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1987 Federal Tax Policy Memo 1 (1987)

handle is hein.tera/fetxcyemo0011 and id is 1 raw text is: TAX FOUNDATION ONE THOMAS CIRCLE, N.W., SUITE 500 50th Anniversary Year WASHINGTON, DC 20005 TELEPHONE (202) 822-9050 DAL A POI M Editor: Edward A. Sprague, Senior Vice President-Program Planning and Tax Policy Congress and the Workplace By Frank B. McArdle The second session of the 99th Congress adjourned Octo- ber 18, 1986. In many ways, it was a remarkable Congress. Tax reform was of course its crowning achievement. But this last session was equally important for other pieces of legisla- tion passed or considered. How is it that Congress, in passing tax reform, sought to lighten the load of government and of tax considerations on private-sector decisions, and ended up involving itself ever more deeply in the workplace, particularly with respect to retirement income, health insurance, and other voluntary employee benefit matters? What Does Tax Reform Do to Employee Benefits? Tax practitioners and employers are struggling to digest this massive bill as quicaly as possible but are up to their ears in this task. Not only must they move quickly to comply with the employee benefit provisions, but in addition, the new law will force them to undertake complete reappraisal of their current employee benefit packages. The effects on benefits come from two directions: from the numerous provisions directly aimed at employee benefits and from the changes in the tax rates. The direct provisions, which took up 114 pages of the Act itself and 179 pages of the Conference Report, aie i'ntnded to produce more compara- ble employee benefit coverage of rank-and-file employees and of highly compensated employees. The pension changes would increase the number of workers with a vested interest in their pensions by some 2 million workers in the first year alone. It would increase pension amounts for rank-and-file employees by limiting the coordination with Social Security benefits. And it would mandate broader and more comparable coverage of rank-and-file employees un- der pension, health, life insurance and other plans. Educa- tion assistance and group legal services will lose their tax ABOUT THE AUTHOR FRANK B. McARDLE is director of Education and Communications for the Employee Benefit Research Institute (EBRI), a public policy research organization based in Washington, D.C. Before joining EBRI, he worked as a legislative and policy analyst for the U.S. Senate Special Committee on Aging and the U.S. De- partment of Health and Human Services. His Ph.D. is from the University of Virginia. The following remarks are adapted from an address to the Tax Foundation's 38th National Conference in December 1986. The opinions expressed are those of the author and do not necessarily reflect those of the Tax Foundation. JANUARY/FEBRUARY 1987 exclusion in 1988; employer-provided transportation bene- fits were allowed to expire. If rank-and-file workers are the intended beneficiaries, higher-paid employees are the intended losers from the benefits provisions. Certainly the higher paid will enjoy lower tax rates. But they suffer potential losses in benefits. Some examples: restrictions on 401(k) salary reduction con- tributions; a new limit effective in 1989 of $200,000 on the amount of compensation that can be taken into account under all qualified plans; a new excess benefit tax of 15 percent on most annual distributions over $112,500; and sharply reduced maximum benefits paid to early retirees under defined benefit plans. Changes in the welfare benefit areas, like health and life insurance, also aim for the same effects: an intended broad- ening of benefits because of tighter nondiscrimination rules that also reduce tax-favored benefits payable to the higher paid. Government staff have argued that reduced tax- favored benefits for the highly paid constitute more com- parable coverage of rank and file and highly paid, when you view the benefits in terms of dollars, rather than as a percent of their compensation. Effect of Tax Rates Despite its good intentions, some unintended conse- quences of the new legislation may actually slow the future growth of benefit coverage and even result in less coverage in that sector of the economy-the small employer sector- where benefit coverage is the least available today. A top rate of 28 percent for the owners of a small business and 15 percent rate for 80 percent of taxpayers may make cash more attractive than benefits, which are also more difficult and more costly to administer under the new rules. The desir- ability of deferring compensation for nonretirement pur- poses under qualified plans is also called into question, because of new penalties on early withdrawals and the ex- pectation that future tax rates may be higher than the new rates. Finally, because of the new restrictions on the higher paid, many employers will face the option of removing the higher paid from their general qualified benefit plans, which could result in a deterioration in benefits for rank-and-file employees. As more of their compensation is provided through nonqualified plans, the higher compensated may lose their stake in the general benefit plan. Obviously, whether nondiscrimination rules cause expanded and more comparable coverage of rank-and-file employees or reduce tax benefits for the highly paid will differ from employer to employer. Employee benefits will remain an important piece of total compensation, but the changes in their tax effectiveness may Material in Federal Tax Policy Memo may be reproduced freely. Credit to Tax Foundation would be appreciated.

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