The Schwartz Center for Policy Analysis (SCEPA)

401(K) Tax Policy May Create Wealth Inequality

Though well-intentioned, the current system of tax deferral for retirement contributions undermines public policy aimed at strengthening retirement security for all Americans. In fact, it has become a regressive policy that contributes to wealth inequality. Two employees who are identical savers and investors in every way except for income, receive different rates of return due only to the effects of the tax code. For example, they can participate in the same 401(k) plan, contribute the same dollar amount each year and allocate their investment portfolios in exactly the same way, yet end up with different results. The high-income earner will enjoy a higher return because they receive a proportionately larger tax deduction. Converting the current system of tax deductions for defined contribution retirement plans to a refundable tax credit would solve this problem and treat all retirement savers the same. A refundable tax credit would give direct grants to workers’ retirement savings accounts instead of acting indirectly through tax deductions. Implementing the fix should not meet opposition. in Congress, whose legislative intent was not to create inequality.

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