The Mythical Deferred Tax Trust Fund

     Five Trillion dollars or $5,000,000,000,000... That is how much our nation is in debt. Some say this debt was caused by military spending, while others claim the debt is due to entitlement spending, some say it was a tax cut that caused the problem. There are plenty of fingers to point around about who is or is not paying their "fair share". Finger pointing is part the legacy of special interest social engineering. As usual, those pointing the fingers are probably a primary source of the problem.

     From one perspective, we are all playing our own little one trillion dollar part of the debt with our IRAs and Pension plans. Yes -- that is trillion, not billion. How do IRAs and pensions cause a such a debt? The short answer is that these financial tools defer paying taxes until one retires and the taxes paid are not equal to the taxes owed on the original income that funded the pension. However, this really doesn't get down to the nitty gritty of the problem.

     To see this problem from the individual (micro) perspective, assume that all IRAs and pensions are called IRAs and that they allow you to defer payment of taxes until retirement. Also assume that you put $2000 into an IRA and this IRA is invested in 'Federal Notes'. Federal Notes are what the government sells to fund its deficits and debt. Each year, the federal government pays interest on these Notes from the taxes you pay. In a couple decades, your $2000 IRA will be worth $20,000. It grew in value each year from the chunk of your income tax payments that went to pay the interest on the federal debt (about 17%). While this is crazy enough of a way to fund a pension, the real problem pops up when you cash in your IRA. Government has to pay you the full value of your $20,000 note. After deducting your original deposit, there is an $18,000 hole in the budget. From there Government only gets back from you what ever measly taxes you pay when you cash the IRA.

     As one might imagine, government quickly ends up with a huge generationally transferred debt problem. How big will be covered in a moment.

     As an aside, economically speaking, a lot of our nation's 'growth' can be attributed to deficit spending (funded by selling notes). Even when your IRA is invested in private sector funds, much of the economic growth for the private sector gets its push directly or indirectly from deficit creating federal programs and is therefore, economically speaking, part of this debt cycle to the extent of the debt and deficit spending that goes on any year.

     For another angle on this, assume that the government collects 500 Billion dollars in income taxes and 5% of those taxes ($25B) are deferred each year by people investing in IRAs. Assume that these deferred taxes are put into some mythical 'Deferred Tax Trust Fund' (DTTF). Like all other trust funds, government goes ahead and spends the trust fund anyway leaving the trust fund full of IOUs. For those who doubt the reality of the mythical DTTF, watch the States scurrying around trying to cover holes in their budgets because they are being prohibited from collecting taxes on pensioners that have moved out of the State.

     After just 20 years, the DTTF at the Federal level has an nifty 500B accumulated funds (20 * $25B). Let us not forget that government has filled the DTTF with IOUs adding another 25Bs a year in interest payments for a grand total of a trillion dollars. Is this any way to run a company? No. Is this any way to run a country? (see company operations). There is very little chance that when it comes time for all those IRAs to be cashed that revenue will cover the 500Bs in interest payments or the 500Bs of actual debt in the DTTF.

     And this is for just twenty years of IRAs. In forty years, the DTTF would (should) have one trillion dollars in it. Lest one think that this is too liberal a fiscal estimate, the 5% savings rate that was used is probably closer to 10% when one looks at who is really paying the bulk of income taxes each year -- people with higher incomes tend to have more pension savings. One also has created the additional problem that you have an entitled constituency that will fight tooth and nail not to pay their fair share of the DTTF debt and interest.

     Can this problem be corrected? Yes. Most all of the problems of the DTTF evaporate when you go to IRAs (such as that going through Congress now) where the taxes are paid up front and allowed to grow tax free from then on. If taxes are paid up front, there is no DTTF, no DTTF full of IOUs, no entitled group fighting against paying their 'fair share'. One would hope that any correction of Social Security also corrects the problems of the DTTF of current pension tax code. Is this anyway to run a company? Yes, most every successful institution collect what is owed up front for use in today's world. No one but governments (who are billions or trillions in debt) are running programs that wait several decades to try to collect what is owed them. Is there some connection here?

     Do I have IRA funds? Yes, I too am part of the problem, but only so much as this is the only form of pension savings that our nation's economic wizards in Congress have supported. Recognizing the problem has promoted me to support the appropriate changes in our IRA and pension system.

     It is also worth mentioning that a flat tax that taxes all wages and then allows investments to earn tax free also provides for the proper realignment of the tax code so that tax payments for pensions are made up front. It is also worth mentioning that under such a flat tax, the government is still collecting tax revenue from the investments. The taxes are being collected at the corporate level to avoid the problem of politicians pandering to reduced taxes for special interests in the general population. Which is, in my opinion, the proper way to design a stable and neutral tax code.

Always Right

     This opinion is not so much for myself, but for my kids, who I don't think should be picking up the tab for my retirement, be it via Social Security or the mythical Deferred Tax Trust Fund. What do you think?