The U.S. government risks compromising the trust of its citizens if proposed taxes on 401(k)s and Roths are passed to raise government revenue.
There are so many rumblings in Washington about who will be taxed what. One example is a Value Added Tax, which would hit everyone, but especially those who spend more because they have the money to do so. Though not welcomed by many, at least this tax seems fair.
However, other threats of taxation are more noxious — for example, taxing 401(k)s and Roths to raise government revenue has been suggested. These proposals seem counterintuitive for a government that theoretically has an interest in keeping its word and, thereby, trust of it citizens. The latter is so important because there is a correlation between trust and prosperity.
Both 401(k)s and Roths were intended to provide for retirement, albeit in different ways. For the 401(k)s, pretax dollars are allowed to grow tax free with the government taking its bit when the benefits are provided. Roth contributors pay tax going in with the money then allowed to grow tax free with no taxation on the other end.
If the government were to tax either beyond what the contributor expects, an understanding between American citizens and the government would be violated. Instead of the anticipated benefits going entirely to the contributor, some part would be directed toward whomever or whatever Congress determined.
One does not want to think that this could happen in this country. Unfortunately, historical evidence indicates it has already.
A case in point is Social Security, the benefits of which were originally meant to be tax free because contributions are made with post-tax dollars. In fact, they were free between 1935, when Social Security was originated, and 1983. Then, Congress approved a law permitting payouts to be taxed. This is double taxation.
Adding insult to injury, in 1985 Congress passed a law allowing up to 50% of Social Security benefits to be taxed; in 1993, this was increased to 85%. Today, a married couple claiming more than $32,000 in income is subject to that federal income tax. For a solo person this figure is $25,000. About one-third of Social Security recipients pay this extra tax. Most retirees who receive Social Security and read this column pay it.
For now, President Obama’s budget recommends capping tax-advantaged savings at $3 million (all accounts). This budget has been sent to Congress and if it passes, then the well-to-do will almost certainly be less so. Confidence in Uncle Sam will once again be compromised. At that point, perhaps some United States citizens will feel compelled to look for another relative.
Then, like Gérard Depardieu, the French actor who found a new tax friendly residence in Russia, they wouldn’t have to pay U.S. taxes at all.