March 7, 2000
Pension Provisions of Tax Bill Coming to House Floor
Would Overwhelmingly Benefit Corporate Executives and Owners
Provisions Could Lead to Pension Reductions for Low- And Moderate-income Workers
click here for a more detailed version of analysis
Tax legislation scheduled for House floor debate during the week of March 6 would substantially expand pension tax preferences for high-income executives but likely lead to some reductions in pension coverage among low- and moderate-income workers and employees of small businesses. This tax legislation will be considered in conjunction with a minimum-wage bill; the House leadership has indicated that the tax bill and the minimum-wage bill will be joined in conference after being considered as separate pieces of legislation on the House floor.
The tax bill the House will consider was approved last fall by the House Ways and Means Committee when it appeared that minimum-wage legislation might move at that time. (One or a few relatively-minor additional tax provisions also are likely to be included.) This legislation is portrayed by the House leadership as easing the effects of a minimum-wage increase on small business. But most of the bill's tax reductions — which are drawn directly from the large tax bill that President Clinton vetoed last summer — would primarily benefit high-income individuals and do little or nothing to assist small businesses in offsetting any increases in labor costs they may incur as a result of a higher minimum wage.
The Tax Bill's Pension Provisions
The tax bill coming to the House floor includes important changes in the tax laws that govern employer-sponsored pensions. These provisions, which would cost $18 billion over 10 years and nearly $3 billion a year by the tenth year, are the second largest component of the legislation. (Proposed reductions in the estate tax are the bill's largest component.) These are the pension provisions that were included in last year's vetoed tax bill, with only minor changes.
These provisions are promoted as expanding pension coverage for working Americans. In fact, as a Center on Budget and Policy Priorities analysis issued last fall demonstrated,(1) while these pension provisions include several useful changes, their principal impact would be a major expansion of pension-related preferences for high-income individuals. In addition, they likely would lead to reductions in pension coverage among ordinary workers.
Analysis by the Institute for Taxation and Economic Policy of the pension provisions of the vetoed tax bill has found that 96.5 percent of the pension tax reductions from those provisions would accrue to the 20 percent of Americans with the highest incomes. Some 87 percent of the pension tax breaks would go to the five percent of the population with the highest incomes. In sharp contrast, the bottom 60 percent of the population would receive less than one percent of these tax benefits. These pension provisions were among the provisions cited as unacceptable by the President when he vetoed last year's tax bill.
What These Pension Provisions Do
These provisions would confer an array of pension tax preferences on highly paid individuals, despite the fact that these are the individuals who already have the most generous pensions. Provisions of current law that place upper limits on the tax-favored contributions that highly paid individuals may make to pension plans would be relaxed. So would the limits on the amount of pension payments that high-income individuals may receive when they retire.
For example, the legislation would increase the maximum tax-favored contribution an employed individual is permitted to make to a 401(k) plan to $14,000 a year by 2004. (The maximum contribution is $10,500 today; CBO inflation forecasts suggest this limit will reach $11,500 in 2004 under current law as a result of inflation indexing.) This increase in the maximum contribution limit would benefit the fewer-than-five-percent of individuals covered by a 401(k) plan who make the maximum $10,500 contribution today; this is a group that receives average pay of $130,000. The bill also would increase the maximum pension benefit a retiree can receive under a defined benefit pension plan from $135,000 a year to $160,000. That change would benefit only those at the very top of the income distribution whose salaries are so large that they would be able to qualify for annual pension payments of more than $135,000 when they retire.
These and the other pension-related tax breaks in the bill have little to do with assisting small businesses in absorbing a minimum-wage increase. These tax breaks would primarily boost pension tax benefits for business owners and executives, rather than offset any increased labor costs that might result from a higher minimum wage. Ironically, the only way these provisions would reduce labor costs would be if employers used these provisions to reduce the pension contributions that they make on behalf of their employees.
Furthermore, it appears that most small businesses do not offer pension plans. In 1993, only 13 percent of full-time workers in firms with fewer than 10 employees — and 25 percent of workers in firms with between 10 and 24 employees — had pension coverage. (By contrast, 73 percent of workers in firms with 1,000 or more employees have pension coverage.(2)) It thus seems unlikely that many small businesses with significant minimum-wage workforces would be affected by these expansions in pension tax breaks for high-income individuals.
Low- and Middle-Income Workers Could Be Adversely Affected
Some of these pension provisions would be likely to lead to reduced pension coverage among lower- and middle-income workers. For example, by raising pension contribution limits for highly-paid corporate executives and owners, these provisions would enable owners and top executives to maintain contributions for their own pension plans while reducing contributions for other employees. The legislation also would weaken "non-discrimination" and "top-heavy" rules that prevent employers from skewing too great a proportion of pension contributions to owners and executives at the expense of ordinary employees. The proposed dilution of these protections could induce further erosion in coverage among low- and moderate-income workers.
Under current law, a firm may make pension contributions on the first $170,000 of an individual's salary. The legislation would raise this limit to $200,000. As a result, if a business owner who makes $250,000 seeks a pension contribution of $10,000 a year for himself, the firm currently must make a pension contribution of 6.5 percent of wages (6.5 percent of $170,000 equals just over $11,000). If the $170,000 limit is raised to $200,000, however, the owner could secure a $11,000 contribution level for himself while lowering the pension contribution rate to 5.5 percent. Such an action would keep pension contributions high for the owner while saving money for the business by reducing pension contributions by nearly one-sixth for the firm's employees.
Those who promote these pension proposals argue these generous new benefits for highly-paid owners and executives would induce more firms to offer pension plans and would result in a trickle-down effect that would benefit low- and moderate-income workers currently lacking pension coverage. As with a number of other areas of tax policy where proponents of tax cuts primarily benefitting well-off taxpayers claim trickle-down effects, however, there is no empirical evidence to support this claim. This legislation is much more likely to reduce pension protections for low- and moderate-income employees than to expand them.
On November 1, when the House appeared to be on the verge of considering these pension provisions as part of minimum-wage legislation, Treasury Secretary Lawrence Summers and Labor Secretary Alexis Herman wrote House Ways and Means Chairman Bill Archer sharply criticizing these provisions. Summers and Herman warned that the pension provisions that "...raise the maximum retirement plan contribution and considered compensation for business owners and executives and weaken the pension anti-discrimination and top-heavy protections for moderate- and lower-income workers....are regressive, would not significantly increase plan coverage or national savings, and could lead to reductions in retirement benefits for moderate- and lower-income workers."
1. Peter Orszag, Iris Lav, and Robert Greenstein, "Exacerbating Inequities in Pension Benefits: An Analysis of the Pension Provisions in the Tax Bill," Center on Budget and Policy Priorities, October 8, 1999. A revised version of this analysis, "Pension Provisions of Tax Bill Coming to House Floor Would Heavily Benefit Highly Paid Executives and Business Owners But Could Jeopardize Pension Benefits for Ordinary Workers," was issued March 6, 2000.
2. U.S. Department of Labor, Social Security Administration, Small Business Administration, and Pension Benefit Guarantee Corporation, Pension and Health Benefits for American Workers, 1994.