Tax Law Changes: Good, Bad and Ugly

Tax Law Changes: Good, Bad and Ugly

Congress has just made major changes to the tax law. They include one change I argued for more than a decade ago. Other changes mix the good with the bad. Some are downright ugly.


One of the most significant changes in retirement policy in recent history was a provision in the pension reform law of 1996. It allowed employers to auto-enroll their employees in 401(k) plans with diversified portfolios without fear of lawsuits if the market happens to go down.

Before that time, many workers were not taking advantage of the 401(k) savings opportunities, even when there was a generous employer match. Many who did join were defaulted into money market funds, with no potential for growth. Those who did select investment options often made poor choices. (See this summary by Brooks Hamilton and Scott Burns.)

Today, an estimated 16 million employees are automatically enrolled in diversified portfolios. As a result, they can expect larger and safer returns during their retirement years. Of course, employees can always decline the enrollment or change the investment choices. But as “nudge theory” predicts, most employees tend to stay where you put them.

Full disclosure: I helped pass that law along with help from Pete Orszag, then at the Brookings Institution. We regarded it as a left/right coming together on an important public policy issue. One aspect of our proposal that didn’t pass was auto-enrollment in an annuity – so that 401(k) balances would be converted into a steady stream of income during the years of retirement. Workers so enrolled would still have been able to cash out and buy a boat, but we hoped they wouldn’t do that.

The new legislation gives employers who offer annuities some of the same safe harbor protections they get from auto-enrollment. It also raises from 10% of salary to 15% the amount of permissible auto-enrollment. And it allows small employers who don’t have 401(k)s the opportunity to participate in multiple employer plans – a change that could add $1 trillion to the market over the next five years.

One not so good change is requiring employers to make the 401(k) option available to part-time employees, although the employer doesn’t have to offer a match. This could be a significant burden for firms that rely on a lot of part-time help and it could induce them to end their 401(k) plans altogether. A better change would have been to allow part-timers to obtain a 401(k) from Fidelity or Schwab or some other financial institution.

Other changes affect deposits to and withdrawals from tax-deferred accounts. Going forward, the law repeals the age cap, currently at 70 ½, for making contributions to a traditional IRA. It also pushed back the age at which mandatory distributions must begin, from 70 ½ to 72. That’s good.

But to pay for these changes the law will require people who inherit IRAs to withdraw funds over the next 10 years instead of the current practice of spreading out withdrawals over the heir’s expected lifetime.

Here is how to evaluate these changes. When people are consuming, they are benefiting themselves. When they put funds in a savings account, they are benefiting others – by providing capital that funds investment, increases productivity and raises worker wages. When other people save they benefit you and me.

That’s why many economists (both left and right) favor taxing consumption but not saving. As long as other people’s funds remain in a savings account, you and I gain. So, it’s in our self-interest for the funds to remain there as long as possible.

Health Care

The new legislation abolishes three taxes that were created by Obamacare: a health insurance tax (HIT) on all commercial health insurance, a “Cadillac tax” on expensive employer health plans and a 2.3% sales tax on medical devices. All told, the abolition of these three taxes will cost the federal government about $400 billion over the next ten years.

These taxes are the reason we have Obamacare. In all three cases the industries affected either agreed to be taxed (or at least didn’t object) in order to fund Obamacare and make its passage possible.

Obamacare has done some good. It has insured people who would otherwise be uninsured. But it has also caused harm. Premiums have doubled, deductibles have tripled and patients are often denied access to the best doctors and the best hospitals.

Something is wrong when we let the special interests who helped give us Obamacare get off scot free without participating in needed reforms of the very system they helped create. Some of the most powerful interests in health care no longer have a stake in making the system better.

In a new editorial, Brian Blase points out that health care changes in the new legislation are more than a missed opportunity. They add to wasteful spending – by giving new funds to hospitals and by limiting the federal government’s ability to curtail improper enrollment in subsidized health plans.

Student Loans

The new law will allow people who put aside funds in a 529 college savings plan to use up to $10,000 in left-over money in those accounts to pay off student loans. I’m not a fan of micro-managing what people do with their savings, but this is a better solution than others I have seen.

New Parents

Within a year of the birth or adoption of a child, parents may withdraw $5,000 from  a tax-deferred retirement account without paying a 10% penalty. They will have to pay income taxes, however.

Again, I’m not a fan of micro-managing retirement savings, but I suppose this is better than government-provided day care.

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