According to Howard Gleckman over at TaxVox, the blog of the Urban and Brookings Joint Tax Policy Center, due to a shortsighted revenue generator Congress put in place several years ago, wealthy individuals will soon be able to convert taxable investments into tax-free nest eggs, and deny the government needed revenues down the road. It's a perfect example of the unintended consequences of public policy and one of those things that make you either want to scratch your head or beat it against the wall, or both.

Back in 2005, President Bush proposed extending "low rates on capital gains and dividends through 2010" and providing "additional temporary relief from the Alternative Minimum Tax," and tasked Congress with paying for it all. The solution was to allow those making over $100,000 a year to convert a traditional Individual Retirement Account (IRA), where investment earnings are taxed at withdrawal, to a Roth IRA, where earnings are tax-free.

Each wealthy individual who chose to do this would have to pay a tax on the money converted; a scheme the Joint Committee on Taxation (JCT) figured would generate about $6.5 billion over a ten-year period. However, once the monies are converted, the rich simply let their investments grow and the government losses out on desperately needed future revenues, a thoughtless mistake Gleckman describes as financing "a set of unaffordable tax breaks with another unaffordable tax break."

A colleague of Gleckman's calculated the long-term revenue loss of this measure at somewhere around $100 billion by 2050 and placed the net present value of the tax break around $15 billion. "For the government, that’s more than $2 lost for every dollar gained." Gleckman then explains how this loss of tax revenue will make fiscal situations even more complicated in the future:

Indeed, Treasury will lose more and more money each year until 2046, when many of those enjoying the windfall will have died off. Worst of all, the greatest drain on the Treasury will occur just when the aging Baby Boomers are putting the most pressure on the federal budget.

If that were not bad enough, Gleckman goes on to describe the unintended consequences of this policy currently affecting us:

First, because stock prices are lower today than JCT thought they’d be, Treasury may end up with much less money inside the budget window than Congress expected. Second, I wonder if some of those taking advantage of the windfall will end up spending less so they can pay the rollover tax, thus slowing the economic recovery. Oops.

Oops indeed.

Image by Flickr user rutty used under a Creative Commons license.