Among both opponents and proponents of favorable tax treatment for Individual Retirement Accounts, many believe that such accounts reduce tax revenue for the government. They reason that if the government gives people a tax deduction for an IRA deposit, the government then collects less tax revenue than otherwise. Their reasoning is incomplete and in most cases incorrect.

First, the government gets much of the original tax revenue, as well as revenue on the earnings of the IRA, when the individual withdraws the funds. Second, contributions to IRAs increase investment in capital formation, which leads to increased corporate taxes. Taking account of both factors, IRAs are likely to decrease the government's debt.

• With a personal income tax rate of 25 percent, if a 45-year-old begins contributing $2,000 annually to an IRA, after four years the increase in corporate tax revenue is $313, which offsets more than half of the $536 loss of personal income tax revenue.

• With these same assumptions, the increase in corporate tax revenue generated by the investment offsets the personal income tax reduction by the ninth year.

• The government debt is lower after 14 years than it would have been without the IRA program.

• By the time the individual retires at age 65, the IRA program has reduced the government debt by $6,397.

• When the individual reaches age 79, the combination of increased personal and corporate income taxes has brought the government debt $64,906 below the level that would have existed without an IRA program.

To create an IRA program that did not lose revenue even in the first year, the government need only replace the current program with one for which contributions are not tax-deductible but all funds are withdrawn tax-free.

• For the same 45-year-old making annual contributions of $2,000, the government gains revenue even in the first year and in all subsequent years.

• By the time the IRA is completed and all funds are withdrawn, this individual's contributions alone would have reduced the national debt by $44,931. —David R. Henderson.

Source: Martin Feldstein, "The Effects of Tax-Based Saving Incentives on Government Revenue and National Saving," Working Paper No. 4021, National Bureau of Economic Research, 1050 Massachusetts Avenue, Cambridge, MA 02138, (617) 868-3900.

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