Academic journal article New England Economic Review

Current Taxation of Qualified Pension Plans: Has the Time Come?

Academic journal article New England Economic Review

Current Taxation of Qualified Pension Plans: Has the Time Come?

Article excerpt

The U.S. Treasury estimates that personal income tax receipts in fiscal year 1992 would have been $51 billion higher without the special provisions accorded employer-sponsored pension plans. It is at best unclear that taxpayers are getting their money's worth from this large tax expenditure. Despite a myriad of legislative changes, all of which combine to increase the likelihood that persons covered by pension plans will actually receive benefits, the U.S. pension system is still a very erratic and unpredictable way to provide retirement income and it benefits a relatively privileged subset of the population. In view of other pressing demands on the federal budget, the time may have come to eliminate some or all of the tax preferences accorded compensation provided through qualified pension plans and introduce some form of current taxation.

The purpose of this paper is to reiterate the case for reassessing the current favorable treatment accorded qualified plans and to explore some possible approaches for introducing current taxation. Part I addresses the issue of revenue loss, considering the impact not only on the personal income tax but also on the payroll tax. Concluding that the revenues forgone are large no matter how they are measured, Part Il explores what taxpayers are buying for their money. Qualified plans provide retirement income to a steadily declining and decidedly nonpoor proportion of the population, and they do not appear to have increased national saving. In short, the favorable tax treatment of compensation received in the form of accrued pension benefits does not appear to be achieving high-priority social goals.

Given the large federal deficits and overwhelming demands on the federal budget, Part III explores mechanisms for taxing qualified plans in order to recoup some or all of the subsidy currently accorded pensions, and looks at the experience of other countries that have made changes in this area.

I. The Current Tax Treatment of Qualified


In the United States, a person's income has generally been viewed as the best measure of his ability to contribute to the cost of government. Tax experts have argued for a broad definition of income and indeed such a broad definition has been incorporated in the Internal Revenue Code. Treasury regulations specify that income includes compensation paid in forms other than money and the U.S. Supreme Court has confirmed that the Code definition "is broad enough to include in taxable income any economic or financial benefit conferred on the employee as compensation, whatever the form or mode by which it is effected."(1) In actual practice, the economic benefit test has not been rigidly followed; certain forms of compensation have been accorded special treatment.

Qualified Plans and the Personal Income Tax

Under the personal income tax, employees are not taxed currently on the value of their accrued pension benefits; rather, they are allowed to defer taxes until benefits are received in retirement. This treatment is equivalent to an interest-free loan from the Treasury and significantly reduces the lifetime taxes of those employees who receive part of their compensation in wages and part in pensions as opposed to those who receive all their compensation in cash wages.

This favorable treatment costs the Treasury money; the estimated revenue loss for fiscal 1992 is $51 billion. This number is the net of two figures: 1) the revenue that would be gained from the current taxation of annual pension contributions and pension fund earnings, and 2) the amount that would be lost from not taxing benefits in retirement, as is done currently. The $51 billion includes the tax expenditure for private pensions, state and local plans, and the federal civilian retirement plans (Table 1); no estimate appears to be made for the military plan. Nevertheless, the exclusion of employer-sponsored pension plan contributions and earnings is the single largest tax expenditure, topping even the revenue loss arising from the deduction of mortgage interest on owner-occupied homes (Table 2). …

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