economic growth, innovation and commerce. Yet since the last major reform effort in 1986, the code has been loaded up with an impressive litany of carve-outs and loopholes that the analogy to Swiss cheese is hardly a stretch. As a result, the code is too complex, too wasteful, and does not help achieve fundamental policy goals, like promoting economic growth and increasing levels of personal savings.
If the goals of tax reform are to simplify the tax code and make it work more effectively and efficiently to achieve shared goals, then the Financial Security Credit could be a potentially critical component of a larger reform effort. The result would be a tax code that is not only more equitable but promotes the broader prosperity for all families that we desperately need.