Wednesday, June 16, 2010

The Retirement Revenue Mirage

Copyright, The New York Times Company
The public debt has accumulated throughout the recession as federal revenue collections declined. But the recent rebound of personal income tax collections may also be bad news for future generations.

The chart below displays amounts collected by the federal personal income tax since the beginning of the recession (to adjust for seasonality, the chart shows the sum over the previous 12 months).

Before the recession began, it was almost $1.2 trillion, but it fell to as low as $847 billion this year. Through May 2010, the federal income tax had collected $869 billion over 12 months.

One policy change tending to increase 2010 federal income tax collections is the one-time opportunity in 2010 for anyone to convert a conventional individual retirement account, in which taxes are deferred until money is withdrawn, into a Roth IRA, where investment gains are tax-free (before, conversions were limited to only people who made less than $100,000 a year). A conversion presents younger taxpayers with a large income tax bill now, which in many cases is offset by income tax savings they will enjoy in retirement.

Thus, as taxpayers take advantage of the opportunity to convert, the Treasury will see an income tax bump, but this bump comes at the cost of revenue in the future, when those taxpayers would have been liable for income taxes on their retirement incomes.

The conversion opportunity is a lot like government debt itself: it presents the government with more revenue to spend now, and less revenue to spend in the future.

But the conversion opportunity is not counted in the official government debt statistics. The reality is that our government is engaged in a tremendous variety of transactions that cannot always be summarized by a few statistics like the “debt,” the “deficit,” or “tax revenue.”

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