Our established clients know that we have been writing about the “January effect” for several years as a supply-side effect of pension plans. I mention this because of commentary that I heard on Bloomberg earlier this week suggesting there may not be much of a January advance in equities this year because December has been so strong on Wall Street. In a cash-flow demand model this would be possible, if the markets simply began to discount that there would be heavy pension contributions in January for those who had maxed out on their IRA's early in the previous year. In a supply model, the market would not do that discounting in advance because pension contributions by individuals are optional. For example, if Jones maxed out last year, maybe he won`t contribute at all this year. This is quite different than a change in the tax law early in the year that is scheduled to take place on January 1 of the new calendar year. There is nothing optional in that example, so discounting will occur months before when the tax law is legislated, and not when it takes effect.
The “January effect” of pension plans may improve in 2004 because the government has been growing more attentive to the baby boomers. Where the maximum contribution of a Roth IRA now is $3,000 annually, and limited to families with less than $150,000 of adjusted gross income, there is now an additional allowance of $500 for a taxpayer over 50 years of age. In 2005, the maximum will go to $4,000 plus the $500 for all eligible taxpayers. The newer Roth IRA remains especially popular because it enables an individual to invest after-tax income instead of pre-tax income, with earnings growth at retirement free of tax. These really amount to new "loopholes" in the tax codes, but the kind that liberal Democrats can support because of the income caps. Even these will almost certainly wither away as 2012 approaches, with a chance there will be a further liberalization this spring. Bill Gates, for example, would probably not open a $3,000 Roth IRA if he was permitted to do so anyway.
The other subtle shift that has been taking place in recent years has been in defined benefit plans, which Treasury had discouraged, but now welcomes. For example, if you are a 60-year-old doctor with a 25-year-old secretary, you can fund your piece of the plan with a contribution of $1000 per week and her piece with $20 per week. These regulatory changes have the same effects at the margin as tax cuts on capital.
Finally, there is the new Medicare bill, where the employers` contribution to workers` Health Savings Accounts would not be subject to Social Security taxes. Treasury said this week that beginning January 1, people under 65 could contribute on a pretax basis to an “HRA” if they have a qualified health plan. This is similar to the IRA, with earnings growing tax free, except funds are not taxed at contribution or withdrawal.
Dow Jones reported on the new Health Savings Accounts as follows:
The accounts can be used to pay unreimbursed medical expenses, retiree health insurance, Medicare expenses, and prescription drugs. Unused funds in a Health Savings Account can grow over the years and be used to meet future medical needs, unlike Flexible Spending Accounts, in which funds are forfeited at the end of each year. There are hurdles for people to qualify for the accounts. To be eligible, taxpayers have to be covered by a health plan with a high deductible of at least $1,000 for individuals and $2,000 for families. The plan also must have a high cap on annual out-of-pocket expenses, $5,000 for individuals and $10,000 for families. Contributions can be made by individuals, their employers and family members. A person can make tax-deductible contributions to a Health Savings Account even if he doesn't itemize deductions on his tax return, the Treasury said.
A company can make contributions that aren't taxed to either the employer or the worker. The contributions are treated as ‘employer-provided coverage for medical expenses’ under an accident or health plan and are excludable for the employee`s gross income, the Treasury said in a news release. The contributions aren't subject to the Federal Insurance Contributions Act, Federal Unemployment Tax Act or the Railroad Contributions Tax Act.
The law lets taxpayers save as much as 100% of a health-plan deductible annually, to a maximum of $2,600 for self-only policies and $5,150 for family policies. In addition, it allows people aged 55 to 65 to make additional tax-free "catch up" contributions of as much as $1,000 a year. Individuals can set up a Health Savings Account at a bank, insurance firm or other designated trustee and custodian. The Health Savings Accounts will cost $6.4 billion in lost tax revenue through 2013, according to Congress`s Joint Committee on Taxation.
Grace-Marie Turner of the Galen Institute told me this tax provision was the chief reason she supported the otherwise messy and costly Medicare bill:
"Giving people control over the money being spent by their employers on health insurance, with an incentive to spend it wisely, is a huge first step toward getting a functional consumer market working in the health sector. Yes, Health Savings Accounts are another tax loophole, but they just may save us from socialized medicine."
* * * * *