Submitted to the
Committee on Ways and Means
Subcommittee on Social Security
Protecting and Strengthening Social Security
Tuesday, June 14, 2005
The American Homeowners Grassroots Alliance (AHGA) appreciates the opportunity to submit this testimony to the Ways and Means Subcommittee on Social Security on the subject of Protecting and Strengthening Social Security. Social Security is a critically important and widely supported tool that supports our nation’s retirees. For most it is not the only source of retirement income, and it was never intended to be the sole source of retirement income. As members of the Ways and Means Committee look at ways to strengthen Social Security we urge that you simultaneously consider other programs and incentives to expand retirement savings. To the extent that other programs may be created or enhanced to increase broad based U.S. retirement savings, the pressure to assure higher future social security program payout rates will be mitigated. For that reason we recommend that the focus of the Subcommittee be broadened to include all elements of retirement savings reform.
Retirement savings reform and other tax reform efforts are inextricably linked from both a policy and political standpoint. No matter what plans to strengthen Social Security and enhance other retirement savings are eventually adopted, there will be costs associated with them. Other pending tax reform proposals, including a variety of tax provisions that will expire in coming years unless extended will also be subject to the same budget pressures, so it makes sense to try to address these issues simultaneously.
It also makes political sense to address these issues as part of a larger effort. The Social Security debate has become quite polarized, but other alternatives to increase retirement savings and other elements of the tax reform debate are at this point less partisan. A broader approach will no doubt be more complex but under the best circumstances may avoid gridlock and lead to a tax reform package that can be supported by a majority of the populace as well as Republicans and Democrats in Congress.
We commend President Bush for his courage in addressing the issue of Social Security. You can debate the timetable, but the projections make it clear that this issue must be addressed. It is much better to begin work on social security reform today, while there are more options, than in the future, when Congress will have fewer options. We believe that the President’s proposal has much to recommend but that thoughtful supporters of a strong Social Security program have pointed out some real challenges as well. We urge the Committee to take the best of the Administration’s package and modify it so as to address the legitimate concerns of many thoughtful Social Security supporters who have made alternative suggestions. It is also important to keep in mind that Social Security is only one part of the puzzle in retirement savings, and that other unrelated retirement savings incentives may be key to expanding retirement saving in the U.S. To the extent that other programs are successful in increasing retirement savings the pressure for higher future social security payouts will be lessened.
For most homeowners the single largest form of savings they can tap for retirement is their home equity. In many cases homeowners retiring today can use the equity in their pre-retirement homes to purchase for cash a very nice retirement home without having to draw upon any other retirement savings. Based on our informal discussions with many recent retirees this is extremely common, and may even be the dominant source of retirement home funding. For retirees, who often have more modest ongoing financial needs than their children or grandchildren, the economics of a reasonable retirement lifestyle that doesn’t involve a monthly mortgage payment is not nearly so daunting as it would be for a couple or individual with only social security and income from relatively modest savings and/or pension.
In the last decade U.S. home ownership has expanded 10 million to nearly 75 million, thanks to economic circumstances, and home ownership programs enacted by Congress and promoted by the Bush and Clinton Administrations. To the degree that these programs have contributed to the expansion of home ownership, they are almost certainly very cost-effective contributors to retirement savings. Home financing has always been highly leveraged. A home that costs $100,000 and appreciates a modest 3% per year provides a substantially higher return relative to it’s fractional down payment, and a huge return on that down payment if the equity is allowed to accumulate over the life of its ownership (or is rolled into successor primary residences).
As appreciating and marketable assets (in most cases) the downside risk to the government’s programs that stimulate home ownership is reduced by a home’s underlying utility and likely long term appreciation. For this reason we believe that expanded home ownership incentives, especially for those at the margin of home affordability and with good indicators of fiscal responsibility, should be a significant component of a comprehensive tax reform package that has, as one of its primary objectives, the growth of U.S. retirement savings. Such a package has to take into account existing negative incentives, such as the fact that some low income home buyers would be giving up subsidized rent if they became homeowners.
Home equity as a savings vehicle has several additional advantages. Serious observers of human behavior of savings patterns have noted that inertia plays a significant role. If someone participates in a company 401K program they are likely to stay in, and if they don’t now they are unlikely to participate in the future. To an even greater degree a mortgage is a forced savings plan relative to the growing home equity because your mortgage lender probably won’t let you opt out of future payments. In addition because the amount of the equity can’t easily be precisely measured at any given time, and accessing that equity through refinancing requires time and effort, there is a good chance that home equity will be left in place and will continue to grow.
There are many ways to increase home ownership and the attendant long term savings through home equity growth. They include the expansion of many existing programs and worthy new policy proposals such as home ownership tax credits and other tax incentives to encourage the use of existing equity for the purpose of home financing. They all deserve consideration. The criteria against which all proposals should be measured are cost effectiveness and the degree to which they create home ownership opportunities for those who otherwise would be unable to afford it.
Of course home ownership is not the only way to increase retirement savings (albeit very likely one the most cost-effective under the right circumstances). President Bush’s personal account proposal is based on the correct historical observation that the stock market outperforms the formula that drives social security payments. Some substantial concerns have been raised about other aspects of the proposal, but many critics of the President’s proposal would not object to the personal account concept if it were funded as a separate program not tied to the existing Social Security program. Budget realities largely drive the need to integrate personal accounts into the existing Social Security system. If revenue could be found to fund incentives for personal accounts through other parts of the tax reform process, personal accounts could make significant contribution to peoples retirement savings, even if it were reduced from its current scope.
President Bush has expressed his willingness to be flexible on his personal account proposal, and given that flexibility there is a basis for a bipartisan approach that could include other concepts to stimulate retirement savings as part of a broad tax reform package. Some other worthy proposals include:
· Make permanent the 401k improvements enacted in 2001 and which sunset in 2010. We suggest that the concepts in the Administration’s personal savings account proposal be blended with an enhanced, means tested version of proposal to expand 401k/IRA or other retirement saving incentives.
· Make 401K participation automatic rather than opt in. Savings patterns suggest that once people participate in retirement savings programs they will stay in. The lowest participation rates (which are declining overall) are among low and moderate income workers. Consider additional incentives for employees (such as faster vesting) and employers (such as incentives to make it easier and cost effective for small businesses to use outside plan administrators).
· Make the tax credit for IRAs and workplace retirement plans permanent (many of the benefits expire in 2006). Increase the contribution limits and make the incentives permanent.
· Expand allowed contributions into health savings account IRAs, and allow annual surpluses to be rolled into retirement years when healthcare costs will typically rise.
· Allow for tax deduction of private mortgage insurance (PMI) premiums and condominium fees as these are both also costs of home ownership.
· Repeal the “new homes tax”, a protectionist tariff which adds approximately $1,000 to the cost of a new home through the taxation of Canadian softwood lumber.
· Create a first time home buyers tax credit of 10% of the home’s price, capped at $6,000 and a new home ownership tax credit to encourage development and rehabilitation of resident-owned housing for those of affordable to low and moderate income.
· Provide tax credits to homeowners and builders to encourage higher standards of energy efficiency in new home construction and remodeling.
· Tax the proceeds of annuities at the rate of dividends rather than ordinary income.
The cumulative cost of all of these proposals would be substantial. Given federal budget realities some of these suggestions will have to be dropped and many of those that survive will have to be means-tested to focus their benefits on segments of the population that are currently unable to increase their savings and segments of the population that could be saving more but do not feel the incentive for savings that was instilled in our nation’s generations who experienced the Great Depression.
Restrictions on existing tax incentives, including some that benefit homeowners, will have to be enacted to generate additional revenues to pay for new incentives.
What benefits will have to be trimmed? To generate additional revenue the current $250,000/500,000 capital gains exemption on home sales might be limited to the application of the proceeds to worthy purposes (there are currently no restrictions on the use of the proceeds). There are some indications that there is an unfortunate and growing trend towards tapping real estate equity for the purposes that do not either contribute to savings or other worthy uses. While there are many productive ways to reinvest real estate equity, we consider the use of tax-favored real estate equity withdrawals for such purposes as fancy vacations a questionable use of this favorable tax treatment. Worthy purposes might include income producing investments upon retirement, home remodeling (since it contributes to equity), the purchase of a second home or a more expensive primary residence (same rationale), education (a worthy investment in the minds of most), and other similarly meritorious investments.
This same philosophy should be applied to all other tax incentives. To the extent that they contribute to individual wealth building, competitiveness, and productivity, they should be retained. Absent evidence that they are making a contribution to those goals, or that their contribution is limited, they should be more precisely targeted to achieve their intended objectives, cut back, or eliminated.
The American Homeowners Grassroots Alliance is a national consumer advocacy organization serving the nation’s 75 million homeowners. AHGA engages in policy issues that significantly impact homeowners and home ownership.