Monday, January 12, 2009

Too much choice?

Can there be such a thing as "too much choice?" Neoclassical economics has traditionally said, "No, more choices can only be a good thing."

But a growing number of policy analysts, including many economists, are not so sure.

Tonight we will be talking about the various provisions of the tax code that provide incentives to save for retirement and education. As the Taxpayer Advocate's recent report to Congress noted, there is a proliferation of different programs. It is hard for even the best educated and most knowledgeable taxpayers to choose the best program for their circumstances. The National Taxpayer Advocate herself, Ms. Olson, is a former tax preparer, a lawyer with an advanced degree in tax law, and a professor at Georgetown University's law school, but she has said she was uncertain as to what educational tax break would be best for her own son in college.

Here is what she recently wrote in her report to Congress:

--> Excessive Number of Education and Retirement Savings Incentives. The Code currently contains at least 11 incentives to encourage taxpayers to save for and spend on education; the eligibility requirements, definitions of common terms, income level thresholds, phase-out ranges, and inflation adjustments vary from provision to provision.17 The Code also contains at least 16 incentives to encourage taxpayers to save for retirement; these incentives are subject to different sets of rules governing eligibility, contribution limits, taxation of contributions and distributions, withdrawals, availability of loans, and portability. Taxpayers wishing to choose the optimal vehicle to save for college must know the difference between a Section 529 plan, a Coverdell Education Savings Account, and the Hope and Lifetime Learning Credits, among other alternatives. Taxpayers wishing to choose the optimal plan in which to save for retirement must know the difference between a traditional IRA, a Roth IRA, a Section 401(k) plan, a Section 403(b) plan, and a SARSEP, among others. The point of a tax incentive, almost by definition, is to encourage certain types of economic behavior. But taxpayers can only respond to incentives if they know they exist and understand them. Choice is good, but too much choice is overwhelming. It is not reasonable to expect the average taxpayer to learn the details of at least 27 education and retirement incentives to determine which ones provide the best fit.

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