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November 13, 1996
I. THE WORKING GROUP'S PURPOSE AND SCOPE
The 1996 Advisory Council on Employee Welfare and
Pension Benefit Plans created a Working Group on the Impact of Alternative
Tax Proposals on Employer- Sponsored Plans. The Working Group was charged
with analyzing the issues and making recommendations based on its
findings, prior to the next session of Congress.
The topic arose due to concerns among Council members
regarding what appeared to them to be inadequate attention to issues
surrounding employer-sponsored plans in the national debate over
fundamental tax reform. Some council members noted that the debate over
tax reform was reaching a depth and seriousness rarely seen in this
century, with advocates of reform arguing not only for changes in the
existing tax code, but for wholesale replacement of the current federal
individual and corporate income tax in favor of some other system.
Such a far-reaching change would have the effect of
eliminating the special tax preferences that now support employer-provided
health benefits and employer contributions and maintenance of qualified
retirement plans established under ERISA. The Council felt that such a
dramatic change that could transform the existing universe of employee
benefits under ERISA required analysis and attention, which was not
occurring in the Congressional and other forums where fundamental tax
changes were being debated.
The Working Group determined that its study would focus
only on qualified retirement plans, and not include employer-provided
health care. This was based on two main reasons. First, the Council
recently had looked in depth at health care issues during the debate over
the Clinton Administration's proposals for health care reform, and it did
not seem timely to take up that range of issues again.
Second, several members said that if tax reform were to
move forward, it might be early in the next Congress. Therefore, in order
to assist in the debate, the Council needed to issue a report this year,
and not make the Working Group on tax reform a multiyear project. At the
same time, members agreed that the Group and the Council would not be
endorsing any particular approach to tax reform, but would concentrate on
raising issues and highlighting important questions.
Based on this discussion, the Working Group established
parameters for this year's work. First, the Group would focus on qualified
retirement plans, and not include health plans. Second, the Group
emphasized that the Council would not make any endorsement of any
particular approach to tax reform, but would instead concentrate on
analysis and raising issues that have been given little attention in the
overall debate over tax reform.
Third, the proceedings of the Working Group would not
devote extensive time to detailed analysis of each competing plan for tax
reform, although key differences among them would be noted where
necessary. As Council member Edward Montgomery stated "there's a
generic issue -- what happens when you remove the tax deductibility of
contributions."
Fourth, because of the Council's statutory charge, the
Working Group would devote special attention to issues flowing out of the
ERISA statute that are not the focus of tax reform plans. Although ERISA
and proposals for tax reform share a broad overall goal of increasing
national savings, Council member Richard McGahey noted the wide range of
"issues that are framed under Title I of ERISA...[that] are of
critical importance...particularly questions about protections,
enforcement, and how this potentially dramatic change in the tax system
would feed back into the existing statutory and regulatory
responsibilities of the Department [of Labor]."
Finally, the Working Group also wanted to focus on how
overall savings and investment allocations patterns might change if the
nation replaced employer retirement plans and moved to an exclusive policy
of individual and household savings and investment for retirement. These
concerns encompassed both whether individuals would invest in the
long-term to provide for adequate retirement income, and what, as Council
chair Judith Mares put it, "could happen to the capital base of
America, the cost of capital and allocation of capital, from
savings."
II. WORKING GROUP PROCEEDINGS
The Working Group received oral and written testimony
and background materials at a series of public hearings, and through
solicitation and submission of analyses and information on topics related
to the Group's focus. (Summaries of the testimony can be found in Section
IV below.)
At the meeting of May 8, 1996, the Working Group
discussed its purpose and scope, deciding to focus on qualified retirement
plans. Due to the short time available for gathering information and
preparing a report, the Group decided to concentrate on several key
questions (discussed in section I above), and also to look for research
and background information that could be made part of the overall record
and report.
Also on May 8, the group heard testimony from Professor
Jonathan Barry Forman of the University of Oklahoma School of Law,
analyzing the impact of moving to a consumption tax on employee benefit
plans.
At the hearing on June 19, the Working Group heard a
variety of testimony, both on the specific impact of tax reform on
retirement savings and ERISA, and on the overall goals and potential
problems with fundamental tax reform. The first witness was Kenneth Kies,
Chief of Staff of the Joint Committee on Taxation of the U.S. Congress.
Mr. Kies discussed both the broad issues related to overall tax reform,
including why he thought that reform was eventually inevitable, and
specific issues related to employer-sponsored pensions and how they might
fare under tax reform.
Mr. Kies was followed by William Gale, a Senior Fellow
at the Brookings Institution, who presented oral and written testimony
based on his research on the effect of tax reform on private pensions,
which he characterized as "one of the great sleeper issues in tax
reform." Mr. Gale discussed statistical estimations of the impact on
tax reform on savings, investment, and pensions, emphasizing that
"all of these estimates are...shrouded in uncertainty," and
pointing out where statistical biases and other factors could add to
uncertain results when analyzing these issues.
The Working Group also heard from Paul Yakoboski, a
Research Analyst with the Employee Benefits Research Institute (EBRI), and
Ron Gebhardtsbauer, Senior Pension Fellow of the American Academy of
Actuaries. Both discussed their analysis of what would happen if, in Mr.
Yakoboski's words, "all forms of savings enjoyed the same
preferential tax treatment currently reserved for qualified retirement
plans." Both analyses focused on possible aggregate impacts of tax
reform, and on possible distributional changes in coverage and levels of
savings.
The final witnesses on June 19 were J.D. Foster, Chief
Economist of the Tax Foundation, and Bradley Belt, Director of the
Domestic Policy Issues Program at the Center for Strategic and
International Studies. Their testimony and discussion focused on broad
issues related to overall tax reform, and why shifting from the current
income tax to an alternative method of taxation might be desirable for the
economy and for savings and investment.
At the Working Group's next hearing on September 11,
1996, oral and written testimony was presented by three practitioners in
the financial, pension, and investment area. The first witness was Kathryn
Smith, an attorney with Bergman, Horowitz, and Reynolds of New Haven,
Connecticut who specializes in tax law, estate planning, and employee
benefits. Ms. Smith's testimony concentrated on practical issues of
implementation, coverage, and distribution if tax reform made significant
changes relating to qualified retirement plans.
Ms. Smith was followed by a panel with two witnesses
with expertise in investment management: Patricia Chadwick, Chief
Investment Strategist of Chancellor Capital Management, and John R.
Serhant, Chairman of the Investment Committee of State Street Global
Advisors. They focused on potential impacts of tax reform on overall
savings and investment, the allocation of assets by individuals,
households, and professional investment managers, and whether, in their
view, tax reform would improve and harm the overall level of retirement
savings and the distribution of saving and retirement income. Mr. Serhant
put his testimony in the context of his advocacy of partial or full
privatization of Social Security, arguing that fixing the private pension
system should be done in the context of overall national retirement
policy, and that some privatization of Social Security was an essential
element of future policy.
III. FINDINGS AND RECOMMENDATIONS
The Working Group is explicitly not taking any position
on overall tax reform, or on the merits or demerits of any particular
reform proposal. But we are concerned at the lack of attention to the
critical issues we have mentioned in this report, especially given the
high degree of uncertainty that surrounds each of them. We heard that the
effect of fundamental tax reform might be to increase overall national
saving, but also that, under plausible assumptions, the net impact on
savings could be close to zero, as pension savings fell while other
savings rose. We heard that employers might reduce or eliminate pensions
without the tax incentive, but also that they might maintain some form of
pension for their employees. This was a particular concern in relation to
small business. Some analysts argued that tax reform could lead to a less
progressive distribution of retirement income and less coverage,
especially for small businesses and lower income workers, while other
experts disagreed with that scenario.
This high degree of uncertainty over the impact of tax
reform on fundamental issues for the nation's retirement policy, and for
ERISA, is perhaps our major finding, and our major concern.
The lack of attention to pension plan issues in the tax
reform debate is perhaps not surprising, but somewhat disturbing. The
debate over fundamental tax reform is shaping up as one of the most
far-reaching debates over taxes in this century, with major public figures
(including Congressional leaders) calling for wholesale replacement of the
Federal individual and corporate income tax. Previous debates over tax
reform, such as those in the 1980s, concentrated on reforming the existing
income tax, not replacing it. Given the scope of issues raised by
proposals to replace the income tax, it is not surprising that pension
issues have not been given much specific attention.
However, the Working Group notes this lack of attention
with concern. There are four major sets of issues that concern the group.
First, most of the tax reform proposals concentrate on
ways to increase the nation's overall savings rate, but one way that the
plans propose to achieve this goal is the elimination of any special tax
preference for retirement savings, with an uncertain impact on the overall
level of savings in the economy.
Second, there has been little attention to how changes
in taxation and savings under tax reform might affect the coverage and
distribution of retirement income for the entire population.
Third, moving from pension-based saving to individual
and household-based saving raises questions about the investment behavior
of those households, both to achieve long-term adequate rates of return on
their savings, and the consequences of their investment behavior on the
allocation of capital in the American economy.
Finally, there are a host of social policy goals and
protections that are reflected in the current body of law and regulation
regarding pensions; moving away from the existing private pension system
could undermine many of those goals and protections.
The Working Group feels strongly that these and related
issues have not been adequately considered to date in the debate over tax
reform, which has focused almost exclusively on the overall national
saving rate. Advocates of tax reform sometimes seem to assume that raising
the savings rate for the nation as a whole will automatically lead to an
adequate retirement income for most Americans, but testimony before the
Working Group indicated substantial uncertainty about the effects of such
tax changes. As one witness, Kathryn Smith, put it, there is a significant
difference between "the nation's saving rate and a national
retirement income policy."
One central goal of all tax reform proposals is to
increase the level of national saving in the American economy, however
that might be achieved -- through a shift to a consumption tax such as a
VAT or a sales tax, a flattening of income tax rates and reducing or
eliminating taxes on capital income, or splitting income between
consumption and saving and only taxing the part consumed, as in a consumed
income tax. As part of the overall reform design, all of these proposals
would sharply curtail or end the existing special tax preference for
employer contributions to qualified retirement plans. The net effect would
be to treat pension and retirement saving in the same way as all other
individual and household savings.
Testimony and materials presented to the Working Group
indicate that many expert analysts view the tax preferences for qualified
retirement plans are among the most significant positive incentives
contributing to national savings. William Gale of the Brookings
Institution, in written testimony submitted to the work group, reported on
analyses showing that "from 1985 to 1992...pension contributions have
averaged about 50 percent of personal savings." If total pension
earnings and returns on investment are included along with contributions,
Gale reported that "pension saving has represented 70 percent or more
of personal saving since the mid-1980s." Based on this and other
testimony, the work group feels that the tax reform debate needs a much
more critical examination of the claim that elimination of existing
incentives would not harm overall savings and would assist in national
retirement policy.
A second major set of issues involves whether tax
reform and elimination of the pension tax preferences could inhibit
pension coverage and lead to a worse overall distribution of savings and
retirement coverage, with employees of small firms and those with lower
incomes on the losing end. Professor Jonathan Barry Forman of the
University of Oklahoma testified on his concerns that tax reform and the
elimination of the existing pension system " would have a tremendous
impact on low and moderate income workers. They are going to get more
cash, and they're going to spend it, and they're going to reach age 65
wanting to retire... and not having the money to do it, and making
increasing demands on our governmental system." Other witnesses,
including John Serhant of State Street Global Advisors, disagreed, arguing
that "I do not think that tax reforms...will have a negative impact
on the low income worker." As one goal of a national retirement
policy under ERISA is expanding pension coverage to as many workers as
possible, policy makers need to carefully consider whether tax reform
might actually reduce coverage or tilt the distribution of pension
benefits away from lower income people.
A third major set of issues that needs more attention
is whether moving away from private pensions to individually-managed
saving would result in inadequate returns on investment and shifts in
investment patterns that would affect capital allocation in the American
economy. Although it is often assumed that individuals will, on average,
make suboptimal allocations of their savings in light of their long-term
retirement needs, research presented to the work group by Council member
Thomas Healey found broadly similar asset allocations between defined
benefit and defined contribution plans. There was a good deal of
speculation on this issue, but the Working Group feels that much more
research needs to be done in this area.
1( Whatever tax system we have, there was universal
agreement by the Working Group that more work needs to be done in
educating individuals about the consequences of their long-term savings
and investment decisions. This issue has been a long-standing one of the
ERISA Advisory Council and of the Department of Labor.)
Finally, the Working Group has concerns about what
impact tax reform might have on the broad social purposes of existing
retirement policy. As work group member Kenneth Cohen noted, there is a
great deal of "embedded social policy that requires the nexus of
employer-provided plans," including reporting and disclosure
requirements, fiduciary rules for investment and management, vesting and
protections against fraud and abuse, retirement equity for women through
joint survivor rules, and many other policy provisions. As tax reform
could cause a sharp reduction or a wholesale elimination of existing
pension plans, the issue of what would happen to existing law and social
policy needs more analysis and attention.
The group heard testimony that moving away from
employer-sponsored pensions under ERISA could create significant
regulatory and administrative burdens for the Department of Labor and the
Federal Government. If existing pensions and regulations were
grandfathered under a new tax system, regulatory and enforcement activity
would have to be maintained, while the nation's overall savings and
retirement policy moved in a different direction. On the other hand, if
existing pensions were phased out and transferred into some new overall
pool of savings, very complex legal, regulatory, and enforcement issues
would arise during a transition, and for some time afterwards.
In summary, the Working Group believes that the complex
and far-reaching implications of fundamental tax reform for the nation's
retirement and pension system have not been given adequate attention or
analysis through existing policy channels, either in Congress or in the
Executive Branch, especially given the complexity of the issues and the
uncertainty that surrounds them.
Accordingly, the Working Group makes the following
recommendations to the Secretary of Labor.
1. As part of the Congressional debate over fundamental
tax reform, the Secretary of Labor should encourage Congressional
committees and leaders to actively seek out a wide range of views of how
such reform might affect pensions and saving for retirement. Expert
witnesses, including those from relevant executive branch agencies, should
be called to testify and submit information to Congress, and organizations
with significant expertise on these questions should be called upon to
assist Congress in its deliberations. Congressional resources like the
Joint Committee on Taxation should consider preparing a report for
Congress on the implications of tax reform for pensions and retirement.
2. The Secretary should raise issues relating to the
impact of tax reform on the private pension system within the
Administration, and with the public at large. A majority of the work group
recommended formation of a national commission on retirement policy to
study private pension and benefit issues. The Working Group is unanimous
in the view that the issues facing private pensions and retirement policy
need to be elevated to a much higher level of study and concern by all
major political decision makers, and that the existing regular channels of
policy debate are not paying adequate attention to this issue.
A majority of the Working Group supported the idea of a
national commission. While recognizing that any solution to the coming
retirement of the "baby boom" generation must consider the
availability of retirement income from all sources, including employee
pensions, those in the work group who support a commission recommend that
its charge be limited to the future of employer-sponsored retirement
savings.
The Secretary might also suggest forming a working
group that would include other key executive branch agencies, such as the
Department of the Treasury, the Pension Benefit Guaranty Corporation, and
the Office of Management and Budget, to analyze the issues surrounding
fundamental tax reform and pensions.
Some Working Group members were concerned that the
complex and critical issues surrounding retirement and pension policy will
not get adequate attention through existing policy channels, either in
Congress or in the Executive Branch.
3. Within the Department, the Secretary should conduct
an analysis of the regulatory and legal issues that would arise if tax
laws are changed to eliminate the tax preference for employer
contributions to qualified pension plans. Two scenarios need more
attention: one in which existing plans, laws, and regulations remain in
place while new policies come to govern future savings and retirement
policy, and a second scenario where the existing body of law and
regulation is phased out in favor of incorporating existing pension assets
into a new overall national savings regime.
4. The Secretary should also consider sponsoring
research and public discussion, alone or in conjunction with academic
experts and non-governmental organizations, on the many questions that
have only partly been researched and analyzed. All of these are questions
where there is some research, but where no consensus is apparent to the
Working Group. Among these issues are:
Considering the significant impact of current pension
contributions and earnings to national savings, how might tax reform
affect total net national savings?
Would tax reform increase or reduce pension coverage
and retirement benefits?
What might the distributional consequences be of such
reform, especially for the self-employed , those working in small
businesses, and lower-income workers?
If pension decisions were made by each individual
rather than professional managers, would asset allocations and investment
strategies change significantly? What might the consequence be of such
changes, both for the distribution of capital investment among economic
sectors, and for the long-term investment returns and adequacy of
retirement funds for individuals?
What legal, regulatory, and enforcement issues might
arise in changing to a new tax system that eliminated any special
consideration for employer contributions to qualified retirement plans?
How would the social policy goals currently embodied in law and regulation
be achieved under a new tax system, and how difficult would it be to
achieve those goals?
Would companies terminate or phase out their qualified
retirement programs if there was no tax preference for them?
IV. SUMMARIES OF TESTIMONY RECEIVED
The following are summaries of testimony received by
the Work Group.
Meeting of May 8, 1996
Testimony of Professor Jonathan Barry Forman,
University of Oklahoma College of Law
Jonathan Barry Forman is a Professor at the University
of Oklahoma College of Law teaching tax and pension law. In addition to a
law degree, Professor Forman holds a Master's Degree in Economics.
Professor Forman observed that most of the tax reform
proposals before Congress will eliminate tax breaks for health care plans
and essentially put qualified pension plans on the same level playing
field with all other savings. In evaluating the impact of this, Professor
Forman reviewed the implications of moving from our current income tax
structure to a consumption tax structure. In his analysis, the following
actions are likely:
Employers will no longer have an incentive to maintain
pension plans and the plans will, therefore, wither and decline;
Employees will desire more cash compensation which may
reduce overall savings;
Low and moderate income workers will be more inclined
to spend their additional savings, placing higher burdens on the social
security system as they retire;
There will be a shift from defined investment plans to
defined contribution plans;
Individual investor may make different investment
choices with their savings versus the long term orientation of company
sponsored investment allocations; and,
Workers would be need to work longer as they would not
be financially prepared for retirement
Companies would loose an effective tool in managing
their workforce.
Some recommended solutions to the potential change in
savings rates and patterns are:
A mandated pension system or some form of mandated
individual savings;
The creation of unlimited retirement savings accounts;
Relaxation of the mandatory retirement age;
Modifications to the Age Discrimination in Employment
Act; and,
Putting constraints around money already saved for
retirement as part of qualified plans.
o Employers will no longer have an incentive to
maintain pension plans and the plans will, therefore, wither and decline;
o Employees will desire more cash compensation which
may reduce overall savings;
o Low and moderate income workers will be more inclined
to spend their additional savings, placing higher burdens on the social
security system as they retire;
o There will be a shift from defined investment plans
to defined contribution plans;
o Individual investor may make different investment
choices with their savings versus the long term orientation of company
sponsored investment allocations; and,
o Workers would be need to work longer as they would
not be financially prepared for retirement
o Companies would loose an effective tool in managing
their workforce.
Some recommended solutions to the potential change in
savings rates and patterns are:
o A mandated pension system or some form of mandated
individual savings;
o The creation of unlimited retirement savings
accounts;
o Relaxation of the mandatory retirement age;
o Modifications to the Age Discrimination in Employment
Act; and,
o Putting constraints around money already saved for
retirement as part of qualified plans.
In conclusion, Professor Forman believes retirement
income has now become a four-legged stool: Social Security, pension,
individual savings and work. He encourages consideration of tax reform's
impact on each of these segments.
Meeting of June 19, 1996
Testimony of Kenneth Kies, Chief of Staff
Joint Committee on Taxation, United States Congress
Mr. Kies testimony focused on three issues that were
germane to the Working Group. First, he suggested that tax reform was
inevitable because of concerns over the level of saving in the economy. He
noted that the U.S. has the lowest national savings rate of any of the
major industrialized countries. Second, when this is combined with the
prospect of the Baby Boom generation impacting Social Security and
Medicare at the same time those systems are undergoing distress, concern
for the adequacy of private saving becomes paramount. Third and perhaps
more important for the political debate, is the fact that the inequities
of the current system have generated widespread dislike or distrust of our
current tax system. The complexity of the current system baffles even tax
experts as reflected in the Money Magazine article in which even
professional tax preparers could not agree on the tax liability of a
sample tax return.
The pension system plays a substantial role in the tax
system as the exclusion for pension contributions and earnings is the
single largest deduction in the current tax system with the next largest
being exclusions for employer provided health care. While it can be
debated how much of pension savings is due to the tax system, there is no
doubt that pensions plays an important role in level of private savings.
There are a number of alternative tax systems proposals in front of
Congress that range from fixing the current income tax system to moving to
a consumption tax systems. While some of the plans retain the current
filing requirements and include deductions for savings and other items,
others do not and are collected like a sales or VAT tax. All of the plans
give tax preference for savings but the distinction between employer
sponsored plans and other savings would be lost under many of them. This
could reduce employer incentives to sponsor plans and hence any forced
saving that results from them could be lost. While putting all savings on
the same plane may be beneficial it does carry risks to the degree
employer paternalism or forced saving is important.
An end to employer plans might also carry some non-tax
risks. Individuals may not select diversified portfolios because of the
lack of fiduciary obligations that force employer plans to do so.
Transition rule for pensions, protections for non-working spouses, and
protections against creditors are issues that must be dealt with if the
ERISA system is abandoned. While increasing savings, revenue neutrality
and distributional fairness are important considerations in any redesign
of the tax system these issues should not be ignored. Despite its critics,
the current tax system does have elements of a consumption tax to
encourage saving and is more progressive than commonly thought, as the top
10 percent of income earners pay 46.8 percent of all income and FICA taxes
while the bottom 40 percent pay just 4.9 percent. Further, moving to a
consumption tax is likely to have major macroeconomic effects that are not
necessarily positive in the short run. The long-term benefits in terms of
increased growth are still being debated by economists.
Testimony of William G. Gale
Senior Fellow, The Brookings Institution
Dr. Gale, an economist with expertise in taxation and
employee benefit issues, testified that the principal potential benefits
of adopting a new tax system are simplicity and a stronger rate of
economic growth. However, whether these goals will be attained depends in
part on how pensions are treated in the tax reform process and how savers
will respond to tax policy changes.
Dr. Gale presented a statistical analysis showing that
since 1986 more than 100% of the net personal savings in the U.S. has
occurred in pensions or tax deferred life insurance products and therefore
is currently occurring under "consumption tax principles", i.e.,
money is taxed only when it is withdrawn from the pension plan and spent.
Responding to questions, Dr. Gale noted that if the
non-discrimination provisions of the current tax were eliminated, the
proportion of low income workers with pensions might be reduced.
Asked to design his ideal tax program to enhance
pensions, Dr. Gale said that he would try to make the tax system much
simpler, particularly in the area of the non- discrimination rules.
Dr. Gale stated that pension, health, charitable
contribution and mortgage deductions are unlikely to disappear in the tax
reform process because they are reflective of social policy that has
become ingrained in the tax code.
Testimony of Ron Gebhardstbauer
Senior Pension Fellow American Academy of Actuaries
Mr. Gebhardtsbauer presented testimony on behalf of the
American Academy of Actuaries Task Force on Tax Reform. His oral and
written presentation concentrated on outlining the Academy task force's
case for simplifying, not overhauling, the tax code, based on an
evaluation of the current system, its advantages and disadvantages, and a
review of the various proposals for tax reform.
The central issues raised in the testimony were:
1) Will removal of the tax advantage eliminate employee
benefits, particularly for small plans?
2) Will equal tax treatment encourage a shift toward
non-qualified plans, discretionary benefits, lack of funding or no
protection of participant rights?
3) Will individuals opt for cash compensation and
further erode their own retirement savings program?
4) Will individuals save more and/or invest more wisely
on their own, than if they were in employer-sponsored plans?
5) Will the government ultimately take on greater
retirement income burden, and be forced ultimately to mandate
employer-sponsored plans?
Several issues arose in Mr. Gebhardtsbauer's oral
testimony and in discussion with members of the working group. It was
generally agreed that tax incentives are the primary reason for
employer-sponsored, qualified pension plans. Such plans ensure broad
coverage of workers at various age and income levels, provide an
opportunity for cost- sharing and investment diversification, enhance
national savings and retirement security and promote global
competitiveness.
On the other hand, the current tax code is complex,
seemingly unfair and a demotivator to personal savings. Unfortunately, the
huge tax break granted to pension funds appears to be at cross purposes
with the federal government's budget deficit reduction initiatives.
A new tax system, as under the various proposals, that
gives the same tax advantages as other forms of savings, will greatly
reduce employers' incentives for establishing and maintaining pension
plans. There is need for careful deliberation of tax reform in light of
national retirement policy issues.
Testimony of Paul Yakoboski
Research Associate, Employee Benefit Research Institute
EBRI has been examining what would happen to qualified
retirement plans if the current preferential tax treatment currently
reserved for them were to be extended to all savings arrangements. Would
employers be willing to offer a retirement plan without a relative tax
advantage; would employees want an employment-based retirement plan or
would they prefer to make their own saving/spending decisions?
A recent survey of employers showed no consensus about
whether or not to retain retirement plans. Decisions will probably be
based on the size and profitability of the organization and whether a
retirement plan is crucial to attracting and retaining the workforce.
Defined benefit plans will probably survive because of their workforce
management function. 401(k) plans, however, might wither away because
workers could achieve the same tax advantages without pre-retirement
withdrawal restrictions in other forms of savings vehicle.
In a separate survey of worker preferences, EBRI found
that, given a choice a choice of contributing to (1) an IRA or 401(k) plan
with pre-retirement withdrawal penalties, one third of respondents
preferred the IRA/401(k) option, and 55 percent selected the other
vehicle. Reasons for the surprising one third vote for IRAs/401(k) might
include the discipline to save and retain assets imposed by the automatic
payroll deduction and withdrawal penalties. However, when asked whether
they would prefer to be responsible for any tax-free savings, 59 percent
of respondents selected their employer, as opposed to 33 percent who said
they would make their own decisions.
One of the motivations for a consumption-based tax is
to increase the national savings rate. This could occur but most of the
savings might be concentrated at the higher income levels. Many
researchers hypothesize that in a situation where all savings mechanisms
are treated equally from the tax point of view, 401(k) plans would
disappear. Mr. Yakoboski said that it is not clear that workers would save
as much as they currently do if the discipline of the 401(k) plan were not
present.
Testimony of J.D. Foster, Chief Economist
The Tax Foundation
Mr. Foster began by describing the work of the Tax
Foundation, which is a non- profit, non-partisan organization that
analyzes a wide range of issues related to taxation and tax policy. He
noted that he was not primarily a pension expert, and was appearing as
part of a broader discussion over the issues related to fundamental tax
reform.
He outlined the twin problems of low national savings
rates and a low rate of capital formation and investment as two major
reasons why fundamental tax reform might be desirable. To him, the main
goal of tax reform is "getting the tax code out of the economic
decisions of individuals and businesses...in other words, coming up with a
more neutral tax system."
Mr. Foster noted that the current American tax system
is not a pure income tax, but a hybrid that contains consumption elements
as well, including the existing tax preference for contributions to
qualified retirement plans and other incentives that favor savings. These
elements, however, are not well integrated, especially in regard to
business taxation. This is why many tax reform plans focus not only on the
personal income tax, but on corporate tax policy.
He agreed with some other analysts that, if the
existing tax preferences were changed, "there's no question there's
probably going to be less savings going on through pensions," but
that lower tax rates overall would allow individuals to save in other
ways, offsetting that reduction and perhaps increasing the total amount of
savings.
While citing the work of several economists who have
studied these issues, Mr. Foster cautioned against trying to extrapolate
too much from studies based on the current system to project what would
happen under an entirely new tax system. He also felt that the issue of
potential changes in asset allocation that might be caused by tax reform
was worthy of study and research, especially the question of whether
individuals "will save and invest as wisely as professional pension
managers."
Testimony of Bradley Belt
Director, Domestic Policy Issues Program
Center for Strategic and International Studies
Mr. Belt was part of a panel describing the goals and
issues facing overall tax reform, with less emphasis on the particular
impact on pensions and the retirement system. He first described the
extensive and long-standing interest of the Center for Strategic and
International Studies (CSIS) in tax policy. The most prominent effort by
CSIS was the Strengthening of America Commission, chaired by Senators Sam
Nunn and Pete Domenici, which called for replacement of the current
federal tax code by a progressive, consumption-based income tax. This
proposal later evolved into the USA (Unlimited Savings Allowance) Tax,
although CSIS is not itself advocating any particular specific change, but
providing the educational and intellectual foundations to make the case
for broad and comprehensive tax reform.
Mr. Belt outlined his concerns over the low saving rate
in the United States, and the changing demography of the American
population, with a rapidly aging population and the coming retirement of
the baby boom early in the next century. These concerns, along with slow
productivity growth and the need for more investment, lead him to
advocated replacing the current tax code. Although noting that the current
code has some consumption tax elements, Mr. Belt argued that "there
is no question that the income tax system, as currently constituted, is
fundamentally biased against savings" in favor of consumption.
Mr. Belt was careful to note that savings and responses
to incentives in the tax code and elsewhere are complex issues, where
leading economists disagree on important analytic issues. And he noted the
difficulty of moving to a new tax code, with problems in transition from
the current system. The USA Tax proposal did outline transition rules, and
it was noted that in so doing, it created a great deal of political
controversy. Mr. Belt concluded by noting that, although Congressional
advocates were proposing major tax reform, it would take Presidential
involvement and leadership for such a sweeping reform to be enacted into
law.
Meeting of September 11, 1996
Testimony of Kathryn Smith, Attorney
Bergman, Horowitz, and Reynolds
Ms. Smith opened by asking how does one move people
without savings to look towards a comfortable retirement.
Ms. Smith detailed how she was more of a
"practical" tax attorney and said her emphasis would concern
small companies that have very little in the way of retirement savings
opportunities. In light of the discussion of the national retirement
income policy, emphasis needs to be placed on how to get people to save
towards retirement.
In addressing the complaint that taxes are too complex,
Congress has suggested fundamental tax reform suggestions such as a flat
tax, VAT tax, consumption tax and wage tax. These changes taken as a whole
both undermine the private pension system and in general replace the
entire existing tax code.
In speaking about the various tax reform proposals, Ms.
Smith made the following points:
The consumption tax that taxes what one uses could be
seen as a discretionary super IRA because taxes are only applicable to
moneys withdrawn and/or consumed.
Elimination of individual income tax leads to
application of a business or corporate level tax wherein companies are
taxed on the value they add and pay in the form of wages or
compensation/pension.
Loosening and simplifying the present tax code would be
more beneficial. This could be achieved through elimination of some
non-discriminatory taxes, minimum participation rules, etc.
Examining the role that voluntary employer-sponsored
pension plans play in this tax reform environment, Ms. Smith observed a
comfortable retirement requires three areas to be secure and used the
three-legged stool comparison featuring personal savings, Social Security
and the private voluntary employer system. Social Security is baseline and
personal savings are almost a non-item in the U.S., which is more a nation
of consumers than savers. Private pension plans have been the one area
that has survived a long-term savings base.
In looking at the history of defined benefit plans and
the impact of both tax reforms and additional regulation on small
companies, Ms. Smith noted:
o Plans became overfunded due to cutting of defined
benefit limits, leaving an excess of assets that went to the federal
government in the form of excise or income taxes. This caused defined
benefit plans to drop in significant numbers.
o The combination of Social Security integration rules,
415 limits and higher corporate tax rates made it more financially
attractive to bonus out any superfluous funds rather than put them in a
qualified plan.
o Pension plans have become almost invisible in small
companies because of changes in tax laws such as:
415 limits (owner's benefits) were reduced,
402(g) amounts (contributable to 401(k) ) dropped,
top heavy minimum benefits were introduced which are
super costly for small businesses,
compensation limits were put in place,
family aggregation was removed and
because of complexity, costliness, yearly changes in
pension laws and OBRA '87's change of full funding rules.
Ms. Smith said defined benefit plans are dying in small
businesses due to IRS audits that disqualify plans for tiny defects. She
concluded her testimony by noting the impacts of the proposed reforms as
follows: The tax reform proposals are going to neutralize the benefits of
405 plans. Owners are not incentivized to set up the SIMPLE plan due to
the 100 percent matching criteria and the $6,000 contribution cap on
employer contributions in 401(k) plans. In the case of the consumption
tax/super IRA, large companies are really not affected as the company gets
a deduction regardless.
By loosening qualification rules, the results include a
return to selective plans, weird vesting and forfeiture rules, no spousal
protections, lack of fiduciary responsibility and an adverse effect on the
retirement system.
Small businesses will react to the new tax reforms in a
negative fashion. the 75 percent that do not have plans will definitely
not be encouraged to initiate plans and the 25 percent that do have plans
will suffer a large fallout. Implementing the new tax reform proposals
will provide people who have money a great opportunity while the low
income folks have no where to look to for investment incentives.
Testimony of Patricia Chadwick
Chief Investment Strategist, Chancellor Capital
Management
Uncertainty in the investment markets was the starting
point for Ms. Chadwick's testimony. Major changes to the U.S. Tax Code
means uncertainty, and financial markets do not like uncertainty due to
the unknown effects on corporations and their earnings. Reducing or
eliminating tax deductions associated with pension plans could eliminate
incentives for employers to offer those plans. Without incentives, most
employers would spend the money on enhancing cash flow to please
stockholders rather than being concerned with employees' retirement
savings. Consequently, actual retirement savings may be reduced and many
individuals left to make their own investment decisions. These individuals
are not capable of investing wisely without additional investment
education. Educational efforts to date have been insufficient and many
individuals are not equipped to make decisions on their own.
The current tax system is supported by a complex system
of deductions, exemptions and graduated tax rates. This complexity makes
it difficult to predict the true economic impact of tax reform on
retirement savings. As an example, Ms. Chadwick pointed to the 1986 luxury
tax that was intended solely to produce revenue from the sale of luxury
items, but in fact almost wiped out the U.S. luxury boat industry causing
many blue collar workers to lose their jobs.
Currently, no sense of urgency exists for individuals
to save for retirement. Many such individuals rely on employers to create
and maintain pension plans to provide for their retirement needs. Changes
in the tax laws could reduce or eliminate deductibility of pension plan
contributions or act as a disincentive to corporations to fund and
maintain their plans. Without corporate plans, individuals do not have the
incentive or the necessary education to successfully save for their
retirement. Lower or middle-income individuals would be hardest hit
because of lower investment education levels, while at the same time
having greater demands for day-to-day living expenses.
Ms. Chadwick suggested that instead of tax reform, an
incentive plan be considered that would start individuals saving for
retirement in their twenties and by age sixty-five have more than enough
funds to retire comfortably without governmental assistance.
Key Points:
Current incentives for retirement savings must be
maintained or even possibly increased.
Eliminating tax incentives for employer-sponsored
pension plans would hurt lower and middle-income individuals the most.
Lower and middle-income individuals do not have sufficient investment
education necessary to invest wisely and under tax reform may not have
adequate incentives to save.
Testimony of John R. Serhant, Chairman
Investment Committee of State Street Global Advisors
Mr. Serhant was strongly in favor or encouraging
retirement savings on all levels. He felt Congress should "do
whatever it takes" to raise retirement savings above existing levels.
Additional retirement savings may require tax reform that would reduce
current regulations and remove limits on amounts individuals can save.
Nationally, pension savings are substantial and should not be taken
lightly. More study is needed in a "savings friendly"
atmosphere. Existing tax reform proposals could balance individual savings
with collective savings in employer-sponsored pension plans. However, tax
reform could also take away incentives for pension plans which may result
in a negative effect on overall national retirement savings.
Mr. Serhant strongly supports any reform of the current
tax system which increases the national savings rate. He suggests this
could be done by simplifying existing pension rules and expanding IRA
eligibility. Loosening existing pension regulations would allow all
individuals the freedom to save, including lower and moderate income level
workers. Mr. Serhant put his testimony in the context of his advocacy of
partial or full privatization of Social Security, arguing that fixing the
private pension system should be done in the context of overall national
retirement policy, and that some privatization of Social Security was an
essential element of future policy.
Key Points:
Make whatever changes are necessary to increase the net
national retirement savings rate.
Existing tax reform proposals might negatively effect
the pension system. Therefore, Congress should first consider simplifying
and reducing existing regulations as a first step while further studying
potential effects of tax reform.
V. TESTIMONY AND OTHER MATERIALS RECEIVED OR PLACED IN
RECORD
For the ADVISORY COUNCIL 1996 TERM:
May 8, 1996:
Suggested Issues for ERISA Advisory Council to
Investigate by Kenneth S. Cohen, 5/6/96
Written Testimony from Jonathan Barry Forman,
University of Oklahoma at Norman, "The Impact of Shifting to a
Personal Consumption Tax on Pension Plans and Their Beneficiaries"
presented originally to a panel on public policy perspective of the April
30, 1996 EBRI-ERF Policy Forum on Comprehensive Tax Reform: Implications
for Economic Security and Employee Benefits.
Written Testimony from the Association of Private
Pension and Welfare Plans on "Flat Tax Side-by-Side" dated
9/5/95.
June 19, 1996:
Written Testimony from Kenneth Kies, chief of staff of
the Congressional Joint Committee on Taxation, which was a copy of the
Selected Materials Relating to the Federal Tax System Under Present Law
and Various Alternative Tax Systems, issued March 14, 1996.
Written Testimony by William G. Gale, senior fellow,
The Brookings Institution, on "Effects of Comprehensive Tax Reform on
Private Pensions and Savings"
Written Testimony submitted by the American Academy of
Actuaries Task Force on Tax Reform as presented by Ron Gebhardtsbauer,
senior pension fellow, on June 19, 1996.
Written Testimony from Bradley D. Belt, domestic policy
director of the Center for Strategic Internal Studies (CSIS), on the topic
of the impact of alternative tax proposals on the ERISA employer-sponsored
pension system.
September 11, 1996:
Written Testimony from Kathryn H. Smith, Bergman,
Horowitz and Reynolds
Written Testimony of Patricia Chadwick, chief
investment strategist, Chancellor Capital Management
Written Testimony of John R. Serhant, chairman of the
investment committee for State Street Global Advisers
Charts prepared by Thomas Healey, Goldman Sachs, and an
ERISA Advisory Council member
October 10, 1996:
New Haven Register Article entitled "Tax reform
could affect workers' benefit plans" by Paul F. Jackson, Register
Business Editor and provided by Working Group Vice Chair Carl S. Feen.
As background for the Working Group, a bound volume
from the Employee Benefit Research Institute--Education and Research Fund
(EBRI-ERF) Policy Forum on April 30, 1996, on Comprehensive Tax Reform:
Implications for Economic Security and Employee Benefits was provided.
Included were:
I. About EBRI-ERF Policy Forums
II. Agenda
III. About the Presenters and Discussants
IV. Michael Graetz, Yale Law School
Daniel Halperin, Georgetown University Law Center
"Comprehensive Tax Reform and Fringe Benefits: The
Case of Employer- Provided Pensions and Health Insurance."
V. James Poterba, MIT, Department of Economics
"The Impact of Fundamental Tax Reform on
Employer-Provided Health Insurance."
VI. David Cutler, Harvard University, Department of
Economics
"Comprehensive Tax Reform and Employer-Provided
Health Insurance."
VII. Stephen Woodbury, W.E. Upjohn Institute for
Employment Research
"Employee Benefits and Tax Reform"
*VIII.William Gale, The Brookings Institution
(co-author, Eric Engen, Board of Governors of the Federal Reserve System)
"Comprehensive Tax Reform and the Private Pension
System."
IX. Giles Archibald, William M. Mercer Co.
"The International Perspective"
X. Richard Sawaya, Atlantic Richfield Company
"Taxes, Pensions & Benefits: A Possible
Employer View."
*XI. Jonathan Forman, University of Oklahoma, College
of Law
"The Impact of Shifting to a Personal Consumption
Tax on Pension Plans and Their Beneficiaries."
XII. Randolf Hardock, Davis and Harman
"The Reality of Tax Reform."
XIII.EBRI Background Materials
* Persons also appearing before the Working Group and
listed previously.
VII. MEMBERS OF THE WORK GROUP
Richard McGahey, Chair
Neece, Cator, McGahey and Associates
Carl S. Feen, Vice Chair
CIGNA Financial Advisors
Judith Mares, Chair of the Advisory Council
Mares Financial Consulting, Inc.
Kenneth S. Cohen
Massachusetts Mutual Life Insurance Company
Glenn W. Carlson
Arthur Andersen LLP
Thomas J. Healey
Goldman, Sachs and Company
David G. Hirschland
International Union, United Automobile, Aerospace
and Agricultural Implement Workers of America, United
Auto Workers
Vivian Lee Hobbs
Arnold and Porter
Marilee P. Lau
KPMG Peat Marwick LLP
Edward B. Montgomery
University of Maryland
Zenaida Samaniego
Equitable Life Assurance Society of the United States
James O. Wood
Louisiana State Employees' Retirement System (LASERS)
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