The case for lifetime savings accounts

Glenn Hubbard, former chair of the CEA, argues that we should not tax savings:

While the Lifetime Saving Account (LSA) offers substantial simplification benefits, it also offers a vehicle to save more easily for a downpayment on a home, children’s education, or for medical expenses. With no withdrawal penalties, the account’s greater liquidity will encourage individuals to save, particularly moderate-income households worried about tying up funds for a long period of time. Like the president’s proposal to eliminate investor-level taxes on dividends, the LSA lays claim to the idea that income should be taxed only once. Indeed, given the generous contribution limits, most households could avail themselves of a consumption tax akin to the Flat Tax. They would pay taxes once when they earned wages or business income, but not again on returns to saving. This is an important step toward fundamental tax reform, particularly if the administration continues its recognition of the costs of double taxation of corporate income.

How much would capital accumulation go up?

To assess the impact on capital formation, one should compare the present value of additional private capital formation to the present value of lost tax revenue. Jonathan Skinner of Dartmouth College and I estimated that with even 25 cents of each dollar contribution as new saving, IRA contributions generate $2.21 of new capital per dollar of net revenue cost. If, as suggested by Harvard economist Martin Feldstein, one includes corporate income tax revenue from the higher capital stock made possible by the saving incentives, the ratio rises to $4.84 of net capital per dollar of new revenue cost. If each dollar of contributions contains 40 cents of new saving and one incorporates higher corporate income tax receipts, the savings incentives are actually self-financing.

My take: I’m totally on board kind of sort of. Until we address runaway government spending, tax changes will only bust the budget in the shorter run. Even with elasticity optimism, we won’t ever arrive at the self-financing equilibrium. Furthermore I will never have that much faith in any particular numerical projection. My main worry is stopping the current drain of resources from the private sector. And no, a trip to Mars is not just what the doctor ordered. Right now U.S. fiscal policy needs credibility and needs it badly. Won’t markets just think that any revenue boost will fly out the window as quickly as it comes in? Isn’t politics, and thus economics, first and foremost about subjective perceptions? Hubbard’s proposal, for all its merits, doesn’t address the core problems.

Addendum: Here is Brad DeLong’s recent post on the fiscal costs of social security privatization plans.