Thirty years have passed since America’s last major tax reform, and any attempt at an encore will face huge policy and political hurdles. That was the blunt overview from Jason Furman, chairman of President Obama’s Council of Economic Advisors, in a speech early this year.
On the bright side, Furman said there was “increasing agreement that we can get additional revenue while improving efficiency through broad-based reductions in tax expenditures for those who derive outsized benefits…under the current system.” Putting it more simply, those who reap the richest rewards should be first in line when the tax reformer cometh. It’s a fairness argument, and Furman claimed it had won the minds of former Council chairs Martin Feldstein, Glenn Hubbard and Greg Mankiw.
Congress should follow their lead and start with the fairest, kindest tax reform of all: a stepped-up timetable for minimum required distributions (MRDs) from tax-deferred retirement accounts. It would bring billions into the Treasury by directly raising certain incomes; could reform be any kinder?
Recall that Furman used the phrase “outsized benefits.” Tax-deferred retirement accounts offer the same breaks to everybody: pre-tax contributions, untaxed investment growth. High-income workers take more advantage, but that’s to be expected. The real outsizing flows from minimum distributions.
To learn how it happens, let’s look at the role of MRDs and the rules that govern them.
Withdrawals from tax-deferred accounts effectively pay the country back for more than 40 years of compound tax breaks. The payback is the income taxes that come due when savers dip into their nest eggs. Over the years, as holdings are drawn down, the Treasury gradually gets it cut of both contributions and investment gains.
There are two options for withdrawals. One is for people who need the money, the other for those who don’t.
The first group gets penalty-free access as early as age 59 1/2. Each withdrawal triggers a tax payback, and smaller balances limit potential gains going forward.
Those who don’t need the money can keep it invested (and likely growing) for another 11 years. Minimum required distributions don’t begin until age 70 1/2, and when they do the accent falls heavily on minimum.
The formula that applies to most accounts calls for a starting distribution of under 3.7 percent. The percentage rises yearly, ever so slowly. Twenty-five years later, at age 95, the MRD is just a shade over 11.6 percent.
MRDs, in fact, double as MRTs: minimum required taxes. Ironically, the rules turn the biggest beneficiaries of tax-deferred accounts into outsized laggards at paying America back.
The starkest example is so-called stretch IRAs. They can string out distributions for generations, even into the next century. President Obama has long been trying to end them; a proposal in his 2016 budget would require most second inheritors to close out their accounts within five years. This change alone would raise an estimated $5.5 billion over the next decade.
Far more important, though, is basic reform: MRDs should begin at age 65. The qualifying year for Medicare is a fitting year to begin repaying the Treasury for those decades of tax breaks (and, in the bargain, helping to keep Medicare solvent). If the current withdrawal percentages made the same five-year shift, the required distribution would reach 11.6 percent at age 90 instead of 95.
In addition to fairness, there’s powerful fiscal reason to create an accelerated MRD schedule for future retirees. Unlimited billions would stream into the Treasury. About 10,000 Americans turn 65 each day, a demographic tide that’s set to roll in until 2030. This year also marks the beginning of required distributions for the first of the country’s 78 million baby boomers. (And no, higher minimums won’t exhaust their savings. Only withdrawals well beyond the minimums could do that.) Larger distributions would also put more money into people’s hands; if the money gets spent, it would help stimulate the economy and grow jobs.
Summing up, minimum distributions should start sooner and grow a touch faster. When Congress finally takes up tax reform, it should begin with the fairest and the kindest.