The Effects of the Economic Growth and Tax Relief Reconciliation Act of 2001 On Retirement Savings and Income Security

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I. Introduction

The ability of individuals and societies to maintain or improve their living standards over time depends on their willingness to save. At an individual level, people need to accumulate sufficient wealth to finance an adequate retirement, protect against economic risks, etc. At an aggregate level, society needs to save enough to provide the capital (financial, physical and human) that is needed to raise future productivity, and in turn raise wages and living standards. Both of these concerns are becoming increasingly important; the baby boomers are starting to retire and they are living longer. All the while, private and national saving rates have remained low.

Policy makers have frequently turned to tax policy to stimulate private saving. For example, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) introduced substantial cuts in income taxes, reductions and eventual repeal of the estate tax, and numerous incentives for increased private saving. EGTRRA is likely to affect both private and national saving through many channels.

This report examines the effects of EGTRRA on private and national saving and on the distribution of federal tax benefits for saving. We find that, while the new tax incentives may induce some increase in private saving, that is likely to be more than offset by the increase in deficits (reduced public saving). As a result, the net effect is likely to be a reduction in national saving that could be as large as 1 percent of GDP from 2002 to 2011.

Pension and IRA tax benefits are mostly concentrated among high- income taxpayers for two reasons. First, they can afford to save. Second, they face the highest marginal tax rates and thus stand to gain the most from tax deductions and exclusion. The EGTRRA changes, when fully phased in, will simply reinforce that pattern, because the increase in contribution limits primarily benefits high-income people who are constrained by the current limits. If the new, temporary, saver's tax credit is extended, it would partially offset this skew because it is targeted at low- and middle-income households. In addition, if the saver's credit were made refundable— that is, available to tax filers regardless of their income tax liability—it would provide a substantial and well- targeted tax benefit to people in the bottom half of the income distribution.

The plan of the paper is as follows. Section II describes the underlying tax model and data sources employed. Section III describes saving rules that existed before EGTRRA took effect and the changes introduced in EGTRRA. Section IV provides estimates of the effects of EGTRRA on private and national saving. Section V examines the distribution of federal tax benefits for saving under pre- and post-EGTRRA law. Section VI provides a summary and conclusions. A technical appendix describes our methodology for measuring the benefit of pension and IRA tax provisions.

Note: This report is available in its entirety in the Portable Document Format (PDF).

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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