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Thiel’s Roth Account Is Not A Policy Failure

By News Creatives Authors , in Business , at October 4, 2021

A couple of decades ago Peter Thiel opened a Roth IRA and put $1,700 in into his account, which he used to purchase stock in a startup called PayPal

. The investment ended up doing extremely well, to put it mildly: The company did an IPO three years later, and today Thiel’s initial investment is worth about five billion dollars. 

 Politicians like Elizabeth Warren and Bernie Sanders are outraged that Thiel’s money won’t be taxed, and they are pursuing legislation that would limit the size of IRAs, the types of investments that can be a part of an IRA, or place an income threshold for participation in one. 

The debate created by Thiel’s IRA raises an important question: Are enormous retirement accounts a problem, and should we legislate to prevent future supersized IRAs?  

In a word, no. 

For starters, most laws that are a response to an anecdote tend to be bad policy with unanticipated side effects, and any effort to prevent another billion-dollar Roth IRA will undoubtedly create a variety of other unanticipated problems that will make our inability to tax some of Peter Thiel’s money seem like small potatoes. 

To understand why we’re in this spot it helps to conceptualize a few basic precepts about how to best go about taxing people’s investment income. The U.S. tax code broadly incentivizes savings for two different reasons: first, we want to ensure that people accumulate enough wealth to be able to support themselves during retirement. Second, our nation’s savings provides capital for businesses to borrow, invest, and expand, which is necessary to increase economic growth. 

The tax code incentivizes savings in several different ways: First, the U.S. does not tax the returns to an investment until the person actually realizes it—an investor who owns a stock that doubles in price doesn’t pay the IRS until he sells it. Second, it taxes certain investment income—most notably capital gains—at a lower rate than ordinary income. And most importantly, people can make investments via a variety of tax-preferred savings accounts, such as individual retirement accounts (IRAs) or their 401(k) retirement accounts set up by their employer. 

 Incidentally, nearly every other country has the same sort of savings incentives in their tax code as well—no one can accuse the U.S. of being an outlier in this regard. 

The tax break for these savings accounts can work in two different ways: The saver can either deduct the money he puts into the account from his ordinary income and then pay taxes on the money only when he takes it out upon retirement, or he can pay taxes up front on the income and then the money in the account goes untaxed upon withdrawal. We generally refer to the latter as a Roth-like tax treatment, named after the Senator who passed the bill creating such accounts. 

Economists have a slight preference for Roth-style accounts; for starters, they make planning much easier. A retiree with $1.5 million in his 401(k) may feel that he’s set for retirement, but if taxes consume 25 to 35 percent of every withdrawal then that nest egg may not make it through his retirement. Roth IRAs have no such issues, since it’s dealing with post-tax income.

The complaint about Thiel’s large Roth IRA is, in part, symptomatic of the fact that many people on the left object to many of the savings incentives built into our tax code since the tax savings go disproportionately to the wealthy. However, it is difficult to conceive of any savings incentive that would not disproportionately benefit the people in the top quintile of the income distribution. 

 For instance, the reduced tax rate on income from capital gains has become a bête noire for the left because the people with capital gains tend to be wealthy. However, the proposals to pare back this tax break—such as by assessing a tax on unrealized capital gains each year or treating capital gains income the same as ordinary income—have foundered: the former would be unworkable for many people (the year after a robust stock market would a trigger a big tax bill for anyone with a stock portfolio and force millions to dispose of a portion of their investments) and the latter would also effectively reduce savings by greatly reducing the long-term real returns. 

And while savings incentives unavoidably tilt towards the rich, the U.S. does devote a lot of time trying to help low and moderate income households save money. For instance, several states offer retirement accounts for low-income workers employed by a firm without a 401(k) where the state provides a matching contribution. Companies that do offer their own 401k accounts have an incentive to automatically enroll new employees and default to an automatic increase of their contributions, which has served to boost the size of most retirement accounts. 

The bigger problem with whacking Thiel’s IRA is that it would signal that the tax code’s promise to leave certain retirement savings alone would be effectively broken. A senior staffer of the Senate Finance Committee who worked with Roth to create the IRA named after him said that they received a great deal of pushback from fellow Republican senators who feared that a large pot of money that was to be untaxed would prove to be too tempting for future Congresses, and the promise made to Roth IRA investors would be undone. 

And once that genie leaves the bottle it will be hard to get it back in: While some people may see Congress’ actions as being just against Peter Theil, many more will see it as a lesson to expect that their own Roth IRA may one day be on the hook as well, and that it’s always been a sucker’s bet.

Peter Thiel made a bet on a company that happened to pay off in spades and it’s extremely unlikely to ever occur again. We should be thinking critically about how to boost savings all across the income distribution rather than basing our tax policy on spite.


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