Academic journal article Generations

The Mutuality of Employee Benefits and Tax Expenditures

Academic journal article Generations

The Mutuality of Employee Benefits and Tax Expenditures

Article excerpt

How tax policy ensures the vitality of employee benefits-which are crucial to public programs.

Employee benefits come in many shapes and sizes. Governmentmandated employee benefits like Social security, Medicare, Unemployment Compensation, and Workers Compensation have been created and expanded since 1937, the year Social security began, with the other programs added in later decades. Voluntary pensions for employees paid for by employers began to sprout in the 1800s, were given special tax treatment early in the 1900s, and have been the subject of numerous tax-law changes over nearly 100 years. Voluntary employer-funded health benefits saw their primary growth begin in the late 1940s when favorable tax treatment was granted and wage and price controls allowed increases in such "fringe benefits" while cash wages were restricted.

While employee benefits have received favorable tax treatment for decades, the government did not begin calculating a "tax expenditure" for those preferences until congressional action in 1974 required an annual accounting. Each year since then, as part of the president's budget, a report is provided on the "tax expenditure" cost to the government of most preferences in the tax code. Employee benefits for public- and private-sector workers are among the largest tax-expenditure costs in the budget.

The tax preference for employee benefits is directed at the individual worker, not at the employer, a point that is important to note because it is frequently misunderstood. Many simply assume that since the cost of employee benefits is a deductible business expense for employers, that is where the tax expenditure arises, but it does not. The tax expenditure arises because the employees are not taxed on the contributions the employer makes to pension plans or the earnings on those contributions until they accept benefit payments, and they are not taxed on the value of health insurance premiums paid by their employer.

Because the provision of employee benefits by the employer does not create immediately taxable income for the employee, employers began by requiring that employees participate in the benefit programs. This requirement was generally the case until the growth of 401 (k)-type plans in the early 1980s and the growth of employee premium payments for health insurance in the inflation surge that began in the 1970s.

This article describes the tax treatment of employee benefits, the types of voluntary plans, the concept and level of tax expenditures, alternative ways of looking at the value they deliver, and the level of participation in employee benefit plans over time, and discusses the possible consequences of changes in the tax treatment of employee benefits.

VOLUNTARY EMPLOYEE BENEFIT PROGRAMS AND TAX TREATMENT

Employees value employee benefit programs. They serve to attract, retain, and motivate. Health insurance is the most important employee benefit for more than 60 percent of workers and is second most important for 15 percent. Defined-contribution retirement plans are the most important for 17 percent and second most important for 38 percent. Retiree health insurance is most important for 5 percent, and second most important for 9 percent. Defined-benefit pension plans are most important for 4 percent, and second most important for 9 percent. Twenty-seven percent of workers report being unwilling to leave their current job because of "job lock" created by their health insurance (Helman and Fronstin, 2004).

Health insurance is now most commonly found with the employer paying about 80 percent of the cost of single or family coverage. Over time, the employer payment has been getting less and less generous, and some employers are now beginning to pay a far smaller portion of family premiums (Mercer, 2004). Tax law provisions allow workers to pay their share of the premiums on either a pretax basis (if the employer sets up the administrative arrangements to allow it), with some tax credit (if they meet income tests), or as a deduction on Schedule B (if total medical expense exceeds 7. …

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