The Future of Retirement in the United States


Thank you for this opportunity to testify on future retirementprospects in the United States. I feel extremely honored to havereceived it.1

My testimony is in three parts. First, I provide an economicoverview of factors that will determine future economic growthwhich, in turn, will determine retirement living standards overcoming decades. This section identifies the types of policies thatappear necessary to maximize each factor's contribution to futuregrowth. It concludes that a faster rate of saving and capitalformation is crucial to sustain high economic growth.

Next, I provide an overview of the long-term federal budgetimplications of current fiscal policies with particular emphasis onSocial Security and Medicare finances. This section concludes witha recommendation for a budget-accounting reform for the federalgovernment.

Finally, I describe the potential hazards households could facefrom participation in tax-deferred saving plans. "Back-loaded'tax-favored plans such as 401(k)s and traditional IRAs--that permittax-free accumulations before retirement and subjectpost-retirement withdrawals to income taxes--could end up harmingsome households on a lifetime basis. This is especially true forlow earners who receive moderate to high rates of return on theirplan contributions. In contrast, 'front loaded' plans are likely tobe more effective as saving incentives. However, when consideringthe overall efficiency of such tax incentives in promoting greaternational saving, it is important to also consider the nature offuture tax and spending policy adjustments that are employed tocompensate for lost federal revenues.

Part I: Economic Overview

Retirement has been widespread in America during the past fewdecades because of robust growth in national output: The huge sizeand productivity of the baby-boom generation ensured sufficientresources for extending generous support to their retiredgrandparents and parents-who, on the whole, suffered much smallerdeclines in their post-retirement living standards compared toretirees in the prewar period.

Many are questioning whether the baby-boomers themselves will beable to continue enjoying living standards close to theirpre-retirement ones after they exit the workforce. I present somecalculations to indicate the size of transfers that must occur tosupport a growing older population.

I. Bulge in the Retiree Cohort:Population projections by the Social Security Administrationindicate that between the year 2003 and 2030, the number ofworking-aged individuals (those aged 20-64) will increase by just13.3 percent. The number of those aged 65 and older, however, willincrease by 93.1 percent. (These rates of population increase were51.6 percent and 71.1 percent respectively during the previous 30years.)

Table 1
Average Annual Consumption and Total Present Value ofResources
Total Versus Retiree Populations
Age Group
20 and older 65 and older
Average Annual Consumption Outlays(Thousands of constant 2003 dollars)
1960-61 16.8 12.4
1987-90 27.3 28.2
Percent change 62.6 126.8
Total Resources by Age Cohort
(Present values in thousands of constant 2003dollars)
1960-61 283.3 161.3
1987-90 453.8 314.1
Percent change 60.2 94.8
Source: Author's calculations based onUnderstanding the Postwar Decline in U.S. Saving: A CohortAnalysis, by Jagadeesh Gokhale, Laurence J. Kotlikoff, andJohn Sabelhaus; Brookings Papers on Economic Activity, I:1996.

Table 1 shows that compared to their counterparts in the early1960s, those who were aged 65 and older in the late 1980s enjoyed a95 percent increase in resources per capita and spent 127 percentmore on consumption per capita. Overall, however, total resourcesand average annual consumption per person increased by only about60 percent.

This information can be used to project retiree consumptionunder "static" and "historical growth" assumptions. In the staticcase, I assume that per capita annual consumption will stayconstant for everyone through the foreseeable future. I also assumethat consumption of the 65-plus group relative to that of theoverall population is the same today as it was in 1987-90-again astatic assumption. Under these assumptions, I calculate that annualconsumption of the 65-plus group equals 20 percent of totalconsumption in 2004. Projecting consumption into the future usingpopulation projections suggests that by 2030, the 65-plus groupwill consume about 35 percent of total consumption. Their "static"consumption share continues to increase gradually through 2080 (seeFigure 1).

During the 1970s and 1980s, rising health-care cost was the mainimpulse underlying consumption growth for the 65-plus population.Medicare actuaries project that those costs will continue outpacingoverall economic growth as retirees use more intensively newer,more effective, but costlier health care technologies. Hence, Imake an alternative projection that is consistent with "historicaltrends" in consumption growth for the 65-plus and the overallpopulation. First, I calculate the relative consumption per capitaof the 65-plus to total population in 2004 by applying the averageannual growth rate in consumption between 1960-61 and 1987-90 (seeTable 1). Future per-capita consumption is also assumed to grow atthese differential rates for the 65-plus and the overallpopulation. This yields in the "historical trend" projection shownin Figure 1. Here, the share of consumption by the 65-plus groupequals 22 percent in 2004 and it nearly doubles by 2030-to 43percent. After 2030, it continues to increase at a more rapid pacecompared to the "static" projection.

Figure 1. Consumption Share of the 65-Plus Population

Source: Author's calculations.

What are the implications of allowing retiree consumption percapita to grow at historical rates? Figure 2 contains the answer:It shows that the consumption per capita of those 64 and youngerwould have to be kept essentially constant throughout this centuryin order to transfer the needed resources to retirees.

Figure 2. Consumption Per Capita of Those Aged 64 and Younger if Consumption Per Capita of 65-Plus Population Grows at Historial Trend

II. Growth in Output: The amount ofresources that future retirees will be able to access will dependon the rate of future economic growth realized in the UnitedStates. The rate of growth will depend upon the growth ofinputs--labor and capital--and theirproductivity.

A. Capital growth: Capital formation is constrained bythe amount Americans save and can borrow from abroad. During pastdecades, the net national saving rate--the amount notconsumed out of net national output as a share of output--hastrended down, pulling with it the net domestic investmentrate--investment net of capital consumption as a share ofnational output (see Figure 2). The investment rate has beensustained above the saving rate because foreign savers have chosento direct their savings to the United States for investment. Priorto 1975, the net national saving averaged more than 10 percent.Since then, however, it has trended down to being barely positivein 2001. There is considerable uncertainty about how much offoreign savings the U.S. will continue to receive in the future.The fact that net domestic investment has also trended down alongwith the net saving rate suggests that national saving constrainsdomestic capital formation.

Figure 3. Net National Saving (NNDS) and Investment Rates (NDIR)

Source: Author's calculations based on data from the Bureau ofEconomic Analysis.

National saving is the sum of saving by households, businesses,and the government. The recent decline in national saving isprimarily the result of high government deficits. However,household consumption levels have also remained high as householdshave been able to cash out their rapidly appreciating homeequities.

Furthermore, continued dependency on foreign savings implies aneed to repay it with interest-reducing Americans' claims on futurenational output. If the trend of declining national saving were tobe reversed, we would be less dependent on foreign savings tofinance domestic investment.

Conclusion: Need to provide effectiveincentives for Americans to save and invest.

B. Labor force growth: Beginning in just a few years,labor-force growth is expected to slow simply because morebaby-boomers will retire than the number of young-adults enteringthe labor force.

An immigration-friendly policy can help alleviate laborshortages that appear imminent.

Another way to counter slower labor-force growth is to increasethe growth of the "effective" work-force by increasing workerskills. Many consider education and job-training subsidies to beeffective means of upgrading worker skills and education. Suchsubsidies probably help, but are not necessarily the most effectivemeans of promoting skill acquisition. At the margin, they maygenerate larger school systems that produce degreed graduates butnot necessarily with additional skills. The real proof of skillacquisition is higher future labor earnings. Hence, a moreeffective inducement to skill acquisition would be the ability toretain the higher earnings as disposable income. Tax rates may below today, but workers (and savers) must believe that they willremain low for them to make the desirable choices.

Figure 4. Labor Force Growth

Source: Author's calculations based on projections made by theSocial Security Administration.

Labor force growth may not slow as much as projected if promisedSocial Security and Medicare benefits cannot be paid. A shortfallin retirement resources may force some workers to stay in the laborforce longer, and induce some recently retired individuals toreturn to work.

Conclusion: Need to maintain acredible low-tax environment for increasing the"effective" labor force.

C. Productivity growth: Productivity growth remainedsurprisingly high during the 2001/2 recession and has surgedthereafter. Most observers ascribe this to continued diffusion ofinternet and IT technologies through other "old" sectors. Ifproductivity continues to improve, it could (perhaps more than)offset the decline in output growth because of slower labor-forcegrowth. Researchers have documented that in earlier episodes oftechnological breakthroughs (steam engine, electricity), the newtechnology's diffusion throughout the economy took several decadesto complete.

Unfortunately, whether the "new economy" will be fleeting or ishere to stay is extremely difficult to predict. Moreover, continuedproductivity growth has usually resulted from successivetechnological breakthroughs, not from applying the same technologyrepeatedly.

Because of the slower projected labor force growth, uncertaintyabout how long superior productivity growth will last and because,at source, continued technological advances require prior capitalinvestments, increasing the rate of saving and capitalformation--both physical and human--is likely to be the mostimportant determinant of future retiree (and overall) livingstandards.

Conclusion: Higher saving and investment arecritical; needed to fuel continued Tech. advance.

Figure 5. Growth in Output Per Hour

Source: Bureau of Labor Statistics.

Summary: Future retiree living standards will bedetermined by the size of future national output and the amount weallocate for retiree consumption. Output growth depends on thegrowth of future production factors and their productivity. Giventhat labor force growth will shrink and the sustainability of thecurrent high productivity growth is uncertain, the rate ofacquisition of human and physical capital will be the mostsignificant determinant of future output growth and livingstandards.

Part II: Social Security, Medicare, and the FederalBudget

Social Security is the most important source of retirementsupport, and Medicare provides the overwhelming portion of retireemedical care.2

Financial projections for the Social Security (OASDI) programthat I constructed as of fiscal year-end 2002 suggest that it has a"fiscal imbalance" of $7 trillion. These projections consider theprogram's entire future without limit.3 This figure shows the size of the total futurefinancial shortfall that Social Security faces.

Here's another way to interpret the $7 trillion number: It isthe amount of money the federal government must have on handtoday, invested in an interest earning account, in orderto never have to change future Social Security payrolltaxes or benefit rules.4 Nothaving this amount on hand, of course, implies that future SocialSecurity benefits must be cut, or future payroll tax revenues mustbe increased to raise an equivalent amount of resources ($7trillion in present discounted value) to eliminate SocialSecurity's financial imbalance.

My calculations show that the accumulated value of past taxesand benefits plus the present discounted value prospective taxesand benefits of those currently alive (as of 2002) equals $8.7trillion. This amount is called the "generational imbalance."

Since the program's total financial shortfall (throughout thefuture) equals $7.0 trillion and the shortfall on account of pastand currently alive generations equals $8.7 trillion, easy mathsays that future generations contribute excess taxes of $1.7trillion dollars in present value (as of 2002).

A positive fiscal imbalance (the $7.0 trillion) implies that theprogram's current rules are not sustainable. Someone must pay moreor receive less than they are scheduled to under those rules.

If we postpone making any changes to Social Security's tax andbenefit rules for a sufficiently long time and then change them toeliminate the imbalance, today's (2002's adult) generations willreceive excess benefits over their payroll taxes worth $8.7trillion and future generations will pay $8.7 trillion in excesstaxes over benefits--$1.7 trillion that they are scheduled to payunder current rules plus $7.0 trillion in additional taxes leviedvia changes in the distant future.

Alternatively, we could make rule changes now and reduce theexcess benefits of current generations down from $8.7 trillionunder current rules. The main point here is that a calculation offiscal and generational imbalances allows us to understand thetrade-offs available in choosing between alternative ways ofrestoring balance to the Social Security system.

Fortunately, the Social Security's actuaries have already begunreporting the fiscal and generational imbalance measures, andMedicare is to begin reporting them Medicare beginning with thisyear's Medicare Part A (Health Insurance) Trustees' report. Similarcalculations would be useful for the entire federal government aswell.

According to my calculations, Medicare's fiscal imbalanceamounts to $36 trillion in present value (as of fiscal year-end2002), using standard assumptions for projecting future health careoutlays.

Medicare, Part A, which covers inpatient hospital and otherservices, faces a financial imbalance of $20.5 trillion and agenerational imbalance $8.5 trillion. That is, both future andliving generations are scheduled to receive more than they will payin Medicare payroll taxes.

Medicare Part B's fiscal imbalance amounts to $16.5 trilliondollars and its generational imbalance equals $6.6 trillion. Theseimbalances include the un-dedicated general revenue transfers thatfinance approximately 75 percent of Medicare Part B's outlays.

Medicare's imbalances cited above do not include the effects ofthe prescription drug coverage enacted in 2003. Independentcalculations show that law to add $8 and $13 trillion in Medicare'slong-term financial shortfall.

Hence, Social Security and Medicare (including prescriptiondrugs) altogether contain a total fiscal imbalance of between $50and $60 trillion.

kAs of fiscal year-end 2002, federal non-Social Security andnon-Medicare programs ("rest-of-federal government) contributedonly $0.5 trillion in present value to the total federal fiscalimbalance. However, federal defense and non-defense discretionaryspending has recently been growing at a very rapid pace. Were thesecalculations to be updated, I am confident that the rest-of-federalgovernment's fiscal imbalance would be considerably larger.

As of fiscal year-end 2002, I had estimated total federal fiscalimbalance at $44.2 trillion. Eliminating an imbalance of thatmagnitude, by my calculations, would require a more than doublingthe payroll tax rate immediately and permanently.Alternatively, income tax revenues would have to be increased byabout 70 percent, again immediately and forever. If spending cutsare considered, future Social Security and Medicare benefits wouldhave to be cut by 45 percent. Eliminating federal discretionaryoutlays today (as of 2002) and forever would not have beensufficient to eliminate federal fiscal imbalance.

These required policy changes to raise the resources necessaryto pay for scheduled government outlays are drastically large andwould devastate the economy. However, waiting to make policychanges would make the cost of doing so even more. The simplereason for this is that, just like debt, fiscal imbalances accrueinterest. Not dealing with the imbalance now means today'sgenerations receive a windfall gain (they don't pay any additionaldollars toward closing the funding gap), and future generationsmust finance this 'giveaway'--that is, bear a higher fiscalburden.

Implications: The size of federal unfundedobligations calculated here mirror the calculations of Part I:where it was shown that the transition of the baby-boomers intoretirement requires a massive shift in consumption toward theelderly. Part II shows, that continuing on the current publicpolicy course is not feasible and massive policy changes arerequired to bring federal revenues and outlays--that are used toeffect the transfer of consumption resources--into balance.

Were retirements in the United States fully funded--perhapsself-financed through mandatory personal savings--the boomers wouldby now have accumulated much more by way of financial assets.Correspondingly, the U.S. economy would have been much bettercapitalized and worker productivity and incomes would have beenhigher than it is today. That would mean higher national output tobe distributed toward retirees. And retirees would have thenecessary financial claims to use to facilitate that transfer. Thefinancial and real economy would work in complementary fashion toachieve retiree economic security.

First: A big chunk of the consumption transfer toward retireesoccurs via pay-as-you-go Social Security and Medicare. By designand because of their generosity toward earlier generations ofretirees, these programs face massive unfunded obligations and mustdepend upon future payroll tax revenues to continue payingretirement benefits. Their pay-as-you-go financial design is suchthat the very act of extinguishing benefit obligations to currentretirees creates new and larger obligations to today's workers(future retirees). And, the expectation of future benefits and theburden of payroll taxes render workers unwilling and unable toaccumulate savings. This leaves the economy with less capital andlower worker productivity.

Second: Although the current impasse is mostly generated byunavoidable demographic developments, the tools of fiscal analysisthat are currently employed to assess future policychoices--backward-looking measures such as national debt andshort-horizon projections of annual deficits--are ill suited forclarifying the fundamental choices policymakers face. Had fiscaland generational imbalance measures been regularly published byofficial budget reporting agencies during the past several decades,policymakers would have been more fully informed and may have begunaddressing the oncoming resource crunch.

Third: It would be better to move away from continuing tofinance the transfer of consumption toward retirees throughpay-as-you-go programs such as Social Security and Medicare.Although these programs are thought to have been very successful ineliminating poverty in the past, that success has likely been verycostly in terms of the cumulative loss--over 7 decades in the caseof Social Security and 4 decades in the case of Medicare--in theeconomy's capitalization and productivity growth. Unfortunately,these costs are not readily observed, which prevents a balancedassessment of these programs' net economic contribution.

Part III: Saving Incentives

The demographic changes slowing work-force growth cannot beeasily countered except through massive immigration. That leavescapital accumulation--to increase output via more machines, betterworker skills, and better technology--which requires greatersaving.

Basic economic theory suggests that in a world with perfectlyfunctioning capital markets and rational individuals, providingsaving incentives through tax-policy would be sub-optimal. Asubsidy to saving would generate a welfare-lowering distortion inthe consumption-saving trade-off that people face.

However, we have (inherited) an economy that already containsconsiderable saving disincentives--in the form of public transferprograms that lower the return to saving, reduce households'abilities to save because of heavy income and payroll taxation, andtransfer resources from high savers (the young) to low savers(retirees). In addition, raising revenues through income ratherthan consumption taxation results in heavier taxation of resourcesdevoted to future rather than current consumption via saving:Earnings are taxed before saving occurs and the return to saving istaxed again in through interest and dividend taxes. This makescurrent consumption cheaper relative to future consumption--leadingto lower household saving. The provision of saving incentives insuch a world is equivalent to reversing existing economicdistortions that reduce saving.

Unfortunately, providing tax incentives that generatesubstantial new saving is not easy. The incentive mustcome in the form of lowering the price of future consumptionrelative to current consumption. However, simply providing asubsidy to future consumption (by increasing the after-tax returnon asset income) generally increases a household's net lifetimeresources. For those who would have saved even in the absence ofthe tax-subsidy, the increase in lifetime resources may stimulatemore rather than less current consumption. The consensus view inthe economics profession is that only about 25-30 percent ofcontributions into tax-favored saving accounts represent netadditions to saving.

The multiplicity of tax-deferred saving vehicles and complexityof rules may have discouraged some potential savers fromparticipating in tax-favored saving plans. The complexity of"back-loaded" saving vehicles [401(k)s and regular IRAs] is notrestricted to their rules; it also emerges from potentialinteractions with income tax rules, including taxes on SocialSecurity benefits, itemized deductions and exemptions.

A recent study that I co-authored analyzes the potentiallifetime gains from participating in 401(k) plans and Roth IRAs.These plans are almost universally recommended for households as away of saving on their lifetime taxes. However, the study'ssurprising result is that low-earners who make substantialcontributions to their 401(k) accounts and receive moderate to highrates of return on those contributions, could end up payingmore in taxes on a lifetime basis. Hence, such householdswould enjoy smaller lifetime consumption because of theirparticipation in such plans.

This counter-intuitive result arises because of the taxinteractions of "back-loaded" plans mentioned earlier. To summarizebriefly, participation in such plans lowers current taxes, butincreases future taxes. The extent of current and future taxchanges depend on participants' tax brackets when contributingversus when withdrawing from such plans. The changes in thesetax-brackets can be potentially quite large--depending on the sizesof contributions and the rates of return earned on plan balancesthrough retirement. Large account accumulation through retirementcan trigger larger withdrawals, pushing participants into highertax brackets relative to those faced without participation. Inaddition, high withdrawals can potentially increase the amount ofSocial Security benefits that become subject to tax and can resultin a greater phase-out of itemized deductions relative tonon-participation.5 Finally,plan contributions can potentially lower participants' tax bracketswhen working, and reduce the value of itemized deductions andexemptions, again compared to non-participation.

Using a model of lifetime consumption and saving thatincorporates in considerable detail provisions of the federalincome tax, state taxes, and Social Security taxes and benefits,the study calculates the implications of participating in 401(k)plans and Roth IRAs for stylized households at different incomelevels.6

Table 2 shows results for low income households. Thecalculations incorporate the provisions of the Economic Growth andTax Relief Reconciliation Act of 2001 which expanded contributionlimits on several types of plans, including 401(k), 403(b), Keogh,traditional and Roth IRAs.7EGTRRA also provides a non-refundable tax credit for qualifiedaccount contributions up to $2000 for households with low earnings,which phases out for households with AGI larger than $50,000).Because this credit is sunset, and the phase-out dollar thresholdsare not indexed, the tax-treatment of plan participants wascalculated under alternative assumptions about whether the creditis indexed or not, and whether it is extended beyond 2010 ornot.

The results show that in each case, some categories oflow-earning households would pay more in lifetime taxes (presentvalue of future taxes) if they participated in a "back-loaded"savings plan and received a moderate (6 percent) rate of return ontheir contributions. In addition, the tax interactions dilute thelifetime tax savings for even those households that benefit, onnet, from participating in "back-loaded" plans.

Table 2:
The Percentage Change in Lifetime Taxes and Spending from 401(k)Participation Under Alternative Assumptions For Selected HouseholdEarning Less Than $50,000 6.0 Percent Real Rate of Return
Age-25 Earnings 401(k) and Traditional IRA Roth IRA
Non-Refundable Tax Credit NotExtended and Not Indexed Non-Refundable Tax Credit Extendedand Indexed
Taxes Spending Taxes Spending Taxes Spending
25,000 1.35 -0.29 -0.68 0.02 -8.96 1.29
35,000 -0.68 0.05 -2.08 0.34 -3.85 0.77
50,000 1.07 -0.36 0.58 -0.24 -3.25 0.81
Note: Lifetime taxes and spending refer to thepresent values of the couples' annual taxes and spending onconsumption, housing, college tuition, and life insurancepremiums.

Despite the non-refundable credit for low earners, Table 2 showsthat some low earner households would lose on a lifetime basis fromparticipating in 401(k) plans and IRAs.

How many U.S. households actually face this jeopardy? I amcurrently co-writing a study on this issue using survey data fromthe Board of Governors of the Federal Reserve. A preliminary resultfrom this study suggests that roughly 10 percent of participatinghouseholds may suffer an increase in lifetime taxes (and areduction in lifetime consumption) as a result of continuedparticipation at their current levels in 401(k) plans.8

Because Roth IRA contributions are made from post-tax resourcesand withdrawals are not subject to tax, participating in such"front-loaded" plans does not result in the tax-interactionsdescribed above for "back-loaded" plans. Hence, Roth IRA-typeincentive plans provide a lifetime tax subsidy even at low earninglevels. The new proposals to introduce Retirement Savings Accountsand Lifetime Savings Accounts are structured similar to Roth IRAsand, therefore, should work better as saving incentives compared to401(k) plans and traditional IRAs. They may be also better thanRoth-IRAs because of their simpler regulations.

The remaining concern about all such (traditional- andRoth-IRA-type) saving incentives is their impact on the federalbudget. Providing tax-incentives to promote greater saving impliesa loss of federal revenue. Absence of other concurrent tax orspending changes to make up the revenue loss implies a largeraccumulation of debt, which must ultimately must be serviced orre-paid through future tax or spending adjustments. If short termdeficits are increased, they could soak up privately investiblesavings and produce only minor net addition to the capital stock,if any. If concurrent tax or spending changes are included to avoidlarger debt accumulation, those tax-policy initiatives may partlyor fully offset the initial saving incentives. Therefore, judgmentabout the efficacy of such incentives requires carefulconsideration of the tax structure on a revenue neutral basis.

Conclusion: The impending entry of baby-boomersinto retirement will require a steep increase in retireeconsumption. Even if real consumption levels per capita stayconstant, retirees will consume an additional 15 percent ofnational output by the year 2030 compared to today. If retireeconsumption levels are to continue increasing at historical rates,the transfer of consumption toward retirees will have to be doubledby the year 2030 compared to today. To achieve this result, theconsumption of per-capita consumption of younger cohorts will haveto be kept constant at today's levels.

The rate at which retiree consumption can grow will beconstrained by the rate of growth of national output.Unfortunately, the transition of baby-boomers into retirementimplies significantly slower labor-force growth. Declining nationalsaving is constraining domestic capital formation despite sizableborrowing from abroad. Finally, although productivity growth hastrended up recently, we have little information about thesustainability of such a trend. Maintaining high productivityrequires rapid capital formation and human skill acquisition--bothof which necessitate higher rates of saving and investment.

The allocation of consumption resources toward retirees isaccomplished in the United States through public transfers viaSocial Security and Medicare. Both of these programs face sizablefiscal imbalances. Social Security's overall fiscal imbalanceequals $7 trillion and that of Medicare including the recentlyenacted Prescription Drug coverage for seniors is roughly 7 timesas large as that of Social Security's. Restoring financial balanceto these programs will require large tax/benefit changes.Understanding the trade-offs in making such policies requires us tocarefully re-structure federal budget accounting systems.

Inducing greater saving through tax policies is desirable torectify existing disincentives arising from income taxation andother public policies. Those policies are continuing to transfersizeable amounts of resources from young workers with lowpropensities to consume toward older individuals with higher andgrowing consumption propensities. In addition, the pay-as-you-gofinancing structures of Social Security and Medicare sap workers'saving incentives and ability.

Providing greater saving incentives via Roth-type tax-favoredplans is superior than via traditional IRA or employer sponsored401(k) plans. The latter plan-types allow tax-free contributions,but withdrawals are subject to the income tax. These featuresgenerate interactions with other income tax provisions and reducethe lifetime tax-subsidy that "back-loaded" plans can provide. Theinitiatives to introduce Retirement Saving Accounts and LifetimeSaving Accounts are similar in design to Roth IRAs and impose fewerrestrictions; hence, they should be more effective in encouraginggreater net saving. However, their ultimate efficiency inincreasing saving and investment will also depend upon how currentand future tax and spending changes make up the lost federalrevenue.


1. I am Jagadeesh Gokhale, SeniorFellow at the Cato Institute in Washington D.C. I have conductedseveral studies on federal fiscal policy including Social Securityand Medicare. I have also written on labor markets, nationalsaving, inequality, and intergenerational transfers, and the(in)adequacy of saving and life insurance in the United States. Ihave also analyzed the potential financial hazards households couldface over their lifetime from participating in tax-deferred savingplans.

2. Social Security provides 37.6percent of income for those over 65--more than earnings (20.7percent), asset income (19.9 percent), employer benefits (18.7percent), and other sources (3.1 percent). (Monthly Labor Review:

3. The numbers I cite here are takenfrom my study with Kent Smetters: Fiscal and GenerationalImbalances: New Budget Measures for New Budget Priorities. Alldollar figures cited here are as of the end of fiscal year2002.

4. The calculations in the studycited in footnote 3 extend the Office of Management and Budget'sfiscal projections as of fiscal year-end 2002. They use OMB'seconomic assumptions and the Social Security Administration'spopulation projections. OMB's economic assumptions incorporate ahigher rate of interest than the rate used by the Social SecurityAdministration when calculating present discounted values of futurebudget calculations reported in the 2003 Social Security Trustees'report. I believe that the appropriate rate of discount is thatwhich the federal government must pay on long-term borrowing(reflecting its true opportunity cost of obtaining funds), and notthe average rate on the maturity range of non-marketable TreasurySecurities that are held in the Social Security Trust Fund.

5. The Economic Growth and Tax ReliefReconciliation Act gradually removes the limitation of itemizeddeductions between 2006 and 2010, but the limitation is reinstatedin 2011 when this EGTRRA provision is sunset.

6. "Who Gets Paid to Save" byJagadeesh Gokhale and Laurence J. Kotlikoff published in TaxPolicy and the Economy, NBER, vol 17, 2003, pages 111-39.

7. For results on stylized householdsat higher earning levels, see Gokhale and Kotlikoff cited infootnote 5.

8. The study finds that 7 percent ofall households may pay more in lifetime taxes by participating in401(k) plans using survey data pertaining to 1995. A recent KPMGretirement study finds that in 1995, about 65 percent of employeesparticipated in employer sponsored tax-deferred saving plans.