The Politics of Roth

This daily blog is usually dedicated to personal retirement planning. But occasionally I feel motivated to digress into public policy. Today is one of those days. It’s not like it’s my birthday or anything. But sometimes it’s just nice to ramble. The weather’s nice. It’s March, so it’s almost spring. Today I’ll digress.

I’ve devoted a number of posts to the pros and cons of saving on a Roth basis instead of a traditional pre-tax basis. I’m trying to help you answer the question, “What’s in my long-term best interest?” But why has Congress offered us all these opportunities? Roth IRA’s. Roth 401(k)’s. Roth conversions. 2010 Roth sale.

Think of it as the stealth triumph of Steve Forbes. Remember him? He lost the Republican primaries in 1996 and 2000. Big time. He campaigned on the misguided platform of a flat tax on all of your compensation income, but excluding any tax on income from your investments. Imagine if his tax policy had carried the day. People wealthy enough not to have to work, who live off their interest, dividends and capital, would not share in the country’s tax burden. I don’t know about the economics of that kind of system, but the politics is just plain nutty.

But that’s what Roth saving is all about. You pay tax when you earn the compensation by not getting a deduction as you would, say, for a pre-tax contribution to your traditional 401(k) plan. And then you never again pay tax on the interest, dividends and capital gains within the Roth account.

So it turns out Steve Forbes has won, but only to some extent. Roth opportunities are limited in amount. A wealthy person can’t just Roth-ificate all his investments; just the part that’s found its way into a tax-favored retirement account. And those parts are limited by law (as described in February 4’s post). But for most Americans, that’s enough. Few of us can afford to save more than the amounts the Tax Code allows us to contribute to our IRA’s, 401(k)’s, and the like. For all but the wealthiest, these accounts can (and do) contain all of our savings. (Well, there’s also our houses, but most capital gain on that is tax-free too.)

How did we get to this point? The Bush administration was, like Forbes, enamored of the concept of excluding capital-based income from taxation. And for a while Bush had the requisite sway with Congress. So he achieved a few steps in that direction: Expansion of Roth opportunities; extremely low tax rates on dividends and capital gains. For years he promoted (unsuccessfully) further expansion of the concept, trying to create Lifetime Savings Accounts, which would have been Roth-like accounts that could be used for any purpose, not just retirement. Bush even feinted toward permanently abolishing all traditional pre-tax retirement accounts (all of them!!!), a recommendation made by his commission to reform the income tax system.

How was Bush so successful with Congress where Forbes fell on his face? It probably didn’t hurt that Roth savings—particularly Roth conversions of large pre-existing traditional IRA’s—generate lots of near-term revenue at the expense of future revenue, a subtle form of inter-generational theft. Roth opportunities help Congress pretend it’s balancing the budget by only looking at 10-year projections, while the real revenue losses don’t hit until many years down the road when the growing army of Roth retirees stop sharing in the tax cost of running the show.

Well, that ramble was fun. Tomorrow I’ll go back to my usual posture: “To hell with the next generation. What’s in it for me?”