NCPA - National Center for Policy Analysis

Tax Deferred IRAs May Raise Federal Revenues

March 20, 2000

Many people -- even economists -- often forget that Individual Retirement Accounts are not tax free, but tax deferred. When qualified workers make deposits to IRAs, they can deduct the full amount from their taxable income. For someone in the 28 percent tax bracket, this means an immediate tax saving of $560.

What the government loses up front from IRA deductions, it makes up at the back end when contributions are withdrawn. Thus the Treasury Department's tax expenditures budget shows that while IRAs reduce federal revenues by $16 billion per year, the long run cost (in present value terms) is just $6 billion.

However, IRAs do not reduce revenues at all in the long run and actually raise revenue for the government, according to a new study by economists Brianna Dussealt and Jonathan Skinner of Dartmouth University, published in Tax Notes. The reason is that investors generally earn a higher return on their IRAs than the government pays on its bonds. When they withdraw their funds and pay taxes on them, they are withdrawing a much larger amount than they put in. And taxes on withdrawals are more than enough to compensate the government for the lost revenue plus interest.

Dussealt and Skinner estimate the federal government made at least $14 billion in net revenue on all IRA contributions between 1982 and 1997, and perhaps as much as $54 billion. And these are conservative estimates because they assume that IRAs did not increase the rate of saving or capital formation.

If this analysis is correct, it removes the only meaningful barrier to expansion of IRAs to all taxpayers and all saving.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, March 20, 2000.


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