WASHINGTON -- You can probably count on half the fingers of one hand the number of times recently that the Concord Coalition, which works for a balanced budget, and the American Association of Retired Persons, which advocates for the elderly, have been on the same side of a public-policy battle. The current debate over the child tax credit is one of those rare instances of common ground.
We are dismayed at the prospect of enacting an unnecessary and large tax cut at this time -- even one benignly labeled a "child tax credit." A large tax cut only makes the job of reducing the deficit that much tougher and leads to deeper program cuts than otherwise would be necessary, including cuts in programs that help children. The economy is not faltering, so there is little justification for stimulating it by pumping another $500 a year per child into consumer spending. Over the long term, the economy needs more savings, which is the chief rationale for balancing the budget in the first place.
Congress and the president nevertheless have signed on to the child tax credit notion, so some version seems likely to be enacted. If there is to be a new children's tax credit, we think an idea that Senators Bob Kerrey and Joe Lieberman and several others have been working on is much better than anything else we have seen.
Although the specific details remain to be worked out, their central idea is simple. Allow a $500 tax-refundable credit for children under age 18 only if the money is invested in qualified retirement accounts for that child's old-age security. Funds in the accounts would not be taxed until they were withdrawn by the child at retirement age.
If the child saves the $500 credit every year from birth for 18 years, there would be a retirement nest egg of $9,000, plus another $4,000 to $16,000 in compounded earnings by the time the child reached age 18. That's nice, but it gets much better. Over every 40-year period since the Great Depression, diversified equity funds have generated returns of somewhere between 6 percent and 10 percent. Even if another penny were never added to the account after age 18, by the time the child reached age 65, the account would be worth a quarter of a million dollars at a 6 percent real rate of return, and three quarters of a million dollars at 8 percent. Leaving the initial $9,000 untouched until age 70 would result in $1.1 million at an average 8 percent return.
These savings would be available to fuel long-term economic growth and could help provide not only future jobs but an improving standard of living for today's children when they are grown. The impressive results of compound earnings over 65 or 70 years would help assure old-age economic security for a generation whose prospects today appear uncertain. Since private pensions today cover fewer than half of all workers, and since economic surveys show most households with inadequate levels of private retirement savings, it is clear that we need a new approach. The income from these individually-owned retirement savings would permit everyone in future generations to supplement Social Security benefits, as originally intended.
In order to minimize unnecessary risk and overhead, these retirement accounts could be administered in the same way as the federal-employee retirement-savings program. There could be a wide range of investment options combined with the efficiencies and safety of large pools of investment funds.
There will inevitably be pressure to permit non-retirement withdrawals from such accounts. Withdrawals for education or health-care needs may very well be in the child's best long-term interests, but any exceptions permitting early withdrawals must be narrow. The full retirement-income benefit to the individual will be at risk from early withdrawal, and one exception leads to pressures for another, undermining the long-term benefit of this approach.
A phase-out for the rich
There is no need, of course, to give a $500-per-child contribution to children whose parents can already provide for their futures. So the tax credit should be phased out for higher-income families with the option for those parents to contribute $500 yearly on an after-tax basis.
The intangible benefits of this approach may be hard to measure, but may ultimately be more important. Children who today see little prospect for their future will have a tangible stake in thinking longer term. The fact that these accounts exist in their names and are growing over time will reinforce the importance of other types of deferred-gratification behavior. We shouldn't discount the impact that such accounts will have on our children, even though they cannot use them immediately.
Any legislative proposal must be evaluated in context as part of a budget package. We need to be especially sensitive to the impact of proposed spending reductions and other tax changes on programs for children, working families and vulnerable seniors. Again, our organizations do not think we should be considering major tax cuts at this point. But if Congress is determined to enact a tax cut, we think it should consider this proposal first. It's good for our children, for the economy and for the long-term needs of future retirement-age Americans.
The concept that Senators Kerrey, Lieberman and others are working on hasn't been introduced as legislation, and we may well disagree with the particulars they finally devise. But at bottom, the general proposal remains a very compelling option. Properly structured, the children's saving credit offers a way to leave a legacy of savings, responsibility and security to Americans of all ages and income levels.
Martha Phillips is executive director of the Concord Coalition. John Rother is director for legislation and public policy of the American Association of Retired Persons.