Democrats Contemplate Abolishing 401(k) Tax Breaks

by Sara Hansard of Investment News

October 18, 2008

Powerful House Democrats are eyeing proposals to overhaul the nation's $3 trillion 401(k) system, including the elimination of most of the $80 billion in annual tax breaks that 401(k) investors receive.

House Education and Labor Committee Chairman George Miller, D-California, and Rep. Jim McDermott, D-Washington, chairman of the House Ways and Means Committee's Subcommittee on Income Security and Family Support, are looking at redirecting those tax breaks to a new system of guaranteed retirement accounts to which all workers would be obliged to “contribute.”

A plan by Teresa Ghilarducci, professor of economic-policy analysis at the New School for Social Research in New York, contains elements that are being considered. She testified October 7, 2008 before Miller's Education and Labor Committee on her proposal.

Under Ghilarducci's plan, all workers would receive a $600 annual inflation-adjusted subsidy from the U.S. government but would be required to invest 5 percent of their pay into a guaranteed retirement account administered by the Social Security Administration. The money in turn would be invested in special government bonds that would pay 3 percent a year, adjusted for inflation.

The current system of providing tax breaks on 401(k) contributions and earnings would be eliminated. "I want to stop the federal subsidy of 401(k)s," Ghilarducci said in an interview. "401(k)s can continue to exist, but they won't have the benefit of the subsidy of the tax break."

Under the current 401(k) system, investors are charged relatively high retail fees, Ghilarducci said. "I want to spend our nation's dollar for retirement security better. Everybody would now be covered" if the plan were adopted, Ghilarducci said.

She has been in contact with Miller and McDermott about her plan, and they are interested in pursuing it, she said. "This [plan] certainly is intriguing," said Mike DeCesare, press secretary for McDermott. "That is part of the discussion," he said.

While Miller stopped short of calling for Ghilarducci's plan at the hearing last week, he was clearly against continuing tax breaks as they currently exist. "The savings rate isn't going up for the investment of $80 billion," he said. "We have to start to think about ... whether or not we want to continue to invest that $80 billion for a policy that's not generating what we now say it should."

No legislative proposals have been introduced and Congress is out of session until next year. However, most political observers believe that Democrats are poised to gain seats in both the House and the Senate, so comments made by the mostly Democratic members who attended the hearing could be a harbinger of things to come.

On Thursday, October 9, the Department of Labor hastily scheduled a public hearing on the issue in Washington for Tuesday, October 21.