TCS Daily

Withholding an Opportunity Society: Why We Need Personal Tax Savings Accounts

By Andrew C. Coors - April 14, 2005 12:00 AM

The government is playing accounting games with taxpayer money by spending withheld income while it should still be the property of the wage-earner.

The concept of ownership society is the backbone of the Bush administration's actions on Social Security, lifetime savings accounts, and health care savings accounts. The motivation behind these issues is the desire to enhance personal choice; the final goal is to increase savings and to foster the opportunity for even the poorest members of society to create wealth. These preferentially tax-treated accounts are designed to fundamentally change the way the public saves money by creating incentives to save, invest and take an ownership role in the process.

History's immovable lesson is that people respond to incentives. Anecdotes abound about private choice yielding better outcomes than government allocation. The Bush administration is actively tackling many of the inefficiencies present in vehicles for retirement, education, and health care saving. This is Bush's vision of an ownership society. Yet in all of the debates about the value of personal savings and ownership, the fact that individuals do not have rights to money earned but withheld for taxes is never mentioned. Withheld income is collected and spent by the government -- like a compulsory escrow account -- while the worker should still be entitled to the funds.

Currently, when an individual withholds too much, that individual is entitled to a refund of the amount of overpayment. When an individual withholds too little they are often subject to penalties on top of their tax bill.

In 1943, the Current Tax Payment Act (legalizing mandatory federal tax withholding) was sold amidst solid opposition, with patriotism and taxpayer convenience the main selling points. Since then, withholding has become so commonplace and sacrosanct that many people today view tax refunds as income and wouldn't know what to do without them. People pray for large refund checks come tax time. The obvious truth is that a refund check is just a refund check -- it is excess money earned but not taken home, lent interest free to the government.

The value of collecting withholding prior to tax day is tremendous to the government. They get to possess and spend accounts receivable months before the funds are owed. Withheld taxpayer income is funneled into a massive pool and used for current government finances. There is no question who gets the short end of this stick. Most people don't complain, however, since withholding is convenient -- like an escrow account on a home mortgage for property taxes and insurance. But this convenience comes to the tune of millions of lost interest dollars for workers.

With the current focus on "ownership society," ownership of withheld income should be restored back to the rightful owners--the taxpayers. Money withheld from paychecks should be an asset of the taxpayer, rather than the government, until the time that the tax burden becomes due. Ownership means letting workers have their withheld income as an invested asset until they rightfully belong to the government. Abolition of withholding is out of the question from a political standpoint; the mention of it raises opposition from multiple fronts. Can you imagine the fallout if every American had to write a check for the full amount of their tax liability on April 15th?

A possible solution does exist. The government could create a vehicle like a health care savings account called a personal tax savings account where withheld income is held until tax time. Taxpayers would have the option of placing withheld income in either the government's hands (the current system) or a personal account, which yields a return, for use in paying future taxes. With a personal tax savings account, any overpayments would yield a tax deferred return for payment of future tax liabilities.

A dollar earned on January 1st should earn 469 days of interest until the government gets it on April 15th. In 2002, $717 billion was withheld from worker's incomes according to the IRS. If this money was earned equally throughout the year, the average dollar earned would accrue 286 days of interest. If that withheld money were invested in 10-year T-Notes, rather than given interest free to the government, taxpayers would have increased their wealth by approximately $28 billion, or approximately $250 per withholding individual. This yield, and any overpayments, is rightfully the property of the worker and should be allowed to compound in the personal tax savings account tax-free and applied towards future tax liabilities. Alternatively, since these savings accounts are assets owned by the worker, excess funds could be withdrawn and taxed as income, rolled over into IRAs, passed on to heirs, etc. The action is simple -- let workers earn a return on their money while still entitled to it -- but the restored efficiencies are huge.

This administration seems interested in initiating an ownership society. When discussing which areas of finance should be tackled, withheld income for paying taxes should not be overlooked. Giving workers the choice to put their withheld money to work is the right thing to do.

The author is Director of Research, Laffer Associates.


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