PAGENO="0001"
DISTRIBUTION AND ECONOMICS OF EMPLOYER-
PROVIDED FRINGE BENEFITS
çf `~) ~
HEARINGS
BEFORE THE
SuBCOMMITTEE ON SOCIAL SECURITY AND
STJECOMIMTTTEE ON SELECT REVENUE MEASURES
OF THE
COMIMIITTEE ON WAYS AND MIEANS
HOUSE OF REPRESENTATIVES
NINETY-EIGHTH CONGRESS
SECOND SESSION
SEPTEMBER 17 AND 18, 1984
Serial 98-98
Printed for the use of the Committee on Ways and Means
~j ~7 ~
U.S. GOVERNMENT PRINTING OFFICE
40-0460 WASHINGTON : 1985
PAGENO="0002"
COMMITI'EE ON WAYS AND MEANS
DAN ROSTENKOWSKI, illinois, Chairman
SAM M. GIBBONS, Florida
J.J. PICKLE, Texas
CHARLES B. RANGEL, New York
FORTNEY H. (PETE) STARK, California
JAMES R. JONES, Oklahoma
ANDY JACOBS, JR., Indiana
HAROLD FORD, Tennessee
ED JENKINS, Georgia
RICHARD A. GEPHARDT, Missouri
THOMAS J. DOWNEY, New York
CECIL (CEC) HEFFEL, Hawaii
WYCHE FOWLER, JR., Georgia
FRANK J. GUARINI, New Jersey
JAMES M. SHANNON, Massachusetts
MARTY RUSSO, Illinois
DON J. PEASE, Ohio
KENT HANCE, Texas
ROBERT T. MATSUI, California
BERYL ANTHONY, JR., Arkansas
RONNIE G. FLIPPO, Alabama
BYRON L. DORGAN, North Dakota
BARBARA B. KENNELLY, Connecticut
BARBER B. CONABLE, JR., New York
JOHN J. DUNCAN, Tennessee
BILL ARCHER, Texas
GUY VANDER JAGT, Michigan
PHILIP M. CRANE, illinois
BILL FRENZEL, Minnesota
JAMES G. MARTIN, North Carolina
RICHARD T. SCHULZE, Pennsylvania
BILL GRADISON, Ohio
W. HENSON MOORE, Louisiana
CARROLL A. CAMPBELL, Ji~,
South Carolina
WILLIAM M. THOMAS, California
FORTNEY H. (PETE) STARK, California, Chairman
JOHN J. DUNCAN, Tennessee
RICHARD T. SCH1JLZE, Pennsylvania
GUY VANDER JAGT, Michigan
W. HENSON MOORE, Louisiana
JAYNE Boyu~, Professional Staff
Josm~ JONAS, Professional Staff
I
Joiss~ J. SALMON, Chief Counsel
JosEPH K. Dowi.EY, Assistant Chief Counsel
ROBERT J. LEONARD, Chief Tax Counsel
A.L. SINGIEFON, Minority Chief of Staff
SUBCOMM1TPEE ON SOCIAL SECURITY
J.J. PICKLE, Texas, Chairman
ANDY JACOBS, JR., Indiana BILL ARCHER, Texas
RICHARD A. GEPHARDT, Missouri BILL GRADISON, Ohio
JAMES M. SHANNON, Massachusetts PHILIP M. CRANE, illinois
WYCHE FOWLER, JR., Georgia WILLIAM M. THOMAS, California
ROBERT T. MATSUI, California
BERYL ANTHONY, JR., Arkansas
ERwTh~ Hy~rs~sa, Professional Staff
Csssiu~Es M. B1IAIIe, Professional Staff
PA'rIucIA E. Dui.EY, Professional Staff
JOSEPH H. Gw~r, Professional Staff
SUBCOMMIrPEE ON SELECT REVENUE MEASURES
CECIL (CEC) HEF1'EL, Hawaii
FRANK J. GUARINI, New Jersey
RONNIE G. FLIPPO, Alabama
BYRON L. DORGAN, North Dakota
BARBARA B. KENNELLY, Connecticut
ED JENKINS, Georgia
(II)
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CONTENTS
Page
Press release of Wednesday, August 29, 1984, announcing the hearings 1
WITNESSES
Department of the Treasury, Ronald A. Peariman, Acting Assistant Secretary
for Tax Policy 28
Department of Health and Human Services:
Robert B. Helms, Acting Assistant Secretary for Planning and Evalua-
tion, and Bruce Steinwald, Acting Deputy Assistant Secretary for
Health Policy 46
Harry C. Ballantyne, Chief Actuary, Social Security Administration, and
Bruce Schobel, Actuary 50
Small Business Administration, Frank S. Swain, Chief Counsel for Advocacy... 188
Alexander, Donald C., Chamber of Commerce of the United States 104
American Federation of Labor & Congress of Industrial Organizations, Ray
Denison and Arnold Cantor 559
Beadle, Carson E., William M. Mercer-Meidinger, Inc 471
Cantor, Arnold, American Federation of Labor & Congress of Industrial Orga-
nizations 559
Castells, Manuel, Kwasha Lipton 518
Chamber of Commerce of the United States, Donald C. Alexander and Mi-
chael J. Romig 104
Curran, Jack, National Coordinating Committee for Multiemployer Plans 551
Denison, Ray, American Federation of Labor & Congress of Industrial Organi-
zations 559
Employee Benefit Research Institute, Dallas L. Salisbury 62
Federal Reserve Bank of Boston, Alicia H. Munnell 417
Georgine, Robert A., National Coordinating Committee for Multiemployer
Plans 551
Hewitt Associates, Susan Koralik 467
International Union, United Automobile, Aerospace & Agricultural Imple-
ment Workers of America, Alan Reuther 573
Kaye, Lloyd S., William M. Mercer-Meidinger, Inc 471
Koralik, Susan, Hewitt Associates 467
Kwasha Lipton, Manuel Castells 518
Mercer-Meidinger, William M., Inc., Carson E. Beadle and Lloyd S. Kaye 471
Millipore Corp., Kenneth D. Simonson 435
Minarik, Joseph J., the Urban Institute 428
Mobil Oil Corp., Robert B. Peters 528
Munnell, Alicia H., Federal Reserve Bank of Boston 417
National Coordinating Committee for Multiemployer Plans, Robert A. Geor-
gine, Jack Curran, and Peter Schmidt 551
Peters, Robert B., Mobil Oil Corp 528
President's Commission on Industrial Competitiveness, Kenneth D. Simonson. 435
Project HOPE, Gail R. Wilensky 455
Prudential Insurance Co. of America, Robert C. Winters 542
Reuther, Alan, International Union, United Automobile, Aerospace & Agri-
cultural Implement Workers of America 573
Romig, Michael J., Chamber of Commerce of the United States 104
Salisbury, Dallas L., Employee Benefit Research Institute 62
Schmidt, Peter, National Coordinating Committee for Multiemployer Plans 551
(III)
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Page
Simonson, Kenneth D., President's Commission on Industrial Competitive-
ness, and Millipore Corp 435
Sun Co., Inc., Howard Weizmann 533
Tiner, Michael L., United Food & Commercial Workers International Union,
AFL-CIO 570
United Food & Commercial Workers International Union, AFL-CIO, Michael
L. Tiner 570
Upjohn, W.E., Institute for Employment Research, Stephen A. Woodbury 448
Urban Institute, Joseph J. Minarik 428
Weizmann, Howard, Sun Co., Inc 533
Wilensky, Gail R., Project HOPE 455
Winters, Robert C., Prudential Insurance Co. of America 542
Woodbury, Stephen A., W.E. Upjohn Institute for Employment Research 448
SUBMISSIONS FOR THE RECORD
U.S. Department of Labor, Robert A.G. Monks, Administrator, Office of Pen-
sion and Welfare Benefit Programs, statement 590
Aetna Life & Casualty, Burton E. Burton, statement 593
AGRI Industries Retirement Committee, Thomas C. Walker, statement 754
Air Line Pilots Association, International, statement 596
Albertine, James J., American Society of Association Executives, letter and
attachment 608
American Academy of Actuaries, Stephen G. Kellison, statement 598
American Council of Life Insurance and Health Insurance Association of
America, joint statement 628
American Dental Association, statement 602
American Dental Hygienists' Association, statement 603
American Hospital Association, statement 605
American Psychiatric Association, Jay B. Cutler, letter 607
American Society of Association Executives, James J. Albertine, letter and
attachment 608
American Telephone & Telegraph Co., statement 622
Ameritech, Donald W. Phfflips, letter 626
Andrews, Emily S., Washington, DC, statement 638
Associated General Contractors of America, statement 655
Associated Specialty Contractors, Inc., statement 656
Association for Advanced Life Underwriting, statement 658
Atlantic Richfield Co., Dwaine H. Smith, statement 665
Bankers Life Co., statement 675
Barber, Jane, Tektronix, Inc., statement 748
BellSouth Corp., Roy B. Howard, Clyde V. Manning, and Randy L. New, joint
statement 678
Biggins, Peter A., LTV Corp., statement 719
Blue Cross & Blue Shield Association, statement 683
Boel, Hal, Pacific Telesis, statement 744
Burton, Burton E., Aetna Life & Casualty, statement 593
Chen, Yung-Ping, Bryn Mawr, PA, statement 686
CIGNA Corp., Hartzel Z. Lebed, statement 687
Chollet, Deborah J., Washington, DC, statement 690
Comprehensive Accounting Services, Paul W. Giesler, letter 701
Connecticut General Life Insurance Co., Hartzel Z. Lebed, statement 687
Cutler, Jay B., American Psychiatric Association, letter 607
Delta Dental Plans Association, Erik D. Olsen, statement 701
Dreux, Joan Albert, National Association of Casualty & Surety Agents, letter. 730
Dunstone, William H., Haddon Craftsmen, Inc., letter 705
Giesler, Paul W., Comprehensive Accounting Services, letter 701
Haake, J.F., Southwestern Bell Telephone, letter 748
Haddon Craftsmen, Inc., William H. Dunstone, letter 705
Health Insurance Association of America and American Council of Life Insur-
ance, joint statement 628
Howard, Roy B., BellSouth Corp., statement 678
Hy-Vee Food Stores, Inc., Ronald D. Pearson, statement 706
Kellison, Stephen G., American Academy of Actuaries, statement 598
Korczyk, Sophie M., Alexandria, VA, statement 709
Lawson, Gary B., Jenkens & Gilchrist, letter 718
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Page
Lebed, Hartzel Z., CIGNA Corp., and Connecticut General Life Insurance Co.,
statement 687
LTV Corp., Peter A. Biggins, statement 719
Manning, Clyde V., BellSouth Corp., statement 678
Maytag Co., Jay R. Storey, statement 728
National Association of Casualty & Surety Agents, Joan Albert Dreux, letter.. 730
National Employee Benefits Institute, statement 731
National Rural Electric Cooperative Association, Martin D. Wood, statement.. 739
Nelson, John M., Rockford, IL, letter addressed to Senator Alan Dixon 744
New, Randy L., BellSouth Corp., statement 678
Olsen, Erik D., Delta Dental Plans Association, statement 701
Pacific Telesis, Hal Boel, statement 744
Pearson, Ronald D., Hy-Vee Food Stores, Inc., statement 706
Pfizer Inc., Edmund T. Pratt, letter 746
Phillips, Donald W., Ameritech, letter 626
Picker International, Russell Spector, letter 747
Pratt, Edmund T., Pfizer Inc., letter 746
Southwestern Bell Telephone, J.F. Haake, letter 748
Smith, Dwaine H., Atlantic Richfield Co., statement 665
Spector, Russell, Picker International, letter 747
Storey, Jay R., Maytag Co., statement 728
Tektronix, Inc., Jane Barber, statement 748
Travelers Insurance Cos., John F. Troy, statement 751
Troy, John F., Travelers Insurance Cos., statement 751
Walker, Thomas C., AGRI Industries Retirement Committee, statement 754
Wood, Martin D., National Rural Electric Cooperative Association, statement. 739
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DISTRIBUTION AND ECONOMICS OF
EMPLOYER-PROVIDED FRINGE BENEFITS
MONDAY, SEPTEMBER 17, 1984
HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND
MEANS, SUBCOMMITTEE ON SOCIAL SECURITY, AND SUB-
COMMITTEE ON SELECT REVENUE MEASURES,
Washington, DC.
The subcommittees met at 10:05 a.m., pursuant to notice, in room
1100, Longworth House Office Building, Hon. J.J. Pickle (chairman
of the Subcommittee on Social Security) and Hon. Fortney H. (Pete)
Stark (chairman of the Subcommittee on Select Revenue Measures)
presiding.
[The press release announcing the hearing and background infor-
mation follow:]
[Press release No. 10, Wednesday, August 29, 1984]
THE HONORABLE J.J. PICKLE (D., TEXAS), CHAIRMAN, SUBCOMMITTEE ON SOCIAL SECIJ-
RITY, AND THE HONORABLE FORTNEY H. (PETE) STARK (D., CALIF.), CHAIRMAN, SUB-
COMMITTEE ON SELECT REVENUE MEASURES, COMMITTEE ON WAYS AND MEANS, U.S.
HOUSE OF REPRESENTATIVES, ANNOUNCE A HEARING TO GATHER GENERAL INFORMA-
TION ON THE DISTRIBUTION AND ECONOMICS OF EMPLOYER PROVIDED FRINGE BENE-
FITS
The Honorable J.J. Pickle (D., Texas), Chairman of the Subcommittee on Social
Security, and the Honorable Fortney H. (Pete) Stark (D., Calif.), Chairman of the
Subcommittee on Select Revenue Measures, Committee on Ways and Means, U.S.
House of Representatives, today announced a joint oversight hearing on the distri-
bution and economics of employer provided fringe benefits.
The hearing will be held on Monday, September 17, 1984, and Tuesday, September
18, 1984, in the Committee's main hearing room, 1100 Longworth House Office
Building, beginning at 11:00 a.m. Testimony will be received from invited witnesses
representing the Administration, plan providers, employee and management organi-
zations, and invited public witnesses.
In announcing the hearing, Chairman J.J. Pickle stated: "The subcommittees do
not have a legislative proposal before them and these hearings are not designed to
draft any particular legislative proposal. Rather these hearings are designed to
gather information and better inform the Congress and the public about certain as-
pects of fringe benefits. First of all, the subcommittees are interested in determining
the prevalence of fringe benefits in the working population in general and among
different types of workers in particular. Secondly, the subcommittees will be explor-
ing the economics of fringe benefits and will be interested in learning how employ-
ers and employees consider the tax status of various fringes in devising a total com-
pensation package. The economic effects of these decisions will also be of interest."
Chairman Stark noted, "Last year the Select Revenue Measures Subcommittee re-
ported out legislation (now part of P.L. 98-369) that codified long-established nonsta-
tutory fringe benefits, but subjected all benefits not expressly exempted to tax. Now
that we have eliminated the distinction between statutory and nonstatutory bene-
fits, it is time to examine on a comprehensive basis all benefits exempted from tax
currently in the Code. We need to understand their true cost, both in terms of lost
revenue and in terms of higher taxes paid on nonexempt forms of compensation.
While no one doubts that fringe benefits serve many useful social purposes, we in
(1)
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2
the Congress do not have a clear understanding of the true cost of these exemp-
tions."
FRAMEWORK FOR HEARINGS
While recognizing that the subject of fringe benefits is diverse and complex the
subcommittees are particularly interested in receiving testimony on the following:
(1) How prevalent are the available fringe benefits. Specifically, what percent of
the work force is covered by the various fringe benefits, such as pensions, and what
percent of compensation do fringe benefits represent? How does this compare with
their historic availability and utilization, and what changes are currently projected
to occur in the future?
(2) Which employees by salary range and occupation receive the various fringe
benefits?
(3) Since different types of fringe benefits are subject to different tax treatment,
how do employers and employees decide to structure a total compensation package
which includes cash, taxable fringe and nontaxable fringe? What is the effect of tax-
favored treatment on the selection of certain fringe benefits in comparison to other
fringe benefits and cash remuneration? What would be the effect of the, availability
and use of various fringe benefits if the favorable tax treatment were changed, for
instance, if FICA tax were imposed?
(4) What are the economic effects of the utilization of fringe benefits? What is the
effect of the tax-favored treatment of certain fringe benefits on the horizontal and
vertical equity of the income tax system? For example, for any given level of overall
federal revenue, would the incidence of the income tax shift significantly if current-
ly nontaxable fringe benefits were subject to income taxes?
(5) How much could FICA tax rates be lowered if nontaxable benefits were includ-
ed in the social security wage base? What is the effect of the exclusion of certain
fringe benefits from the social security wage base on social security benefits re-
ceived by various types of workers?
(6) What would be the effect of placing a fixed dollar cap, flat excise tax, or a
limit on the percent of compensation which could be accorded tax-exempt or tax-
deferred treatment? What levels or limits would be necessary in order to prevent
further erosion of tax bases?
(7) What is the relationship between fringe benefits provided by employers and
social programs provided by government agencies? What social purposes are served
by various fringes? If certain fringe benefits were not provided by employers, would
there be an increased dependency on existing federally funded social programs or a
need to create federafly funded social programs? Which is the most efficient use of
resources in providing specific services or benefits: encouraging employers to pro-
vide them through perferred tax treatment or providing them through directly
funded public programs?
WRITTEN STATEMENTS FOR THE RECORD OF THE HEARING
Testimony will be received from invited witnesses only. All other interested par-
ties wishing to submit written statements for the record of the hearing are encour-
aged to do so. Persons submitting written statements should submit at least six (6)
copies by the close of business Friday, September 21, 1984, to John J. Salmon, Chief
Counsel, Committee on Ways and Means, U.S. House of Representatives, 1102 Long-
worth House Office Building, Washington, D.C. 20515. If those ffling written state-
ments for the record of the hearing wish to have their statements distributed to the
press and the interested public, they may provide 100 additional copies for this pur-
pose to the Committee office, 1102 Longworth Building, before the hearing begins.
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3
[JOINT COMMITTEE PRINT]
OVERVIEW OF THE TAX TREATMENT
OF FRINGE BENEFITS
SCHEDULED FOR JOINT HEARINGS
BEFORE THE
SUBCOMMITTEE ON SOCIAL SECURITY
AND THE
SUBCOMMITTEE ON SELECT REVENUE
MEASURES
OF THE
COMMITTEE ON WAYS AND MEANS
ON
SEPTEMBER 17 AND 18, 1984
PREPARED BY THE STAFF
OF THE
JOINT COMMITTEE ON TAXATION
w
SEPTEMBER 14, 1984
U.S. GOVERNMENT PRINTING OFFICE
38-301 0 WASHINGTON: 1984 JcS-33-84
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4
CONTENTS
Page
INTRODUCTION . 1
I. SUMMARY . 2
II. OVERVIEW OF TAX TREATMENT OF FRINGE BENEFITS 5
A. Statutory Fringe Benefit Provisions 5
B. Miscellaneous Fringe Benefits 11
C. Benefits Provided Under a Cafeteria Plan 13
D. Welfare Benefit Plans 14
E. Qualified Pension, Profit-Sharing, and Stock
Bonus Plans 17
III. BACKGROUND DATA RELATING TO TAX TREATMENT OF
CERTAIN FRINGE BENEFITS 19
A. Revenue Implications 19
B. Growth in Fringe Benefits 20
(III)
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5
INTRODUCTION
The Subcommittee on Social Security and the Subcommittee on
Select Revenue Measures of the Committee on Ways and Means
have scheduled joint public hearings on September 17 and 18, 1984,
on the Federal tax treatment of fringe benefits.
In the press release announcing the oversight hearing, Chairman
Pickle of the Social Security Subcommittee stated that "the sub-
committees do not have a legislative proposal before them and
these hearings are not designed to draft any particular legislative
proposal. Rather, these hearings are designed to gather informa-
tion and better inform the Congress and the public about certain
aspects of fringe benefits. First of all, the subcommittees are inter-
ested in determining the prevalence of fringe benefits in the work-
ing population in general and among different types of workers in
particular. Secondly, the subcommittees will be exploring the eco-
nomics of fringe benefits and will be interested in learning how
employers and employees consider the tax status of various fringes
in devising a total compensation package. The economic effects of
these decisions will also be of interest."
Chairman Stark stated that "last year the Select Revenue Meas-
ures Subcommittee reported out legislation (now part of P.L. 98-
369) that codified long-established nonstatutory fringe benefits, but
subjected all benefits not expressly exempted to tax. Now that we
have eliminated the distinction between statutory and nonstatu-
tory benefits, it is time to examine on a comprehensive basis all
benefits exempted from tax currently in the Code. We need to un-
derstand their true cost, both in terms of lost revenue and in terms
of higher taxes paid on nonexempt forms of compensation. While
no one doubts that fringe benefits serve many useful social pur-
poses, we in the Congress do not have a clear understanding of the
true cost of these exemptions."
The first part of the pamphlet is a summary. This is followed by
a more detailed overview of the Federal tax treatment of fringe
benefits, including qualified pension, profit-sharing, or stock bonus
plans, qualified annuity plans, and tax-sheltered annuities. The
final part sets forth background information, including revenue im-
plications of the tax treatment of certain fringe benefits' and
growth in certain fringe benefits.
(1)
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6
I. SUMMARY
In general
The Code defines gross income for purposes of the income tax
and the tax on self-employment income (SECA) as including "all
income from whatever source derived" and specffies that it in-
cludes "compensation for services" (sec. 61). Similarly, the social se-
curity and unemployment insurance payroll taxes (FICA and
FUTA) and income tax withholding generally apply to all remu-
neration for employment, including noncash remuneration. Any
fringe benefit that does not qualify for exclusion under a specific
statutory provision is inducible in gross income, and subject to em-
ployment taxes, at the excess of its fair market value over any
amount paid by the employee for the benefit.
Statutory fringe benefit provisions
As a general rule, if an employer-provided fringe benefit pro-
gram qualifies under a specific statutory provision of the Code,
then the benefits provided under the program are excludable (gen-
erally, subject to dollar or other limitations) from the employee's
gross income for income tax purposes. The costs of benefits that are
excluded from an employee's income nonetheless are deductible by
the employer provided they constitute ordinary and necessary busi-
ness expenses. The income tax exclusions also generally apply for
payroll tax purposes.
The Code provides specific exclusions, among others, with respect
to employer provision of (1) up to $50,000 of group-term life insur-
ance; (2) up to $5,000 of death benefits; (3) accident or health bene-
fits; (4) parsonage allowances; (5) certain benefits provided to mem-
bers of the Armed Services; (6) meals and lodging for the conven-
ience of the employer; (7) group legal services; (8) commuting
through use of a van pool; and (9) dependent care assistance.
Miscellaneous fringe benefits
The Economic Recovery Tax Act of 1981 (P.L. 97-34) extended
through December 31, 1983, a moratorium on the issuance of Treas-
ury regulations relating to the income tax treatment of nonstatu-
tory fringe benefits. The Treasury Department has announced that
the Treasury and the IRS "will not issue any regulations or rulings
altering the tax treatment of nonstatutory fringe benefits prior to
January 1, 1985," and that "present administrative practice will
not be changed during this period" (Ann. 84-5, 1984-4 I.R.B. 31).
Under the Tax Reform Act of 1984 (P.L. 98-369), certain miscella-
neous fringe benefits provided by an employer are excluded from
the recipient employee's gross income for Federal income tax pur-
poses and from the wage and benefit bases for purposes of social
security and other employment taxes. The excluded fringe benefits
(2)
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7
3
are those that qualify under one of the following five categories as
defined in the Act: (1) a no-additional-cost service, (2) a qualified
employee discount, (3) a working condition fringe, (4) a de minimis
fringe, or (5) a qualified tuition reduction. Special rules apply with
respect to certain parking or eating facilities provided to employees
and certain on-premises athletic facilities.
In the case of a no-additional-cost service, a qualified employee
discount, a subsidized eating facility, or a qualified tuition reduc-
tion, the exclusion applies with respect to benefits provided to offi-
cers, owners, or highly compensated employees only if the benefits
are also made available to other employees on a nondiscriminatory
basis.
The provisions of the Act generally take effect on January 1,
1985, except that the tuition reduction exclusion applies with re-
spect to education furnished after June 30, 1985.'
Benefits provided under a cafeteria plan
Under a cafeteria plan, a participant is offered a choice between
cash and certain fringe benefits. (Under the law in effect prior to
the Tax Reform Act of 1984, a participant in a cafeteria plan could
choose among cash, any taxable benefits (such as use of an employ-
er-provided vacation facility), and nontaxable benefits (such as cov-
erage under an accident and health plan). If the plan meets certain
conditions generally related to nondiscrimination in favor of highly
compensated employees, the participant is not treated as having re-
ceived cash or a taxable fringe benefit solely because the partici-
pant has the opportunity, before the benefit becomes available to
the participant, to choose among the taxable and nontaxable bene-
fits offered under the plan.
On February 10, 1984, the IRS issued a news release (IR-84-22)
stating that so-called "flexible spending arrangements" offered as
part of a cafeteria plan did not provide employees with nontaxable
benefits under the Code because, under such arrangements, em-
ployees are assured of receiving the benefit of what they would
have received had no covered expenses been incurred. In May,
1984, the IRS issued proposed regulations with respect to the cafe-
teria plan rules and the statutory rules governing the exclusion of
benefits from gross income.
The Tax Reform Act of 1984 limits an individual's choices under
a cafeteria plan to cash and fringe benefits that are excludable
under a specific provision of the Code (other than scholarships or
fellowships, van pooling, and those benefits excludable under the
miscellaneous fringe benefit provisions of the Act). The Act also
amends the cafeteria plan rules to provide that if, for a plan year,
more than 25 percent of the total nontaxable benefits are provided
to key employees, the key employees are taxed as if they received
all available cash and taxable benefits under the plan. The Act im-
poses certain reporting requirements on employers maintaining
cafeteria plans.
I Also, the Act imposes a moratorium, with respect to lodging furnished after December 31,
1983, and before January 1, 1986, on the issuance of income tax regulations providing for the
inclusion in gross income of qualified campus lodging.
PAGENO="0014"
8
4
The cafeteria plan provisions of the Act are effective on January
1, 1985. In addition, the Act provides transition relief from the ap-
plication of some requirements of the proposed regulations up to
January 1, 1985, or, in some cases, July 1, 1985.
Welfare benefit plans
The Tax Reform Act of 1984 modified the tax treatment of em-
ployers with respect to certain benefits provided to employees
under a welfare benefit plan. Under the Act, deductions for contri-
butions to a welfare benefit fund are limited to qualified costs.
Qualified costs generally consist of (1) qualified direct costs and (2)
additions, within limits, to a qualified asset account. In general, the
qualified asset account limit is the amount estimated to be neces-
sary under actuarial assumptions, which are reasonable in the ag-
gregate, to fund the liabilities of the plan for the amount of claims
incurred but unpaid to provide certain benefits and the administra-
tive costs of such benefits. In addition, the Act provides that the
qualified asset account may include, within limits, amounts reason-
ably necessary to accumulate reserves on a level annual basis
under a welfare benefit plan so that a medical benefit or life insur-
ance benefit (including a death benefit) payable to or on behalf of a
retired employee is fully funded upon retirement.
The Act modifies the rules relating to the unrelated business tax-
able income of certain tax-exempt organizations that provide em-
ployee benefits, and establishes new nondiscrimination standards
for these organizations.
These provisions of the Act generally are effective for contribu-
tions paid or accrued after December 31, 1985. A special effective
date is applied to plans maintained pursuant to a collective bar-
gaining agreement in effect on July 1, 1985. In addition, the Act
provides certain transition rules with respect to existing reserves.
The provisions of the Act relating to nondiscrimination require-
ments apply to taxable years beginning after December 31, 1984.
Qualified pension, profit-sharing, and stock bonus plans
If a pension, profit-sharing, or stock bonus plan qualifies under
the tax law, then (1) a trust under the plan is generally exempt
from income tax, (2) employers are generally allowed deductions
(within limits) for plan contributions for the year for which the
contributions are made, even though participants are not taxed on
plan benefits until the benefits are distributed, (3) benefits distrib-
uted as a lump sum distribution may be accorded special long-term
capital gain treatment or 10-year income averaging treatment, or
may be rolled over, tax-free, to an individual retirement account or
annuity (IRA) or another qualified plan, and (4) certain partial dis-
tributions may be rolled over, tax-free, to an IRA. Special rules are
provided for tax-sheltered annuity contracts and simplified employ-
ee pensions.
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9
II. DESCRIPTION OF TAX TREATMENT OF FRINGE
BENEFITS
A. Statutory Fringe Benefit Provisions
In general
Gross income, for income tax purposes, includes "all income from
whatever source derived" (Code sec. 61(a)). This provision "is broad
enough to* include in taxable income any economic or financial ben-
efit conferred on the employee as compensation, whatever the form
or mode by which it is effected" (Comm `r v. Smith, 324 U.S. 177,
181 (1945)).
The social security and unemployment insurance payroll taxes
(FICA and FUTA, respectively) and income tax withholding apply
to "wages," defined in the statutes as all remuneration for employ-
ment, including the cash value of all remuneration paid in any
medium other than cash (secs. 3121(a), 3306(b) and 3401(a)). The
railroad retirement tax (RRTA) applies to any form of money re-
muneration (sec. 3231(e)). Regulations applicable to these statutes
specify that the value of any noncash item is to be determined by
the excess of its fair market value over any amount paid by the
recipient for the item (see, e.g., Reg. sec. 31.3121(a)-1(e)).
As a general rule, if an employer-provided fringe benefit pro-
gram qualifies under a specific statutory provision of Federal
income tax law, then the benefits provided under the program are
excludable (generally, subject to dollar or other limitations) from
the employee's gross income for income tax purposes. Similar ex-
clusions also generally apply for employment tax purposes. The
costs of benefits that are excluded from the employee's income
nonetheless are deductible by the employer, provided they consti-
tute ordinary and necessary business expenses (Code sec. 162).
The social security tax on self-employment income under the
Self-Employment Contributions Act (SECA) applies to net earnings
from self-employment defined generally as gross income from an
individual's trade or business, less the deductions allowed under
the income tax which are attributable to the trade or business.
Thus, the fringe benefits excluded from income of self-employed in-
dividuals under the income tax generally also are excluded from
the base of the self-employment tax.
The Internal Revenue Code provides specific income tax exclu-
sions, among others, with respect to employer-provided benefits of
(1) up to $50,000 of group-term life insurance; (2) up to $5,000 of
death benefits; (3) accident or health benefits; (4) parsonage allow-
ances; (5) certain benefits provided to members of the Armed Serv-
ices; (6) meals and lodging for the convenience of the employer; (7)
legal services; (8) commuting through use of a van pool; and (9) de-
(5)
PAGENO="0016"
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6
pendent care assistance. These fringe benefits have commonly been
referred to as statutory fringe benefits.
In addition, the Tax Reform Act of 1984 provided statutory exclu-
sions for certain other fringe benefits (see Miscellaneous Fringe
Benefits, below).
Nondiscrimination rules
Under present law, exclusions for most of the statutory fringe
benefits are conditioned upon compliance with rules prohibiting
discrimination in favor of employees who are owners, officers,
shareholders, and highly compensated employees. These nondis-
crimination rules generally prohibit discrimination as to eligibility
to participate and as to contributions or benefits.
A plan or program generally is required to meet the eligibility
requirement by covering a classification of employees determined
by the Internal Revenue Service not to result in prohibited discrim-
ination. A self-insured medical reimbursement plan or group-term
life insurance plan may also satisfy the requirement by covering a
stated percentage of the employer's employees.
Generally employees covered by a collective bargaining agree-
ment and who are not covered by a plan can be excluded from con-
sideration in applying the nondiscrimination rules if the benefits
provided by the plan or program are the subject of good faith bar-
gaining between the employer and employee representatives. The
eligibility rules for self-insured medical reimbursement plans also
provide that employees need not be taken into account if they have
not completed three years of service, have not attained age 25, or
are part-time or seasonal employees.
The present-law nondiscrimination rules applicable to certain
types of fringe benefit plans and programs also prohibit discrimina-
tion as to contributions or benefits. With respect to self-insured
medical reimbursement plans, present law specifically requires
that all benefits available to the 5 highest-paid officers, 10-percent
shareholders, or the 25-percent highest-paid employees must also
be available to all other plan participants.
Under present law, if a plan is found to discriminate in favor of
employees who are officers, shareholders, or highly compensated,
the otherwise applicable income exclusion generally is denied for
all benefits provided under the plan, including those benefits pro-
vided for rank-and-file employees. (The nondiscrimination rules
generally do not provide express guidance as to when an employee
is considered highly compensated, or the extent of stock ownership
required before an employee is considered a shareholder, because
such factors depend on the facts and circumstances of individual
cases.) However, under a discriminatory self-insured medical reim-
bursement plan or group-term life insurance plan, only those em-
ployees with respect to whom discrimination is prohibited are re-
quired to include amounts in gross income; other employees retain
the benefit of the income exclusion.
Group-term life insurance
Under present law (sec. 79), the income exclusion for the cost of
employer-provided group-term life insurance is subject to several
limitations: (1) the exclusion is limited to the cost of the first
PAGENO="0017"
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7
$50,000 of such insurance on the employee's life, computed pursu-
ant to tables prescribed by the Treasury Department; (2) no exclu-
sion is provided for any "key employee" (officers, five-percent
owners, one-percent owners with compensation in excess of
$150,000, and certain employee-owners) if the program discrimi-
nates in favor of key employees as to either eligibility to partici-
pate or the life insurance benefits actually provided under the
plan; and (3) no exclusion is provided for self-employed individuals
(sole proprietors or partners). The cost of group-term life insurance
purchased by an employer for an employee for a taxable year is in-
cluded in the employee's gross income to the extent that the cost is
greater than the sum of the cost of $50,000 of life insurance plus
any contribution made by an employee to the cost of the insurance.
If a group-term life insurance plan maintained by an employer dis-
criminates in favor of any key employee, the exclusion for the cost
of the first $50,000 of this insurance is not available. In that event,
the full cost of the group-term life insurance for any key employee
is included in the gross income of the employee.
The Tax Reform Act of 1984 made three changes in the treat-
ment of group-term life insurance. First, the $50,000 limitation on
the amount of group-term life insurance that may be provided tax-
free to employees also applies to retired as well as active employees
(but not to disabled employees). Second, the nondiscrimination
rules are applied to plans covering former employees, whether re-
tired or disabled. Third, under the Act, if a plan fails to qualify for
the exclusion because it is discriminatory, then key employees
(whether active or former employees) must include in income the
actual cost of their insurance benefit rather than the uniform table
cost prescribed by the Treasury. The provisions of the Act are gen-
erally applicable to taxable years beginning after December 31,
1983.2
Under FICA, the entire amount of any payment on account of
death made to, or on behalf of, an employee or dependents under a
plan or system for employees generally or for a class or classes of
employees is exempt from tax. Any amount paid by an employer
for insurance or annuities or into a fund to provide for such a pay-
ment also is exempt from FICA (sec. 3121(a)(2)).
Death benefits
Present law generally excludes from a beneficiary's gross income
proceeds of death benefits received under a life insurance contract
(sec. 101(a)) and provides a limited exclusion for other benefits paid
by or on behalf of an employer by reason of an employee's death
(sec. 101(b)). As stated above, death benefits are entirely exempt
from FICA if paid under a plan or system for employees generally
or for a class or classes of employees.
2 The new provisions extending the $50,000 limitation and the nondiscrimination rules do not
apply to any group-term life insurance plan in existence on January 1, 1984 (or to any compara-
ble successor plan), but only with respect to those individuals who retire under the plan, who
were employed during 1983 by the employer maintaining the plan, and who attained age 55 on
or before January 1, 1984. Also, these new provisions generally do not apply to any employees
who retired before January 1, 1984. However, the new rules will apply to any plan that is dis-
criminatory after December 31, 1986, with respect to any individual retiring after that date.
40-046 0 - 85 - 2
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8
The income tax exclusion for death benefits for employees not
paid under an insurance contract is subject to several limitations:
(1) only the first $5,000 of benefits attributable to any one employee
is eligible for the exclusion; (2) amounts which are income in re-
spect of a decedent (e.g., uncollected salary or unused vacation pay)
are not eligible for the exclusion; (3) no exclusion is provided for
amounts with respect to which the employee had a nonforfeitable
right to receive the benefits, unless the source of payment is a
qualified pension profit-sharing, or stock bonus plan or certain an-
nuity plans; and (4) no exclusion is provided for amounts received
under certain joint and survivor annuities if distribution to the
participant had commenced prior to death. Except with respect to
certain amounts payable from or under qualified plans, this exclu-
sion generally is not available to self-employed individuals (sole
proprietors or partners).
Accident and health benefits
Under present law, an employer's contributions to a plan provid-
ing accident or health benefits are excludable from the employee's
income (sec. 106). No similar exclusion is provided for self-employed
individuals (sole proprietors or partners).
Benefits actually paid to employees under accident and health
plans generally are includible in the employee's gross income to
the extent attributable to employer contributions (sec. 105(a)). Re-
imbursements for costs incurred for medical expenses (within the
meaning of sec. 213) and disability payments which compensate for
permanent injury and are computed without reference to the
period of absence from work are excluded from gross income (secs.
105(b) and (c)). However, in the case of self-insured medical reim-
bursement plans (sec. 105(h)), no exclusion is provided for benefits
paid to any employee who is among the 5 highest-paid officers, a
10-percent shareholder, or among the 25-percent highest-paid em-
ployees if the program discriminates in favor of this group as to
either eligibility to participate or the medical benefits actually pro-
vided under the plan.
Under FICA, payment of medical or hospitalization expenses in
connection with sickness or accident disability made to, or on
behalf of, an employee or dependents under a plan or system for
employees generally, or for a class or classes of employees, are
exempt from social security tax. Any amount paid by an employer
for insurance or annuities or into a fund to provide for such a pay-
ment also is exempt from FICA (sec. 3121(a)(2)).
Also, any payments to or on behalf of an employee on account of
sickness or accident disability, or medical or hospitalization ex-
penses in connection with such disability, are exempt from FICA
after the expiration of six calendar months following the last calen-
dar month in which the employee worked for the employer (sec.
3121(a)(4)). In addition, FICA exempts payments to employees on
account of retirement for disability under a plan which makes pro-
vision for employees generally or a class or classes of employees
(sec. 3121(a)(12)). Finally, any payment to an employee while the
employee is entitled to disability insurance benefits under section
223(a) of the Social Security Act is exempt from FICA if the entitle-
ment commenced prior to the calendar year in which the payment
PAGENO="0019"
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9
is made and if the employee did not perform any services for the
employer during the period for which the payment is made (sec.
3121(a)(15)).
Parsonage allowances
Present law permits a minister of the gospel to exclude from
gross income the rental value of a home provided as part of com-
pensation, or a rental allowance paid as compensation to the extent
used to rent or provide a home (sec. 107). The exclusion is subject
to several restrictions: (1) the amount of the exclusion is limited to
the rental value of the home or actual amounts paid to rent or pro-
vide a home; (2) the exclusion is available only if the home or
rental allowance is paid as remuneration for services; and (3) the
exclusion for rental allowance is available only if the employer des-
ignates such payment as a rental allowance in advance of payment.3
F~social security tax purposes, ministers generally are treated
as self-employed individuals subject to SECA (rather than as em-
ployees subject to FICA). SECA liability is computed without
regard to the income tax exclusion for the rental value of parson-
ages (sec. 1402(a)(8)).
Benefits provided to members of the Armed Forces
Present law permits military personnel to exclude a variety of
in-kind benefits and cash payments from gross income. Specific ex-
clusions apply to certain disability pensions (sec. 104(a)(4)); qualify-
ing combat pay (sec. 112); mustering-out payments (sec. 113); and
subsistence, housing, and uniform allowances, as well as the value
of quarters or subsistence provided in kind (Regs. sec. 1.61-1(b)). A
similar exclusion is provided for FICA (sec. 8121(i)(2)).
Meals and lodging for the employer's convenience
Present law excludes from gross income the value of certain
meals or lodging furnished to an employee (or to the employee's
spouse or dependents) by or on behalf of the employer for the con-
venience of the employer (sec. 119).
The exclusion for meals is available only if the meals are fur-
nished (1) on the employer's business premises and (2) for the con-
venience of the employer. The exclusion for lodging is available
only if (1) the lodging is furnished on the employer's business prem-
ises; (2) the lodging is furnished for the convenience of the employ-
er; and (3) the employee is required, as a condition of employment,
to accept such lodging.
FICA exempts the value of any meals or lodging furnished by or
on behalf of the employer if it is reasonable to believe that the em-
ployee will be able to exclude such items from income under sec-
tion 119 (sec. 3121(a)(19)). For social security tax purposes, minis-
`In 1983, the IRS ruled that ministers may not take deductions for mortgage interest and
real estate taxes on their residences to the extent that such expenditures are allocable to tax-
free housing allowances provided for ministers (Rev. Rul. 83-3, 1983-1 C.B. 72). The new deduc-
tion disallowance rule generally applied beginning July 1, 1983. Under a transitional rule, in
the case of a minister who owned and occupied a home before January 3, 1983 (or had a contract
to purchase a home before that date), the deduction disallowance rule generally will not apply
until January 1, 1985. The 1984 Act extends this transitional rule date to January 1, 1986.
PAGENO="0020"
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ters generally are treated as self-employed individuals subject to
SECA (rather than as employees subject to FICA). SECA liability is
computed without regard to the income tax exclusion for meals and
lodging furnished for the convenience of the employer (sec.
1402(a)(8)).
Legal services
Present law excludes from gross income employer contributions
to a qualified prepaid legal services plan, as well as the value of
any legal services received by, or amounts paid as reimbursement
for legal services for, the employee or the employee's spouse or de-
pendents (sec. 120). Also, the exclusion is available to self-employed
individuals covered by qualified prepaid legal services plans.
This exclusion is subject to several limitations: (1) the program
may provide only for personal (i.e., nonbusiness) legal services; (2)
no exclusion is available if the program discriminates in favor of
employees who are officers, shareholders, or highly compensated,
as to either eligibility to participate or the benefits provided under
the plan; and (3) no more than 25 percent of the employer contribu-
tions to the plan may be attributable to the group consisting of em-
ployees (and their spouses and dependents) who own more than
five percent of the stock or of the capital or profits interest in the
employer.
This exclusion is scheduled to terminate for taxable years ending
after 1984.
FICA excludes any contribution, payment or service provided by
an employer which may be excluded from gross income under sec-
tion 120.
Van pooling
Present law excludes from an employee's gross income the value
of certain employer-provided transportation ("van pooling") be-
tween an employee's residence and place of employment (sec. 124).
This exclusion is subject to several limitations: (1) the exclusion
is available only for transportation furnished through use of a com-
muter van; (2) no exclusion is provided if the vanpooling arrange-
ment discriminates in favor of employees who are officers, share-
holders, or highly compensated; and (3) no exclusion is permitted
for self-employed individuals (sole proprietors and partners).
This exclusion is scheduled to terminate for van pooling provided
in taxable years beginning after 1985.
Dependent care assistance
Present law excludes from an employee's gross income amounts
paid or incurred by an employer for dependent care assistance pro-
vided under a qualified dependent care assistance program (sec.
129). Also, the exclusion is available to self-employed individuals
(sole proprietors or partners).
This exclusion is subject to several limitations: (1) the amount ex-
cluded may not exceed the employee's earned income (or, if the em-
ployee is married, the lower of the earned income of the employee
or the employee's spouse); (2) the exclusion is only provided for ex-
penses for household services or care of qualifying individuals (de-
pendents under the age of 15 or physically or mentally incapacitat-
PAGENO="0021"
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11
ed dependents or spouses) that are incurred to enable the taxpayer
to be gainfully employed; (3) no exclusion is available for amounts
paid for qualifying services rendered by the employee's dependent
or child of the employee who is under the age of 19; (4) no exclu-
sion is available if the dependent care assistance program discrimi-
nates in favor of employees who are officers, owners, or highly
compensated individuals (or their dependents); and (5) no exclusion
is available if more than 25 percent of the total benefits paid are
for the group consisting of employees who own more than five per-
cent of the stock or of the capital or profits interest in the employ-
er (or their spouses or dependents).
FICA excludes any payment made or benefit furnished if it is
reasonable to believe that employee will be able to exclude the pay-
ment or benefit from income under section 129 (sec. 3121(ä)(18)).
B. Miscellaneous Fringe Benefits
Background
A moratorium first enacted in 1978 prohibited issuance of Treas-
ury regulations relating to the income tax treatment of nonstatu-
tory fringe benefits. The legislative moratorium expired on Decem-
ber 31, 1983. The Treasury Department has announced that Treas-
ury and the IRS "will not issue any regulations or rulings altering
the tax treatment of nonstatutory fringe benefits prior to January
1, 1985," and that "present administrative practice will not be
changed during this period" (Ann. 84-5, 1984-4 I.R.B. 31).
General rule
The Tax Reform Act of 1984 provides a statutory exclusion from
income and FICA and other employment taxes for (1) no-additional-
cost services; (2) qualified employee discounts; (3) working condition
fringes; (4) de minimis fringes; and (5) qualified tuition reductions.
No fringe benefit (other than a de minimis fringe) is excluded
under the Act if another section of the Code provides rules for the
tax treatment of that general type of benefit.
Under the Act, any fringe benefit that does not qualify for a stat-
utory exclusion is expressly includible in gross income, and subject
to employment taxes, at the excess of its fair market value over
any amount paid by the employee for the benefit.
The rules of the Act do not make any change in existing statuto-
ry or regulatory exclusions for benefits for military personnel.
Exclusion provisions
No-additional-cost service.-A service provided to an employee is
excluded if-
(1) the employer incurs no substantial cost (including foregone
revenue) in providing the service;
(2) the service is provided by the employer or another business
with whom the employer has a written reciprocal agreement, and
is of the same type ordinarily sold to the public in the line of busi-
ness in which the employee works;
(3) the service is provided to a current or retired employee, or a
spouse or dependent child of either, or a widow(er) or dependent
children of a deceased employee; and
PAGENO="0022"
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(4) for certain highly compensated employees, nondiscrimination
requirements are met (see below).
Qualified employee discount.-A discount on merchandise provid-
ed to an employee is excluded to the extent it does not exceed the
employer's gross profit percentage (in the relevant line of business).
The exclusion does not apply to discounts on real property or to
discounts on personal property of a kind commonly held for invest-
ment.
A discount on services provided to an employee is excluded to the
extent it does not exceed 20 percent of the selling price of the serv-
ices to nonemployee customers (with no gross profit percentage re-
striction).
The following conditions generally must be satisfied for the ex-
clusion to apply:
(1) the property or service is provided by the employee and is of
the same type ordinarily sold to the public in the line of business
in which the employee works;
(2) the property or service is provided to a current or retired em-
ployee, a spouse or dependent child of either, or to a widow(er) or
dependent children of a deceased employee; and
(3) for certain highly compensated employees, nondiscrimina-
tion requirements are met (see below).
Working condition fringe.-Property or services provided to an
employee are excluded to the extent that they would be deductible
as ordinary and necessary business expenses (under Code sees. 162
or 167) if the employee had paid for them.
The Act excludes, as a working condition fringe, the value of free
or reduced-cost parking provided to employees on or near the em-
ployer's business premises.
De minimis fringe.-Property or services not otherwise tax-free
are excluded if their fair market value is so small, taking into ac-
count the frequency with which similar fringe benefits (otherwise
excludable as de minimis fringes) are provided and other relevant
factors, as to make accounting for the benefits unreasonable or ad-
ministratively impracticable. For example, benefits that generally
are excluded as de minimis fringes include the typing of a personal
letter by a company secretary, occasional personal use of the com-
pany copying machine, monthly transit passes provided at a dis-
count not exceeding $15, occasional company cocktail parties or pic-
nics for employees, occasional supper money or taxi fare for em-
ployees because of overtime work, and certain holiday gifts of prop-
erty with a low fair market value.
Subsidized eating facilities operated by the employer also are ex-
cluded as a de minimis fringe if located on or near the employer's
business premises, if revenue equals or exceeds direct operating
costs, and if (for certain highly compensated employees) nondis-
crimination requirements are met (see below).
Athletic facilitie.s.-An exclusion is allowed for the value of on-
premises athletic facilities provided and operated by an employer
for use of its employees. Under Code section 274, the employer is
not allowed a deduction for the costs of an athletic facility if the
facility is not primarily for the benefit of employees (other than
employees who are officers, shareholders or other owners, or highly
compensated employees).
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Qualified tuition reduction.-The Act provides that a reduction
in tuition provided to an employee of an educational institution is
excluded for income and employment tax purposes if (1) the tuition
is for education below the graduate level provided by the employer
or by another educational institution; (2) the education is provided
to a current or retired employee, a spouse or dependent child of
either, or to a widow(er) or dependent children of a deceased em-
ployee; and (3) certain nondiscrimination requirements are met (see
above).
Nondiscrimination requirements.-The exclusions for no-addition-
al-cost services, qualified employee discounts, subsidized eating fa-
cilities, and qualified tuition reductions are available to officers,
owners, or highly compensated employees only if the property or
service is provided on substantially the same terms to each
member of a group of employees defined under a reasonable classi-
fication, set up by the employer, which does not discriminate in
favor of employees who are officers, owners, or highly compensated
employees.
Effective dates.-Under the Act, the provisions generally are ef-
fective beginning January 1, 1985. The provisions of the Act relat-
ing to qualified tuition reductions are effective for education für-
nished after June 30, 1985.
C. Benefits Provided Under a Cafeteria Plan
In general
Under a cafeteria plan, a participant is offered a choice between
cash and one or more fringe benefits. The mere availability of
cash or certain taxable benefits under a cafeteria plan does not
cause an employee to be treated as having received the available
cash or taxable benefits for income tax purposes if certain condi-
tions are met (sec. 125). Thus, a participant in such a cafeteria plan
is required to include in gross income only those taxable benefits
actually received.
A highly compensated participant is treated as having received
available cash and taxable benefits if the cafeteria plan discrimi-
nates in favor of highly compensated individuals as to eligibility or
as to benefits or contributions. A highly compensated individual in-
cludes an officer, a five-percent shareholder, a highly compensated
individual, or a spouse or dependent of any of the preceding indi-
viduals.
The cafeteria plan rules generally do not affect whether any par-
ticular benefit offered under the plan is a taxable or nontaxable
benefit. Thus, a benefit that is excludable under the Code when Of-
fered separately is an excludable benefit under a cafeteria plan
only if the rules providing for the exclusion of the benefit from
gross income continue to be satisfied when the benefit is provided
under the cafeteria plan.
IRS release, regulations
On February 10, 1984, the Internal Revenue Service issued a
news release (IR-84-22), stating that so-called "flexible spending ar-
rangements" offered as part of cafeteria plans do not provide em-
ployees with nontaxable benefits under the Code because employ-
PAGENO="0024"
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14
ees are assured of receiving the amounts available under the ar-
rangement without regard to whether covered expenses are in-
curred.
In May, 1984, the Internal Revenue Service issued proposed regu-
lations with respect to the cafeteria plan rules and the statutory
rules governing the exclusion of benefits from gross income. These
proposed regulations provide that an otherwise nontaxable benefit
will be nontaxable if offered in a cafeteria plan only if it continues
to satisfy the provisions governing exclusion of the benefit from
gross income. Accordingly, the proposed regulations provide that
employer contributions with res~ect to an accident or health plan,
a qualified group legal services plan, or a dependent care assist-
ance program are not excluded from a participant's gross income
under the Code to the extent that the participant is assured of re-
ceiving benefits under the plan without regard to whether the par-
ticipant incurs covered expenses.
Provisions of the Tax Reform Act of 1984
The Tax Reform Act of 1984 provides that under a cafeteria plan,
an employee generally can choose only among cash and fringe ben-
efits that are excludable from gross income under a specific section
of the Code (other than scholarships or fellowships, van pooling,
and those benefits excludable under the miscellaneous fringe bene-
fit provisions of the 1984 Act).
Also, the Act amends the cafeteria plan rules to provide that if,
for a plan year, more than 25 percent of the total excludable bene-
fits are provided to employees who are key employees with respect
to the plan for such year (as determined under the rules of sec.
416(0(1)), then the key employees will be taxed as though they re-
ceived all available taxable benefits under the plan. Generally, in
determining the portion of the total excludable benefits that is pro-
vided to key employees, coverage under a plan (e.g., an accident or
health plan) and not actual expense reimbursements are to be
counted.
Under the Act, certain reporting requirements are applied with
respect to cafeteria plans. The Act provides both general and spe-
cial transition relief through January 1, 1985, or, in certain cases,
July 1, 1985, with respect to the proposed Treasury regulations on
cafeteria plans, for cafeteria plans and "flexible spending arrange-
ments" in existence on February 10, 1984. Finally, the Act provides
that the Secretary of Health and Human Services, in cooperation
with the Secretary of the Treasury, is to submit a report by April
1, 1985, to the House Committee on Ways and Means and the
Senate Committee on Finance on the effect of cafeteria plans on
the containment of health costs.
D. Welfare Benefit Plans
Deductions for contributions to funded benefit plans
The Tax Reform Act of 1984 modified the tax treatment of em-
ployers with respect to welfare benefits provided to employees.
Under the Act, deductions for contributions to a welfare benefit
fund are limited to qualified costs, generally defined as the sum of
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15
(1) qualified direct costs and (2) additions, within limits, to a quali-
fied asset account.
Limitations on qualified asset account.-The Act provides rules
relating to the limitation on additions to a qualified asset account.
Such an account consists of assets set aside for the payment of dis-
ability benefits, medical benefits, supplemental unemployment
compensation or severance pay benefits, and life insurance or
death benefits. To the extent the qualified asset account exceeds
the account limit, additions to the account are not currently de-
ductible.
In general, the account limit is the amount estimated to be nec-
essary, under actuarial assumptions that are reasonable in the ag-
gregate, to fund the liabilities of the plan for the amount of claims
incurred but unpaid, for benefits described in the previous para-
graph, and administrative cOsts of providing those benefits, as of
the close of the taxable year. Claims are incurred only when an
event entitling the employee to benefits, such as a medical expense,
a separation, a disability, or a death, actually occurs. The allowable
reserve includes amounts for claims estimated to have been in-
curred but which have not yet been reported, as well as those
claims which have been reported but have not yet been paid.
Child care facilities and other capital expenditures.-Under the
Act, in determining qualified direct costs with respect to a child
care facility held by a fund, the adjusted basis of the facility is
treated as deductible ratably over a period of 60 months. A child
care facility is tangible property of a character subject to deprecia-
tion and located in the United States, and must be a child care
center primarily for children of the employees of the employer.
Qualified direct costs with respect to other capital expenditures are
those that would be allowed under the usual Code rules which
would be applied if the employer owned the asset.
Prefunding of life insurance, death benefits, or medical benefits
for retirees.-The qualified asset account limit includes amounts
reasonably necessary, within limits, to accumulate reserves under
a welfare benefit plan for the medical benefit or life insurance (in-
cluding death benefit) payable to a retired employee during retire-
ment. These amounts may be accumulated no more rapidly than
on a level basis over the working life of the employee with the em-
ployer, subject to certain additional limitations.
Safe harbor.-The Act provides that an actuarial certification by
a qualified actuary (determined under Treasury regulations) justi-
fying the taxpayer's reserve computations is not necessary if the
amount in the qualified asset account does not exceed a prescribed
safe harbor level equal to the sum of separate safe-harbor amounts
computed with respect to each benefit for which a safe harbor is
provided.
Certain collectively bargained plans.-The Act provides that
before July 1, 1985, the Treasury Department is to publish final
regulations establishing special reserve limit principles with re-
spect to welfare benefit funds maintained pursuant to certain col-
lective bargaining agreements.
Transitional rule.-Under the Act, in the case of a plan that was
in existence on June 22, 1984, special rules are provided for the de-
PAGENO="0026"
20
16
termination of the deduction limit for each of the first four years to
which the provision applies.
10-or-more-employer plans.-For a plan year in which no employ-
er (or employers related to an employer) is required to contribute
more than 10 percent of the total contributions, the Act provides
that the deduction limits do not apply.
Effective date.-These provisions generally apply to contributions
paid or accrued after December 31, 1985. However, in the case of a
plan maintained pursuant to a collective bargaining agreement in
effect on July 1, 1985, or ratified before that date, the provisions do
not apply until the termination of the contract, determined with-
out regard to any contract extension agreed to after that date.4
Excise taxes on funded benefit plans
Under the Act, an excise tax is imposed on the employer equal to
100 percent of the disqualified benefits provided by a fund under a
welfare benefit plan.
The Act defines a disqualified benefit as (1) any medical benefit
or life insurance benefit provided with respect to a retired key em-
ployee (sec. 416(i)) other than from a separate account established
for that employee under the new rules relating to deductions under
funded welfare benefit plans (sec. 419A(d)); (2) any medical or life
insurance benefit provided with respect to a retired employee
unless the benefit is provided from a fund that meets the addition-
al requirements for tax-exempt status provided by the Act (sec.
505(b)(1)); and (3) any portion of a welfare benefit fund reverting to
the benefit of the employer.
These excise tax provisions generally apply to contributions paid
or accrued after December 31, 1985. However, in the case of a plan
maintained pursuant to a collective bargaining agreement in effect
on July 1, 1985, or ratified before that date, the provisions do not
apply until the termination of the contract, determined without
regard to any contract extension agreed to after that date.
Tax treatment of exempt benefit organizations
Unrelated business income.-Under the Act, the special rules ap-
plicable to voluntary employees' beneficiary associations (VEBAs)
and social clubs for purposes of the tax on unrelated business tax-
able income are extended to supplemental unemployment compen-
sation benefit trusts (SUBs) and group legal service organizations
(GLSOs). In addition, more specific limits are provided with respect
to the amount that may be set aside for exempt purposes by such
an organization without incurring unrelated business income tax;
these limits generally are the same as those applicable for purposes
of limitations on deductions for plan contributions.
In addition, the Act generally applies to any contribution of a facility to a welfare benefit
fund after June 22, 1984. Under the Act, deductions with respect to such a contribution are to
be determined under the usual Code rules applicable to recovery of the cost of assets (but taking
account of the special rule for child care facilities described above). Further, these rules apply to
other contributions, such as cash, made after that date which are to be used to acquire a facility,
so that later acquisition of a facility with the use of such funds will limit the deduction for the
original contribution. This rule does not apply for any facility acquired by the fund under a
binding contract in effect on and at all times after that date, or any facility under construction
by or for the fund before June 22, 1984.
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21
17
The Act also provides for a tax on an employer who maintains a
welfare benefit fund that is not exempt from income tax. Under
the Act, in the case of any welfare benefit fund, such as a retired
life reserve account, that is not exempt from income tax as a social
club, VEBA, SUB, or GLSO, the employer who maintains the fund
is to include in gross income for the taxable year an amount equal
to the fund's deemed unrelated income. Deemed unrelated income
is the amount of income which would have been subject to the un-
related business income tax if the fund were a tax-exempt organi-
zation.
Discrimination.-The Act establishes new nondiscrimination
standards for a tax-exempt VEBA or GLSO. With respect to the
nondiscrimination rules, certain employees who are not covered by
a plan may be excluded from consideration in applying the nondis-
crimination standards. These employees are employees who have
not attained the age of 21, employees who have not completed 3
years of service with the employer, less than half-time employees,
employees who are included in certain collective bargaining units,
and certain nonresident aliens.
Effective date.-These provisions generally apply after December
31, 1985. However, in the case of a plan maintained pursuant to a
collective bargaining agreement in effect on July 1, 1985, or rati-
fied before that date, the provisions do not apply until the termina-
tion of the contract, determined without regard to any contract ex-
tension agreed to after that date.
The nondiscrimination provisions apply to taxable years begin-
ning after December 31, 1984.
E. Qualified Pension, Profit-Sharing, and Stock Bonus Plans
If a pension, profit-sharing, or stock bonus plan qualifies under
the tax law (sec. 401(a) or 403(a)), then (1) a trust under the plan is
generally exempt from income tax, (2) employers are generally al-
lowed deductions (within limits) for plan contributions for the year
for which the contributions are made, even though participants are
not taxed on plan benefits until the benefits are distributed, (3)
benefits distributed as a lump sum distribution may be accorded
special long-term capital gain treatment or 10-year income averag-
ing treatment, or may be rolled over, tax-free, to an individual re-
tirement account or annuity (IRA) or another qualified plan, and
(4) certain partial distributions may be rolled over, tax-free, to an
IRA.
Qualified plans are generally subject to minimum standards (in-
cluding standards relating to employee participation, vesting, forms
of benefits, and fiduciary conduct) and to limits on contributions or
benefits. These plans are prohibited from discriminating in favor of
employees who are officers, shareholders, or highly compensated.
Pension plans are generally subject to a minimum funding stand-
ard. In addition, benefits under a defined benefit pension plan are
generally guaranteed (within limits) by the Pension Benefit Guar-
anty Corporation.
Certain qualified plans may include a qualified cash-or-deferred
arrangement (sec. 401(k)). Under a qualified cash or deferred ar-
rangement, an employee may elect to receive compensation from
PAGENO="0028"
22
18
the employer currently or to have the compensation deferred.
Amounts deferred under a qualified cash or deferred arrangement
are taken into account in computing social security and unemploy-
ment compensation benefits and taxes.
No minimum standards or special limits apply to an unfunded
plan of deferred compensation. Generally, under ERISA, these
pians may not be provided for rank-and-file employees.
Under a tax-sheltered annuity program, amounts paid by an edu-
cational institution or by an eligible tax-exempt organization to
purchase an annuity contract for an employee are excluded from
the employee's income, subject to certain limits (sec. 403(b)). Ex-
cludable contributions to custodial accounts investing in stock of a
regulated investment company (e.g., a mutual fund) are also per-
mitted. No nondiscrimination standard applies in the case of a tax-
sheltered annuity program. Amounts distributed or made available
under tax-sheltered annuities or custodial accounts generally are
includible in gross income. However, certain distributions may be
rolled over, tax-free, to another such annuity contract or to an
IRA.
If an IRA qualifies as a sir~iplified employee pension (SEP), the
annual IRA deduction (generally, the lesser of $2,000 or 100 per-
cent of compensation) is increased by the lesser of $30,000 or 15
percent of compensation. The increase in the deduction limit ap-
plies only to employer contributions (sec. 219). Except in the case of
certain correcting distributions, all distributions from SEPs are in-
cludible in gross income unless rolled over to another IRA.
FICA generally excludes payments under or to a qualified pen-
sion, profit-sharing, or stock bonus plan, a SEP, a tax-sheltered an-
nuity, an exempt governmental deferred compensation plan, or a
plan to provide cost-of-living adjustments in benefits under these
provisions. However, FICA applies to contributions under a quali-
fied cash-or-deferred arrangement or to contributions under a tax-
sheltered annuity made by reason of a salary reduction agreement
(sec. 3121(a)(5)).
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23
III. BACKGROUND DATA RELATING TO TAX TREATMENT
OF CERTAIN FRINGE BENEFITS
A. Revenue Implications
Table 1 below shows the estimated increases in revenues that
would result from terminating the present-law exclusions for those
benefits described in Part II A and E of this pamphlet.
Each entry in the table has two lines. The first represents the
estimated increase in income tax receipts that would result if the
benefit were included in gross income. The second line shows the
estimated increases in social security tax receipts that would result
if the benefit were included in the FICA tax base.
In terms of revenue effect, qualified pension plans are the largest
fringe benefit shown in this table, followed by health insurance.
Each of the~other fringe benefits shown in this table have less reve-
nue impact.
Table 1. Effects of Including Certain Benefits in the Federal
Income Tax Base and the FICA Tax Base
[In billions of dollars]
Item 1984 1985 1986 1987 1988 1989
1. Employer contributions
for medical insurance:
Income tax 17.6 20.2 23.0 26.2 29.9 34.1
FICA 6.7 7.7 8.8 10.1 11.9 13.7
2. Premiums on group term
life insurance:
Income tax 2.2 2.4 2.6 2.9 3.2 3.5
FICA 5 .8 .9 .9 1.0 1.1
3. Contributions to prepaid
legal services plans:
Income tax (1) (1)
FICA (1) (1)
4. Employer provided child
care:
Income tax (1) .1 .1 .1 .2 .2
FICA (1) (1) (1) (1) .1 .1
5. Employee meals and
lodging (other than mili-
tary):
Income tax 7 .8 .9 .9 1.0 1.1
FICA 2 .2 .3 .3 .3 .3
(19)
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24
20
Table 1. Effects of Including Certain Benefits in the Federal
Income Tax Base and the FICA Tax Base-Continued
[Tn billions of dollars]
Item
1984
1985
1986
1987
1988
1989
6. Benefits and allowances
.
to Armed Forces person-
nel:
Income tax
1.9
2.0
2.2
2.3
2.4
2.6
FICA
(2)
(2)
(2)
(2)
(2)
(2)
7. Net exclusion for pension
contributions and earn-
.
ings
Income tax
47.3
52.7
59.0
66.0
73.9
82.9
FICA
(2)
(2)
(2)
(2)
(2)
(2)
1 Less than $50 million.
2 Not available.
B. Growth in Certain Fringe Benefits
Tables 2 and 3 present data from the national income accounts
on the growth between 1950 and 1981 of employer contributions to
group health insurance and group life insurance, the two largest
generally available statutory fringe benefits which are shown in
Table 1, measured in terms of revenue effect.
Table 2 shows that during this period, these two benefits have
grown considerably faster than wages and salaries. Group health
insurance grew from 0.5 percent of wages in 1950 to 3.8 percent of
wages in 1981, and group life insurance contributions increased
from 0.2 percent of wages in 1950 to 0.4 percent of wages in 1981.
Group health insurance, has grown at a much faster rate than
group life insurance. Group health insurance has continued to
grow throughout the period, while group life has been approxi-
mately the same percentage of wages since 1965. Although many
factors have influenced the growth of these two fringe benefits, it
should be noted that the tax treatment of group term life insur-
ance changed in 1964, when a limit was placed on the amount of
employer contribution which could be excluded from gross income
for income tax purposes.
Table 3 shows another way of examining the growth in employer
contributions to health and life insurance during this period. These
figures compare the increase in wages to the increase in the fringe
benefit during this period.
Between 1950 and 1955, for example, health contributions in-
creased 1.5 cents for every dollar of increase in aggregate wages.
By the end of the period, health benefit contributions increased ap-
proximately 5.5 cents for each dollar of increase in wages. Thus,
there was a significant acceleration in the growth of health bene-
fits relative to wages over the 1950 to 1981 period, although this
trend stabilized during the 1970s.
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25
21
In contrast, increases in group term life insurance as percentage
of wage increases declined over the 1950-1981 period. During the
first five years, group term life insurance contributions increased
0.5 cents for every dollar of wage increase. This figure reached a
peak during the last part of the 1950s. Since that time, however,
the increase in life insurance as a percentage of wage increases de-
clined significantly, so that by 1981 these contributions increased
by only 0.3 cents for every dollar of wage increases.
Table 2. Employer Contributions to Group Health and Life Insur-
ance as Percentage of Wages and Salaries, United States, 1950-
1981
[In percent]
Group Life
1950
0.5
0.2
1955
0.8
0.3
1960
1.3
0.4
1965
1.6
0.5
1970
2.2
0.5
1975
3.0
0.5
1980
3.7
0.5
1981
3.8
0.4
Source: Computed from U.S. Department of Commerc
e data.
Table 3. Increase in Total Employer Insurance Contributions as
Percentage of Total Increase in Wages, United States, 1950-1981
[In percent]
Group Life
1950-55
1.5
0.5
1955-60
2.8
0.9
1960-65
2.7
0.6
1965-70
3.3
0.7
1970-75
4.7
0.6
1975-80
4.5
0.3
1980-81
5.5
0.3
Source: Computed from U.S. Department of Commerce data.
0
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26
Chairman PICKLE. This is a joint hearing today of the Subcom-
mittee on Social Security and Subcommittee on Select Revenue
Measures on the Committee of Ways and Means. We sit today on a
joint committee basis. As chairman of the Social Security Subcom-
mittee, I welcome you all here this morning as these two subcom-
mittees meet on the question of the distribution and economics of
the employer-provided fringe benefits.
I am glad these hearings are at long last being held. I have rec-
ommended on a number of occasions during the past year that
hearings be held to examine the whole subject of employee benefits
to give Congress a better understanding of this enormous subject
and to allow employers and employees to present their views.
The only purpose of these hearings is to gather information, to
ask questions, and to explore as fully as possible in the time we
have all of the various forms of employee benefits. But I want to
stress to you that these hearings are not intended to be a forum for
competing philosophies. Such a hearing would not serve any pur-
pose.
We are not considering any specific legislation. We are not pro-
posing any course of action. We simply want to understand this
subject better. I want to make it clear that I do not think that Con-
gress has any intentions of taking away fringe benefits. This is not
the purpose of this hearing.
On the contrary, Congress acted this summer to eliminate some
of the uncertainty in the fringe benefit area in the Deficit Reduc-
tion Act, by legislation that came from the Subcommittee on Select
Revenue Measures itself. So there is no need for anyone to get
frightened about this or to launch a campaign to lobby Members of
Congress to protect certain fringe benefits.
All we want to do is to examine the issues calmly, responsibly
and thoroughly. The issues here are too important for our national
economy, for our employees, our businesses and for the Federal
Government to let us continue heading blindly on. Congress must
decide in the years ahead whether there is a need to take any fur-
ther action in this area and, if so, what action should be taken.
I hope these hearings will allow us to gather the hard facts we in
Congress and you in the public can use to make responsible deci-
sions. In conclusion, let me say that I am glad you could all be here
to assist us in this endeavor. I look forward to hearing and study-
ing your testimony.
As I said, I am joined here this morning by my colleague, Mr.
Pete Stark, chairman of the Subcommittee on Select Revenue
Measures, who has taken a very positive lead in examining this
issue previously and has brought us some very important legisla-
tion on the subject. I am pleased to yield to him on this at this
time to make any statement at the beginning of this hearing that
he would care to make. Mr. Stark?
Chairman STARK. Thank you, Mr. Chairman. It is a pleasure to
be here with you and share this podium with your subcommittee.
The work which our subcommittee did this summer was to estab-
lish, I guess, a guidance for what will be allowed as fringe benefits
in the Tax Code. Actually, anybody can pay any kind of fringe ben-
efit to any employee that they choose. The only issue is who will
pay taxes if anyone, on the value of the particular fringe.
PAGENO="0033"
27
Chairman Pickle is to be commended for often a lonely vigil to
protect the base on which the FICA and FUTA taxes are levied.
And Jake takes a marvelously statesman-like long-range view of
protecting retirement and Medicare system that is so important to
so many Americans. I share his concern that this is not a hearing
that is intended to open up debate on what additional fringes
should be made tax free or indeed, on the other hand, we certainly
have no intention of taking any existing fringes and subjecting
them to income tax.
There is concern that I share about the growing creativity and
growing number of fringe benefits. And at some point, we are going
to have to face the question if it can be established, that the wage
base will be decreasing greatly over the next decade. It may im-
pinge on the social security financing and we may have to do some-
thing. But I am not sure that any member of either subcommittee
has any preconceived notions.
I welcome the chance to discuss this in terms particularly of how
much revenue we are losing and might indeed lose in the future if
a variety of alternatives are taken. And I appreciate and applaud
Chairman Pickle for his interest in taking the lead in bringing
these hearings about, because they have been long overdue.
Chairman PICKLE. Thank you, Mr. Stark. Mr. Duncan, would you
care to make a statement?
Mr. DUNCAN. I have no prepared statement, Mr. Chairman. I ap-
preciate the fact that you have assured those present and others
who have an interest in the subject that we are not going to do
anything that would jeopardize the fringe benefit legislation passed
last year.
We have been on this subject for several years. I hope these hear-
ings allow us to finally establish a permanent set of fringe benefit
rules. I thank you for calling these hearings.
Chairman PICKLE. Mr. Gradison.
Mr. GRADISON. Thank you, Mr. Chairman. I, too, would like to
congratulate the chairmen of the two subcommittees for these
hearings, which are very timely. It appears to me that we have had
an extraordinary growth in fringe benefits; that fringe benefits
have been growing faster than cash compensation and that tax-free
fringe benefits have been growing faster than other kinds of fringe
benefits.
This, no doubt, is what Congress intended. But there are some
problems and I hope that these hearings will help us gain addition-
al insight into whether these problems are serious or not. Certainly
the narrower the tax base, the higher the tax rates. Those of us
who are concerned about bringing tax rates, especially marginal
rates, down lower than they are today, necessarily have to show
some concern about the extent to which the tax base is being nar-
rowed.
In addition, I think we have to recognize that these fringe bene-
fits are not available to everybody on an entirely fair basis. Em-
ployees of small businesses generally don't fare as well as employ-
ees of larger businesses. Lower paid employees don't usually come
out as well as higher paid employees. Sole proprietors and farmers
operating as sole proprietorships are particularly disadvantaged as
against employees of corporations.
40-046 0 - 85 - 3
PAGENO="0034"
28
One of the disquieting things to me, Mr. Chairman, is that the
ink was barely dry on the Deficit Reduction Act, which attempted
to put to rest the uncertainty about these fringe benefits and their
taxation, when pressures began to build up for changes-liberaliza-
tions in some of the actions taken by the Congress and this com-
mittee last year.
I am especially glad that the announcement for this hearing indi-
cated that we were interested in comments on the idea of caps. I
personally think that these are worth thinking about and explor-
ing, not necessarily with the idea that anything is going to happen
tomorrow, but with the recognition that, as we look into the future,
something along this line may be appropriate if we are going to
continue to move in a meaningful way to lower tax rates.
Thank you, Mr. Chairman.
Chairman PICKLE. Thank you, Mr. Gradison.
Let me make it plain that this is a joint subcommittee hearing
and that I am not calling this hearing by myself. The leadership on
this program in many respects has come from the Subcommittee on
Select Revenue Measures. I appreciate the work they did last year.
This is a joint hearing. It is to be held because not only are both
our subcommittees affected by this, but the entire Congress and
business community are likewise affected.
So that is why it is a joint hearing. I also say to you, Mr. Gradi-
son, I am pleased-yesterday I noticed on the TV that you ap-
peared on a show on this general subject. I thought your comments
were appropriate and were helpful. I think we probably will see
other programs like this as we move forward. This is a very impor-
tant element in our Nation's economy.
Mr. GRADISON. Thank you for mentioning that, - Mr. Chairman.
Unfortunately, I was dealt the unpopular side. I hope it didn't
show in my district.
Chairman PICKLE. Well, you were responsible, Mr. Gradison. I
appreciate it.
Our first witness this morning will be Mr. Ronald Pearlman, who
is the Acting Assistant Secretary for Tax Policy. Mr. Peariman, we
are glad you could be with us this morning and share your views
with us. If you will proceed, we will be glad to have your testimo-
ny.
STATEMENT OF RONALD A. PEARLMAN, ACTING ASSISTANT
SECRETARY FOR TAX POLICY, DEPARTMENT OF TIlE TREASURY
Mr. PEARLMAN. Thank you, Mr. Chairman, Mr. Stark, members
of the subcommittee. I appreciate the opportunity of being here
this morning so that we can discuss the Treasury Department's
views on the appropriate taxation of employer provided fringe ben-
efits.
As several members of the subcommittees have already men-
tioned, the Deficit Reduction Act of 1984 made several significant
changes in the rule governing fringe benefits. We think that in
general, the actions taken by the Congress this summer were ap-
propriate steps in rationalizing the tax treatment of employer pro-
vided benefits.
PAGENO="0035"
29
Needed clarification was provided to individual taxpayers and
employees alike and progress was made in limiting the expansion
of fringe benefits. This morning I would like to outline the areas of
continuing concern to the Treasury Department with respect to the
tax treatment of employee fringe benefits.
We are concerned, as Mr. Gradison apparently is concerned, that
the expansion in fringe benefits excluded from the Federal income
and Social Security tax bases has caused tax rates to be higher
than they would otherwise be. Our efforts in recent years to con-
tain increases in marginal rates and our continuing efforts to try
to contain those increases in the future, as well as increases in the
Social Security tax rates, could be undermined quickly and signifi-
cantly by any major narrowing of the range of compensation sub-
ject to tax.
We also are concerned that the tax benefits derived from the ex-
isting statutory fringe benefits are not fairly distributed among
taxpayers. Finally, we are concerned that, in some instances, the
exclusion of benefits from gross income fails to promote the policies
underlying such favorable treatment.
I would like to begin my comments by focusing first on the
impact on the income and social security tax bases of statutory
nontaxable benefits. One of the announced purposes of these hear-
ings was to gather information concerning the prevalence and con-
sequent revenue implications of tax-favored fringe benefits.
Studies in this area indicate that the volume of tax-favored bene-
fits has grown dramatically over the past several years and signifi-
cant future growth will occur even if current restrictions on the
availability of such fringe benefits are maintained. If these restric-
tions are relaxed in any significant way the inevitable result would
be further, possibly serious erosion in both the Social Security and
income tax bases.
In recent years the list of statutory fringe benefits has grown to
include employer-provided programs aimed at promoting expendi-
ture of compensation in specified ways. These more recent statuto-
ry fringe benefits include employee stock ownership plans, group
legal service programs, van pooling, educational assistance pro-
grams and dependent care assistance programs.
We have estimated the nontaxable employer contributions for
qualified pension and profit-sharing plans, group health insurance
and group life insurance from the period from 1955 through the
present and have projected such contributions through 1989. We
have also calculated the portion of total wages these contributions
have constituted and the revenue effect of excluding these contri-
butions from the Federal income tax and Social Security tax bases.
These estimates are summarized in table 1 attached to the testi-
mony. And I think it is interesting to look at table 1. You will see
that it covers the period from 1955 through 1989. A couple of
things will jump out at you if you look at the table. First, if you
look at the very bottom line of the table the percentage of wages
that were attributable to these three categories of statutory fringe
benefits-and let me point out here that this does not include a
number of the newer fringe benefits that have been enacted in
more recent years-was 3.2 percent of total wages in 1955.
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30
By 1975, a 20-year period, that number had grown to 8.5 percent
of taxable wages, with most of the growth occuring in the pension
and profit-sharing area. From 1975, forward, if you look again, for
example, from the period 1975 to 1985, which includes a projected
period, but a fairly short period of projection-most of it is actual
data-you will see that the growth again is dramatic.
Indeed, it is about the same number of absolute percentage
points, five, as has occurred during the first 20 years-slightly less
than five. But the contrast I think you will see is that the growth
is not in the pension and profit-sharing area. There has been some
growth there. I suspect in part because of Congress' actions in con-
nection with ERISA, that has been stemmed a bit, but the growth
in group health insurance has been dramatic.
You can see the growth has more than doubled from 1975
through the projected period of 1989 and has grown very dramati-
cally, although it has not quite doubled from 1970 into the early
1980's. So I think this table would say to us that there is a-there
has been a dramatic growth in the amount of wages that has been
excluded from the income tax base because of the growth in the
nonstatutory fringe area and that indeed if you look at the period
from 1983 to 1989, even though the percentage growth is not as
dramatic, of course, the dollars involved are very substantial, that
the growth is projected to continue.
It is the expansion in the scope and volume of tax-favored fringe
benefits that represents a significant threat to the Federal income
tax and Social Security tax bases. If pressures to increase Social Se-
curity and marginal income tax rates are to be resisted, hard
choices must be faced as to which fringe benefits can be granted
tax-favored treatment and as to whether the tax advantages cur-
rently available to fringe benefits can be modified without impair-
ing the social policy objectives underlying their favorable tax treat-
ment. This is a challenge, I think, that is both on us and the com-
mittee.
Now I would like to turn to a discussion of one of the more con-
temporary areas of statutory fringe benefits; namely, cafeteria
plans and so-called flexible spending arrangements which were the
subject of recent regulations by the Treasury Department and were
the subject of some legislation action in the Deficit Reduction Act.
Recent growth in tax-favored benefits provided under employer-
sponsored plans has been stimulated by the statutory authorization
of cafeteria plans. This is so because they permit individual em-
ployees to choose which fringe benefits they will receive, in effect
allowing employees to design fringe benefit packages tailored to
their individual needs.
We recognize that where an employer has historically provided
his employees with a very rich tax-favored benefit fringe package,
a cafeteria plan may result in a net decrease in the tax benefit in-
crease received by such employees. However, in the aggregate, cafe-
teria plans significantly narrow the Federal income and Social Se-
curity tax bases.
For fiscal years 1984 through 1989, we estimate that assuming
the continued exclusion of group legal services through December
31, 1984, cafeteria plans will reduce individual income tax receipts
PAGENO="0037"
31
by $5.5 billion and Social Security receipts by $3.2 billion, for a
total reduction of $8.7 billion.
I think some information on the growth of those revenue receipts
impact should be of interest on the committee. Our estimate reve-
nue reduction for 1984 will be approximately $67 million. For 1985,
we expect that revenue impact to more than double to a deficit of
about $248 million, growing to $1 billion in 1987 and to a stagger-
ing $4.4 billion in 1989.
These projections indicate that cafeteria plans provide a powerful
incentive for tax-favored forms of compensation. Even more sub-
stantial losses in revenue would result, however, if the cafeteria
plan rules authorized the exclusion of benefits provided through so-
called flexible-spending arrangements. Generally, a flexible-spend-
ing arrangement permits an employee to designate some portion of
his or her otherwise taxable salary as available fOr the tax-free re-
imbursement of specified expenses, such as medical care, legal serv-
ices, or dependent-care assistance. Under an FSA, the employee is
assured of receiving, in the form of cash or some other benefit, any
portion of the designated amount not utilized for the specified ex-
pense.
We have concluded, as I am sure you are aware and as proposed
Treasury regulations on cafeteria plans reflect, that the statutory
provisions granting tax-favored treatment to specified benefits and
the cafeteria plan rules themselves do not authorize FSA's. There-
fore, a benefit does not fall under any of the applicable statutory
exclusions if the benefit is provided through an FSA.
Our revenue estimates indicate that FSA's would have a dramat-
ic effect on the Federal tax base. For the 1984 through4l989 fiscal
years, assuming that the exclusion for group legal services is not
extended beyond December 31, 1984, we estimate that the $8.7 bil-
lion projected revenue loss attributable to cafeteria plans would
double to approximately $17 billion if favorable treatment were
granted to FSA's.
Turning again, this time to welfare-benefit funds, including
VEBA's, let me make a few comments. In general, the costs of em-
ployee compensation, including employer-provided welfare benefits,
are deductible by the employer at the time when the compensation
is actually provided to the employees. In addition, if an employer
sets aside amounts for future employee compensation, income
earned on the amounts set aside is included in the emloyer's gross
income for income tax purposes.
Exceptions to these general rules have permitted employers, in
certain circumstances, to deduct currently contributions to prefund
deferred welfare benefits. The critical advantage to an employer in
setting aside funds in VEBA's and other effectively tax-exempt en-
tities is that the income on such funds accumulates on a tax-
exempt basis.
The historical development of the VEBA rules indicates that the
effectively unlimited tax-exemption for VEBA's did not come about
in a considered and deliberate fashion by the Congress. Indeed,
before the Deficit Reduction Act, Congress seems not to have ap-
preciated the potentially substantial tax benefits that an employer
could derive through a VEBA. Instead, Congress generally viewed
VEBA's simply as vehicles through which employees could join to-
PAGENO="0038"
32
gether to provide certain welfare benefits for themselves without
adverse tax consequences.
In recent years, however, the growth in the number of VEBA's
has substantially accelerated. According to the IRS, 7,091 active
VEBA's had received favorable tax IRS determination letters from
the commencement of VEBA's in the late 1920's through Novem-
ber 30, 1980. By the end of 1983, however, more than 9,400 VEBA's
had received favorable determination letters.
Thus, over 17 percent of the VEBA's in existence as of the end of
1983 have come into existence during the last 3 of the 55 years for
which VEBA's have been tax exempt. One of the reasons for this
recent increase was, in our opinion, enactment of the additional
limit, reduction in the section 415 limit on contributions and bene-
fits and the top heavy rules on qualified pension and profit-sharing
plans in TEFRA. VEBA's are subject to neither of these restric-
tions.
The Deficit Reduction Act does contain rules that limit the
extent to which an employer may use a VEBA or similar entity to
provide deferred benefits to employees. Let me say we think the ef-
forts made by the Congress in the Deficit Reduction Act were very
constructive in trying to restrict the scope of VEBA's. In spite of
these very important limits, however, significant tax benefits
remain for employers using VEBA's or similar entities.
I would like to turn now and comment for a moment on the hori-
zontal inequity of statutory fringe benefits. This really is a com-
ment that can apply to all statutory fringe benefits.
The exclusions for fringe benefits from gross income generally
are conditioned upon the delivery of the benefits through an em-
ployer-sponsored plan. The limitation of tax-favored benefits to em-
ployees covered by an employer plan may be seen to discriminate
against individuals not so covered. That is, people, for example,
who are self-employed.
This latter group of noncovered individuals must pay for bene-
fits, such as health care, with after-tax dollars, whereas covered
employees are able to purchase the same benefits with pretax dol-
lars. We have prepared some data showing the percentage of civil-
ian employees in different income classes who are covered by pen-
sion or profit-sharing plans as well as the percentage who are cov-
ered by employer-provided group health insurance. This data is
summarized in table II, attached at the end of this testimony. As is
reflected-4n table II, the percentage of employees coveted in the
very lowest income categories is substantialy smaller than for both
the middle- and upper-income groups.
Now a couple conclusions can be reached from that. One certain-
ly is the question about the fairness of the existing tax treatment
of fringe benefits and whether they are-whether the taxation pro-
duces an unfair distribution of such benefits among income groups.
Current data showing significantly lower employer plan coverage
for lowest paid employee groups itself, however, is of concern to us.
We would suggest that a comprehensive judgment about fairness
should await additional data which we, and I think it is accurate to
say, HHS, is undertaking to develop. Let me make one other com-
ment regarding this table and the problem of horizontal inequity.
And that is, we think that there may well be a correlation between
PAGENO="0039"
33
people who are in the lower income groups and those people who
are not typically covered by employer-provided benefits.
But I would not want to suggest to you that there is an absolute
correlation and therefore again, I would recommend that you not
take these data as an absolute conclusion that current rules pro-
vide unfairness in our system among income groups. But we did
want to make that data available.
Chairman PICKLE. I would like for you to refer to table 2 in a
little more detail so we can understand it.
Mr. PEARLMAN. OK.
Chairman PICKLE. I have it before me now.
Mr. PEARLMAN. All right.
Chairman PICKLE. Would you walk us through that table?
Mr. PEARLMAN. Certainly. I will try to do that for you.
What this table is designed to show is, if you look at employees
and the amount of wages they get, just using wage categories, that
is, under $5,000, $5,000 to $10,000 and so forth, and I should em-
phasize we are talking about wages here, not taxable income or the
like, then the first column will show the number in millions.
Excuse me. In thousands. But it turns out to be millions of employ-
ees in each category.
So for example, we have 17.7 million workers who earn $5,000 or
less.
Chairman PICKLE. All right.
Mr. PEARLMAN. The next two categories, excuse me, the next two
columns identify the number and percent of workers covered by
pension plans. That is, employer-sponsored pension plans. For ex-
ample, again looking at the less than $5,000 category, you will find
1.5 million employees or workers covered by employer-sponsored
pension plans representing 8.8 percent of the entire work force in
that wage category.
Now, the percentage of the entire work force in a wage category
would include, of course, people not covered by employer-provided
plans. The same approach is taken with respect to health plans.
Chairman PICKLE. Are you saying that the total wage of salary
workers in the first category, 5,000, there would be some 17 million
of them, and that in the percentage of workers with pension pro-
grams there would be 8 million? Am I interpreting this correctly?
Mr. PEARLMAN. I have missed your 8 million. Oh, that is 8 per-
cent.
Chairman PICKLE. That is percentage. Yes.
Mr. PEARLMAN. If you look at the prior column, 1.5 million.
Chairman PICKLE. Yes.
Mr. PEARLMAN. Then that is the number.
Chairman PICKLE. I have got you. Now, you are comparing the
17,766,000 to the 1,568,000?
Mr. PEARLMAN. Yes; but let me emphasize again, Mr. Chairman,
that the total wage and salary worker column includes people not
covered by the employer-provided plans, OK?
Chairman PICKLE. Yes.
Mr. PEARLMAN. So what we are trying to show you by this table
is how many of the total work force are covered by employer-pro-
vided plans, and how many, because they are self-employed, for ex-
ample, are not. And what this table suggests clearly is that people
PAGENO="0040"
34
in the lower wage categories are less likely to be covered both by
pension plans and health plans. And the caution-that is of con-
cern to us. That raises to us questions of fairness. But what I want
to caution is, I wouldn't go overboard in attaching final judgment
to this data. We are still working on this data and we hope to be
able to provide more defmitive data in the coming months.
Let me also just emphasize to you the footnote to that table,
which is a very important footnote. And that is that when you are
looking, particularly with health coverage, this has to do with
health coverage, at people covered in two-earner families, where
both spouses are working, obviously, typically there will be an in-
centive for one to choose not to be covered beqause the other
spouse is covered. And we have to make sure in looking at health
plan coverage that we take that into consideration in making the
judgment as to whether the distribution data accurately presents
data we can use for evaluating fairness.
Can I go on, Mr. Chairman?
Chairman PICKLE. Yes.
Mr. PEARLMAN. Another area where we certainly want to make
sure that in making judgments about current statutory fringe ben-
efits and about future statutory fringe benefits is the area of non-
discrimination. We think that the Congress has very properly
made, as a basic justification for providing a tax benefit in the
form of an exclusion from gross income, the objective of promoting
the delivery of the tax-favored fringe benefit to a broad cross sec-
tion of employees on a nondiscriminatory basis.
It is thus important that effective coverage and nondiscrimina-
tion rules apply with respect to each employer-provided benefit eli-
gible for an exclusion from gross income.
Coverage and nondiscrimination rules apply to most tax-favored
benefits, such as group-term life insurance, self-insured medical re-
imbursement plans, group legal service plans, and dependent care
assistance programs. However, medical plans provided by an em-
ployer under a policy with an insurance company are not subject to
nondiscrimination rules. Thus, discrimination in favor of the key
and highly compensated employees still is possible in the case of
insured health plans.
We also are concerned that cafeteria plans undermine the effec-
tiveness of the statutory coverage and nondiscrimination rules that
presently apply with respect to each of the statutory exclusions.
These coverage and nondiscrimination rules generally are based on
the availability of the particular benefit provided under the plan.
In the absence of a cafeteria plan, an availability-type test ordinari-
ly will assure that the benefit is provided to a broad cross section
of employees on a nondiscriminatory basis. Availability-based tests,
however, are not effective where employees are free to trade tax-
favored benefits for cash or other benefits. Also, the existing cover-
age and nondiscrimination rules applicable to cafeteria plans gen-
erally are not adequate to assure that the basic coverage and non-
discrimination objectives are being protected.
Now, the last part of my testimony, Mr. Chairman, deals with
health policy considerations. And the basic message we are sending
there is that we think that there is a serious question as to wheth-
er tax incentives provided in employer-provided welfare benefit and
PAGENO="0041"
35
health plans really are in fact achieving other important policy ob-
jectives. Most specifically, our objective in trying to contain health
costs. My written testimony can stand for what it states. I am, how-
ever, willing to defer, because of Mr. Helms' presence from HHS, to
him to comment on health policy considerations which are clearly
more in his expertise than they are mine.
Chairman STARK. Would the gentleman yield for just a moment
because I wanted to ask, Mr. Helms touches on this in his testimo-
ny, do you have any feeling, you mentioned what we had done in
nondiscrimination. One of the major areas which we have not
placed nondiscrimination rules is in health insurance. Mr. Helms'
testimony touches on the fact that the same distortion in the distri-
bution lies in that.
Do you think it is conceivable that we should put nondiscrimina-
tion rules and have them apply to health insurance as well?
Mr. PEARLMAN. I think, Mr. Stark, our belief is what, I think, in
general Congress' belief has been. And that is nondiscrimination
rules generally should be applicable to all statutorily provided
fringe benefits.
Again, Mr. Chairman, because I think Mr. Helms can better com-
ment on the health policy issues than I can, I think I am going to
stop at this point. I appreciate the opportunity of being here this
morning and giving you our comments. We have a mandate, as you
know, from the Congress to provide some additional data to you in
the area of statutory fringe benefits. And we will be doing that.
And as is usual, we are happy to not only try to answer your ques-
tions this morning but provide you any additional assistance we
might be able to provide. Thank you.
[The prepared statement follows:]
STATEMENT OF RONALD A. PEARLMAN, ACTING ASSISTANT SECRETARY (TAx Pouc~),
DEPARTMENT OF THE TREASURY
Mr. Chairman and Members of the Subcommittees: I am pleased to appear before
you today to present the Treasury Department's views on the appropriate tax treat-
ment of employer-provided fringe benefits.
In the recently enacted Deficit Reduction Act of 1984, Congress made several sig-
nificant changes in the rules governing fringe benefits. Among the more important
of these were (i) the extension to retired employees of the limits applicable to tax-
favored group-term life insurance; (ii) the application of deduction and other limits
to voluntary employees' beneficiary associations (VEBAs) and other welfare benefit
funds; (iii) the codification of an exclusion for formerly nonstatutory fringe benefits,
such as employee discounts and free parking; and (iv) the exclusion from cafeteria
plans of taxable benefits other than cash, group-term life insurance in excess of
$50,000, certain taxable life insurance for dependents of the employee, and vacation
days. The Deficit Reduction Act also adopted reporting requirements, key employee
limits, and special transition rules for cafeteria plans.
The Deficit Reduction Act was an appropriate step in rationalizing the Federal
tax treatment of employer-provided fringe benefits. Needed clarification was provid-
ed to individual taxpayers and employers alike, and progress was made in limiting
the expansion of fringe benefits.
My testimony today will outline areas of continuing concern to the Treasury De-
partment with regard to the tax treatment of employee fringe benefits. I will focus
on the so-called statutory fringe benefits, those benefits exempted from tax under
specific provisions of the tax law, and will discuss in particular the growth in fringe
benefits provided under employer-sponsored welfare benefit plans.
We are concerned that the expansion in fringe benefits excluded from the Federal
income and social security tax bases has caused tax rates to be higher than they
would otherwise be. Our efforts in recent years to contain increases in marginal
PAGENO="0042"
36
rates of income taxation and in the social security tax rates could be undermined
quickly by any significant narrowing of the range of compensation subject to tax.
We also are concerned that the tax benefits derived from the existing statutory
fringe benefits are not fairly distributed among taxpayers. Current provisions direct
a disproportionate share of such preferences to individuals able to participate in em-
ployer-sponsored benefit plans.
Finally, we are concerned that in some instances the exclusion of benefits from
gross income fails to promote the policies underlying such favorable treatment.
IMPACT ON THE INCOME AND SOCIAL SECURITY TAX BASES
Statutory Nontaxable Benefits-One of the announced purposes of these hearings
was to gather information concerning the prevalance and consequent revenue impli-
cations of tax-favored fringe benefits. Our studies in this area indicate that the
volume of tax-favored fringe benefits has grown dramatically over the past several
years and that significant future growth will occur even if current restrictions on
the availability of tax-favored fringe benefits are maintained. If these restrictions
are relaxed in any significant way, the inevitable result would be further and possi-
bly serious erosion in the social security and income tax bases.
Generally, an employee is required to include in gross income, for both Federal
income and social security tax purposes, all amounts received as compensation,
whether in the form of cash or any other benefit, including welfare benefits. Subject
to statutory limits, however, benefits provided under an employer-sponsored plan
that satisfies the applicable Code provisions are excluded from the income and
social security tax bases.
Generally, an employer-provided benefit qualifies for an exclusion only if the plan
satisfies certain eligibility, coverage, and nondiscrimination rules. (A notable excep-
tion is health benefits provided by an employer under a policy of insurance with an
insurance company.) The purpose of these rules is to assure that the tax-favored
benefit is provided to a broad cross-section of the employer's employees on a nondis-
criminatory basis.
Prior to the enactment of the Employee Retirement Income Security Act of 1974
(ERISA), the major statutory fringe benefits were qualified pension and profit-shar-
ing plans, group-term life insurance, and medical benefits. The favorable tax treat-
ment was intended to encourage employers to provide benefits that would protect
employees and their families from hardship on account of contingencies such as sep-
aration from service, death, and sickness or disability. Beginning with ERISA, how-
ever, the list of statutory fringe benefits has grown to include employer-provided
programs aimed not at encouraging the extension of protection against hardship re-
sulting from specified contingencies, but instead merely at promoting the expendi-
ture of compensation in specified ways. These more recent statutory tax-favored
benefits include employee stock ownership plans, group legal services programs, van
pooling, educational assistance programs, and dependent care assistance programs.
The expansion of the statutory nontaxable benefits has the effect of reducing the
cost of a broad range of goods or services that are purchased by a wide spectrum of
the population. Predictably, this expansion has put pressure on employers to pro-
vide increasing portions of compensation in tax-favored forms so as to maximize the
"tax effectiveness" of employee compensation packages.
We have estimated the nontaxable employer contributions for qualified pension
and profit-sharing plans, group health insurance, and group life insurance for the
period from 1955 through the present, and have projected such contributions
through 1989. Also, we have calculated the portion of total wages that these contri-
butions have constituted, and the revenue effect of excluding these contributions
from the Federal income and social security tax bases. These estimates are summa-
rized in Table I, attached at the end of this testimony.
Table I illustrates that, as a percentage of total wages, the total nontaxable em-
ployer contributions for qualified pension and profit-sharing plans, group health in-
surance, and group life insurance were 3.2 percent in 1955, 5.2 percent in 1965, 8.5
percent in 1975, and 11.1 percent in 1983. We project that this percentage will be
11.5 percent in 1985 and will increase further to 13.4 percent in 1989. In 1983, ex-
cluding these employer contributions from the Federal income and social security
tax bases reduced Federal income tax revenues by about $53 billion and social secu-
rity tax revenues by about $11 billion; for 1985 the corresponding revenue reduc-
tions are projected to be $64 billion and $14 billion.
The expansion in the scope and volume of tax-favored fringe benefits represents a
significant threat to the Federal income and social security tax bases. If pressures to
increase social security and marginal income tax rates are to be resisted, hard
PAGENO="0043"
37
choices must be faced as to which fringe benefits can be granted tax-favored treat-
ment and as to whether the tax advantages currently available to fringe benefits
can be modified without impairing the social policy objectives underlying their fa-
vorable tax treatment.
Cafeteria Plans and Flexible Spending Arrangements.-Recent growth in tax-fa-
vored benefits provided under employer-sponsored plans has been stimulated by the
statutory authorization of cafeteria plans. Cafeteria plans permit individual employ-
ees to choose which fringe benefits they will receive, in effect allowing employees to
design fringe benefit packages tailored to their individual needs.
The flexibility inherent in cafeteria plans substantially eliminates "employee jeal-
ousy" as a restraint on the amount of compensation provided in tax-favored forms.
In the absence of a cafeteria plan, employees would choose compensation in the
form of nontaxable fring benefits only if the benefits were more desirable than the
after-tax value of the additional salary that would otherwise have been paid. Be-
cause the desirability of particular benefits differs from employee to employee,
fringe benefit compensation generally is sought by some employees and opposed by
others. Employee disagreement over the desirability of particular nontaxable bene-
fits historically has served as an important restraint on the amount of compensation
provided in any particular form. Cafeteria plans virtually eliminate this restraining
factor by permitting individual employees to select the fringe benefits which meet
their particular needs.
Also, where an employer is unwilling to provide additional benefits on a tax-fa-
vored basis, cafeteria plans enable employees to use pre-tax dollars, rather than
after-tax dollars, to purchase such additional benefits. For example, in the absence
of a cafeteria plan, an employee would have to make the required employee contri-
bution to a contributory medical plan with after-tax dollars. But if the employer
makes the contributory medical plan available through a cafeteria plan, the employ-
ee would be able to make the required contribution with pre-tax dollars.
We recognize that, where an employer historically has provided its employees
with a very rich, tax-favored fringe benefit package, a cafeteria plan may result in a
net decrease in the tax-favored benefits received by such employees. However in the
aggregate, cafeteria plans significantly narrow the Federal income and social securi-
ty tax bases. For fiscal years 1984 through 1989, we estimate that, assuming the ex-
clusion for group legal services is not extended beyond December 31, 1984, cafeteria
plans will reduce individual income tax receipts by $5.5 billion and social security
receipts by $3.2 billion, for a total reduction of $8.7 billion.
These projections indicate that cafeteria plans provide a powerful incentive for
tax-favored forms of compensation. Even more substantial losses in revenue would
result, however, if the cafeteria plan rules authorized the exclusion of benefits pro-
vided through so-called "flexible spending arrangements." Generally, a flexible
spending arrangement (FSA) permits an employee to designate some portion of his
or her otherwise taxable salary as available for the tax-free reimbursement of speci-
fied expenses, such as medical care, legal services, or dependent care assistance.
Under an FSA, the employee is assured of receiving, in the form of cash or some
other benefit, any portion of the designated amount not utilized for the specified ex-
pense.
We have concluded, as proposed Treasury regulations on cafeteria plans reflect,
that the statutory provisions granting tax-favored treatment to specified benefits
and the cafeteria plan rules themselves do not authorize FSAs. Therefore, a benefit
does not fall under any of the applicable statutory exclusions if the benefit is provid-
ed through an FSA.
If FSAs were granted favorable tax treatment, employers would be better able to
style ordinary compensation as a tax-free reimbursement of their employees' person-
al expenses. Such expenses are otherwise nondeductible for fax purposes, or, as in
the case of expenses for medical or dependent care, entitled to a deduction or credit
only under statutory limitations. The effect of granting favorable tax treatment to
FSAs would be write out of the Code, at least for employees in cafeteria plans, the
existing limits on deductions and credits for a number of personal expenses.
Our revenue estimates indicate that FSAs would have a dramatic effect on the
Federal tax base. For the 1984 through 1989 fiscal years (assuming that the exclu-
sion for group legal services is not extended beyond December 31, 1984), we estimate
that the $8.7 billion projected revenue loss attributable to cafeteria plans would
double to approximately $17 billion if favorable treatment were granted to FSAs.
Welfare Benefit Funds, Including VEBAs.-Generally, the costs of employee com-
pensation, including employer-provided welfare benefits, are deductible by the em-
ployer at the time when the compensation is actually provided to the employees. In
addition, if an employer sets aside amounts for future employee compensation,
PAGENO="0044"
38
income earned on the amounts set aside is included in the employer's gross income
for income tax purpose.
Exceptions to these general rules have permitted employers, in certain circum-
stances, to deduct currently contributions to prefund deferred welfare benefits. The
critical advantage to an employer in setting aside funds in VEBAs and other effec-
tively tax-exempt entities is that the income on such funds accumulates on a tax-
exempt basis. Generally, neither the employer, the plan or VEBA, or the employee-
beneficiaries are taxed currently on the fund's growth.
The historical development of the VEBA rules indicates that the effectively un-
limited tax-exemption for VEBAs did not come about in a considered and deliberate
fashion. Indeed, before the Deficit Reduction Act, Congress seems not to have appre-
ciated the potentially substantial tax benefits that an employer could derive
through a VEBA. Instead, Congress generally viewed VEBAs simply as vehicles
through which employees could join together to provide certain welfare benefits for
themselves without adverse tax consequences.
Congress originally enacted a statutory tax exemption for VEBAs in 1928. The ex-
emption was available only for VEBAs with respect to which at least 85 percent of
the income was collected from members to pay benefits or administrative expenses.
Later, in response to the Internal Revenue Service's argument that employer contri-
butions, if in excess of 15 percent of a VEBA's income, destroyed the VEBA's tax-
exempt status, Congress provided that employer contributions would be treated as
member contributions for purposes of the 85 percent test.
Even after the change in treatment of employer contributions, the 85 percent test,
by effectively limiting the investment income in a VEBA to 15 percent of the
VEBA's income, prevented employers from using VEBAs to accumulate substantial
tax-favored reserves. The Tax Reform Act of 1969, however, in a move apparently
intended to restrict the tax advantages of VEBAs, subjected VEBAs to the unrelated
business income tax and eliminated 85 percent test; Congress appeared to believe
that applying the unrelated business income tax rendered the 85 percent test unnec-
essary. Under the applicable unrelated business income tax provisions, however,
VEBA income was not subject to tax if it was "set aside" to provide permissible ben-
efits. Thus, there were no longer any limits on the amounts that an employer could
set aside in a VEBA to pay a permissible benefit, or on the tax-free earnings that
could accumulate on the amounts set aside.
In recent years, and especially since Treasury regulations under the Tax Reform
Act of 1969 were issued in 1980, the growth in the number of VEBAs has substan-
tially accelerated. According to the IRS, only 7,791 active VEBAs had received fa-
vorable IRS determination letters by November 30, 1980. By the end of 1983, howev-
er, more than 9,400 VEBAs had received favorable letters. Thus, over 17 percent of
the VEBAs in existance as of the end of 1983 have come into existence during the
last three of the 55 years for which VEBAS have been tax-exempt. One of the rea-
sons for this recent increase was the enactment of the additional limits-the reduc-
tion in the section 415 limits on contributions and benefits and the top-heavy
rules-on qualified pension and profit-sharing plans in the Tax Equity and Fiscal
Responsibility Act of 1982. VEBAs are subject to neither of these restrictions.
The combination of the current deduction for deferred welfare benefits and the
tax-exempt growth of funds set aside for such benefits provides employers with sub-
stantial tax benefits. For example, an employer subject to a 46 percent marginal
income tax rate generally bears about 54 percent of the cost of providing an employ-
ee with a welfare benefit and the Federal government (or taxpayers generally),
through the tax system, bears about 46 percent of the cost of the benefit. To the
extent that the employer is able to prefund, on a deductible basis, a deferred benefit
through a tax-exempt entity, such as a VEBA, a portion of the cost of the benefit
will be purchased with tax-exempt income earned by the entity. In such a case, the
Federal government (or taxpayers generally) will pick up a greater share of the
total cost of the benefit. If the tax-favored prefunding occurs many years in advance
of when the benefit is provided, the government's share of the cost will far exceed
the employer's share due to the greater accumulation of tax-exempt income. It is
important to note that this shifting of costs to the government occurs even though
the funding is actuarially sound, and thus the problem is by no means limited to
cases involving acturial overfunding.
One way of ifiustrating the magnitude of this tax benefit is by comparing the
after-tax amounts generated if the same amounts are set aside, over a period of
years, on a deductible and tax-exempt basis, on the one hand, and on a non-deducta-
ble and taxable basis, on the other. For example, assume that a corporation is will-
ing to devote $2,000 at the beginning of each year for 10 years toward providing a
benefit at the end of the 10th year. Assume further that the corporation is in the 46
PAGENO="0045"
39
percent tax bracket for each of these years, and that the annual interest rate is 10
percent.
If the corporation uses a VEBA to fund the benefit, it will be allowed to deduct
the $2,000 in each year of its contribution to the VEBA. If, however, the corporation
merely uses a taxable bank account to fund the benefit, it will be able to set aside in
each year only the after-tax value of $2,000, which is $1,080. After ten years of accu-
mulation, the VEBA fund will be $35,062.33, whereas the balance in the bank ac-
count will be only $14,587.83. The bank account balance, however, will support a
benefit of $27,014.50, which would be financed by the tax savings attributable to the
deduction for this benefit (.46 x $27.014.50) and the $14,587.83 account balance.
Thus, in this example, funding the benefit through the VEBA permits the corpora-
tion to provide a 30 percent greater benefit than funding through the taxable bank
account.
The Deficit Reduction Act contains rules that limit the extent to which an em-
ployer may use a VEBA or similar entity to provide deferred benefits to employees.
Employer deductions to a VEBA for a year are limited to the sum of the benefits
provided during the year plus an amount, determined under reasonable acturial
standards, to cover benefit claims incurred but unpaid as of the end of the taxable
year and to cover projected post-retirement life insurance and medical benefits.
Also, to the extent that the reserves set aside in a VEBA or similar entity exceed
the permitted reserve limits (without regard to the reserve for post-retirement medi-
cal benefits), the income of the VEBA or similar entity will be subject to the unre-
lated business income tax. Finally, the Deficit Reduction Act limits the levels of
benefits that may be provided to employees for purposes of calculating these deduc-
tion and reserve limits.
The Deficit Reduction Act also contains rules aimed at limiting the extent to
which an employer may use a VEBA or similar entity for unintended purposes. For
example, the Act applies eligibility, coverage, and nondiscrimination rules to
VEBAs and provides that funds set aside to provide post-retirement life insurance
and medical benefits to a key employee of the employer must be credited to a sepa-
rate account and, to the extent attributable to post-retirement medical benefits,
must be counted under the annual section 415 limits as employer contributions to a
defined contribution plan. Also, a key employee may receive the promised post-re-
tirement benefits only out of the funds credited to his or her separate account. In
spite of the important limits imposed by the Deficit Reduction Act, significant tax
benefits remain for employers using VEBAs or similar entities.
HORIZONTAL INEQUITY
The statutory exclusions of fringe benefits from gross income generally are condi-
tioned upon the delivery of the benefits through an employer-sponsored plan. The
limitation of tax-favored benefits to employees covered by an employer plan may be
seen to discriminate against individuals not so covered. This latter group of non-cov-
ered individuals must pay for benefits, such as health care, with after-tax dollars,
whereas covered employees are able to purchase the same benefits with pre-tax dol-
lars.
We have prepared data showing the precentage of civilian employees in different
income classes who are covered by pension or profit-sharing plans as well as the
percentage who are covered by employer-provided group health insurance. This data
is summarized in Table II, attached at the end of this testimony. As is reflected in
Table II, the percentage of employees covered in the very lowest income categories
is substantially smaller than for both the middle and upper income groups.
Comprehensive judgments about the fairness of the existing tax-treatment of
fringe benefits should await additional data concerning the distribution of such ben-
efits among income groups. Current data showing significantly smaller employer
plan coverage for the lowest paid employees is itself, however, cause for concern.
Moreover, it is worth emphasizing that the degree of unfairness attributable to the
tax treatment of fringe benefits varies directly with the volume of benefits exempt-
ed from tax. As the percentage of compensation paid in the form of tax-favored
fringe benefits increases, the issue of how the related tax benefits are distributed
among taxpayers takes on increasing importance. Further growth in the volume of
tax-favored fringe benefits can only exacerbate already significant concern over tax-
payer fairness.
NONDISCRIMINATION AND HEALTH POLICY OBJECTIVES
Nondizcrimination.-A basic justification for providing a tax benefit in the form
of an exclusion from gross income is to promote the delivery of the tax-favored bene-
PAGENO="0046"
40
fit to a broad cross-section of employees on a nondiscriminatory basis. It is thus im-
portant that effective coverage and nondiscrimination rules apply with respect to
each employer-provided benefit eligible for an exclusion from gross income.
Coverage and nondiscrimination rules apply to most tax-favored benefits, such as
group-term life insurance, self-insured medical reimbursement plans, group legal
service plans, and dependent care assistance programs. However, medical plans pro-
vided by an employer under a policy with an insurance company are not subject to
nondiscrimination rules. Thus, discrimination in favor of the key and highly com-
pensated employees still is possible in the case of insured health plans.
We also are concerned that cafeteria plans undermine the effectiveness of the
statutory coverage and nondiscrimination rules that presently apply with respect to
each of the statutory exclusions. These coverage and nondiscrimination rules gener-
ally are based on the availability of the particular benefit provided under the plan.
In the absence of a cafeteria plan, an availability-type test ordinarily will assure
that the benefit is provided to a broad cross-section of employees on a nondiscrim-
inatory basis. Availability-based tests, however, are not effective where employees
are free to trade tax-favored benefits for cash or other benefits. Also, the existing
coverage and nondiscrimination rules applicable to cafeteria plans generally are not
adequate to assure that the basic coverage and nondiscrimination objectives are
being protected.
Health Policy Considerations-The magnitude of the tax benefits available for
employer-provided welfare benefit plans may create incentives inconsistent with
other important policy objectives. In particular, we are concerned that the generous
tax treatment of employer-provided health benefits may have contributed to, rather
than helping to contain, increasing health care costs.
Section 106 of the Code provides employees with an unlimited exclusion from
gross income for the cost of employer-provided health coverage. Medical care and
expense reimbursements received under such coverage are provided with an unlim-
ited exclusion under section 105(b). A primary effect of these provisions is that em-
ployees are supplied with extraordinarily generous health benefits, often with no in-
ternal controls on costs or utilization of health care. Some employer-provided health
plans are so generous that employees bear little, if any, of the cost of routine doc-
tors' visits, hospital care, or medical tests. As a result, the employees tend to over-
use doctor and hospital services and medical tests. Such overuse contributes to
rising health care costs.
In recognition of the effect on health care costs of the tax treatment of employer-
provided health benefits, the Administration has proposed a cap on the health bene-
fit premium that may be excluded from an employee's gross income. There may be
additional methods of encouraging employers to introduce more cost-sharing into
their health plans and otherwise to reduce private health spending. All parties-
Congress, the Administration, and private industry-should work together to target
the tax benefits for health plans more effectively.
Furthermore, we believe that health care cost considerations also dictate that fa-
vorable tax treatment not be granted to FSAs in cafeteria plans. Because FSAs
would allow existing cost-sharing in health plans to be made with pre-tax dollars,
the permissive treatment of FSAs would contribute to rising health costs.
We recognize the argument that, in particular situations where an FSA replaces
first-dollar coverage, the FSA may introduce a relative incentive for employees not
to use health care. However, granting favorable tax treatment' to FSAs would
permit employees to use pretax dollars to pay for health-related expenses that are
currently paid with after-tax dollars. These expenses-cost-sharing under health in-
surance, payments for services not covered by insurance, and employee contribu-
tions to employer-sponsored health plans-are expected to grow to $118 billion by
1990, according to Department of Health and Human Services estimates. If, through
the availability of FSAs, a substantial share of the $118 billion were to be financed
with pretax dollars, demand for health services would be increased and health care-
cost inflation exacerbated.
More effective and equitable strategies than FSAs are available to aid employers
in controlling health care costs. For example, utilization review, second opinions, re-
structuring of benefits (e.g., to cover noninstitutional care), special service delivery
arrangements (e.g., preferred provider organizations), and the promotion of health
maintenance organizations are examples of proven and developing strategies for pri-
vate health cost containment. Also, cafeteria plans without FSAs permit employers
to price health benefit options to encourage employees to select the options with ad-
ditional employee cost-sharing. An employee who selects a lower-option health bene-
fit would then have additional amounts available to purchase other benefits or to
PAGENO="0047"
41
receive as cash, which if necessary could be used to pay for health expenses that are
unreimbursed due to the higher deductible or co-payment.
We believe thorough analysis clearly indicates that even though FSAs may facili-
tate a particular employer in attempting to introduce incentives for its employees to
reduce excessive use of health care services, the dominant effect of granting permis-
sive tax treatment to FSAs would be to increase health care costs. We thus believe
that granting such treatment to FSAs would undercut the effort to formulate an
effective health cost containment policy.
TABLE 1.-EMPLOYER CONTRIBUTIONS FOR PENSION AND PROFIT SHARING PLANS, GROUP HEALTH
INSURANCE, AND GROUP LIFE INSURANCE
Calendar year
1955
Actual
Projected
1985 1989
1960
1965
1970
1975 1980
1983
Pension and profit sharing:
Amount' (dollars) 4,506
7,479
11,317
20,284
42,776 80,791
99,596
124,933
196,585
Percent of wages 2.1
2.8
3.1
3.7
5.3 6.0
6.0
6.4
7.3
Individual income tax liability
effect -1,153
-1,915
-2,574
-5,059
-12,046 -26,579
-30,188
-37,230
-58,582
Group health insurance:
Amount' (dollars) 1,706
3,374
5,890
12,099
21,301 45,380
77,199
90,370
148,420
Percent of wages 0.8
1.2
1.6
2.2
2.6 3.3
4.7
4.6
5.5
Individual income tax Oability
effect (dollars) -357
-707
-1,096
-2,469
-4,908 -12,214
-19,629
-22,032
-37,334
Group life insurance:
Amount (dollars) 561
1,080
1,651
2,891
4,368 6,359
7,592
9,186
13,449
Percent of wages 0.3
0.4
0.5
0.5
0.5 0.5
0.5
0.5
0.5
Individual income tax liability
effect (dollars) -126
-243
-330
-634
-1,081 -1,839
-2,022
-2,408
-3,525
Total:
Amount (dollars) 6,773
11,933
18,858
35,274
68,445 132,530
184,387
224,489
358,454
Percent of wages..... 3.2
4.4
5.2
6.4
8.5 9.8
11.1
11.5
13.4
1 Includes federal civifan, state and local government pension contributions.
2 Actuals are based on Department of Commerce reported data and include employer contributions fur short. and lxng.term disability insurance
covering private employees and their dependents for 1955-1970. Actual amounts, for 1975-1983 and Department of Health and Human Services
projections for 1985-1989 do not include disability insurance.
Source: Office of the Secretary of the Treasury, Office of Tax Analysis, September 14, 1904.
TABLE 11.-DISTRIBUTION OF TOTAL CIVILIAN WAGE AND SALARY WORKERS, AND CIVILIAN WAGE
AND SALARY WORKERS WITH AN EMPLOYER PENSION PLAN, OR ON EMPLOYER GROUP HEALTH
PLAN BY WAGE AND SALARY CLASS 1
Total wage
1903 Wages and salary
workers
workers with
employer plan
Pension
Health
(thousands)
Number
(thousands)
Percent of
workers
Number
(thousands)
Percent of
workers
Less than $5,000
$5,000-$10,000
17,766
16,961
29,926
1,568
4,908
17,405
8.8
28.9
58.2
$10,000-$20,000
$20,000-$30,000
16,103
8,544
12,216
6,672
75.9
78.1
$30,000-$50,000
Over $50,000
2,088
1,529
73.2
Total
91,388
44,298
48.5
3,196 18.0
9,126 53.8
24,484 81.8
14,701 91.3
7,968 93.3
_______________________________________ 1,898 90.9
61,373 67.2
1 Source: 1984 Current Population Survey (refers to 1983 levels). Data shown is self reported and may not completely agree with employer
reported data.
Note: A substaxtial number of workers not covered by their own employers health play are covered by the health plan of a family member. lx
1977 about 73 percent of the civilian noninstitutional population under age 65 was covered by employer health insurance; about 9 percent of the
civilian noninstitutional Population under age 65 was not covered by insurance.
Source: Office of the Secretary of the Treasury, Office of Tao Analysis, September 14, 1984.
PAGENO="0048"
42
Chairman STARK. Could you comment for a moment on whether
or not you looked at what the various tax proposals that are float-
ing about would do to both revenue and fringe benefits? For exam-
ple, the flat-tax-type proposals or value-added tax proposals which
could very well tax services and goods, applied to small companies,
have you looked at that?
Mr. PEARLMAN. One of the areas we are looking at in connection
with our study of fundamental tax reform is both what is the role
of statutory provided fringe benefits, and what is the effect on the
statutory fringe benefits. You know, one of the things we are doing
in connection with our study, Mr. Stark, is developing, which un-
fortunately is not yet developed, a very substantially expanded
weight of data base, which every one, including members and the
staffs of the Hill, will be able to call upon to make more intelligent
judgments about what the revenue impacts on various statutory
changes are, both on the short term when we deal with the target-
ed legislative proposal and when we are looking at more fundamen-
tal issues.
So the answer to your question is yes, we are looking at that.
And we hope, and the data base piece is a mechanical problem. We
are hopefully within a couple weeks of having a data base. At least,
our fingers are crossed that we will, and that that will permit us to
do more intelligent revenue analysis than is possible today.
Chairman STARK. Thank you.
Chairman PICKLE. All right, go ahead, Mr. Pearlman. Have you
finished with your testimony?
Mr. PEARLMAN. I have finished, yes, sir.
Chairman PICKLE. Mr. Pearlman, have you, before you conclude,
made any recommendations about actions for the Congress to take?
Mr. PEARLMAN. No, sir; at this point we have not. We are look-
ing, obviously, as Treasury generally does, at what things continue
to need to be done. Now, we have in our testimony mentioned a
few general things. We are interested in the subject of nondiscrim-
ination. We are interested in the subject of fairness. Is the current
system fair? But two things have occurred that would suggest to us
that specific recommendations perhaps might not be appropriate at
this point. One is we are taking a hard look at the subject of fringe
benefits in connection with our fundamental tax reform study. The
second thing is the Congress took some very significant actions--
Chairman PICKLE. Mr. Pearlman, pardon me. You said you are
taking a hard look at fringe benefits with respect to the package
you might offer. Did I understand you?
Mr. PEARLMAN. We believe that part of our commitment in re-
sponding to the President's directive to give him some recommen-
dations on fundamental tax reform is to look at the subject of
statutorily provided fringe benefits in a continuing income tax, or,
if our system were to change. And in that regard we are looking at
the current system of the delivery of fringe benefits.
Chairman PICKLE. Can you tell the committee at what point you
might make such recommendations or analyses, further analyses to
this committee or the Congress?
PAGENO="0049"
43
Mr. PEARLMAN. I would think realistically, Mr. Chairman, unless
we are called upon earlier, that the most likely time that we would
be making specific recommendations to the Con~ress and whether
we will or not, you know, at this point I just can t tell, would be in
connection with the budget. But I think, absent additional hear-
ings, that I would think certainly not on the very short term.
Chairman PICKLE. What I am trying to establish is that you do
feel that there is discrimination that should be corrected; that
there is a loss of revenue; and that the tax base is being eroded.
And that these matters ought to be corrected. And assuming the
continuation of this administration, you would probably make a
recommendation to make changes after the first of the year?
Mr. PEARLMAN. Well, no, I just can't say that because I just don't
know. I think that at this point, because of the work we are under-
taking now, coupled with the fact that we don't have, and 1 don't
think anyone does, in hand what the real implications of the 1984
legislation are. I think at this point I am simply not in a position to
tell you that some 6 months from now we will be in a position to
make recommendations. We know we have got a commitment to
Congress that was imposed upon us by the 1984 legislation to make
a report to the Congress in the flexible cafeteria plan spending by
next April, and we will certainly do that.
Chairman PICKLE. I understand that all things in general, since
your testimony points out that there is discrimination, and some
unfairness, that there is a-that the employers are taking large de-
ductions and that some changes should be made, that we can an-
ticipate a recommendation at some point for correction of these
things. So whenever that occurs, we would be of course interested
in having it.
Let me ask you for my information. On your page 9 you said that
nondiscrimination rules do apply to life, group health, group legal
services, and so forth. However, medical plans provided are not
subject to nondiscrimination rules. Why is that?
Mr. PEARLMAN. Mr. Chairman, I just can't answer you. I just
don't know the answer to that question. I was not around at the
time of that legislation, and I don't know why insured plans were
excepted. That is one of the areas, however, that we want to look
at and we want to try to get handle on what the effect of that is on
the broad delivery of tax-favored fringe benefits. But I simply can't
answer your question. I don't know.
Chairman PICKLE. Perhaps we ought to ask ourselves why that
is, to observe this is the last big area which has not been covered.
Let me ask you one question that has been submitted to me to ask.
We are going to receive testimony shortly from the HHS and SSA.
We anticipate, based on the testimony we expect to receive, learn-
ing how Social Security tax rates could be reduced without decreas-
ing revenues under various assumptions of different amounts of
fringe benefits being included in Social Security wage base. Maybe
this is what Secretary Regan has referred to as changes in Social
Security.
Now, we requested this information on tax rates with all fringe
benefits being included in the wage base, without further increase
in fringe benefits and other projections. So I am wondering if you
could provide us with similar-type information on the effect of
40-046 0 - 85 - 4
PAGENO="0050"
44
fringe benefits on income tax rates. For example, if revenue were
held constant, how much could tax rates be reduced if all fringe
benefits were included in the income tax base? And what could be
done to rates if there were no further increases in nontaxable
fringe benefits? I would like for you to give us some information
when you can, as quickly as you can.
Mr. PEARLMAN. Certainly. We will be happy to provide that.
TREASURY RESPONSE
The exclusion from the individual income tax base of employer contributions to
pension and profit sharing plans, group health insurance, and group life insurance
resulted in a reduction in 1983 Federal income tax liability of $53 billion computed
at 1983 tax rates. Had these items been included in the individual income tax base,
the current law level of receipts could have been maintained with an average reduc-
tion in rates of about 12 percent.
Chairman PIcKu~. The Chair would recognize Mr. Duncan now
for any questions that he might have.
Mr. DUNCAN. Thank you, Mr. Chairman.
Mr. Pearlman, in your study of fringe benefits, have any general
conclusions been reached as to the amount individual tax rates
could be reduced by increasing the kinds of fringe benefits that are
taxed?
Mr. PEARLMAN. No, Mr. Duncan. Really, that is the reason we
did not provide that data this morning. One of our hopes is that by
the expanded data base we are working on that we will be better
able to make those judgments. At this point we simply don't have
those data.
Mr. DUNCAN. Does Treasury view the tightening of the fringe
benefits nondiscrimination rules as a means of limiting fringe ben-
efits?
Mr. PEARLMAN. Oh, I think clearly the-I don't think it would be
fair to say that we view the nondiscrimination rules-I mean they
will have that effect. I don't think we view the nondiscrimination
rules as necessarily a vehicle that should be used to limit them. I
think we view the nondiscrimination rules as a, simply a condition
that should be applied as a matter of fairness and equity to any
statutory fringe benefits that are provided by Congress. If, for ex-
ample, we were to suggest to you the expansion of the nondiscrim-
ination rules to a particular fringe benefit, it would not be for the
purpose of cutting down revenue loss, for example. It would be be-
cause we think it is fair that these fringe benefits be provided on a
nondiscriminatory basis.
But we do believe that the discrimination rules are important
and that they should continue to apply to all statutory fringe bene-
fits. To the extent they don't apply, we think those are areas we
should look at and maybe indeed we will be coming back to you
making some suggestions in that area.
Mr. DUNCAN. Do you have any idea of what period of time will
have to elapse before Treasury gets a fairly accurate reading of
how the fringe benefit rules in the 1984 act are actually working?
Mr. PEARLMAN. Realistically, if you want really reliable data, the
only source of data that we have generally available to us that is
really reliable is tax return data. Now, if we wait that long we are
talking about some years. Our hope is that we will be able, through
PAGENO="0051"
45
data that is voluntarily provided by the industry, interested indus-
try groups, and through data which we hope that the Internal Rev-
enue Service can develop that is other than pure tax return data,
that we may be able to provide you some information in shorter
than the normal period of time.
For example, now we have good tax return data through 1981
but nothing that is very firm beyond that. So you can see there is a
lapse of a few years. And if we wait that long it is going to be
awhile.
Mr. DUNCAN. Thank you very much, Mr. Pearlman. Thank you
very much, Mr. Chairman.
Chairman STARK. By referral I was asked to inquire of you, but I
think the answer to this question is self-evident. It said there is
concern that if you limit the amount of tax-free employer contribu-
tions to a health plan, it would result in reducing health benefits.
The guess, I would say the other side of that question is, if you
limit the amount, you raise the cost, either way, raise costs or limit
benefits. Is there any other option in that area?
Mr. PEARLMAN. Well, I would really like Mr. Helms to comment
on this, too. So I will give you my uninformed comment. That is it
seems to me that there is another option. That is how employers
tailor their plans. Maybe we are saying the same thing. Raise the
cost, but if employees have to-it seems to me that employers and
employees have to recognize that it can't be a free ride. That incur-
ring health care costs just can't be a free ride to anyone, because it
in fact is not. For me, if I am the employee, it will be raising my
costs. If there is a higher deductible, there is a higher copayment,
that means the cost may go up to me. It may not though. It may
mean that without being irresponsible, and I think that is impor-
tant, that we are not forcing employees to forgo needed health
care, that employees can make a judgment that health services
that are really not needed, that are luxurious or duplicative, could
be forgone without increasing costs. That it just forces people to
make better judgments.
And I think one of the things we are concerned about in terms of
the cafeteria plan, for example, is that employees are not forced to
make that decision.
Chairman STARK. So what you are saying is, they may discrimi-
nate or be more discriminatory in how they use their benefits if it
costs them something?
Mr. PEARLMAN. That is correct.
Chairman STARK. That I think is a halfway post, between either
providing fewer services or increasing cost for the existing ones. And
I would share your opinion that, obviously, having it just open ended
and-tends to generate things like I suppose cosmetic surgery and
dentistry and a lot of things that are likely to advance in the cos-
metic world we live in, but may not be something the Federal Gov-
ernment wants to pay for.
I think our next witness, then-does anyone else have any ques-
tions? Yes. Mr. Secretary, while you are perfectly welcome to stay
and participate, Secretary Pearlman, we could excuse you and call
on Dr. Robert Helms, Acting Assistant Secretary for Policy and
Evaluation, Department of Health and Human Services, Mr. Bal-
lantyne, Chief Actuary of the Social Security Administration.
PAGENO="0052"
46
Are you two testifying separately?
STATEMENT OF ROBERT B. HELMS, ACTING ASSISTANT SECRE-
TARY FOR PLANNING AND EVALUATION, DEPARTMENT OF
HEALTH AND HUMAN SERVICES, ACCOMPANIED BY BRUCE
STEINWALD, ACTING DEPUTY ASSISTANT SECRETARY FOR
HEALTH POLICY
Mr. HELMS. Thank you, Mr. Chairman.
I have with me Bruce Steinwald, Acting Deputy Assistant Secre-
tary for Health Policy.
It is a pleasure to be with you today and to represent the Depart-
ment of Health and Human Services and talk about employer-pro-
vided fringe benefits. I will focus, as you said, primarily on the
topic of employer-provided health care benefits.
The availability of employer-provided health insurance protec-
tion has contributed to the welfare of most Americans. According
to the best data available, 80 percent of the nonaged population are
covered by private health plans, of which 82 percent were group
plans. The predominance of employer-provided health insurance fi-
nancing must be recognized as a success story of major proportions.
Indeed, we tend to forget how employer-employee financed group
health plans have shaped national policy. In 1965, we took the
model of a private health insurance plan for the model of medi-
care, and most of the proposals over the years for serious reform
have been based on a system of private employer-provided health
insurance. In other words, we have never considered other types of
models, such as those they used in Europe.
Eventually, we realized that our diverse and dynamic system of
private insurance was not just a suitable model, but was in fact a
superior system to a monolithic national health insurance scheme.
But having made that important choice, we were left with some
unresolved issues. The dominant role of group health insurance fi-
nancing is partly an evolutionary response to preferential tax
treatment. The cumulative influence of tax incentives led to plan
designs that went well beyond financial protection. Plans were ex-
panded to the point of providing coverage paying for routine, budg-
etable medical bills, often with no cost-sharing or other controls on
excessive use of services. In an environment of liberal third-party
financing, hospitals and physicians expanded services utilization
and accelerated the pace of medical technology.
And so it was that insurance financing in the private sphere, al-
ready recognized as a great and beneficial institution, came to be
recognized also as contributing to our severe and continuing medi-
cal expenditure inflation. As we know only too well, this inflation
has added to fiscal imbalance, reduced access to care by those not
adequately insured, distorted production and consumption incen-
tives, and diverted more and more household income from other
forms of consumption.
The administration made health care cost inflation a first priori-
ty matter. Policy recommendations have focused on reforming in-
centives rather than regulating behavior. Two key legislative pro-
posals aimed at incentives were developed early in this administra-
tion. A plan for prospective payment of hospitals under medicare
PAGENO="0053"
47
has been enacted and is already producing constructive results. We
also proposed a limitation on the amount of income employees
could receive tax-free in the form of health insurance.
Under pressure from rising health care costs, and realizing that
neither Congress nor the administration would support a regula-
tory solution, employers proceeded to adopt a variety of innovative
strategies for containing costs. One of these is cost sharing.
Cost sharing is rapidly being introduced and extended, often in
the context of cafeteria plans offering choice among different levels
of coverage. According to a recent Hay-Huggins survey, about one-
third of a broad sample of private firms had recently increased de-
ductibles; another third were considering such an increase.
We know from many types of evidence-most recently and deci-
sively from the Rand Health Insurance Study sponsored by my
office-that cost sharing significantly affects utilization of services,
a result that is repeatedly confirmed by the experience of employer
plans where deductibles have been instituted or raised.
Second surgical opinions, private utilization review and monitor-
ing of physician treatment patterns are all proving effective in cut-
ting claims cost.
Innovative health care financing and delivery systems, such as
preferred provider organizations [PPO] are continuing to prolifer-
ate. Enrollment in health maintenance organizations [HMO's] a
proven efficient alternative to traditional insurance financing of
health care, is growing at over 15 percent per year.
I might add that our recent proposed regulations that would
open up the HMO's to the medicare population we think will in-
crease the rate of HMO growth.
We can say that in the 1970's the degree of comprehensiveness
for employer-provided health care reached a peak. The 1980's are
shaping up as a period of growing discipline in plan design and
management. This is a constructive trend that I would like to see
continue.
As constructive as this direction of movement appears to be, it
does not portend immediate solutions to longstanding problems.
Indeed, new problems seem to come along as fast as old ones abate.
The issue of flexible spending accounts [FSA's] has already been in-
troduced by Mr. Pearlman. I would like to elaborate on that sub-
ject.
As an initial point, let me emphasize the difference between a
cafeteria plan-recently referred to also as a flexible benefit plan-
and the flexible spending account. To illustrate the distinction, con-
sider a prototype cafeteria plan. It might offer employees a choice
among standard comprehensive benefits, a low option with a siza-
ble deduction, and an HMO. It might also offer other benefits such
as a deferred income plan and dependent care. The total value of
benefits would be set by the employer but might be augmented by
an employee contribution.
Flexible spending accounts, developed by some companies and
their consultants early in this decade, extended the above concept
by allowing employees even wider latitude in determining the pro-
portion of their incomes devoted to nontaxable fringe benefits.
Such plans were often packaged with increases in cost-sharing
under the employer-sponsored health plan. The essential attribute
PAGENO="0054"
48
of a flexible spending account is the opportunity it affords the em-
ployee to transform the financing of out-of-pocket medical ex-
penses, and sometimes other purchases from after-tax income to
before-tax income.
Testimony by the Department of the Treasury has stressed the
potential revenue effects of widespread adoption of FSA's. Recent
IRS rules restrict the operation of FSA accounts. Most importantly,
no cash refund or carryover is permitted except for some plans
that are temporarily grandfathered, and under current rules a
flexible spending account can operate only as part of a cafeteria
plan. But the cafeteria plan need not include the essential features
of a flexible spending account.
For this reason, we should be careful to discriminate between ef-
fects attributable to FSA's and those associated with cafeteria
plans. This distinction is especially important when considering
health policy issues relating to tax reform and incentives.
Concern about the potential revenue impact of FSA's is based on
a projection of household expenses that could be channeled through
FSA's barring specific restrictions. It must be remembered that not
only a wide class of employee expenses but also employee contribu-
tions for health insurance plan premium payments could be paid
from such accounts. Out-of-pocket health-related expenses of em-
ployees with potential access to FSA's are now preliminarily esti-
mated to be over $60 billion and will grow to $100 billion by 1990.
Employee premium contributions are $20 billion and will be over
$35 billion in 1990.
Despite the potential for FSA's to be used as a tax-sheltering
device, it is possible that under certain circumstances there may be
some benefits to be derived from the invention of FSA's. Under the
obvious tax-shelter features of FSA's there exists a basically good
idea-the combination of increased front-end cost sharing on
health benefits and a specific employee-controlled account guaran-
teeing availability of funds to pay medical bills engendered by that
cost sharing.
Results from the Rand experiment and other evidence show that
front-end cost sharing reduces spending on health services with no
appreciable effect on employee health. Health spending reductions
affect income tax revenues in two ways: reduced corporate ex-
penses for health care means higher corporate profits and taxes;
and reduced employee compensation in the form of health benefits
means more dollars are available for taxable wages.
The question remaining about FSA's is how much simple tax
sheltering might be expected for any given set of qualifications on
use. In addition to the tax revenue losses that could occur, we must
also recognize that allowing employees to pay out-of-pocket ex-
penses with pretax dollars makes those purchases cheaper, and so
encourages utilization of the services thus purchased. This relation-
ship could cancel possible constructive effects mentioned above.
To resolve these issues, many questions must be answered. Rec-
ognizing the need for more information, as you know, Congress
mandated further study of the issues as a provision of DEFRA. My
office, with the cooperation of the Treasury Department, has un-
dertaken this study. We expect to report the results by April 1,
1985.
PAGENO="0055"
49
Before concluding, I would like to touch on another policy issue
inherent in the distribution of employer-provided health benefits-
the issue of equity. Employer-provided benefits are given preferen-
tial tax treatment, and the advantages bestowed by this treatment
increase with income. According to available data, employer-premi-
um contributions for health benefits rise from an average of about
$800 for covered workers in the lowest 15-percent-income bracket
to $1,300 for workers in the top 40-percent bracket. The higher paid
workers have more to gain by receiving compensation in the form
of nontaxed benefits because their income tax brackets are higher.
In stark contrast, some workers-most often those in marginal,
part time, and temporary jobs, the self-employed, and workers be-
tween jobs-have no coverage at all. These workers tend to be low
income but they receive no benefit whatsoever from the current
preferential tax treatment of health insurance.
I have touched on three problem areas in employer-provided
health insurance: inflation, the flexible spending account phenome-
non, and equity. It is only appropriate to mention again a legisla-
tive initiative that addresses all these. That is the proposal to place
a limit on the total amount of income that employers can pay in
the form of tax-free health insurance coverage.
The motivating rationale for such a limit remains, as always, to
reduce the distorting effect of the tax preference leaving employ-
ment groups to develop cost-containment innovations that suit
their own needs. It is not a punitive tax on benefits, but rather an
effort to make the tax law more neutral in the choice between
added wages and added benefits. Such a limit would be enormously
helpful in accelerating the trend to more efficient health plans that
I summarized earlier. It would facilitate the search for ways to cap-
ture the advantages of flexible spending accounts without the ad-
verse effects. And it would contribute to fairness.
In closing, I will reiterate my admiration for the dynamic world
of employer-provided health benefits. The achievements in this
area are both evidence of the genius of the private sector and a
continuing challenge to public policy. The problems that have been
associated with the growth of employer-provided health care are
transient effects that may be controlled through a balancing of in-
centives.
In the interest of retaining the advantages of private-sector re-
sponsibility, I hope to see the goal of Federal policy remain that of
making employer provision of health and other fringe benefits even
more efficient, fair, and conducive to a stable economy.
I would be glad to try to answer your questions, Mr. Chairman.
Chairman STARK. Thank you, Doctor.
I gather that you share the Treasury's view that it would be a
good matter of equity to enforce the salary nondiscrimination rules
in the area of health benefits or health programs, medical-care pro-
grams?
Mr. HELMS. You mean the question you put to Mr. Pearlman
about nondiscrimination?
Chairman STARK. Yes; it is one of the major areas in fringe bene-
fits where we don't say the plan has to be the same for all levels of
salary, and can't discriminate on the basis of income.
PAGENO="0056"
50
Mr. HELMS. Let me make a couple of points about that, Mr.
Chairman.
In particular, table 2-first of all, I would go along with Mr.
Pearlman. I think we would like to consider that these nondiscrim-
ination rules be applied to the health-care sector. But, having said
that, I am personally not aware that they have been presented as
any particular problem. I think the evidence is that most employer-
provided plans are made available across the board to employees of
each company.
The problem addressed in Mr. Pearlman's table 2 is that you
have a low percentage of the people in the lower income brackets
having health coverage. I don't think they would be greatly affect-
ed by nondiscrimination rules. That is mostly a phenomenon of a
lot of employed people who work for small firms; they are simply
not insured.
We have found that over half the noninsured people are full-time
workers and their dependents. I just don't think the application of
the nondiscrimination rules would directly affect that problem.
Chairman STARK. No, I don't think it would, either. It would
probably raise a little revenue.
There probably is a fairly widespread practice in smaller groups
where the owners or highly paid executives have substantially
more benefits than the average worker, but that is not to say the
average worker's benefits are not good. They may not take care of
orthodontia and fitness center trips and cosmetic surgery and the
like, hair transplants and some other more--
Mr. HELMS. Gymnasiums.
Chairman STARK. No. Gymnasiums now have to be on a nondis-
criminatory basis.
Mr. HELMS. OK.
Chairman STARK. Mr. Duncan.
Mr. DUNCAN. I have no questions, Mr. Chairman. Thank you.
Chairman STARK. Thank you.
We look forward to working with you on this matter.
Mr. HELMS. Thank you.
Chairman STARK. Our next witness is Harry Ballantyne, Chief
Actuary, Social Security Administration.
Welcome to the committee, Mr. Ballantyne. Your entire state-
ment will appear in the record. You may proceed to summarize it,
expand on it, in any fashion you prefer.
STATEMENT OF HARRY C. BALLANTYNE, CHIEF ACTUARY,
SOCIAL SECURITY ADMINISTRATION, DEPARTMENT OF
HEALTH AND HUMAN SERVICES, ACCOMPANIED BY BRUCE
SCHOBEL, ACTUARY, SSA
Mr. BALLANTYNE. Thank you, Mr. Chairman.
Mr. Chairman and members of the subcommittees, I am Harry
Ballantyne, Chief Actuary of the Social Security Administration. I
have with me Bruce Schobel, one of my assistant actuaries.
I am happy to be here today to discuss with you the effects of
employer-provided fringe benefits on Social Security program fi-
nancing and benefits. My prepared statement is quite short and
covers essential points, so I will just present it.
PAGENO="0057"
51
Chairman STARK. Please proceed.
Mr. BALLANTYNE. For purposes of this statement, "fringe bene-
fits" refers to that portion of an employee's total compensation
that is not covered for Social Security purposes.
As the subcommittees are aware, the proportion of employee
compensation represented by nontaxable fringe benefits has grown
from about 8 percent in 1960 to about 16 percent this year. From a
Social Security perspective, the growth of fringe benefits brings
about a concomitant erosion in the proportion of total employee
compensation represented by wages. This proportion has thus de-
clined over the years, from 92 percent in 1960 to 84 percent this
year. Based on the intermediate-Alternative TI-B-assumptions of
the 1984 OASDI Trustees Report, we project this figure will decline
to about 66 percent by 2060-about 75 years from now.
Based on the wage and productivity assumptions in Alternative
IT-B, we project that, over most of the next 75 years, wages will
grow at an average annual rate of 5.5 percent. Total employee com-
pensation, however, is projected to grow at an average annual rate
of 5.8 percent. If the rate of growth in fringe benefits outpaces the
growth in wages to the extent assumed in the 1984 Trustees
Report, by the year 2060 fringe benefits will represent some 34 per-
cent of total compensation.
I am submitting for the record a graph showing these trends as
well as other projections based on the subcommittees' requests.
This projection, under present law, reflects the assumption that
total wages, as a percentage of total compensation, will decline at a
long-term rate equal to about three-fourths the rate of decline over
the last 30 years. In part, this slower rate of decline in the future
reflects the actions taken by the Congress since 1980 to alter the
tax treatment of fringe benefits.
As you know, in accordance with the recommendations of the
National Commission on Social Security Reform, the 1983 Social
Security amendments contained a provision subjecting to Social Se-
curity taxes payments into section 401(k) cash or deferred arrange-
ments. Such arrangements are among several kinds of fringe bene-
fits that are now treated differently for purposes of the Social Secu-
rity payroll tax and for the Federal income tax. Also, the Deficit
Reduction Act of 1984 provides that any fringe benefits not specifi-
cally excluded by statute are taxable for income tax and Social Se-
curity tax purposes.
The importance of the erosion in wages as a percentage of com-
pensation, for purposes of Social Security, is that, because the
OASDI program receives most of its income from a tax on covered
wages, a decline in the proportion of total compensation subject to
payroll taxes can cause income to the program to be lower than it
otherwise would be and thus affect the level of the tax rates neces-
sary to fund the program adequately-the same is true for the hos-
pital insurance program.
In addition, if an income shortfall results from continued faster
growth in nontaxable fringes, the burden of making up that short-
fall would fall not only on those workers who benefit from the ad-
ditional fringes but also on those workers whose nontaxable fringe
compensation does not keep up with the general rise.
PAGENO="0058"
52
Finally, as the mix of covered wages and noncovered fringe-bene-
fit compensation changes, workers have a smaller proportion of
their total compensation included for purposes of computing their
social security benefits. Thus, workers and their families stand to
get lower social security benefits when they retire, become disabled
or die than they would if the amounts credited to them as earnings
for social security benefit purposes more closely resembled their
total compensation package.
In this connection, I am submitting for the record illustrative ex-
amples of the effects of future growth in nontaxable fringes on the
amounts of employees' social security taxes and benefits, prepared
at your request. These figures can vary considerably, depending on
the underlying assumptions.
Before I discuss the long-range social security cost effects of the
tax and benefit status of fringe benefits, it is important to refer to
technical matters that may well have significant impact on any
long-range cost figures.
In estimating the financial effects, we have assumed that any ex-
tension of social security coverage to fringe benefits that are cur-
rently exempt from taxation would provide for the inclusion of
those earnings for benefit-computation purposes, as well. This as-
sumption, however, raises a number of other technical questions.
The most important among these is the question of whether any
taxable fringe benefits-that is, fringe benefits that would be sub-
ject to social security taxes and creditable toward social security
benefits-would be included in the annual calculation of the aver-
age wage series that is used for purposes of indexing covered earn-
ings, the earnings base, the retirement earnings test exempt
amounts, and the benefit-formula bend points.
Including a broader compensation base in these computations
would raise future benefits for today's workers, even for those who
get no fringe benefits. Such extra benefits would significantly offset
any long-range gain in trust fund income. Consideration of such ef-
fects could lead to important policy decisions on the part of the
Congress and the administration, as to the proper definition of the
wage series to be used for indexing.
Let me now turn to specific estimates of the effects of including
currently nontaxable, fringe-benefit compensation in taxable
income for social security purposes. I will respond to the subcom-
mittees' requests in the order in which they were stated in Chair-
man Pickle's letter of September 11.
I might note that the subcommittee requests were phrased in
terms of the long-range tax rates necessary to keep trust fund
ratios at currently projected levels over the long range if nontax-
able fringes were made taxable for social security purposes under
four assumptions with respect to the relative mix of taxable wages
and nontaxable fringe benefit compensation.
First, if nontaxable fringe benefits as a proportion of total com-
pensation were to be maintained at 1984 levels, the long-range
OASDJ actuarial balance would increase by 0.50 percent of taxable
payroll-implying that a reduction of 0.50 percentage points could
be made in the average combined employee-employer OASDI tax
rate over the normal 75-year valuation period.
PAGENO="0059"
53
Second, if, as a percentage of total compensation, nontaxable
fringe benefits were allowed to grow at half the rate implicit in the
Trustees Report Alternative IT-B assumptions, the long-range
OASDI actuarial balance would increase by 0.25 percent of taxable
payroll.
Third, if nontaxable fringe benefits were to be brought down to
their 1960 level, as a proportion of total compensation, and were
kept at that level, the long-range OASDI actuarial balance would
increase by 0.65 percent of taxable payroll.
Fourth, if all current and future fringes were to be taxable for
social security purposes, the long-range OASDI actuarial balance
would increase by 0.80 percent of taxable payroll.
In conclusion, let me return to the policy matters I referred to
earlier and note that these long-range savings would be higher if
currently nontaxable fringes that would be subject to social securi-
ty taxes and creditable for benefits were not to be included in the
computations of the average-wage series used for wage indexing. I
am not taking a position on whether such exclusion would be desir-
able, but rather wish to highlight this area as one that may need
further investigation.
That concludes my prepared statement. I will be happy to re-
spond to your questions.
[The attachments to the statement follow:]
PAGENO="0060"
FRINGE BENEFITS
AS A PERCENTAGE OF TOTAL COMPENSATION
40%
35%
30%
25%
20%
15%
10%
5%
0%
1955 1970 1985 2000 2015 2030 2045 2060
Projections are based on the intermediate (alternative Il-B) assumptions of the 1984 Trustees Report.
PAGENO="0061"
55
Table 1
Illustrations of additional contributions and benefits
for employee with "average" earnings
Assuming no further growth
in taxable fringe benefits as a percentage of compensation
Social Security Administration
Office of the Actuary
September 17, 1984
Additional employee
contributions
OASDI OASDI-HI
Additional initial
monthly benefits
Primary
insurance Family
amount maximum
$65 $81 $3.30 $6.20
A.
Retirement
1.
Age 60 in
at age 65
January 1984, retires
in January 1989
2.
Age 45 in
at age 65
January 1984, retires
and 4 months in May 2004
1,705
2,104
93.50
170.10
3.
Age 21 in
at age 67
January 1984, retires
in January 2030
22,345
27,572
868.50
1,570.40
B.
Disability
.
1.
Age 21 in
at age 30
January 1984, disabled
in January 1993
240
297
29.50
44.20
2.
Age 45 in
at age 55
January 1984, disabled
in January 1994
306
379
34.50
51.70
3.
Age 21 in
at age 55
January 1984, disabled
in January 2018
7,636
9,422
392.20
588.30
C.
Survivor
1.
Age 21 in
at age 30
January 1984, dies
in January 1993
240
297
30.50
54.80
2.
Age 45 in
at age 55
January 1984, dies
in January 1994
306
379
34.50
63.40
3.
Age 21 in
at age 55
January 1984, dies
in January 2018
7,636
9,422
392.20
714.10
PAGENO="0062"
56
Table 2
Illustrations of additional contributions and benefits
for employee with "average" earnings
Assuming one-half of the growth projected under present law
in taxable fringe benefits as a percentage of compensation
Additional initial
monthly benefits
Additional employee Primary
contributions) insurance Family
OASDI OASDI-HI amount maximum
A. Retirement
1. Age 60 in January 1984, retires
at age 65 in January 1989 $33 $41 $1.50 $2.20
2. Age 45 in January 1984, retires
at age 65 and 4 months in May 2004 836 1,032 46.20 83.40
3. Age 21 in January 1984, retires
at age 67 in January 2030 10,813 13,342 419.10 758.50
B. Disability
1. Age 21 in January 1984, disabled
at age 30 in January 1993 118 147 14.30 21.40
2. Age 45 in January 1984, disabled
at age 55 in January 1994 151 187 16.80 25.20
3. Age 21 in January 1984, disabled
at age 55 in January 2018 3,720 4,591 190.50 285.80
C. Survivor
1. Age 21 in January 1984, dies
at age 30 in January 1993 118 147 14.90 25.60
2. Age 45 in January 1984, dies
at age 55 in January 1994 151 187 16.80 31.00
3. Age 21 in January 1984, dies
at age 55 in January 2018 3,720 4,591 190.50 346.30
Social Security Administration
Office of the Actuary
September 17, 1984
PAGENO="0063"
57
Chairman STARK. Thank you very much, Mr. Ballantyne.
On your Table 1, do some back-of-the-envelope arithmetic, if you
will, with me. Under "A. Retirement," a person 45 years old-take
that one-he retires at about 20 years, and under your table that
would mean they would put in approximately $100 a year in addi-
tional employee contributions under FICA.
Am I interpreting that right-somewhere between $1,705 or
$2,100, if you include health insurance?
Mr. BALLANTYNE. Yes; I think that is right.
Chairman STARK. So, in round figures, you can say a man today,
or an employee today-single employee, I gather this is-if they
paid an additional $200, which is the FICA tax there that they are
not paying because of their fringe benefits being tax-free, they
would have about-if you take the average for the primary
amount-somewhere between $90 and $170-say, $130 a month, to
pick a middle figure. So for paying $200 a year for 20 years--
Mr. BALLANTYNE. About $100 a year?
Chairman STARK. I beg your pardon?
Mr. BALLANTYNE. Wasn t it $100 a year, Mr. Chairman?
Chairman STARK. No. It is about $200-excuse me. Yes, $100 a
year, yes.
You end up getting $100 a month increase in your annuity, as it
were.
Now, can you tell me roughly what it would cost somebody to
buy an annuity to provide, let's say, $1,400 a year or $1,500 a year,
or $1,000-whatever is easy to do-and make 20 payments? I have
no idea. But I would imagine substantially more than $100 a year.
I say this only because I think many times people in my town
meetings will say, "I can take this money and invest it and make
so much more than social security, if you let me go to E.F.
Hutton."
I am guessing; you probably have to earn 30 or 40 percent return
year-in and year-out on your money tax-free to come anywhere
close to getting these kinds of benefits.
I understand the employer is paying in as well, but I am just
talking from the standpoint of the social security beneficiary. It is
a fabulously good deal for people. And I would wonder if they
wouldn't be encouraged-if they had any idea how much this
would return to them-to just almost voluntarily go ahead and pay
the increased FICA on their fringe benefits.
I am looking at this table correctly, am I?
Mr. BALLANTYNE. Yes; that is right. I agree with you that the
return would be much higher than for a private annuity.
Chairman STARK. And be better for the system, would it not, be-
cause of the other side of the issue-that you have the employer's
contributions?
Mr. BALLANTYNE. It would be better for the system because there
would be a long-range gain.
Chairman STARK. So, in effect, by taxing, as far as FICA, we
would be giving, by any commercial standard, outstandingly gener-
ous, almost unobtainable benefits. I mean, in the realm of commer-
cial practice, you couldn't buy a benefit that begins to approach
that.
Mr. BALLANTYNE. Right.
PAGENO="0064"
58
Chairman STARK. Secondly, we would be helping the economic vi-
ability of the system.
Mr. BALLANTYNE. Right.
I think it is difficult to compare with private annuities, but I
think that if a reasonable and well-balanced analysis of that issue
were to be made you would have to take account of several things,
such as the duration of time during which benefits would be re-
ceived, interest rates, and cost-of-living-adjustment increases in
benefits, as well.
I think that by and large the comparison between how much a
worker pays in increased contributions-the total amount-and the
total benefits he might expect to receive, would be on the average
somewhat less than it is under present law, which is--
Chairman STARK. Doesn't this example that we are talking
about-or this phenomenon-impact favorably the low income
worker far more? Your figures are based on an average salary. But
if we take those people that are below $15,000 or below $12,000,
whatever the average is, isn't the effect on their benefits even
greater?
Mr. BALLANTYNE. Right; because of the weighting of the benefit
formula.
Chairman STARK. And the maximum is at $30,000--
Mr. BALLANTYNE. $37,800.
Chairman STARK. Somebody way above that would be getting
proportionally less.
So if we were to tax or apply the FICA tax to these fringe bene-
fits, it would be heavily weighted in favor of the lowest income
workers?
Mr. BALLANTYNE. There would be somewhat more weighting to-
wards them. A worker with more than the maximum wouldn't be
affected because I would assume the wages would be counted first,
and he is already paying the maximum. So he would have to be
under the maximum.
Chairman STARK. So it would not be overly progressive in terms
of their burden.
Mr. BALLANTYNE. Right.
Chairman STARK. Well, Chairman Pickle unfortunately had
some-not unfortunately for the rest of the world, because he has a
speech to make on the floor which I think he is delivering about
now, or has just delivered-he wanted to emphasize particularly
that last question, that there is a tremendous benefit to the em-
ployees, and that benefit is very progressive as to its benefits. And
I think I am adequately stating that that is his concern; that
people are losing, one, a tremendous opportunity; two, the cost is
minimal; and three, I think it is safe to say in behalf of Chairman
Pickle that it would be a great benefit to the survival or the sound-
ness of the trust fund if we add what seems now to be kind of deal-
ing penny-wise and perhaps even pound-foolish-I know there are
people concerned that one fringe benefit may be singled out over
another to pay taxes on. But I think that in the interests of the
working people of this country they would be clamoring to get
FICA taxes applied to every fringe benefit they could find.
Wouldn't that make economic sense if they were just doing it in
a rational sort of approach to their own economic health? They
PAGENO="0065"
59
can't buy, as near as I can tell-and I really would appreciate it if
you would take one of these examples and say, if you assume the
average worker you can assume the average marginal bracket,
which is somewhere around 30-some percent, and take it out as to
what they would have to earn to accomplish this as individuals. I
still think there are people out there who think they can do better;
that social security to them is just not a good buy. I think we
would do them all a favor if we could dispell that myth.
So in behalf of Chairman Pickle, I thank you for preparing this
information. And I would like to look forward to working with your
office to get this even into simpler language that the average wage-
earner like myself can understand.
Mr. Duncan.
Mr. DUNCAN. I have no questions. Thank you, Mr. Chairman.
Chairman STARK. Thank you very much for your excellent testi-
mony. We appreciate your appearance.
Mr. BALLANTYNE. Thank you, Mr. Chairman.
Chairman STARK. The committee will stand in recess until 10
o'clock tomorrow morning.
[Whereupon, at 12:33 p.m., the subcommittees recessed, to recon-
vene at 10 a.m., Tuesday, September 18, 1984.]
40-046 0 - 85 - 5
PAGENO="0066"
PAGENO="0067"
DISTRIBUTION AND ECONOMICS OF
EMPLOYER-PROVIDED FRINGE BENEFITS
TUESDAY, SEPTEMBER 18, 1984
HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND
MEANS, SUBCOMMITTEE ON SOCIAL SECURITY AND SUBCOM-
MITTEE ON SELECT REVENUE MEASURES,
Washington, DC.
The subcommittees met at 10:10 a.m., pursuant to notice, in room
1100, Longworth House Office Building, Hon. J.J. Pickle (chairman
of the Subcommittee on Social Security) and Hon. Fortney H. (Pete)
Stark (chairman of the Subcommittee on Select Revenue Measures)
presiding.
Chairman PICKLE. The Chair calls to order the joint Subcommit-
tees on Social Security and Select Revenue Measures, for consider-
ation of employee benefits. When we opened the hearing yesterday
we asked for any preliminary remarks by individual members. I
am pleased to recognize, before we start our hearings this morning,
the distinguished gentleman from Hawaii, Mr. Heftel, a member of
the Subcommittee on Select Revenue Measures, and a very effec-
tive member of our committee.
Mr. Heftel.
Mr. HEFTEL. Mr. Chairman, as we carry on with these delibera-
tions, I think we are going to have to recognize something that is
occurring in the nation, namely that the American people no
longer tolerate a tax system in which taxpayers with the same
income pay different effective tax rates, and we will have to make
that a part of our deliberations, if they are going to be meaningful.
Thank you very much.
Chairman PICKLE. I thank the gentleman for his comments. Do
any other members wish to make preliminary statements?
I am pleased to have you with us this morning, Mr. Heftel. You
always make a valuable contribution to our hearings.
We have several panels today, and therefore we are going to ask
the participants to summarize and condense their testimony as
much as possible. We are not trying to race through these hearings
but, due to the number of people testifying, we hope we can make
as much progress as possible.
The first panel this morning will consist of Mr. Dallas Salisbury,
president of the Employee Benefit Research Institute; Mr. Donald
C. Alexander, Esq., on behalf of the U.S. Chamber of Commerce,
-and Mr. Frank Swain, chief counsel, Office of Advocacy of the U.S.
Small Business Administration. Also we have Mr. Michael Romig,
(61)
PAGENO="0068"
62
director of the Employee Benefits and Human Resources Policy
Center with the chamber of commerce.
Our first person will be Mr. Dallas Salisbury, representing the
EBRI, a very important and valuable research institution in the
United States.
STATEMENT OF DALLAS L. SALISBURY, PRESIDENT, EMPLOYEE
BENEFIT RESEARCH INSTITUTE
Mr. SALISBURY. Mr. Chairman, it is a pleasure to be here today
for this important discussion of employee benefits. I refer your at-
tention to the package of charts that are in your stack, for my tes-
timony.
In terms of the press release announcing this hearing, a number
of specific questions were asked. First, the question of how preva-
lent are employee and fringe benefit programs, and thus how does
this compare to the past. Chart 1 in that package provides informa-
tion on the prevalence of primary benefits.
Chairman PICKLE. Mr. Salisbury, let me interrupt. We have two
different forms. Is this your statement?
Mr. SALISBURY. No, it is underneath that. It is a much smaller
package. Mr. Heftel has it.
Chairman PICKLE. You have reference to the charts?
Mr. SALISBURY. Right.
Chairman Piciu~. Are you following your summary?
Mr. SALISBURY. I am following the charts.
Chairman PICKLE. The charts, not the summary?
Mr. SALISBURY. Right.
Chart 1 shows clearly, as was evidenced by Treasury data yester-
day, and Health and Human Services data, that primary employee
benefits are nearly universal in medium and large employment sit-
uations.
As will be shown in detail by the SBA testimony, they are not
nearly as universal in small businesses, but for those working in
employment settings above 250 employees, we find retirement pen-
sions for 82 percent of those employees, life insurance for 96 per-
cent, health insurance for 96 percent, health insurance for depend-
ents in 93 percent of those situations, long-term stability for 45 per-
cent, and sickness and accident for 49 percent.
How does this compare to the past? One finds that these levels
have been fairly consistent for the last 10 years. There has not
been significant percentage growth, even though there has been
very significant numbers growth, the absolute numbers of millions
of Americans protected.
Chart 2 provides a slightly different measurement.
It looks at retirement coverage, future benefit receipt or vesting,
if you will, and health insurance coverage for the entire civilian
work force as well as what we have dubbed the ERISA work force
because it is those over age 25 in full-time jobs. For that smaller
population, you find that among all businesses, 70.1 percent of full-
time workers have pension coverage, 36.84 percent have a vested
right to benefits. That number has been growing significantly, and
83 percent currently have health insurance coverage.
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63
Second, you have asked a question of how much do benefits repre-
sent as a percentage of compensation. Chart 3 provides pie dia-
grams to give you an indication of what we are talking about when
we present data on employee benefit programs. You will see that
9.5 percent is required payments, taxable benefits represent 13.9
percent of wages and salaries, tax-favored benefits 9 percent, 4.6
percent of this is health and other fringe benefits, if you will, 4 per-
cent is current contribution to employer retirement programs.
On the right, the percentage of all benefits, you see that the tax-
favored benefits represent approximately 27 percent of all benefits
currently provided by employes.
Third, you asked the question of how much have tax-favored em-
ployee benefit costs grown. Chart 4 presents a schematic diagram,
bearing out the information provided by your witnesses yesterday.
As the lines indicate, during the high inflation years of the 1970s,
the percentage cost of employee benefits grew very dramatically. I
think it is interesting to note that preliminary data on 1983 and
1984 shows that these lines have significantly leveled out.
In fact, in terms of what is happening in the future, current sur-
veys indicate that in 1984, employer pension contributions in the
private sector are expected to drop by approximately 15 percent,
health care inflation from a high in recent years of 17 to 20 per-
cent in premium increases, this year down to 4 and 5 percent.
You have asked the question of how much do benefit costs vary
by industry. I think chart 5 is a very interesting graphic presenta-
tion of this tremendous cost variation. The tremendous equity
issues, if you will, that would arise attempting to put various bene-
fit caps into place, they may well be justifiable policy, but they
would be very complex. As you see, for businesses today, expendi-
tures on tax-favored benefits plus Social Security vary from 12.5
percent of wages and salaries to 29 percent of wages and salaries
on average for the Fortune 500.
Were one to take this graph and expand it to show the extremes,
one would find that some are spending only 6 and 7 percent, others
as much as 42 to 43 percent. So, in terms of changing the tax struc-
ture, these overriding equity issues would have to be carefully con-
sidered.
You also asked which employees by salary range receive employ-
ee benefits. Chart 6 attempts to show that in a clear graphic way.
One finds that both for coverage and vesting of pension programs,
very wide distributions. For those below the poverty level, as was
pointed out by the Treasury Department yesterday, coverage is
only approximately 32 percent. As one moves to the middle income
ranges of $10,000 to $50,000 per year, one finds those numbers
climbing to as high as 82 percent, and for those $50,000 and over,
85 percent.
I think, interestingly, the inference of the Treasury witness yes-
terday was that this implies that pensions principally accrue to the
most highly paid. As a result, in order to explore that issue, we
provide chart 7.
Chairman PICKLE. Before you go to chart 7, do you have a chart
showing the number of people that are not involved in these pen-
sions?
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64
Mr. SALISBURY. You could get this simply by subtracting. In the
$50,000 and over it would be 15 percent of the people earning that
amount of money are not currently covered by those programs. For
$25,000 to $50,000, it would be 18 percent of the civilian work force
that would not be covered, and for $10,000 to $49,000 you would be
going to 32 percent that were not.
If one looks at the issue, as was discussed yesterday, in terms of
equity of the distributions, chart 7 shows that 51 percent of those
employed earn between $10,000 and $25,000 per year. They repre-
sent 59 percent of those covered by pensions, an overrepresentation
for that income group, if you will, and 62 percent of those who are
vested in pensions, again an overrepresentation.
If one looks at the highest income categories, they also are over-
represented, with 2 percent of employment, 2.9 percent of coverage,
and 4 percent of vesting. But to conclude that the pension system
principally provides for the wealthy and the highly paid is clearly
not held forth by Census Bureau data and Health and Human
Services data, as well as private sector data.
If one looks at health insurance as a benefit, chart 8 presents
that information graphically. One finds that health insurance is
much more broadly held than pensions, largely because employer
surveys indicate that health insurance is generally the first benefit
program that any employer chooses to adopt. Those percentages
speak for themselves.
Looking at the distributional question, chart 9 shows you that
45.2 percent of all those with health insurance coverage earn be-
tween $10,000 and $25,000 per year, 17.1 percent between $25,000
and $50,000 per year. Only 2.8 percent of all those with health in-
surance earned over $50,000 per year in the last year. I think,
again, this indicates the broad distribution of these programs, the
fact that any attempt to make a statement that they principally
benefit the highly paid and the wealthy is significantly misplaced.
Another question that was asked in the press release was how
does employee benefit provision vary by industry. Chart 10 pro-
vides that information. As you will see from chart 10, there is sig-
nificant variation. The lowest coverage levels are found in con-
struction, retail trade, and business and professional services. The
highest levels are in the chemical, primary metals, and public em-
ployment areas.
For health insurance, it indicates that rates of over 97 pecent are
found in primary metals, automobiles, chemicals, communications,
while business and personal services firms provide only 59 percent
at the low end of that scale. So there is in fact, in terms of yester-
day's discussion of what we might describe as horizontal equity, do
all firms provide equally, the answer is no.
I think Mr. Swain's testimony will provide some explanations
from the viewpoint of Small Business Administration research as
to why that may be the case.
You asked what are the economic effects of tax incentives for
benefits, and what effects would changes in tax treatment have.
Chart 1 presents that information. Yesterday you heard witnesses
make statements about levels of tax expenditures, and you had a
chart presented to you as table 2 by the Treasury, basically on pro-
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65
viding coverage information and implying that these benefits prin-
cipally, and the tax incentive principally benefited the highly paid.
Chart 11 is taken from a Treasury Department report from the
Joint Economic Committee and the Joint Tax Committee in 1982. I
think it is very interesting to see what they found in the distribu-
tion of taxes paid versus the tax value of benefits. As you see for
those under $10,000 per year, in 1981 they paid a toal of 2.6 percent
of all taxes paid to the Federal Government, yet received at the
minimum 4 percent of the pension tax deferral value, and for non-
taxable disability employer-provided programs, a full 83 percent of
the tax value.
If one goes to the middle income categories, one finds that in the
pension area, between $25,000 and $50,000 per year, all of those
middle earners actually get more as a percentage of the tax defer-
ral value than they pay as a percentage of national taxes. It is only
as you get to the wealthy that you find that they would actually be
better off economically by the Treasury's estimates of the value to
them of pension tax deferrals relative to the amount of income
taxes that they pay. So I think this is a Treasury study the com-
mittee should definitely ask for and look at as a supplement to the
testimony provided yesterday.
The tax deferral question, I noticed in the Washington Post this
morning the principal thing they noted out of yesterday's hearing
was the size, the dollar size of revenue losses to the Treasury. I
think chart 12 makes an interesting distinction, the question of
revenue lost versus revenue deferred in terms of retirement income
programs. If one looks at the pure cash flow methodology and the
Treasury itself, former Treasury officials such as Dan Halperin
have argued numerous times that a lifetime methodology in this
area would be desirable.
As you see, that lifetime methodology indicates that only 14 per-
cent in noninflation adjusted terms, 40 percent in inflation adjust-
ed terms, of the pension tax expenditure is actually ultimately lost
to the Treasury.
I will not even argue over the accuracy of the Treasury figure of
approximately $50 billion in this year's budget as revenue lost. I
think the important point in terms of long-term economic security
is what ultimately is lost to the Government in return for retire-
ment income provision. If one takes their estimate of approximate-
ly $50 billion for 1983, in that year approximately $87 billion in
pension benefits were paid, and those are taxed, so we already have
what one might describe as a favorable economic balance.
Chart 13 responds to a question that was asked on the effect of
tax changes. I note for reference of the committee, and I think the
Department of Health and Human Services should be asked to
very carefully look at this particular issue, because many employee
benefits are nontaxable today, such as medical benefits, the way in
which they are priced for convenience is they are described as a
dollar amount per employee. That has been easy, it has been con-
venient, and in terms of age levels, it has been nondiscriminatory,
if you will, because it has not provided a disincentive to hire older
workers.
Life insurance, on the other hand, is taxed in excess of $50,000
per year. To accommodate that, the Treasury Department and the
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66
IRS, through Congress' mandate, have created a so-called section
79 table that relates the cost of insurance to an actual tax value.
Economic theory and tax theory would suggest that if medical ben-
efits were taxed, they would have to be priced over this same basis,
such that for the 55-year-old worker, the taxable value of life insur-
ance would have to be treated as approximately $6,000 per year,
whereas the same policy for the worker at age 25 would have a tax-
able value of only approximately $700 per year.
Chart 13 shows graphically the tremendous increase in the
actual outlay cost, because of the amount of benefit paid to an indi-
vidual that comes about from these programs. In that sense, plac-
ing a tax on the premium might well result in the equivalent of
deciding that you want to tax benefits as they are received and
paid, rather than the premium income. You may well want to do
that, but I think this effect is one that you should carefully consid-
er.
It is an effect that, if one looks for consistency in the Tax Code,
would almost be required if health insurance taxes were put into
effect.
Tenth and finally, you ask what would happen if you put tax
caps into effect. Meeting the objective of avoiding any-and I
repeat, any, because that is what the press release said-any fur-
ther tax base erosion from employee benefit and fringe benefit ex-
penditures, which was the question in the press release, I would
stress to the committee there is absolutely no way to totally avoid
any further tax base erosion, unless you were to follow a course
that are to very, very significantly tax benefits already being pro-
vided, and almost lower that limit every year as new employers
coming into business decided to provide health insurance or other
benefits.
I say this not to tell you that you necessarily shouldn't do it, but
I think as you look at the numbers and carry it through, if you
were, for example, in the health area or in all benefits to say any-
thing above 20 percent of compensation will be subject to FICA
taxes, for some employers that would mean as much as 20 percent
of current wages and salaries would become subject to FICA tax for
some of their employees, on the employer and the employee side.
Yet for the hundreds of thousands of businesses that Mr. Swain
will speak about, small businesses that do not yet have benefit pro-
grams, they would still be able to put in benefit programs and
spend up to that 20-percent level.
So a total elimination of tax base erosion, I would suggest, is
almost impossible, unless you want to take a step that basically
makes all of these things taxable. A policy option, yes, but it needs,
I think, to be understood that there is a stark line to be drawn. It
can't be done, given that tremendous cost variation shown in one of
the charts, easily.
Employer-sponsored programs and social programs, a unique
team. Social Security, highly redistributionable, providing signifi-
cant benefits to those without pension coverage and low-income
persons with pension coverage. Supplemental Security Income, to
provide for those who fall totally through the cracks. Individual re-
tirement accounts, at least for those without pension coverage, pro-
viding an option. Employer-sponsored programs have been shown
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to provide at least for those with employers of over 250, a nearly
universal supplement to retirement income provisions. The system
is now maturing. Of new retirees, over 50 percent of married cou-
pies are now receiving pension income, over 75 percent will by the.
turn of the century.
In terms of the dollar-for-dollar value, if one looks at health in-
surance, the Treasury noted yesterday, a tax expenditure in 1983
was approximately $17 billion. This financed approximately $77 bil-
lion in health benefit payments for working Americans. In 1983,
employer-sponsored retirement programs represented a tax expend-
iture of approximately $50 billion. This financed approximately $87
billion in retirement benefits in 1983, and have led to an accumula-
tion of public and private pension reserves of over $1 trillion for
the purpose of paying future benefits.
If one looks on the balance of what the government has gotten,
what one might be spending from the government from Social Se-
curity and Medicare, in the absence of private employee benefits,
for working Americans-and I stress for working Americans more
than for employers or any other group-for working Americans
this has indeed been an effective investment.
Thank you, Mr. Chairman.
[The prepared statement follows:]
STATEMENT OF DALLAS L. SALISBURY ~, PRESIDENT, EMPLOYEE BENEFIT RESEARCH
INSTITUTE
SUMMARY
Retirement, health, life, and disability benefits are widespread, with between 70
percent and 83 percent of full time workers over the age of 25 covered.
Nationally an average of 4.6 percent of wages and salaries is spent on voluntary
tax exempt benefits and 4.0 percent on tax-deferred benefits.
These benefits are provided across the salary range, with most going to middle-
income households. Over 75 percent of those with coverage earned less than $25,000
in 1982.
Studies by the Treasury and by private economists indicate that benefits enhance
tax equity and that taxation of benefits would have the most adverse effect on the
lowest earners.
FICA taxes could be lowered if benefits were subject to FICA tax. As the maxi-
mum taxable wage base rises, the rate could be decreased as well. Current govern-
ment estimates overstate the amount, however, because of the assumption that ben-
efits will continue to grow until all compensation is paid as benefits.
Econometric studies indicate that taxation of benefits would lead to reduced avail-
ability, but the exact extent cannot be established. Further, it is impossible to assess
how much higher direct expenditures might have to be to accommodate these cut-
backs.
Imposition of limits or caps that would "prevent further erosion of the tax bases"
would (a) mean that no organizations without programs today could establish them
or (b) that all employers now with programs would have to pay tax on some portion
in order to allow expansion room. Some employers and employees would have to
begin paying tax on more than 20 percent of wages and salaries now paid in the
form of benefits out of current earnings.
Employer-provided benefits complement social programs, help to maintain public
confidence in them, reduce demands placed upon them, and strengthen the economy
in the process. Employer retirement plan benefit payments in 1983 exceeded the
government calculated tax expenditure. by $37 billion and health benefit payments
by $60 billion. And costs per covered participant were far below the per participant
expense of social programs.
* The views expressed in this statement are those of Dallas Salisbury and should not be attrib-
uted to the Employee Benefit Research Institute, its officers, trustees, sponsors, or other staff.
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Employer-provided benefit programs and social programs appear to be an effective
partnership. Each provides for particular segments of the population in an effective
manner. Each adds to economic security. There are some programs that do not meet
this test. During this time of limited resources, they should be reconsidered.
STATEMENT
Mr. Chairman, I am pleased to appear before the Committee today to discuss em-
ployee benefits. Following these hearings I would look forward to an opportunity to
provide additional assistance to the Committee.
The Committee is to be commended for holding this exploratory hearing into em-
ployee benefits and the tax code. The general tax treatment of employee benefit pro-
grams has been relatively consistent over time, with health insurance being tax
exempt and retirement and capital accumulation programs being tax deferred. The
tax treatment of fringe benefits is in transition, with additional "sunsets" ahead.
Nearly all current American workers have experienced the present tax treatment of
primary benefits for their entire careers. These workers have come to take the pres-
ence of social and employer-provided employee benefits for granted: including the
current tax treatment of primary employer provided benefits.
Tax laws favoring specific employer retirement and health insurance plans and
other statutory employee benefits were enacted under the premise that extensive
coverage of workers and their dependents under these plans is desirable social
policy. Numerous research studies have documented the fact that these employer
based programs complement Social Security and Medicare and reduce long-term de-
mands on these social programs. Further, as I will document, they complement the
design of these programs.
The press release announcing this hearing asked a number of specific questions
that I will attempt to answer for the Committee. First, how prevalent are employee
benefit and fringe benefit programs, and how does this compare to the past?
Chart 1 provides information on prevalence for the primary benefits of retire-
ment, life, health, sickness, and disability for medium and large firms among full-
time workers. Health, life, and disability programs are provided to between 90 and
95 percent of these full-time workers and retirement programs to 82 percent. Infor-
mation is not collected on the fringe benefits (education, legal, van pool) because
very small numbers of employees are covered by these programs.
Not all workers are with medium and large firms, however, so we must also look
at the total civilian work force. Data collected by the Bureau of the Census in May
1983 for EBRI and the U.S. Department of Health and Human Services provides
this information for retirement and health programs.
Chart 2 and Table 1 show that retirement and health programs are prevalent,
particularly among those working over 1,000 hours per year. Among full-time em-
ployees over the age of 25, 70.01 percent are covered by a pension and 36.84 percent
currently are entitled to a vested benefit. Of all civilian workers age 14 to 64, 52.07
percent are covered and 24.35 percent are entitled to a vested benefit. Health insur-
ance is also more readily available to full-time workers, with 83.07 percent having
primary coverage compared to 59.66 of all civilian workers.
Retirement program and health insurance coverage have grown significantly in
absolute terms, but remained relatively constant in percentage terms over the past
ten years.
Second, how much do benefits represent as a percentage of compensation?
According to Chamber of Commerce data, presented in Chart 3 and Table 2, em-
ployer contributions to tax-exempt and tax-deferred employee benefits totaled 9.0
percent of wages and salaries in 1982.
Employer contributions to tax-favored benefits-those that are not taxed as cur-
rent income to the employee-can be divided into two groups: benefits on which
taxes are deferred and benefits that are tax exempt.
Tax-deferred benefits include primarily employer contributions to retirement
income and capital accumulation plans. These constituted about 4.0 percent of
wages and salaries in 1982. Taxation of these benefits is deferred until the employee
withdraws funds from the plan.
Tax-exempt include employer contributions to group health insurance and a vari-
ety of smaller benefits that include dental insurance, child care, merchandise dis-
counts, and employer-provided meals. These benefits constituted 4.6 percent of
wages and salaries in 1982.
Failure to distinguish among the growth of legally required employer payments,
fully taxable employee benefits, tax-deferred benefits, and tax-exempt benefits has
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greatly distorted the perception of the tax-base erosion that can be attributed to tax-
favored and tax-exempt benefits.
Third, how much have tax-favored employee benefit costs grown?
Over the past thirty years, tax-favored employee benefits have grown more rapid-
ly than wages and salaries and slightly faster than either legally required employer
payments or fully taxable employee benefits. Consequently, tax-favored benefits
have absorbed a rising share of total compensation. Chart A and Table 3 show that
pension and profit sharing contributions grew significantly in the post ERISA
period, and health care cost inflation felt by employer and social programs doubled
expenditures for group health insurance. The recent slower growth of employer pen-
sion contributions appears to be likely to continue, according to the most recent em-
ployer surveys. The slower growth between 1980 and 1982 of employer health insur-
ance contributions as a share to total compensation may reflect the maturation of
group health coverage and benefits, as well as employer efforts to contain the cost of
private health insurance plans.
"Fringe" benefit expenditures have not increased significantly over this 30 year
period. Government data shows that expenditures are less than .5 percent of wages
and salaries.
Fourth, how much do costs vary by industry?
The cost of discretionary employee benefits varies significantly from employer to
employer, even within industries. Further, there is significant variation among in-
dustries. During 1982 total average expense ranged from 12.5 to 29.0 percent of total
compensation among Fortune 500 firms. The expenditure would be lower for very
young and small businesses. Chart 5 and Table 4 present data for the Fortune 500
for twelve different industry groups. It documents significant variation in expendi-
tures for voluntary tax-exempt and tax-deferred employee benefits.
Fifth, what is expected to happen in the future?
Retirement program and health insurance coverage may well be at a plateau for
the near term. For retirement programs, benefits receipt will continue to grow as
the system continues to mature, but there are structural questions that need to be
explored.
Employee benefit cost rate growth is likely to continue to slow. Employer contri-
butions to retirement programs are expected to decline by 15 percent in 1984 as
more plans reach the point of full funding. Health cost inflation is down significant-
ly, which will hold down premium growth. Additionally, employers are moving on
many fronts to control health care expenditures today and in the future. Surveys of
employers indicate that a changing work force, changing industry structure, and
international competition, are combining to put an effective lid on excessive future
employee benefit growth.
Employee expenditures on a tax-favored basis, however, are expected to continue
to grow. These "salary reduction" features were a part of the Revenue Act of 1978.
And contributions to Individual Retirement Accounts (IRAs) are expected to contin-
ue to grow also.
Expenditures on all other employee and fringe benefits combined are small, as
shown by Chart 3 and Table 2, and these expenditures are not expected to grow sig-
nificantly.
Sixth, which employees by salary range receive employee benefits?
Primary benefits are broadly distributed across the income spectrum. Charts 6
and 7 and Table 5 show that nearly 83 percent of all nonagricultural wage and
salary workers earn less than $25,000 per year. Pension coverage and vesting follow
this pattern with 76 percent of those covered earning less than $25,000 and 70 per-
cent of those vested earning less than $25,000. The table also shows that while the
proportion of those earning over $50,000 participating in a retirement program is
high, these persons represent only 2.89 percent of all pension participants.
Growth of employer group health insurance coverage among workers and their
dependents has promoted wide access to health care throughout the population.
Health insurance is the `most common benefit offered employees in the United
States. Charts 8 and 9 and Table 6 show that in 1982 health insurance enjoyed a
broad distribution across the income spectrum. Those earning less than $25,000 con-
stituted 80.1 of those with health insurance protection.
Other employee and fringe benefits now, as a matter of law, have to be provided
on a non-discriminatory basis. While data is not available, this requirement likely
means that distributions are similar.
Seventh, how does employee benefit provision vary by industry?
Retirement program coverage, as shown in Chart 10 and Table 7, varies consider-
ably by industry. The lowest coverage levels are found in construcition, retail trade,
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and business and professional services. The highest levels are in the chemical, pri-
mary metals, and public employment areas.
Chart 10 and Table 7 indicate that health insurance provision is more consistent
across industries, but that variation does exist. Rates of over 97 percent are found in
primary metals, automobiles, chemicals, and communications, while business and
personal services firms provide for 59.92 percent. Health insurance is generally the
first benefit employers provide.
Eighth, what are the economic effects of tax incentives for benefits and what ef-
fects would changes in tax treatment have?
A number of studies have been done to assess horizontal and vertical equity of the
tax provisions. The Treasury Department conducted such a study in 1982. The re-
sults of that study are confirmed by a just completed study by economist Sophie
Korczyk. Chart 11 and Table 8 show that the tax value of employee benefit incen-
tives parallels tax payments, with low income persons getting more of the value of
the tax reductions than their share of tax payments and the highest paid getting
less. In other words, a change in the tax treatment of benefits would lead to a re-
gressive result. More recent studies by economists Deborah Chollet and Sophie
Korczyk confirmed these findings, as did a CBO analysis of the health care tax cap
proposal published in 1983.
Private retirement program tax expenditures form the single largest category of
tax expenditures in the federal budget. They arise from the deferral of taxes paid
on: (1) pension and retirement saving contributions and (2) earnings on these contri-
butions. The dollar value of the tax expenditure demands that equity and efficiency
questions be explored (see Appendix II for a brief discussion of the tax expendi-
tures). A major new study by Sophie Korczyk assesses these incentives in a lifetime
context. She finds that the economic value to the government is significantly great-
er than looking at tax expenditure numbers alone would imply. As much as 72 per-
cent of the real (i.e., inflation-adjusted) value of taxes deferred during the pension
participants' working career is ultimately repaid as income tax during retirement.
Chart 12 and Table 9 show that Treasury tax expenditure statistics, calculated on
a cash-flow basis, leave the impression that the proportion of current tax deferrals
permanently lost to the Treasury is very large. Treasury statistics imply that 83
cents out of every deferred dollar is permanently lost, with the other 17 cents ac-
counted for by current tax payments by retirees. When examined in a lifetime con-
text, the proportion of deferred taxes lost to the Treasury ranges from 14 cents out
of every dollar to 40 cents, depending on whether or not one adjusts for inflation
and interest on deferred taxes and the interest factor used.
One factor that has not generally been considered is discussing changes in the tax
treatment of employee benefits, however, that could involve a significant shift in
the incidence of the income tax is the increasing cost, and therefore value of bene-
fits, as workers age. This would represent a major effect of tax policy change.
Employee benefits such as defined-benefit pensions and health insurance are
almost always discussed as a flat dollar cost per employee or as a level percentage of
pay per employee. Employee representatives, employees, and employers have been
content with this approach since the actual distribution of cost does not affect either
the taxes to be paid by the employee or the employer. As a result, the only attention
given to date to actual per employee cost variation has been undertaken very re-
cently to assess: (1) approaches to health care cost containment and (2) possible dis-
incentives to hiring or keeping on older workers. These recent studies show very
significant cost variation by age (Chart 13 and Table 10).
Does this cost variation make a tax policy difference? The answer will be yes if
employee benefits were to be subjected to income tax or FICA tax. Employees would
come to recognize the inequity involved in paying taxes without reference to the
true economic value of the benefit being provided. This could lead to demands for
taxing based upon the actual dollar value of the benefit provided or a move to tax
the benefits paid instead of the premium. This would require a total restructuring of
the way in which benefit programs are run.
Present approaches to health insurance pricing and delivery were developed in
the present tax environment. A major change in that environment will have a
major affect on those approaches and structures. Nearly all of the government and
academic research done on this subject to date assumes that a change in tax policy
will not change the method of providing or pricing benefits.
Finally, econometric estimates of private health insurance suggest that significant
numbers of persons now covered would not choose to purchase health insurance if it
was not available from an employer and largely paid for by the employer.
Tenth, what levels or limits would have to be placed on benefit expenditures to
prevent further tax base erosion?
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Meeting the objective of avoiding any further tax base erosion from employee ben-
efit and fringe benefit expenditures could be achieved in a number of ways, but
none would be simple.
1.FICA
a. Any expenditures beyond those now being made would be subject to FICA tax.
This would mean that on average expenditures above 9 percent of wages and sala-
ries would be subject to FICA. But it would also mean that any new plans estab-
lished would be subject to FICA beginning with the first dollar of expenditure.
b. Any expenditures beyond the current national average would be subject to
FICA. Table 4 shows that this would require some employers and employees to
begin paying FICA on more than 20 percent of wages and salaries where it is not
now paid. To avoid any further erosion, any organization putting in a plan for the
first time would pay FICA on every dollar.
c. Any expenditures above 5 percent of wages and salary would be subject to
FICA. This would require almost all organizations with benefit programs to pay
FICA on some portion of their current expenditures (some on 24 percent of wages
and salaries-or more) but would allow room for new organizations to establish pro-
grams.
Under present law organizations can spend 15 percent of compensation on retire-
ment programs, and last year the value of the federal civil service pension contribu-
tion was over 27 percent. Health, life, and disability add more. This would mean
very significant employee tax payments out of current income.
2. INCOME TAX
The same alternatives are available. In the income tax area as well, a goal of "no
further erosion"would lead to inequities and to major individual worker and organi-
zational transitions. Table 2 shows the average level above which contributions
would have to be taxable, and Table 4 shows how such caps would affect different
industries.
Finally, what is the relationship of employer sponsored benefits to social pro-
grams?
Social Security, employer-sponsored pensions, and IRAs are complementary, work-
ing together to assure retirement incomes. They are not perfect substitutes in terms
of benefit delivery, but change in one would effect public pressures for, support for,
and confidence in the others.
Social Security provides a floor of protection on a redistributional basis, with
lower earners receiving proportionally greater benefits. Many of those who rely
most heavily on Social Security do not have high enough incomes to allow savings,
and their work is such that they are unlikely to have employer-sponsored retire-
ment plans. Social Security is a pay-as-you-go program. Research indicates that it
has no effect, or a negative effect, on aggregate national savings.
Employer-sponsored plans provide another form of "forced" savings that repre-
sents a tier of income above Social Security. Among employers with more than 250
employees, these programs are almost universal. Among smaller employers they are
not. For a significant portion of the population these advance funded programs rep-
resent their only real savings. As a result, research indicates that each dollar con-
tributed to a pension increases aggregate national savings by at least 35 cents.
IRAs are a vehicle for voluntary savings. They are used by 17 million persons as
compared to over 50 million with pension coverage. Over 13 million IRA holders
also have pension coverage.
There are also differences in what these programs provide, or must provide, under
current law. These differences affect the degree to which employer-sponsored plans
and IRAs "complement" Social Security in terms of retirement income provision.
Social Security only pays benefits as a stream of monthly benefits.
Employer-sponsored plans are of two types: (1) those that only pay benefits as a
stream of monthly benefits-most defined-benefit plans and some defined-contribu-
tion plans such as TIAA-CREF and (2) those that make one time "lump-sum" pay-
ments at change of employment or at retirement age and thus may or may not
produce retirement income-most defined-contribution plans.
IRAs allow the money to be withdrawn at any time with the payment of a small
penalty and after age 59 and ½ allow it to be removed as a lump-sum.
Employer-sponsored health programs provide risk protection to most workers and
their dependents. Research indicates that taxation of these programs might lead to
a reduction in coverage. This in turn could produce significant pressure for a gov-
ernment program to complement present health programs for the poor (Medicaid)
PAGENO="0078"
72
and the elderly (Medicare). Employers also increasingly are providing health insur-
ance for retirees to supplement Medicare. Were these programs eliminated it could
increase long-term costs of Medicare due to a reduction in wellness.
In 1983 health insurance, according to the Treasury, represented a tax expendi-
ture of approximately $17 billion. This financed approximately $77 billion in benefit
payments. In 1983 employer-sponsored retirement programs represented a tax ex-
penditure of approximately $50 billion. This financed approximately $87 billion in
retirement benefits paid in 1983. Numerous research studies have been undertaken
to assess the degree to which contributions to retirement programs, over $100 billion
in 1983, add to national savings. The most pessimistic of these studies concludes
that there is a 35 percent addition, or $35 billion in 1983.
Proposals for tax reform, therefore, need to be carefully scrutinized. To the degree
the full taxation of these programs as income rests on the assumption that they will
continue to exist, research indicates that for mfflions of workers they will not. Fur-
ther, taxation could lead to an unintended age discrimination effect if health insur-
ance were given an income value equal to the benefit provided, which would in-
crease dramatically with age.
CONCLUSION
During a time when there are no apparent limits on direct federal expenditures,
or on "tax incentives," analysis may not need to focus on the diversity of employee
benefits. During a time of apparent limitations, however, when priorities must be
decided upon, careful analysis is required of each employee benefit and why each
employee benefit exists. You are to be commended for undertaking this review
effort. I would welcome the opportunity to be of additional assistance in the future.
Thank you.
PAGENO="0079"
Chart 1
Insurance and pension plans: Percent of full~time employees covered,
medium and large firms, 1983
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics, Employee Benefits in
Medium and Large Firms, 1083, Bulletin 2213 (Washington, DC: ll.S. Government
Printing Office, August 1984).
Retirement pension
Life Insurance
Health insurance~
employees
Health inaurance,
dependents
Long-term disability
insurance
Sickness and
accident insurance
82%
96%
96%
93%
45%
49%
50
Percent
PAGENO="0080"
C)
F-
C)
Retirement Coverage Future Benefit Health Coverage
Source: Employee Benefit Research Institute
Chart 2
Prevalence of Employee
Benefits
LEGEND
Civilian Employment
~ ERISA Work Force
90
80
70
60
50 -
40 -
30
20
-C)
6)
>~
0
E
LU
0
PAGENO="0081"
Table 1
Employment, Retirement Program Coverage, Future Benefit Eritit]ement,
and Primary Health Insurance Coverage, Hay 1983
Retirement Future Benefit Primary Health
Employment Coverage Entitlement Insurance Coverage
(000's and % of Employed)
Civilian Employment 98,964 51,530 24,095 59,041
(All employees & self-- 100.00% 52.07% 24.35% 59.66%
employed)
ERISA Work Force 54,363 38,057 20,027 45,161
(age 25 to 64, working 100.00% 70.01% 36.84% 83.07%
1000 hours or more, one
year of tenure or more)
SOURCE: Preliminary Employee Benefit Research Institute tabulations of the May 1983
EBR1/IIHS CI'S pension supplement and May 1979 DOL/SSA CPS pension supplement.
PAGENO="0082"
Chart 3
Composition of Employee Benefits
I
jT*x_F*?~.dD.~.tLt~
T&ubl. B.n.t1t.
T*z~b1. ~
E.q~th~d P&y~.~L. 9.8Z
Percentage of Wages and Salaries
R.q~ir.4 ~
T.z--F~,~.d H.~.t1t.
Percentage of All Benefits
Source: Employee Benefit Research Institute
PAGENO="0083"
77
Table 2
ç~~oaitior oL.~ loyce Bertef its by Benefit Group. 1982
Employer Pay~'enis Employer Payments
as a Percentage of as a Percentage of
Benefit Group Wages and Salaries All Benefits
Total Benefit Payments 32.5 100.0
Le~aily Required Erployer Payments: 9.5
Social Security (FICA) 5.2 160
Unemployment Compensation 1.1
Workers' Compensation 0.9 2.8
Other Legally Required Payments a/ 2.3 7.1
DIscretionary Taxable Benefits: 13.9 42.8
Time not worked b/ 9.8. 30.2
Rest Periods 3.3 11.7
Other Taxable Benefits cl 0.3 0.9
Discretionary Tax-Favored Benefits: 9.0
Contributions to pension and
Profit-Sharing Plans d/ 4.0 12.3
Group Health, Life, Short-Term
Disability Insurance 4.4 13.5
Other Tax-Favored Benefits e/ 0.6 1.3
Surs4cZ:
Legally Required Employer Payments and
Discretionary Taxable Benefits 23.5 72.0
All Discretionary Benefits 23.0 61.5
Fully Taxable Benefits 13.9 42.8
Tax-Favored Benefits 9.0 27.7
SOURCE: EBRI tabulations of estimates produced by the U.S. Chamber of
Commerce, Employee Benefits 1982 (1983), pp. 11 and 28.
a! Includes government employee retirement, Railroad Retirement Tax, Railroad
Unemployment and Cash Sickness Insurance, and state sickness benefits
insurance.
b/ Includes paid vacations and payments in lieu of vacation; payments for
holidays not worked; paid sick leave; payments for State or Rational Guard
duty; jury, witness, and voting pay allowances; and payments for time lost
because of death in family or other personal reasons.
c/ EBRI estimate based on Chamber of Commerce report of amount of Christmas
or other special bonuses, service awards, suggestions awards, special wage
payments ordered by courts, and payments to union stewards.
d/ EBRI estimate of Chamber of Commerce report of employer contributions to
profit-sharing plans.
a! EBRI estimate of Chamber of Commerce report of employer-paid dental
premiums, merchandise discounts, employee meals furnished by company,
payments for vision care and prescription drugs, moving expenses, and
contributions to employee thrift plans and employee education
expenditures. Tax-preferred benefits are overstated by the amount of
separation or termination pay received by employees but not
distinguishable from other tax-favored benefits in the Chamber of Commerce
estimates.
PAGENO="0084"
6
5
U, 3
~1
/
/ ~
/7
- - - - -
- - - - - - - - . - - -- -- -
- -;~ - -
:--~
Chart 4
Employee Benefits Growth
1950 - 1962
Type of BenefiL
L~gU11y U dUtUd fl~~UUfit~
- - P&i~~~t~ P~~UI!~~ U~d 1'~~11t ~
C m.~t Empk,y~~' LLU~Ut
- - - GzUup U..d~h ~
GrUup Lif. 1n.ur.rnU.
2
o I
1950 1960 1970 1982
Yer~r
Source: Employee Benefit Re8earch Institute
PAGENO="0085"
79
Table 3
Employer Outlays for Employee Benefits in the National Income and Product
Accounts br Selected Years, 1950-1982
950 1960 1970 1982
Total Total Total Total
Amoont Cottttten,atton Smoont Cootpensotton An,oont Cotttpcn~ntton At,tount Cornpcnntstton
Type of ttoooflt (ttttltom) (tomcat) (tiUtkots( (I'omottt) (11ttttoo~) (t'emo,tt) (Litlltoos) l1'et'centl
Legaily mandated benefits
Social Security Old-Age
Survivors and
Disability Insurance 81.3 0.0 $5.6 1.9 816.2 2.6 $69.2 3.7
Social Security Hospital
insurance a a a a 2.3 0.4 16.4 0.9
Unemployment Insurance 1.5 1.0 2.8 1.0 3.5 0.6 17.4 0.9
Worker's Compensation J.,Q Q,,~ ..J.2 Q.2 _i2 _.Q.~ J.2.2 ._U.
Total 13.8 2.4 110.3 3.6 $26.7 4.4 8122.9 6.6
Voluntary benefits
Private pensions and
profit-sharing 1.7
Federal, state, and local
government employees'
retirement plans 1.1 0.7
Group health insurance 0.7 0.5
Grcup life insuratacie 0.3 - 0.2
1.1 ::, 4.9 1.6 13.1 2.1 65.2 3.5
2.9 1.0 7.8 1.3 33.8 1.8
3.4 (.1 12.1 2.0 65.7 3.5
1.1 0.4 2.9 0.5 7.2 0.4
SOURCE: Sophie M. Korc:yk, Retirement Security and Tax Policy (Washington, DC:
Employee Benefit ~
PAGENO="0086"
Chart 5
Employee Benefits Cost Variation
Low
LEGEND
Avg.
Htgh
Worker Ineur~nce
Source: Employee Benefit Research Institute
Retiree Die. & Health
Total
PAGENO="0087"
81
Table 4
Low, Average and High Esployer Contributions to Discretionary
Employee Benefits as a Percent of Total Compensation, 1982
Source: ~RI calculations of data provided by Hewitt Associates.
1/ Based on Fortune magazine's industrial classifications.
2/ Total worker retirement includes employer contributions to defined benefit and defined contribution
pension plans, and profit sharing plans.
3/ Total worker insurance benefits includes employer outlays to group life and survivor plans long-
and short-term disability plans, and health insurance (including medical, dental and vision plans).
4/ Total retiree disability and health includes employer contributions to health insurance arid
disability income for retirees.
Total Worker Total Worker Total Retiree
Retirement !f Insurance BenefitsYDis. Health - Grand Total
iP~3trial Classifications!' _Avg. Hughi Low Avg. High ~ Higj~ Low Avg. High
Petrolesm S Refining 8.6 11.2 13.9 6.9 9.0 11.2 .7 .9 1.1 16.2 21.1 26.2
Electronics (Appliances) 6.0 7.6 9.2 7.2 9.0 10.9 .5 .6 .7 13.8 17.2 20.8
Office Equipment (includes
computers) s.i 6.5 7,7 7.6 9.6 11.3 .6 .7 .8 13.3 16.8 19.8
Industrial and Farm
Equipment
Pharmaceuticals
Chemicals
Paper, Fiber and Wood
Products
Fond
Utilities
Life Insurance
Banks
Retailing
Fortune 500
15.9 .20.7 29.0
16.3 19.4 21.5
19.4 22.3 28.8
7.5
9.7
13.6
7.8
10.1
14.1
.7
.9
1.3
7.4
8.8
9.8
8.1
9.7
10.8
.8
.9
1.0
10.1
11.6
15.0
8.5
9.8
12.6
.8
.9
1.2
7.5
9.2
10.3
8.0
9.9
11.1
.9
1.1
1.2
16.4
8.3
10.0
11.6
8.2
9.9
11.5
.7
.9
1.0
17.3
7.4
10.1
12.6
6.9
9.5
11.9
1.1
1.5
1.9
15.4
8.1
12.5
15.0
6.0
9.1
11.1
1.0
1.6
2.0
15.1
l1.~,/l3.9
15.0
7.2
8.8
10.0
.7
.8
.9
19.3
20.2 22.6
20.8 24.1
21.1 26.4
23.2 28.3
23.5 26.8
14.9 16.4
20.6 29.0
6.0 7.1 7.8 6.2 7.4 8.1 .3 .4 .4 12.5
5.1 9.8 15.0 6.0 9.8 14.1 .3 1.1 2.0 12.5
PAGENO="0088"
ft
2
80
50
8
.5
30
LEGEND
Coven~ed
Vc~ted
Chart 6
Pensions by Earnings
Source: Employee Benefit Research Institute
PAGENO="0089"
st0000
Vesting
Chart 7
Pensions by Earnings
Percentage Distribution Across Income Groups
$io.000 -
Employment Coverage
Source: Employee Benefit Research Institute
PAGENO="0090"
84
Table 5
Employment Coverage and Vesting:
Distribution by Earnings for
Nonagricultural Wage and Salary Workers, Nay 1983
Number of Workers (000's)*
Earnings Employment Coverage Total Vested Benefits
Total
80,289
47,372 27,603
$l-4,999
10,014
2,433 358
$5,000-9,999
15,323
5,747 2,023
$lO,000-14,999
17,827
10,328 5,484
$15,000-19,999
13,101
9,422 5,874
$20,000-24,999
10,283
8,159 5,641
$25,000-29,999
5,515
4,365 3,048
$30,000-50,000
6,611
5,547 4,072
$50,000 and over
1,615
1,371 1,106
Percentage
Employment
Distribution Within Income Group
% Covered % Vested
Total
to Employed to Employed
100.00%
59.00% 34.38%
$1-4,999
100.00
24.29 3.57
$5,000-9,999
100.00
37.51 13.20
.
$lo,000-l4,999
100.00
57.93 30.76
$15,000-19,999
100.00
71.92 44.83
$20,000-24,999
100.00
79.34 54.85
$25,000-29,999
100.00
79.14 55.26
$30,000-50,000
100.00
83.91 61.57
$50,000 and over
100.00
84.90 68.50
Percentage
% Employ-
Distribution Across Income Groups
% of % of Total
Total
ment
Coverage Vesting
100.00%
100.00% 100.00%
$1-4,999
12.47
5.14 1.30
$5,000-9,999
19.08
12.13 7.33
$10,000-14,999
22.20
21.80 19.87
$15,000-19,999
16.32
19.89 21.83
$20,000-24,999
12.81
17.22 20.43
$25,000-29,999
6.87
9.21 11.04
$30,000-50,000
8.23
11.71 14.75
$50,000 and over
2.01
2.89 4.01
*Excludes workers without reported earnings
SOURCE: Employee Benefit Research Institute tabulations of May
1983 EBRI/HHS CPS pension supplement.
PAGENO="0091"
Chart 8
Health Insurance by Earnings
100
90
60
~7O
0
*~ 60
C;'
~50
~ 40
ci
~ 30
0~
20
10
0
$1 - $9999 $10000 - $24999 $25000 - $49,999 $50,000 & Over
Source: Employee Benefit Research Institute
PAGENO="0092"
Chart 9
Health Insurance by Earnings
Percent of All Workers with Coverage
$50,000 & Over 28%
$10000 - $24,999 ~
$25,000 - $49,999
Source: Employee Benefit Research Institute
PAGENO="0093"
87
Table 6
Distribution of Workers
Covered by an Employer Group Health
Insurance Plan by Personal Earnings, 1982 al
Workers with Percent of
Employer Percent of All Workers
Coverage b/ Workers within with Employer
Personal Earnings (in nillions) Earnings Group Coverage
Loss 1.1 41.2 0.5
$ 1-$ 4,999 29.5 53.3 18.4
5,000- 7,499 10.8 64.6 8.1
7,500- 9,999 9.1 74.1 7.9
10,000- 14,999 19.0 84.7 18.8
15,000- 19,999 14.3 90.0 15.1
20,000- 24,999 10.5 92.5 11.3
25,000- 29,999 6.8 93.6 7.5
30,000- 34,999 4.2 93.0 4.6
35,000- 39,999 2.3 93.0 2.5
40,000- 49,999 2.3 90.8 2.5
50,000- 59,999 1.1 91.1 1.2
60,000- 74,999 0.7 88.3 0.7
75,000 or more 0.9 86.2 0.9
Total, All Workers cl 112.7 75.9 100.0
Summary:
Loss-$ 9,999 50.5 59.2 34.9
$10,000- 24,999 43.8 88.3 45.2
25,000- 39,999 13.4 93.3 14.6
40,000 or more 5.1 89.7 5.3
SOURCE: Employee Benefit Research Institute tabulations of the March 1983
Current Population Survey (U.S. Department of Commerce, Bureau of the
Census).
a! Includes all nonagricultural civilian workers who reported employer group
health insurance coverage at any time during 1982, except workers in
families in which the greatest earner is a member of the Armed Forces or
an agricultural worker.
b/ Includes coverage from the worker's own employer group plan or from the
plan of another worker.
~/ Items may not add to totals because of rounding.
PAGENO="0094"
PAGENO="0095"
89
Table 7
Employment and Coverage in the
ERISA Work Force by Industry, May 1983
SOURCE: Preliminary Employee Benefit Research Institute tabulations of
the May 1983 EBRI/HHS CPS pension supplement and May 1979
DOL/SSA CPS pension supplement.
a Number of workers too small to be statistically significant.
INDUSTRY
Employment
(000's)
Percent Covered
Pension Health
GOVERNMENT
11,905
88.26%
88.73%
DURABLE MANIJ.
Primary Metals
Automobiles
8,492
702
823
*
79.84
89.81
92.56
94.17
97.70
98.41
NONDURABLE MANLY.
Apparel
Chemicals
5,862
697
970
72.56
45.82.
91.89
90.52
75.55
97.38
TRANSPORTATION
(ex-railroads)
1,454
`
68.98
86.56
~
CONSTRUCTION
2,130
44.56
`71.93
PUBLIC UTILITIES
811
93.11
95.30
*
COMMUNICATIONS
1,200
88.75
97.46
MINING
660
82.72
96.43
FINANCE, INSURANCE
& REAL ESTATE
.
3,444
,
72.42
84.20
PROFESSIONAL
SERVICES
6,401
.
63.95
.
74.48
WHOLESALE TRADE
2,682
63.26
86.50
RETAIL TRADE
5,833
45.96
64.56
BUSINESS & PER-
SONAL SERVICES
3,184
33.83
59.92
PAGENO="0096"
C-)
M
ci
ci
* Chart 11
Benefits
Revenue Loss and rFaxes Paid
LEGEND
IIoclth
Wkr. Cmp.
F~~J
Lillill
Pon~ion
In~rnc.
Tcixc~c Pd.
0
$lOtc - $15k
Source: Employee Benefit Research Institute
PAGENO="0097"
`laI)lO 8
ftuVcuLiO Louc (or Hajor bunaftia and Tuxea Paid by licuic Clasu lie
Pucunt of Total Adjusted Cross Income Class, i9Ul~
tJOTL': Purcente may not add to 100.0 pecont due to rounding.
1981 income levels and 1982 law.
blncludes the exclusion of contributions and earnings for employer plans and plans for the self employed
arid others. -~
CIziclild~ promluma for group-term life ineurenca and accident and disability insurance.
Exclusion of
Employer Con-
~xcluaton of
Uci
Adjusted Groua
income Claus
tributions for
liedical
insurance &
Hedicel Care
Exclusion
Woikur'~
pensatiori
Benefits
of
Corn-
Untaxed Unem-
ploynont In-
surance
Benefits
Excluaion
Disability
Pay
of
txclusion of
Pencion Con-
tributlons 6
tarningab
Exclusion
Insurance
Premlumac
of
Percent
of Total
Taxes
Paid
Leac than
$10,000
6.5%
29.4%
50.6%
83.0%
4.01.
4.5%
2.61.
$ 10,000 to $ 15,000
8.7
16.6
26.4
14.4
5.6
6.1
5.7
$ 15,000 to $ 20,000
10.7
11.7
9.7
0.7
7.8
8.8
8.0
$ 20,000 to $ 30,000
28.3
24.8
12.8
2.0
22.6
24.0
20.6
$ 30,000 to $ 50,000
32.8
12.9
0.4
-
34.1
34.7
30.4
$ 50,000 to *100,000
10.6
3.5
-
-
17.8
15.2
18.1
$100,000 t.~ *200,000
1.9
0.7
-
-
6.0
4.8 .
8.3
$200000 and over
0.4
0.3
-
-
2.1
1.9
6.3
SOUUCE: EBRI calculations based on U.S. Congress,
1r~c~t~ Tax, July 1983 (Washington, D.C.;
and 63.
Congressional Budget Office, ~~Ln~jp4jy1~oJ.
U.S. Government Printing Office, 1983), Table 9, pp. 62
PAGENO="0098"
T.x.. I~at~
Chart 12
Pensions
Revenue Lost Vs. Deferral
Lifetime - Real/Discounted
T.. D.t.n~d
Treasury Cash Flow Lifetime - Nominal
T.x.. Dsf.n.d
Source: Employee Benefit Research Institute
PAGENO="0099"
93
Table 9
How Muchof Pension-Related ~. Deferrals is Lost to the Treasury?
Taxes
Method Used Taxes Lost Deferred
Treasury Method
83%
17%
Lifetime Method:
Nominal dollars a!
14
86
Real dollars b/
28
72
Discounted for interest:
Cl
at pension rate
40
60
at federal rate
36
64
SOURCE: Sophie N. Korezyk, Retirement Security and Tax Policy
(Washington, DC: Employee Benefit Research Institute,
1984).
~/ Before adjusting for inflation.
b/ After adjusting for inflation.
c/ Interest rate used to discount taxes paid in retirement to
the year of retirement.
PAGENO="0100"
300
-s-c
U]
0
L)
sf50
Of)
~0
i-c
-cc' 200
9-i
0
11) 150
U
I-c
1)
13-c
100
Chart 13
Benefit Cost by Age
350
Type of F3cnefit.
- Medical
Defined l3ancfit
- - - Life Inscurence
/ V
~- /\
I /~
7,
/7
/_,,
50
--------------~-~
7
7
7
/
/
Under 30 35 - 30 45 - 49 55 - 59 65 - 130
30-34 40-44 50-54 60-64
Age
Source: Employee Benefit Research Institute
PAGENO="0101"
Summa r~y~
95
Table 10
of Cost Factors by Age for Use in Costing Benefit Plans
SOURCE: The Costs of Employing Older Workers (Washington, DC: U.S.
Special Committee on Aging and the Employee Benefit Research
Institute, forthcoming).
Note: Same life insurance cost is assumed for 65-69 as. for 60-64
because it is assumed that the benefits will be reduced to
equal cost; regulations allow a 30% reduction.
If benefits are not reduced, assume costs at 65-69 are about
30% higher.
Age Gr~~
Medical Cost
Factor as % of
Average Cost
Defined Benefit
Cost Factor as
Z of Average
Cost
Life Insurance
Cost as Z of
Pay for One
Times Pay
Under 30
80.0%
23.0%
0.1%
30-34
80.0%
33.0%
0.1%
35-39
80.0%
.
48.0%
0.2%
40-44
80.0%
69.0%
0.3%
45-49
100.0%
100.0%
0.6%
50-54
112.5%
146.0%
1.0%
55-59
125.0%
216.0%
1.5%
60-64
160.0%
323.0%
. 2.3%
65-69
225.0%
*
2.3%
Defined contribution costs are the same by age.
PAGENO="0102"
96
ENDNOTES
Should you wish to review the primary economy research on which this statement
is based the following are suggested.
For background on flexible benefits plans and their relevance to changing employ-
ee needs, see Dallas L. Salisbury, ed., America in Transition: Implications for Em-
ployee Benefits (Washington, DC: Employee Benefit Research Institute, 1982); EBRI
Issue Brief, "Flexible Compensation and Public Policy," No. 24 (Washington, DC:
Employee Benefit Research Institute, November 1983); and Chapter XXII, "Flexible
Compensation Plans" in Fundamentals of Employee Benefit Programs (Washington,
DC: Employee Benefit Research Institute, 1983).
For further analysis of the tax treatment issues, see Sophie M. Korczyk, Retire-
ment Security and Tax Policy (Washington, DC: Employee Benefit Research Insti-
tute, 1984). See also EBRI Issue Brief "Pension-Related Tax Benefits," No. 25 (Wash-
ington, DC: Employee Benefit Research Institute, December 1983); and EBRI Issue
Brief "Employee Benefit Research Institute, February 1984).
For discussion of the interrelationship of programs see Sylvester J. Schieber,
Social Security: Perspectives on Preserving the System (Washington, DC: Employee
Benefit Research Institute, 1982).
Alternative tax systems would require detailed judgments about the treatment of
various sources and uses of income. Both would also create some formidable imple-
mentation and transition problems. These problems and issues are treated in detail
elsewhere. For a discussion of employer pensions in basic tax reform, see Sophie M.
Korczyk, Retirement Security and Tax Policy (Washington, DC: Employee Benefit
Research Institute, 1984) and EBRI Issue Brief, "Basic Tax Reform: Implications for
Employee Benefits," No. 28 (Washington, DC: Employee Benefit Research Institute,
March 1984. For a wide-ranging discussion of theoretical and practical issues in
basic tax reform, see Dallas L. Salisbury, ed., Why Tax Employee Benefits? (Wash-
ington, DC: Employee Benefit Research Institute, 1984).
In smaller plans, the cost of providing health insurance for the marginal employ-
ee is based on the average costs of insuring the insured population of that communi-
ty. In larger plans, the cost of insuring the marginal employee is based on the aver-
age cost of insuring the population represented by that employer's work force.
While these two methods would be likely to yield different insurance costs for any
given employee, under either method the cost of insuring that employee does not
represent the cost of that employee's expected claims.
For a thorough discussion of health insurance see Deborah J. Chollet, Employer-
Provided Health Benefits: Coverage, Provisions, and Policy Issues (Washington, DC:
Employee Benefit Research Institute, 1984), p. 94. An EBRI simulation of private
health insurance suggests that 56 to 87 percent of all covered workers with 1979
family income less than $15,000 would not have purchased private health insurance
if an employer had not offered and contributed to their health insurance plan.
APPENDIX I
WHAT ARE EMPLOYEE BENEFITS?
Employee benefits represent virtually any form of compensation that is provided
in a form other than direct wages, paid for in whole or in part by the employer,
even if provided by a third party. Generally, media articles, cost surveys, and re-
ports lump all benefits together. But different benefits serve different social and eco-
nomic needs. For legislative policy assessment purposes, benefits can be classified
into at least nine categories:
1. Legally required benefits (including employers contributions to Social Security,
Medicare, unemployment insurance, and workers' compensation insurance);
2. Discretionary benefits that are fully taxable (primarily, payment for time not
worked);
3. Discretionary benefits that insure the employee against financial risks and are
tax exempt (including employer contributions to health, life, and disability insur-
ance plans);
4. Discretionary benefits that help the employee meet special needs and are tax
exempt (including employer contributions to child care and legal plans);
5. Discretionary benefits that have traditionally been called fringes and are in-
tended to meet employer needs and are tax exempt (including employer provision of
purchase discounts, job site cafeterias, special bonuses and awards, van pools, clubs,
and parking);
6. Discretionary "reimbursement account" benefit programs that have been legal-
ly allowed since 1978 which allow employees to have reimbursement accounts-
PAGENO="0103"
97
funded by the employer or through salary reduction-to pay expenses that fall into
"statutory benefit" areas and are tax exempt (including health care reimbursement,
child care reimbursement, etc.);
7. Discretionary benefits that provide retirement income as a stream of payments
and for which taxes are deferred until benefits are received (including employer
contributions to defined benefit pension plans and to defined contribution plans
which require payment in the form of an annuity);
8. Discretionary benefits that provide for the deferral of salary until termination
of employment, generally pay benefits as a lump sum, and for which taxes are de-
ferred until benefits are received (including contributions to some profit sharing
plans, to money purchase plans and ESOPs); and
9. Discretionary benefits that provide for the deferral of salary until special needs
arise (loans and hardship), or until termination of employment, generally pay bene-
fits as a lump sum, and for which taxes are deferred until benefits are received (in-
cluding contributions to some profit sharing plans, thrift-savings plans, and salary
reduction plans).
APPENDIX II
A COMMENT ON THE CONTROVERSEY OVER TAX EXPENDITURE ESTIMATES FOR PENSION
PLANS
(By Dallas L. Salisbury*)
The United States Treasury makes annual estimates of tax expenditures in re-
sponse to mandate of the Congressional Budget Act of 1974. These estimates are
published each year in the President's Budget along with many cautionary notes on
how they can legitimately be used.
A reading of academic, public, and other publications leads one to the irrefutable
conclusion that these cautions are frequently unneeded. For example, some use
them to indicate the revenue that would be gained by the government if the law
were changed. The Budget points out that this is not a proper use of the numbers
because, among other reasons, they are calculated as if no other tax provisions ex-
isted and as if human behavior would in no way be affected by eliminating the tax
preference.
The Employee Benefit Research Institute (EBRI) is concerned with economic secu-
rity and with doing what it can to assure that policy makers have appropriate infor-
mation available to them as they assess policy choices. Early in 1983, EBRI received
press inquiries regarding the tax expenditure numbers in the FY 84 Budget. As a
result of those discussions, the then EBRI resarch director and economist Sylvester
J. Schieber wrote and published EBRI Issue Brief Number 17 (April 1983) on the
subject of "Retirement Program Tax Expenditures."
Alicia H. Munnell suggests in her note on this subject that the Issue Brief "initi-
ated the debate over the accuracy of the estimates." The literature indicates that
this debate has been ongoing, but I will agree that the Issue Brief was an addition
to the debate. Munnell then mentioned that "a primary concern of EBRI was that
the figures published by the Treasury jumped dramatically and apparently without
explanation from year to year."
The Issue Brief raised other concerns as well:
Budget deficits might cause pension policy to be made based upon considerations
of perceived cost without sufficient consideration of benefits provided.
Tax expenditure estimates could be used inappropriately as indicators of revenue
that could be gained by changes in the tax treatment of pensions without reference
to the limitations inherent in the numbers which are outlined in the budget.
Dramatic increases in the numbers which were unexplained might inappropriate-
ly be attributed to a changed pension system rather than inclusion of public pen-
sions for the first time.
The Issue Brief then explored the question of whether or not the figures, as pres-
ently published by the Treasury, accurately reflect the revenue loss associated with
the favorable tax treatment of pensions. Munnell's note failed to deal with the most
important factor in making this determination: the partial equilibrium nature of
the Treasury calculations. Partial equilibrium means that real world behavior is as-
sumed away. That is, if the law is changed, everyone is assumed to still behave in
exactly the same way. If the IRA tax preference were removed, people would still
* President, Employee Benefit Research Institute. The views expressed herein are the authors
and should not be attributed to EBRI.
PAGENO="0104"
98
put their money in IRA's. The budget goes to great lengths to warn against using
the tax expenditure numbers to assess how much revenue could be gained if a par-
ticular tax incentive were removed. In other words, no partial equilibrium number
is "accurate."
Munnell then says that "two arguments could be made that the calculated figures
exaggerate the impact of employer-sponsored pension plans on tax revenues." She is
correct that pension fund earnings may be overstated. She is also correct that con-
tributions overstate the cost of current benefits. She ignores other reasons however.
For example:
Other tax code provisions such as the elderly double exemption bring marginal
rates down. This reduces pension repayment and increases what is called the pen-
sion tax expenditure. But this increase is due to the other provision.
The cross section approach used in the budget offsets this year's contributions and
earnings against benefits paid this year. These numbers relate to different groups of
people and fail to account for the age of the pension system or the fact that this
relationship will change in the future. This overstates the tax expenditure today
and will understate it thirty years from now.
The current method of calculation counts as pension tax expenditures amounts
that would not be taxed in the absence of pensions due to other provisions of the
code such as capital gains tax deferrals, municipal bonds, the elderly real estate
gain exclusion, etc.
Munnell then quickly notes: "On the other hand, the revenue loss for public plans
is almost certainly underestimated since these funds are not fully funded and hence
contributions are less than accruing benefits." Whether under Social Security, civil
service retirement, military retirement or private pensions, the concept that the tax
expenditure should be calculated on the benefit accrual rather than contributions is
revolutionary. Under such a new approach the Social Security and Medicare tax ex-
penditures would dwarf those for pensions, and employees would be "charged with
income" that they might never see due to the benefits being unfunded. Munnell's
new approach cannot be justified. Yet, it is the only reason she provides for stating
that the tax expenditures are understated.
Therefore, Munnell's conclusion that "In view of the offsetting errors, then, the
Treasury's current estimates of the tax expenditure for pension plans probably pro-
vide a reasonable approximation of the revenue loss" cannot be supported. And
Munnell certainly does not document it in her note.
Munnell then states: "Essentially, the calculation is designed to meausre how
much higher federal revenues would be in a given year if a particular subsidy had
not been enacted." This statement directly contradicts the budget of the United
States. The budget specifically warns against using the number for this purpose be-
cause of its partial equilibrium limitations. The number could only be used in this
way if the preference being evaluated were the only tax preference item available.
Munnell then agrees with the Issue Brief in noting that a lifetime basis should be
used to calculate the pension tax expenditure. Munnell then undertakes a partial
equilibrium present value exercise that approximates a lifetime estimate. She pro-
duces a high number and concludes: "Thus, the revenue loss associated with the fa-
vorable treatment of pension contributions and earnings is substantial regardless of
how it is measured."
Again, Munnell cannot support her numbers or her conclusion. By using the cur-
rent level of contributions, investment earnings and benefit payments, Munnell as-
sumes that the system will never change. Demographic changes in the future will
guarantee that this assumption is wrong. Further, Munnell's new calculation is still
partial equilibrium and has all the weaknesses that the budget attributes to the
Treasury numbers.
Munnell concludes her note with the comment that: "The debate over the precise
magnitude of the tax expenditure is an unproductive digression that diverts atten-
tion froth the important topic of whether the favorable tax treatment accorded con-
tributions to private pension plans represents an efficient and equitable use of
scarce federal resources."
The problem is that one can only assess whether benefits are sufficient to justify
the cost, if one knows tl~e cost. The tax favored pension plans will, according to gov-
erriment estimates, pay $87.5 billion in benefits to retirees in 1985. What should this
be measured against? $28 billion; $50 billion; $62 billion? Do all these numbers indi-
cate that at this point the government gets more than it gives?
Munnell never mentions anything but the tax expenditure. Her articles don't pro-
vide the information that would allow one to pursue the "important topic." Munnell
is prepared to use the tax expenditure number in a way that the budget says it
cannot be used; EBRI is not. EBRI attempts to provide information to allow persons
PAGENO="0105"
99
to assess both the cost and the benefit issue; Munnell does not. Munnell advocates
particular policy courses; EBRI does not.
EBRI subscribes to the American notion that there is a role to be played by the
public sector, the private sector, and the individual in meeting economic security
needs; Munnell's written work indicates that she believes it could best be done by
Social Security. Munnell distributes critiques of the work of others without first dis-
cussing the work being critiqued with the author-as the Munnell note evidences;
EBRI does not.
A debate over any established public policy is justified and further, should take
place from time to time to assure that a national consensus still exists. Such debate,
when it involves the pension benefits of over 16 million current retirees and over 50
million current workers, must be based upon an accurate assessment of costs and
benefits-as should all debates. No time spent attempting to get to accurate num-
bers can legitimately be labeled "an unproductive digression." Those who feel that a
call for facts is "an unproductive digression" cannot be viewed as objective analysts.
Thus, Munnell should be seen as an advocate for the policy positions she has articu-
lated in her written work. Munnell has already reached her conclusions without aid
of accurate estimates of the cost of the pension tax incentives and without the facts
on the benefits the system provides. EBRI is doing over $1 million in research each
year to get the facts. Whatever they are, they are broadly distributed. They will, in
time, provide the basis for informed decisions on whether tax incentives for pen-
sions are efficient and effective. They have already provided a basis for more com-
plete understanding than was possible when Munnell reached her conclusions in
1981.
EMPLOYEE BENEFITS-RETIREMENT AND HEALTH-BY STATE
Reports have been issued in the past assessing pension and health insurance cov-
erage for the nation. The tables that follow break down the 98.9 million civilian
workers by state for two populations:
Tables 1 and 2 present the informatiOn for all civilian workers. The tables indi-
cate significant state by state variation in coverage levels. Nationally pension cover-
age is 52 percent; varying from 37 percent in Arkansas to 62 percent in Delaware
for all workers. Health coverage nationally is 59 percent; varying from 37 percent in
Montana to 66 percent in Delaware.
Tables 3 and 4 present the information for the "ERISA work force": those over
age twenty-five with at least one year on the job and working more than 1,000 hours
during the year. Among these full-time, full-year workers, pension coverage is 70
percent nationally; varying from 53 percent in Florida to 82 percent in Delaware.
Health coverage was 83 percent nationally; varying from 72 percent in North
Dakota to 89 percent in North Carolina.
This second population is more useful for analysis since these are work related
benefits. The total civilian work force, for example, includes all persons over age
fourteen who work at all for pay during the year.
The tables also provide average income figures for all workers and for those with
pension and health protection.
For the total civilian work force, average income is 22 percent below that of those
with benefit protection. The total civilian work force has average income 21 percent
below the older ERISA work force. Those with pension and health coverage earn 9.2
percent more, on average, than the total ERISA work force.
PAGENO="0106"
-I
~ ~ 2~5 ~ 22 ~ ~-= ~ 2 ~*= ~ -~ ~ co.
~ q ~ -~
2.~ 8~1
m
a.
0
C
0
C,
0
a.
0)
(5
0)
0
C
0
m
0 -
* ~
>1
0~
a. ~
(5 0~
0 ?
I-
m
C
U
PAGENO="0166"
Chart 2.
Employee Benefits as Percent of Payroll, by Type of Benefit, 1951.79.
Percent of payroll
1951 1953 1955 19571959 1961 1963 1965 1967 19691971 197319751977 1978 1979 1951 19531955 1957 1959 1961 1963 1965 1967 1969 1971 1973 19751977 1978 1979
PAGENO="0167"
Table 5.
Percent of Companies Paying Employee Benefits, 1955.79.
Type of benefit
1. Legally required payments (employer's share snly):
a. Old-Age, Survivors, Disability, and Health Insurance (FtCA taxes)
b. Unemployment Compensation
c. Workers' compensation )including estimated cost of self-insured)
d. Railroad Retirement Tax, Railroad Unemployment and Cash Sickness
Insurance, state sickness benefits insurance, etc
2. Pension, insurance, and other agreed-upon payments (employer's share only):
a. Pension plan premiums and pension payments not covered by insurance-
type plan (net)
b. Life insurance premiums: death benefits: hospital surgical, medical, and
major medical insurance premiums, etc. (net)
c. Salary continuation or long-term disability
d. Dental insurance premiums
e. Contributions to privately financed unemployment benefit lards
Separation or termination pay allowances
g. DiscoUnts on goods and services purchased from company by employees
h. Employee meals furniohed by company
i. Miscellaneous payments (compensalion payments in excess of legal
requirements, separation or termination pay allowances, moving eopenses,
etc.)
3. Paid rest periods, lunch periods, wash-up time, travel time, clolhes-change time,
get-ready time, etc
4. Payments tar time not worked:
a. Paid vacations and payments in lies of vacation
b. Payments for holidays not worked
c. Paid sick leave
d. Payments for State or National Guard duty; jury, witness, and voting pay
allowances; payments for time lost due to death in family or other personal
reasons, etc
5. Other items:
a. Profit-sharing payments
b. Contributions to employee thrift plans
c. Christmas or other special bonuses, service awards, suggestion awards, etc.
d. Employee education expenditures (tuition refunds, etc.)
e. Special wage payments ordered by courts, paymeetsts union stewards, etc.
99
99
93
100
99
93
too
99
94
roo
99
95
too
99
96
99
98
91
99
98
90
99
99
95
roo
97
95
100
98
93
100
98
94
100
98
96
100
99
96
100
99
96
8
10
14
12
8
9
9
10
10
10
10
11
9
9
75
81
86
86
85
85
85
86
89
90
89
91
89
86
96
2
12
15
97
8
11
14
98
8
20
17
98
8
17
15
21
99
6
10
13
18
99
6
13
15
20
98
5
15
13
18
99
4
14
15
22
99
4
16
16
20
99
4
16
16
25
100
35
12
16
22
100
42
19
17
22
99
48
27
16
21
100
49
33
15
18
19 19 26 22 18 20 22 23 29 27 28 26 26 27
57 57 62 63 64 62 72 78 77 81 83 81 81. 79
98 97 98 97 98 96 96 98 97 98 98 97 98 96
93 95 93 95 95 96 97 98 - 98 98 99 97 98 95
56 49 54 54 54 57 59 65 67 73 76 76 77 78
37 40 60 53 41 48 51 63 67 71 75 76 73 73
5
7
8
10
13
16
18
20
18
20
53
4.3
36
37
43
43
41
43
45
46
46
45
50
16
15
21
24
34
33
37
40
40
46
48
34
34
35
36
34
32
1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1978 1979
Dana ootrequeotedforrhio benefit
PAGENO="0168"
Chart 3.
Percent of Companies Paying Employee Benefits, by Type of Benefit, I 955.79.
Percent
PAGENO="0169"
Table 6.
Type of benefit
1. Legally required payments (employer's share only):
a. Old-Age, Survivors, Disability, and Health Insurance (RCA taxes)
b. Unemployment Compensation
c. Workers' compensation )including estimated cost of self-insured)
d. Railroad Retirement Tax, Railroad Unemployment and Cash Sickness
Insurance, state sickness benefits insurance, etc.
2. Pension, insurance, and other agreed-upon payments employers share only):
a. Pension plan premiums and pension payments nut covered by insurance-
type plan (net)
b. Life insurance premiums: death benefits: hospital surgical, medical, and
major medical insurance premiums, etc. (net)
c. Salary continuation or long-term disability
d. Dental insurance premiums
e. Contributions to privately financed unemployment benefit funds
Separation or termination pay allowances
g. Discounts on goods and services purchased from company by employees
h. Employee meals furnished by company
i. Miscellaneous payments (compensation payments in excess of legal
requirements, separation or termination pay allowances, moving expenses,
etc.)
3. Paid rest periods, lunch periods, wash-uptime, travel time, clothes-change time,
get-ready time, etc
4. Payments for time nut worked:
a. Paid vacations and payments in lies of vacation
b. Payments for holidays not worked
c. Paid sick leave
d. Payments for State or National Guard duty: jury, witness, and voting pay
allowances; payments for time lost due to death in family or other personal
reasons, etc
5. Other items:
a. Profit-sharing payments
b. Contributions to employee thrift plans
c. Christmas or other special bonuses, service awards, suggestion awards, etc.
d. Employee education expenditures (tuition refunds, etc.)
e. Special wage payments nrdered by courts, payments to onion stewards, etc.
1.8 2.1 2.3 2.7 3.0 2.7 3.9 4.6 4.5 5.3 5.7 5.4 s.e 5.6
1.0 1.0 1.1 1.5 f.7 1.4 1.0 0.8 0.7 1.2 1.0 1.5 1.7 1.5
0.7 0.8 0.7 0.8 0.8 0.8 0.9 1.0 1.0 1.0 1.3 1.5 1.7 r.8
0.5 0.7 0.5 0.6 1.5 1.3 i.e t.i 1.0 1.1 1.1 1.1 0.7 0.5.
4.6 4.4 4.8 4.8 5.5 5.7 6.2
2.9 3.0 3.2 3.6 4.5 4.7 5.2
0.6
0.8
1.3 1.3 1.0 0.9 1.2 0.9
0.5 0.5 0.3 0.5 0.4 0.4
1.1 0.9 1.1 0.8 0.9 1.0 1.0
1.3 0.9 1.1 0.9 0.8 0.9 0.9
Average Benefit Costs as Percent of Payroll for Companies Paying Employee Benefits, 1955-79.
1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1978 1979
5.1 5.1 5.0 4.9
2.1 2.3 2.3 2.6
0.6 1.4 1.1 1.2
0.2 0.3 0.2 0.3
1.0 0.8 0.7 0.8
1.9
6.5 6.3 6.3
5.9 5.6 5.7
0.6 . 0.6 0.6
0.9 0.8 0.8
07 07
0.8 0.8 0.8
1.6 1.6 1.4 1.2 1.2 t.f 0.8 0.9 0.8 1.0 0.8 0.8 0.9 0.9
3.9 4.0 3.9 4.1 4.2 4.0 3.8 4.0 4.4 4.3 4.4 4.3 4.4 4.5
4.4 4.3 4.4 4.5 5.0 4.8 5.3 5.1 5.0 4.9
2.7 2.7 2.7 2.8 3.0 3.1 3.4 3.3 3.3 3.3
1.3 1.3 1.3 1.4 1.5 1.5 3.6 1.6 1.6 1.6
3.5 3.9 4.0 4.3
2.2 2.4 2.5 2.6
1.1 1.2 1.2 1.3
0.5 0.5 0.3 0.4
5.5 5.4 5.6 4.7
2.0 1.7 1.2 1.4
0.2
0.6 1.0 0.5 0.5
0.5 0.5
3.9 5.5
1.7 1.6
1.4 1.2
0.2 0.3
0.6 0.5
Data not requested forthis benefit.
Figure shown is conoiderablyleox than legairate, because most reporting companies had only a small proportion of employees covered by tax.
0.5 0.5 0.5 0.6 0.6 0.5 0.5 0.5
5.7 5.2 5.5 5.7 5.5 5.5 6.6 6.7
1.5 1,6 1.5 1.4 1.5 1.9 1.8 1.4
1.1 1.1 1.0 0.9 0.9 0.9 0.8 0.9
0.3 0.2 0.3 0.2 0.3 0.3 0.3 0.3
0.6 0.5 0.6 0.5 0.5 0.5 0.5 0.6
PAGENO="0170"
Table 7.
Employee Benefits as Cents per Payroll Hour, by Type of Benefit, 1951.79.
Total employee benefits as cents per payroll hour
1. Legally required payments (employer's share only(
a. Old-Age, Survivors, Disability, and Health Insurance (FICA tanes(
39.247.454.8
61.6
68.8
71.5
82.298.3122.3
154.1
193.2
226.4
267.6
5.8 5.8 6.9 8.4 10.0
12.4
15.2
14.2
18.3
22.3
25.2
35.6
43.8
2.3 2.4 3.5 4.4 5.4
6.7
8.1
7.8
12.2
16.0
17.9
25.1
30.9
33.4
60.0
65.8
b. Unemployment Compensation
2.4 2.0 1.9 2.3 2.6
3.7
4.6
3.9
3.1
2.7
2.9
5.6
5.5
93
42.3
c. Workers' compensation (including estimated cost of selt-insured( ..........
1.0 1.3 1.4 1.6 1.7
1.7
2.2
2.1
2.5
3.2
4.0
44
68
9.0
10.8
122
d. Railroad Retirement Tan, Railroad Unemployment and Cash Sickness
Insurance, state sickness benefits insurance, etc,**
0.1 0.1 0.1 0.1 0.3
0.3
0.3
0.4
0.5
0.4
0.4
05
0.6
2. Pension, insurance, and other agreed-upon payments (employer's share only(
a. Pension plan premiums and pension payments not covered by Insurance-
9.0 10.7 12.2 14.9 17.3
19.8
20.9
22.3
24.7
29.4
39.8
49.1
0.4
0.3
79.0
81.6
88.7
type plan (net(
6.0 6.8 7.3 8.9 10.2
10.4
10.5
10.8
12.5
14.7
19.4
24.0
30.1
36.7
37.4
39.7
b. Life Insurance premiums; death benefits; hospital surgical, medical, and
major medical insurance premiums, etc. (net(
2.3 3.2 3.8 4.8 5.5
6.7
7.8
8.7
10.0
12.5
17.8
21.8
28.3
36.7
37.2
41.5
c. Salary continuation or long-term disability
1.1
1.5
2.0
2,1
d. Dental Insurance premiums
0.5
1.0
1.5
1.9
e. Contributions to privately financed unemployment benefit tunds
* 0.2 0.2
0.3
0.2
0.2
0.2
0.1
0.2
0.1
Separation or termination pay allowances
0.1 0.1 0.1 0.1 0.1
0.2
0.3
0.2
0.2
0.3
0.3
0.3
g. Discounts on goods and services purchased from company by employees ..
0.3 0.2 0.4 0.2 0.3
0.4
0.5
0.6
0.6
0.4
0.6
0.7
0.9
0.8
0.7
0.7
h. Employee meals furnished by company
1.0
0.8
0.8
0.6
0.7
0.6
1 0
1 0
1.1
1.2
1,1
I. Miscellaneous payments (compensation paymento In excess of legal
requirements, separation or termination pay allowances, moving expenses,
etc.(
0.3 0.4 0.6 0.7 1.0
0.8
0.8
1.0
0.6
0.7
0.9
1.2
1.3
1.2
1.6
1,7
3. Paid rest periods, lunch periods, wash-up time, travel time, clothes-change time,
get-ready time, etc
4, Payments for time not worked
a. Paid vacations and payments in lieu of vacation
3.2 3.6 4.2 5.0 5.8
6.4
7.2
7.2
8.5
10.3
13.4
16.3
10.3 11.2 12.2 15.0 17.3
18.8
20.9
22.4
24.3
29.1
36.4
43.7
55.1
60.0
243
26.0
5.5 6.0 6.8 8.3 9.6
10.6
11.5
12.0
12.9
15.3
19.3
22.2
28.1
30.7
32.9
34.1
b. Payments for holidays not worked
3.4 3.7 3.9 5.0 5.5
6.0
7.0
7.6
8.0
9.6
11.7
14.1
18.2
19.5
21.7
c. Paid sick leave
1.0 1.1 1.1 1.3 1.7
1.7
1.9
2.1
2.5
3.1
39
5.3
6.5
d. Payments for State or National Guard duty; jury, witness, and voting pay
8.3
9.0
allowances; payments for time lost due to death in family or other personal
reasons, etc
0.4 0.4 0.4 0.4 0.5
0.5
0.5
0.7
0.9
1.1
1.5
2.1
2.3
2.3
2.5
2.7
5. Other items
a. Profit-sharing payments
3.2 3.3 3.7 4.1 4.4
4.2
4.6
5.4
6.4
7.2
7.5
9.4
1.1 1.1 1.4 1.7 2.1
2.0
2.4
3.2
3.7
4.1
4.1
5.3
60
68
15.8
9.1
18.1
10.4
b. Contributions to employee thrift plans
0.3
0.3
0.4
0.6
0.8
1.1
1.5
2.3~
2 1
2.1
c. Christmas or other opecial bonuseo, service awards, suggestion awards, etc.
1.8 1.8 1.9 1.7 1.7
1.7
1.3
1.3
1.6
1.7
1.7
1.8
2.3
2.4
2.5
3.1
d. Employee education espenditures (tuition refunds, etc.(
e. Special wage payments ordered by courts, payments to union otewards, etc.
0.3 0.4 0.4 0.7 0.6
0.5
0.1
0.5
0.2
0.4
0.2
0.5
0.3
0.5
0.4
0.5
0.4
0.8
0.6
1.0
0.~
1.1
1.0
1.1
1.2
1.3
Data votrequented for this bene6t.
.
**Less than O.OSy.
~Figure show is considerably less than legal rate, because mostreporting companie
shad only a smallproporlion of em
ployee
s cove
red by
tax.
PAGENO="0171"
C;'
Table 8.
.
Employee Benefits as Dollars per Year per Employee,
by
Type
of
Benefit,
1951-79.
*
Type of benefit 1951
1953
1955
1957
1959
1961
1963
1965
1967
1969
2,052
1971
2,544
1973
3,230
1975
3,984
1977 1978
4.692 5,138
1979
5.560_
Total employee benefits as dollars per year per employee 644
720
819
981
1,132
1,254
1,431
1,502
1. Legally required payments (employer's share only) 119
121
145
170
205
256
313
297
383
468
522
746
903
1,087 1,249
1.368
a. Old-Age, Survivors, Disability, and Health lnsursnce (FICA faxes) 47
49
50
42
73
41
91
44
112
53
134
76
168
95
163
82
254
65
335
57
372
60
527
117
636
114
693 783
193 232
877
229
b. Unemployment Compensation
29
32
35
40
45
45
52
67
82
92
141
186 225
255
c. Workers' compensation (including estimated coot of self-insured) 21
d. Railroad Retirement Tax, Railroad Unemployment and Cash Sickness
2
3
5
6
5
7
12
9
8
10
12
15 9
7
Insurance, slate sickness benefits innijrance, etc.~ 2
185
222
254
310
360
398
436
468
513
612
824
1.032
1,302
1,637 1,697
1.444~
2. Pension, insurance, and other agreed-upon payments (employer's only)
a. Pension plan premiums and pension payments not covered by insurance-
122
141
153
185
214
211
.
218
226
261
306
402
503
620
759 779
,
825
type plan (net)
,
b. Life insurance premiums; death benefits; hospital surgical, medical, and
47
67
80
99_
114
136
162
184
209
260
369
457
582
760 774
861
major medical insurance premiums, etc. (net)
23
31 41
46
c. Salary continuation or long-term disability
11
22 30
40
d. Dental insurance premiums
1
5
5
4
5
4
3
3
4
3
e. Contributions to privately financed unemployment benefit funds
2
1
1
2
2
5
6
4
3
5
5
6
f. Separation or termination pay allowances
5
8
5
5
6
11
13
13
9
12
15
18
16 15
14
g. Discounts on goods and services purchased from company by employees ..
20
17
17
12
15
13
22
21
23 24
23
h. Employee meals furnished by company
i. Miscellaneous payments (compensation payments in escess of legal
requirements, separation or termination pay allowances, moving esperoes,
8
8
11
14
20
16
17
20
12
14
19
26
27
26 34
35
etc.)
3. Paid rest periods, lunch periods, wash-up time, travel time, clothes-change time,
64
74
89
104
119
131
151
150
179
214
280
341
408
448 504
539
get-ready time, etc
4. Payments for time not worked 211
233
254
311
358
382
435
471
511
609
755
914
1137
1,245 1,362
1434
a. Paidvacalions and payments in lieu of vacation 112
125
141
81
171
104
199
114
211
126
240
145
252
161
271
169
321
200
400
244
466
295
580
376
636 684
405 452
710
482
b. Payments for holidays not worked 70
21
22
24
27
35
35
39
43
52
65
81
110
134
156 174
187
c. Paid sick leave
d. Payments for State or National Guard duty; jury, witness, and voting pay
allowances; payments for time lost due to death in family or other personal
8
8
8
9
10
10
11
,
15
19
23
30
43
47
48 52
55
reasons, etc
77
86
90
87
96
116
133
149
163
197
234
275 326
375
5. Other items 65
a. Profit-sharing payments 23
23
28
36
45
40
50
5
67
6
77
8
85
12
86
16
112
22
123
31
141 189
47 43
216
43
b. Contributions to employee thrift plans
38
41
36
35
36
28
27
33
35
35.
37
47
50 52
64
c. Christmas or other special bonuses, service awards, suggestion awards, etc.
d: Employee education enpenditures (tuition refunds, etc.)
9
8
14
10
1
10
2
11
6
10
4
11
6
11
8
18
8
18
12
21
15 20
22 22
25
27
e. Special wage payments ordered by courts, payments to union stewards, etc.
Data not requested forthis benefit.
Figure shown is considerably less than legal rate, because most reporting companies had only a small proportion of employees covered by tax.
PAGENO="0172"
Table 9.
Total Employee Benefits as Percent of Payroll, by Industry Groups, 1951-79.
Industry group
Total, all industries
Total, all manufacturing
Manufacture of:
Food, beverages, and tobacco
Textile products and apparel
Pulp, paper, lumber, and furniture
Printing and publishing
Chemicals and allied products
Petroleum Industry
Rubber, leather, and plastic products
Stone, clay, and glass products
Primary metal Industries
Fabricated metal products (excluding machinery and
transportation equipment)
Machinery (excluding electrical)
Electrical machinery, equipment, and supplleu
Transportation equipment
Instruments and miscellaneous manufacturing Industries
Total, all nonmanufacturing
Public ulilities electric, gas, water, telephone, etc.)
Department stores
Trade (wholesale and other retail)
Banks, finance companies, and trust companies
Insurance companies
I~Jospitals
Hotels
Miscellaneous nonmanufacturing industries
Data vulshuwrt separately for this industry group.
16.2 16.0 19.3 20.5 22.6 25.0 25.2
15.7 16.0 18.0 20.4 20.9 23.6 23.9
16.5 17.0 19.7 20.3 21.5 23.4 24.0
15.1 15.0 17.9 21.1 21.3 22.8 23.6
17.6 17,9 20.4 20.6 22.7 24.1 25.0
22.2 23.4 22.9 24.2 25.1 27.1 27.8
20.6 20.5 22.8 23.5 24.3 25.6 26.3
18.5 17.9 20.1 20.9 20.7 22.2 23.6
26.4 28.7 30.5 31.7 31.7 33.5 32.9
21.7 22.8 25.5 26.7 27.1 27.7 29.3
15.6 17.7 13.0 13.4 13.8 20.4
17.3 21.4 25.1 25.4 25.1 24.4 23.7
22.9 24.3 24.6 28.7 32.5 35.1 37.8 38.7 36.4
24.1 25.5 26.8 30.1 32.0 36.1 37.5 32.4 36.9
23.7 24.8 26.5 29.6 30.5 35.0 36.6 37,1 36.7
23.1 25.9 28.5 35.0 34.1 39.9 39.1 40.5 39.0
23.8 25.3 25.9 31.0 32.2 34.8 34.0 36.4 36.4
26.9 28.2 29.3 31.0 33.9 34.4 35.8 36.1 35.7
26.9 28.7 30.3 32.5 34.8 37.5 39.7 40.2 40.6
23.1 22.8 23.1 24.2 28.1 28.4 32.0 31.5 31.7
24.1 23.3 21.7 24.5 28.8 28.2 30.7 28.9 28.8
32.1 32.5 33.9 35.6 37.2 37.3 39.9 39.2 39.4
27.0 29.0 30.3 31.8 35.2 35.2 36.5 38.2 38.3
24.0 25.7 27.1 28.2
21.2 23.6 25,1 25.4 27.5 32.2 33.7 38.6 34.4
1951 1953 1955 1957 1959 1961 1963 1965 1967 1069 1971 1973 1975 1977 1978 1979
18.7 19.2 20.3 21.8 22.8 24.9 25.6 24.7 26.6 27.9 30.8 32.7 35.4 36.7 36.9 36.6
16.4 16.8 18.5 20.3 21.6 23.6 24.2 23.6 25.6 27.0 30.6 32.0 36.1 37.3 37,4 37.2
17.7 20.0 19.7 21.0 21.8 25.4 27.0 27.3 28.0 30.3 33.1 32.6 36.2 36.6 35.0 36.9
14.1 14.5 16.2 17.4 20.0 19.3 20.2 18.9 20.6 22.2 23.6 25.5 27.8 29.0 28.8 29.2
14.8 14.3 15.6 17.5 18.8 20.4 21.8 20.4 22.6 23.9 28.4 29.2 32.7 34.0 34.4 36.1
15.1 15.5 19.3 20.0 19.9 20.1 20.8 21.1 25.0 25.6 27.4 28.3 32.2 34.9 34.3 35.0
20.4 20.9 21.8 24.0 25.0 27.6 27.3 27.4 30.9 32.2 34.3 37.0 42.2 43.3 43.4 43.1
22.5 24.5 24.3 27.3 28.3 27.0 28.9 28.0 30.8 32.4 35.7 38.2 39.2 40.8 42.3 44.5
16.2 15.6 18.2 20.9 22.6 26.1 25.3 25.2 26.4 27.1 30.4 32.5 40.4 38.0 32.6 35.0
14.2 15.8 17.1 19.0 19.4 21.6 22.0 23.2 25.0 27.4 31.3 33.8 35.1 36.5 37,7 36.4 ~&
14.6 16.7 17.3 20.2 22.4 25.6 25.1 25.0 28.6 29.9 34.8 33.9 40.6 43.3 41.6 43.0 C
PAGENO="0173"
Table 10.
Total Employee Benefits as Cents per Payroll Hour, by Industry Groups, 1951-79.
Industry group 1951
Total, all industries 31.5
Total, all manufacturing 28.9
Manufacture of:
Food, beverages, and tobacco 29.5 35.5
Teotile products and apparel 21.5 22.0
Pulp, paper, lumber, and furniture 24.8 25.9
Printing and publishing 30.6 35.0
Chemicals and allied products 34.2 39.7
Petroleum industry 46.4 56.0
Rubber, leather, and plastic product's 26.1 27.3
Stone, clay, and glaaa products 22.8 27.8
Primary metal industries 26.1 33.6
Fabricated metal products (escluding machinery and
transportation equipment) 28.4 30.6
Machinery )encluding electrical) 29.1 31.3
Electrical machinery, equipment, and supplies 27.4 312
Transportation equipment 27.9 30,1
Instruments and miscellaneous manufacturing industries 27.1 30.5
Total, all nonmanufacturing 35.3 40.0
Public utilities )electric, gas, water, telephone, etc.) 36.5 40.3
Department stores
Trade )wholesale and other retail) 23.9 26.0
Banks, finance companieo, and trust companies 42.0 47.4
Insurance companies 32.5 36.1
Hoapilala
Hotels' 15:6 19.7
Miscellaneous nonmanufacturing industries 31.3 . 46.1
Data nut shown separately for this industry group.
1953
1955
1957 1959
1961
1963
1965
1967
1969
1971
1973
34.6
39.2
47.4 54.8
61.6
68.8
71.5
82.2
98.3
122.3
154.1
1932
226.4
247.1
267.6
31.5
37.7
44.9 53.0
59.5
65.3
67.6
78.3
93.0
118.8
146.2
191.3
224.5. 246.1
267.1
38.7
44.6 50.3
61.5
71.9
77.9
80.8
101.5
126.3
142.6
184.8
205.8
222.8
247.8
26.0
30.3 38.0
36.8
41.5
38.7
45.5
58.4
72.0
87.3
108.2
124.6
132.7
150.4
30.5
36.3 42.3
46.9
54.8
57.2
66.3
74.9
104.0
124.9
163.7
194.3
216.9
242.8
45.4
51.3 53.6
~56.4
62.4
68.3
87.3
98.5
113.6
138.8
177.8
212.1
236.0
257.2
45.2
52.9 61.6
70.8
76.0
79.9
98.7
115.8
142.3
176.5
239.5
281.0
308.0
340.1
61.0
78.2 83.6
81.2
90.4
99.7
118.2
1392
164.1
200.8
248.9
306.8
361.0
432.7
34.1
44.8 51.0
63.7
63.1
65.8
76.2
84.4
108.2
144.9
190.1
209.0
194.9
223.1
32.2
39.4 46.7
55.6
59.3
65.3
70.6
91.1
117.3
145.0
179.7
208.8
233.5
246.9
37.0
47.2 60.2
69.4
72.7
77.2
94.2
109.2
137.0
162.5
232.7
281.5
285.9
314.4
39.3
46.3 55.3
61.5
67.4
65.7
75.0
84.2
110.5
150.7
182.7
218.2
244.3
248.3
39.3
51.1 54.7
63.3
67.1
72.6
80.0
95.5
120.9
151.9
197.4
234.1
290.9
276.0
38.1
43.4 51.3
58.6
64.2
63.1
72.7
90.1
116.5
138.4
186.9
218.0
244.5
269.3
38.3
53.7 56.1
63.4
70.7
70.1
85.2
102.8
138.7
163.4
224.0
252.5
299.2
315.7
38.5
45.0 52.7
62.0
67.8
63.8
72.8
85.0
116.4
143.6
177.1
189.1
228.7
250.8
41.4
48.3
50.8 58.1
55.4 63.7
65.6
71.4
74.6
77.7
79.0
86.2
88.6
100.5
106.1
121.1
127.8
144.3
165.4
185.9
195.8
239.2
229'l\
286.8
247.4
319.3
268.2
356.4
46.6
49.3
56.1
66.6
97.3
108.5
134.7
141.6
156.0
32.8
40.4\ 43.0
50.2
57.4
56.7
60.4
62.4
88.8
113.4
134.1
167.7
179.8
184.7
56.4
65.6 " 70.1
77.0
80.0
87.0
92.6
108.4
133.3
167.4
186.6
223.9
239.9
258.0
44.5
53.6 58.8
64.3
72.5
72.8
90.2
105.6
128.5
162.2
189.5
217.9
244.4
267.0
107.1
129.5
1472
162.6
14.4
16.0 18.4
27.5
57.0
66.6 68.8
68.8
73.2
74.1
83.7
104.8
112.4
151.1
206.9
251.8
288.2
285.8
PAGENO="0174"
Table 11.
Total Employee Benefits as Dollars per Year per Employee, by Industry Groups, 1951.79.
Industry group ___________________________________________________________________________________________
Total, all industries
Total, all manufacturing
Manufacture of:
Food, beverages, and lobacco
Textile products and apparel
Pulp, paper, lumber, and furniture
Printing and publishing
Chemicals and allied products
Petroleum industry
Rubber, leather, and plastic products
Stone, clay, and glass products
Primary metal Industries
Fabricated metal products (excluding machinery and
tranoportation equipment(
Machinery (excluding electrical)
Electrical machinery, equipment, and supplies
Transportation equipment
Instruments and miscellaneous manufacturing industries
Total, all nonmanufacturing
Public utilities (electric, gas, water, telephone, etc.)
Department stores
Trade (wholesale and other retail)
Banks, finance companies, and trust companies
Insurance companies
Hospitals
Hotels
Miscellaneous nonmanufacturing industries
Data not shown separately for this industry group.
1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1978 1979
644 720 819 981 1,132 1,254 1,431 1,502 1,719 2,052 2,544 3,230 3,984 4,692 5,138 5,560
609 667 801 940 1,103 1,236 1,372 1,437 1,656 1,g65 2,482 3,111 3,g54 4,683 5,164 5,605
636 752 827 961 1,078 1,314 1,517 1,620 1,682 2,143 2,668 3,024 3,822 4,307 4,713 5,193
433 451 553 626 801 767 855 839 962 1,198 1,501 1,834 2,183 2,63g 2,786 3,098
535 568 673 794 930 994 1,210 1,245 1,460 1,652 2,229 2,794 3,447 4,134 4,611 5,062
574 674 907 1,007 1,077 1,156 1,250 1,358 1,827 1,996 2,272 2,853 3,633 4,312 4,734 5,114
725 846 946 1,110 1,303 1,505 1,614 t,6g2 2,086 2,444 3,028 3,721 5,008 5,894 6,459 7,061
975 1,178 1,278 1,650 1,754 1,719 1,977 2,143' 2,539 2,938 3,443 4,258 5,280 6,481 7,715 9,125
512 541 698 897 1,039 1,302 1,316 1,358 1,618 1,798 2,290 3,121 3,915 4,367 4,042 4,611
477 587 676 835 980 1,162 1,219 1,377 1,464 1,921 2,468 3,059 3,694 4,390 4,903 5,249
575 716 787 975 1,212 1,377 1,500 1,656 1,902 2,298 2,761 3,395 4,784 5,747 5,875 6575
598 648 825 959 1,100 1,258
630 674 851 1,071 1,142 1,319
583 666 801 903 1,083 1,203
594 649 820 1,099 1,156 1,312
571 630 798 952 1,101 1,312
709 809 847 1,035 1,188 1,335
769 845 1,019 1,165 1,342 1,497
517 551 698 872 912 1,059
813 939 1,125 1,294 1,384 1,522
621 706 873 1,056 1,152 1,259
353 442 332 354 401 601
592 882 1,037 1,329 1,461 1,390
1,421 1,404 1,593 1,784 2,347 3,241 3,723 4,574 5,099 5,324
1,403 1,553 1,722 2,053 2,506 3,277 4;162 4,883 5,568 5,919
1,327 1,348 1,539 1,879 2,427 2,880 3,834 4,489 5,103 5,554
1,463 1,523 1,763 2,146 2,879 3,490 4,582 5,303 6,321 6,665
1,434 1,364 1,556 1,812 2,429 3,015 3,590 3,942 4,839 5,252
1,525 1,618 1,822 2,181 2,637 3,398 4,025 4,704 5,083 5,501
1,625 1,825 2,133 2,551 3,038 3,917 5,003. 6,005 6,681 7,466
961 1,010 1,128 1,347 1,965 2,141 2,659 2,866 3,034
1,196 1,188 1,252 1,298 1,843 2,345 2,795 3,478 3,719 3,857
1,591 1,715 1,831 2,171 2,708 3,344 3,745 4,482 4,886 5,277
1,429 1,427 1,769 2,070 2,513 3,189 3,717 4,262 4,790 5,268
2,204 2,675 3,052 3,359
1,550 1,552 1,802 2,219 2,383 3,192 4,384 5,168 5,918 5,775
PAGENO="0175"
Table 12.
Total Employee Benefits as Percent of Payroll, by Region, and by Size of Company, 1951.79.
Item
By region
Total, all regions*
Northeast
East North Central
Southeast
West
* Slates in each region are:
NORTHEAST: Connecticut, Maine, Massachusetts, New Hampshire, New Jersey. New York, Pennsylvania, Rhode Island, and Vermont.
EAST NORTH CENTRAL. Illinois, Indiana, Michigan, Ohio, and Wisconsin.
SOUTHEAST: Alabama, Arkansas, Delaware, Dislrict of Columbia, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Camlina, Oklahoma, South Carolina, Tennessee, Texas, Virginia, and West Virginia.
WEST: Alaska, Arizona, Caiifomia, Colorado, Hawaii, Idaho, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, Nevada, New Meoico, North Dakota, Oregon, South Dakota, Utah, Washington, and Wyoming.
1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1978 1979
18,7 19.2 20.3 21.8 22.8 24.9 25.6 24.7 26.6 27.9 30.8
19.7 20.7 22.3 23.4 24.6 26.5 27.0 26.6 28.4 29.1 32.8
17.7 17.3 19.1 20.6 21.7 23.9 24.9 24.6 26.1 28.5 31.4
17.2 18.8 19.0 21.2 21.0 23.3 24.9 22.1 24.9 25.7 28.2
19.8 19.5 19.4 20.9 22.7 23.7 24.9 24.1 25.3 27.0 29.4
By size of company
Total, all companies
Under 500 employees
500-999 employees
1,000-2,499 employees
2,500-4,999 employees
5,000 employees and over
32.7 35.4
35.0 36.9
33.3 36.2
29.0 32.7
31.6 34.4
18.7 19.2 20.3
19.4 20.2 19.4
18.5 18.6 20.7
18.5 18.8 20.9
18.8 18.6 20.3
18.4 19.0 21.5
36.7 36.9 36.6
37.8 37.7 38.1
37.9 38.7 37.9
33.7 33.5 33.9
36.4 35.8 35.2
21.8 2?.8 24.9 25.6 24.7 26.6 27.9 30.8 32.7 35.4 36.7 36.9 36.6
21,1 22.3 24.1 24.6 23.7 25.8 27.0 29.2 31.6 . 34.0 35.6 35.3 35.1
22.1 22.5 24.5 25.3 24.6 26.6 27.7 30.2 30.8 33.4 36.7 35.9 35.2
22.3 23.5 25.5 26.6 25.8 27.1 28.4 31.5 33.8 36.8 35.8 36.5 37.5
21.6 23.7 25.3 26.9 25.3 27.3 29.3 33.4 34.9 36.2 . 37.3 39.4 38.1
23.0 23.0 25.3 26.1 25.6 29.4 29.6 33.0 34.6 38.1 40.0 40.8 40.5
PAGENO="0176"
Chart 5.
Total Employee Benefits as Percent of
Payroll, by Size of Company, 1951.79.
Percent
5,000 aq~ver
25oo.4.999~....~/
1,000-2,499
A / *.`~ 500-999
SUnder 500 employees
Percent
Chart 4.
Total Employee Benefits as Percent of
Payroll, by Region, 1951 -79.
40
35
30
25
20
15
10
5
0
I I I I I I I I I
195119531955 195719591961 1963 1965196719691971 1973 1975197719781979
PAGENO="0177"
0
0
Table 13.
Pensions as Percent of Payroll for All Companies in Surveys, by Industry Groups, 1951.79.
3.6
3.8
3.8
4.1
4.3
4.2
3.9
3.7
4.0
4.2
4.9
5.1
5.5
5.9
5.6
5.4
4.7
Industry groups
Total, all industries
Total, all manufacturing
Manufacture of:
Food, beverages, and tobacco
Textile products and apparel
Pulp, paper, lumber, and furniture
Printing and publishing
Chemicals and allied products
Petroleum industry
Rubber, leather, and plastic products
Stone, clay, and glans prodocts
Primary metal industries
Fabricated metal products (excluding machinery and
transportation equipmenl(
Machinery (excluding electrical(
Electrical machinery, equipment, and supplies
Transportation equipment
Instruments and miscellaneous manufacturing industries
Total, all nonmanufacturing
Public utilities (electric, gas, water, telephone, elc.(
Department stores
Trade (wholesale and other retail(
Banks, finance companies, and trust companies
Insurance companies
Hospitals
Hotels
Miscellaneous nonmanafacturing industries
1.1
1.6
2.0
2.3
2.8
2.9
2.0
2.1
2.0
1.3
1.6
2.0
1.9
2.7
2.6
2.6
2.7
2.3
2.3
2.2
3.0
3.2
3.5
4.1
4.6
4.1
1.8
2.1
4.0
3.5
2.8
2.1
2.0
2.2
3.4
3.3
3.6
3.9
4.1
5.1
4.9
5.0
2.5
4.4
4.1
4.3
4.0
4.4
5.6
6.5
6.9
6.7
6.4
3.3
3.6
4.0
4.0
8.6
4.3
8.9
8.2
7.6
4.1
4.7
4.9
7.2
8.0
9.3
9.6
10.3
11.1
8.1
8.8
3.8
3.9
3.3
3.1
3.4
3.8
5.3
4.5
6.7
4.9
2.5
3.3
1.1
1.6
1.8
3.5
3.2
3.1
2.6
3.7
3.9
4.9
5.5
4.7
5.9
5.2
5.2
3.4
3.0
2.9
3.5
5.6
5.7
2.1 2.0 2.7 2.9 3.0 3.6 3.6 2.6 2.9 2.4 3.5 3.9 4.4 4.4 4.6 4.1
2.1 2.5 2.9 3.5 3.8 3.7 3.8 3.3 3.5 3.3 3.9 4.1 4.7 5.3 5.3 4.8
1.8 2.2 2.5 2.4 2.9 3.0 2.8 2.6 2.4 3.1 3.6 3.8 3.8 4.9 4.6 3.7
1.8 2.0 2.5 3.3 3.3 3.2 2.8 2.9 3.3 3.5 4.6 4.7 5.3 6.1 5.4 4.9
2.8 3.3 2.8 2.8 3.2 3.8 3.5 2.6 2.4 2.6 4.3 3.7 4.4 4.3 4.9 4.5
5.2 5.8 5.3 5.9 6.1 5.9 5.7 5.5 5.4 5.5 6.0 6.2 6.4 6.9 6.5 6,4
5.8 6.2 6.7 6.6 7.2 6.7 6.8 6.8 6.8 - 6.8 7.8 7.6 8.7 9.5 9.6 9.8
1.9 2.0 1.7 1.8 2.5 2.7 2.1 2.7 2.7
1.5 1.9 2.2 2.3 2.3 2.0 2.4 1.7 2.0 1.6 2.3 2.4 2.6 3.2 2.4 2.2
6.4 7.3 7.8 8.2 7.8 7.7 7.3 6.8 6.1 6.1 6.2 6.1 6.4 7.5 7.0 6.4
5.6 5.4 6.9 7.9 8.1 7.4 7.1 6.2 6.7 6.7 6.9 7.0 7.0 7.2 7.2 7.1
2.5 3.3 2.6 3.5
1.4 2.4 0.4 0.8 0.6 0.7
1.8 3.6 5.9 2.7 2.5 2.1 2.2 2.4 2.5 3.4 2.9 4.0 4.2 5.1 6.0 4.8
Sara notohown separately foriiiis industr, group.
PAGENO="0178"
Table 14.
Pensions as Percent of Payroll for Companies Reporting Pension Payments, 1955-79.
1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1978 1979
5.1 5.1 5.0 4.9 4.6 4.4 4.8 4.8 5.5 5.7 6.2 6.5 6.3 6.3
3.8 3.9 3.9 4.0 3.7 3.4 3.9 4.0 4.6 4.8 5.6 5.8 5.6 5.5
4.0 4.1 3.5 4.6
3.3 3.1 3.6 2.9
2.9 2.9 3.3 3.0
.5.3 4.2 3.0 2.5
4.4 4.5 4.8 5.1
8.3 8.6 8.9 8.8
3.2 4.0 4.3 5.2
3.8 4.4 3.~. 3.6
3.3 3.3 4.1 4.0
Industry group
Total, all industries
Total, all manufacturing `
Manufacture of:
Food, beverages, and tobacco
Teotile products and apparel
Pulp, paper, lumber, and furniture
Printing and publishing
Chemicals and allied products
Petroleum industry
Rubber, leather, and plastic products
Stone, clay, and glass products
Primary metal industries
Fabricated metal products (eucluding machinery and
transportation equipment)
Machinery (excluding electrical)
Electrical machinery, equipment, and supplies
Transportation equipment
Instruments and miscellaneous manufacturing industries
Total, all nonmanufacturing ,
Public utilities (electric, gas, water, telephone, etc.)
Department stores
Trade (wholesale and other retail)
Banks, finance companies, and trust companies
Insurance companies
Hospitals
Hotels
Miscellaneous nonmanufacturing industries
Data not shown separately for this industry group.
4.7 4.1 4.8
3.8 2.1 2.7
3.2 2.8 3.3
3.1 2.7 3.8
4,7 4,7 4.9
8.5 4.8 4.7
4.9 3.9 3.6
4.2 3.6 4.3
4.0 3.9 4.9
4.8 5.6 5.8
2.9 2.7 3.3
2.7 3.6 3.4
3.7 3.8 4.4
4.5 4.9 5.8
4.9 7.2 ~M.o
4.2 5.7 4,5
4.5 5.4 5.7
4.9 5.6' 5.4
5.9 6.4 5.2 6.4
3.6 2.6 2.5 2.9
4.0 4.6 5.1 5.1
4.7 5.1 5.3 5.6
6.5 7.2 6.9 6.8
9.3 9.6 10.3 11,1
6.7 4.9 3.3 4.0
4.9 6.2 5.5 5.2
7.6 6.7 6.5 6.5
4.0 3.8 3.7 4.3 4.4
3.7 4.4 4.4 4.2 4.4
3.4 \3.7 3.6 3.9 3.7
3.4 4.0 3.9 . 3.4 . 3.3
4.1 3.5 3.8 4.4 4.7
6.9 7.0 6.9 6.7 6.1
6.8 6.7 7.3 6.8 6.9
2.6 2.6 2.8 24 2.7
8.1 8.5 8.1 7.9 7.7
7.1 7.9 8.1 7.7 7.5
2.7 3.2 2.9 2.4
10.7 3.2 3.9 3.4 3.1
5.2
5.5
4.9
3.8
4.0 4.0
4.8
4.8
5.5
6.0
6.0
5.7
3.3
3.3
3.9
4.6
5.1
4.9
5.6
5.8
5.1
3.1
3.9
3.9
4.7
5.2
6.0
6.5
5.8
5.4
2.8
3.3
3.8
4.7
4.2
5.5
4.8
54
55
6.0
6.0
6.3
6.6
6.7
7.0
7.5
7.2
7.3
6.9
6.9
7.0
7.8
7.6
9.0
9.5
9.8
9.9
2.4
2.3
2.2
2.3
3.0
3.1
3.2
2.9
3.2
2.2
2.7
2.3
3.0
3.4
3.1
4.8
3.5
4.0
7.2
6.9
6.8
6.8
6.3
7.1
7.9
7.6
6.6
6.6
6.9
6.8
7.3
7.3
7.5
2.6
7.4
3.4
7.6
2.7
7.8
3.7
PAGENO="0179"
Table 15.
.
Distribution of Pensi
on Payments a
s Percen
t of
Payr
oIl, 1951.79.
.
Item
1951
1953
1955
1957
1959
1961 1963
1965 1967 1969 1971 1973 1975 1977 1978 1979
Average pension payments as percent of payroll:
All companies 3.6 3.8 38 4.1 4.3 4.2 3.9 3.7 4.0 4.2 4.9 5.1 5.5 5.9 5.6 5.4
Companies reporting pension payments 4.7 4.8 5.1 5.1 5.0 4.9 4.6 4.4 4.8 4.8 5.5 5.7 6.2 6.5 6.3 6.3
Percent of companies reporting pension payments 77 80 75 81 86 86 85 85 85 86 89 90 89 91 89 86
Percentage distribution of pension payments:
0% 23 20 25 19 14 14 15 15 15 14 11 10 11 9 11 14
0.1-1.9% 19 18 14 15 15 14 15 15 15 15 11 9 9 7 8 8
2.0-3.9% 19 22 19 20 25 26 31 32 28 25 24 23 21 20 21 20
4.0-5.9% 17 18 19 22 21 21 19 18 18 21 20 22 18 19 21 19
6.0-7.9% 11 11 11 10 12 11 10 10 11 12 15 17 16 16 14 14
8.0-9.9% 6 5 6 7 7 7 5 5 7 7 10 10 11 13 10 11
10.0-11.9% 3 3 3 3 3 3 3 3 4 3 5 5 8 9 8 7
12.0-13.9% 1 2 2 2 1 2 1 1 1 2 2 2 4 4 3 4
14.0% and over 1 1 1 2 2 2 1 1 1 1 2 2 2 3 4 3
Total .c- 100 100 100 100 100 100 100 100. 100 100 100 100 100 100 100 100
Pension payments as percent of payroll:
Premium payments 3.3 3.2 2.9 2.8
Payments not covered by insurance-type plan 1.0 1.0 1.0 0.9
Premiums under insurance and annuity contracts S 2.3 2.4 2.6 2.9 3.0 3.3 3.2 3.1
Payments to uninsured trusteed pension plans 1.4. 1.5 2.0 2.0 2.3 2.4 22 2.1
Payments under unfunded pension plans 0.3 0.3 0.3 0.2 02 02 0.2 0.2
Total 3.6 3.8 3.8 4.1 4.3 4.2 3.9 3.7 4.0 4.2 4.9 5.1 5.5 5.9 5.6 5.4
Percent of companies reporting payroll deductions for pensions .. 34 31 31 26 28 26 26 24 21 20 18 17 17 15
Deductions for pensions as percent of payroll: .
Alt companies 0.5 0.5 0.6 . 0.5 0.5 0.5 0.5 0.4 0.3 0.3 0.3 02 0.2 ~0.3
Companies reporting deductions ... .. ... 1.8, 1.6 1.8 1.9 1.7 `1.8 1.7 1.6 1.6 1.5 1.5 1.4 .1.4 1.8
This item is notshswn separately.
PAGENO="0180"
Table 16.
Insurance Payments as Percent of Payroll for All Companies in Surveys, 1951 ~79.
Industry Group ______________
Total, all industnes
Total, all manufacturing
Manufacture of:
Food, beverages, and tobacco
Textile products and apparel
Pulp, paper, lumber, and furniture
Printing and publishing
Chemicals and allied products
Petroleum industry
Rubber, leather, and plastic products
Stone, clay, and glass products
Primary metal industries
Fabricated metal products (excluding machinery and
transportation equipmnnt(
Machinery (excluding elect rlcal(
Electrical machinery, equipment, and supplies
Transportation equipment
Instruments and miscellaneous manufacturing industries
Total, all nonmanufacturing
Public utilities (electric, gas, water, telephone, etc.(
Department stores
Trade (wholesale and other retail(
Banks, finance companies, and trust companies
Insurance companies
Hospitals
Hotels
Miscellaneous nonmanufacfuring industries
Data not shown separately forth/s industry group.
1951 1953 19551957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1978 1979
1.4
1.4
1.8
1.8
2.0
2.0
2.2
2.3
2.3
2.4
2.7
3.0
2.9
3.2
3.0
3.3
3.2
3.5
3.5
4.0
4.5
5.3
4.6
5.3
5.2
6.1
5.9
6.9
5.6
6.3
5.7
6.6
1.5
1.5
1.5
1.1
1.3
0.9
1.7
1.3
1.5
2.3
2.0
1.3
1.0
1.8
1.5
1.6
1.9
2.0
2.6
2.0
1.7
1.3
1.9
1.6
2.3
1.7
2.5
2.4
1.9
1.8
1.5
2.1
1.7
3.0
2.1
2.7
2.6
2.0
2.1
1.6
2.4
1.7
3.1
2.1
3.1
2.9
2.2
2.4
1.8
3.0
1.8
4.1
2.9
4.6
3.2
2.2
2.7
2.0
3.1
1.8
3.6
3.0
4.7
3.8
2.1
2.8
2.2
3.3
2.5
4.2
3.1
4.9
3.5
2.2
3.0
2.5
3.5
3.2
4,1
3.2
4.8
4.0
2.6
3.5
2.8
4.0
3.8
4.3
4.1
5.8
5.0
3.4
4.9
2.9
4.7
3.9
5.8
5.7
7.4
4.2
3.7
5.0
3.6
5.1
3.3
5.5
6.3
7.2
5.1
4.1
5.6
4.9
5.8
3.7
8.0
6.3
8.1
5.6
4.9
6.3
5.0
7,2
4.0
7.9
7.2
9.8
6.0
4.2
5.3
4,7
6.1
4.5
6.0
7.6
8.1
6.4
5.3
5.9
5.4
6.6
6.5
6.0
6.7
7.9
1.9
1.4
1.4
1.3
1.1
1.3
1.3
1.0
1.6
1.2
1.9
0.2
2.0
1.8
1.7
1,7
1.6
1.8
1.4
1.4
2.2
1.5
3.1
2.6
2.4
2.1
1.7
2.1
1.6
1.9
1.8
1.6
2.2
1.9
1.9
1.1
2.6
2.3
2.1
2.6
1.9
1.9
1.8
1.7
2.2
1.8
1.8
1.6
2.7
2.5
2.3
2.6
2.1
2.1
2.0
1.5
2.5
2.0
1.9
3.2
3.1
2.8
2.7
2.6
2.1
2.1
1.5
2.7
1.8
1.8
3.6
3.3
2.9
3.3
3.1
2.3
2.3
1.7
2.7
1.9
3.4
3.8
3.1
3,5
3.0
2.4
2.6
1.4
2.0
2.7
2.3
3.7
3.7
3.4
3.5
3.3
2.6
3.2
1.4
2.4
2.6
2.4
4.0
4.4
3.9
4.7
3.4
2.8
3.3
1.6
2.2
2.9
2.4
.
5.5
5.5
4.9
6.9
4.4
3.3
3.8,
1.8
3.2
3.5
2.6
6.1
5.8
4.7
6.3
4.1
3.6
4.2
2.0
3.2
3.8
3.3
6.2
6.9
5.5
7.8
5.4
3.8
4.5
2.5
3.3
3.7
3.3
2.9
7.1
8.2
6.4
7.5
5.8
4.6
5.1
4.0
4.2
4.9
4.2
3.7
6.9
7,1
6.1
7.8
5.4
4.5
5.2
3.1
4.0
4.7
4.3
3.6
6.8
6,7
5.9
8.1
5.7
4.4
5.2
3.0
4.1
4.9
4.3
3.6
PAGENO="0181"
Table 17.
Insurance Payments as Percent of Payroll for Companies Reporting InsurancePayments, 1955.79.
Industry group 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1978 1979
Total, all industries 2.1 2.3 2.3 2.8 29 30 3 2 36 4.5 47 5.2 5.9 56 5.7
Total, all manufacturing 2.0 2.3 2.4 30 3.2 33 36 40 53 54 6.1 70 6.4 6.6
Manufacture of:
Food, beverages, and tobacco 2.7 2.5 2.7 3.0 3.3 3.8 3.5 4.1 5.2 4.4 5.1 5.9 6.0 6.4
Textile products and apparel 2.0 2.0 2.0 2.3 2.3 2.1 2.2 2.6 3.5 3.7 4.1 4.9 4.4 , 5.3
Pulp, paper, lumber, and furniture 1.8 1.9 2.1 2.4 2.7 2.8 3.2 3.5 4.9 5.1 5.6 6.6 5.3 5.9
Printing and publishing 1.3 1.5 1.6 1.8 20 22 2.6 2.9 3.0 36 4.9 5.0 4.9 5.'~"
Chemicals and allied products 1.9 2.1 2.4 3.1 3.1 3.4 3.5 4.0 4.7 5.1 5.8 7.2 6.2 6.6
Petroleum industry 1.6 1.7 1.7 1.8 1.8 25 32 38 39 3.7 3.7 4.4 4.5 5.5
Rubber, leather, and plastic products 2.3 3.0 3.1 `4.1 3.6 4.2 4.2 4.3 5.8 5.5 8.0 7.9 6.0 6.0
Stone, clay, and glass products 1.7 2.2 2.1 2.9 3.0 3.1 3.2 4.1 5.7 6.3 6.3 7.2 7.6 6.7
Primary metal industries 2.5 2.8 3.1 4.7 4.7 49 49 58 7.4 72 8.1 9.8 8.1 7.9
Fabricated metal products (excluding machinery and
transportation equipment) 2.5 2.7 2.7 3.2 3.6 3.4 3.7 4.0 5.5 6.1 6.3 7.1 6.9 6.8
Machinery (excluding electrical) 2.1 2.3 2.6 3.1 3.3 3.8 3.7 4.4 5.5 5.8 6.9 8.2 7.1 6.7
Electrical machinery, equipment, and supplies 1.7 2.1 2.3 2.8 2.9 3.2 3.4 3.9 5.0 4.9 5.5 6.4 6.1 5.9
Transportation equipment `2.1 2.6 2.6 2.8 3.4 36 3.7 4.8 6.9 63 78 7.5 7.8 8.1
Instruments and miscellaneous manufacturing industries 1.7 2.0 2.2 2.7 3.1 3.0 3.3 3.5 4.4 4.1 5.4 5.8 5.4 5.7
Total, all nonmanufucturing 2.1 2.0 2.2 2.2 2.4 2.4 2.7 2.9 3.3 37 38 46 4.5 4.4
Public utilitiex (electric, gas, waler, telephone, etc.) 1.8 1.8 2.0 2.1 2.3 2.6 3.2 3.3 3.8 4.2 , 4.5 5.1 5.2 5.2
Department stores 1 5 1 4 1.7 1.9 20 25 40 3.1 3.0
Trade (wholesale and other retail) 1.6 1.9 1.6 1.5 1.8 2.0 2.5 2.3 3.2 3.6 3.3 4.2 4.5 4.1
Banks, finance companies, and trust compunies 2.2 2.2 2.5 2.7 2.7 2.8 2.6 2.9 3.5 3.8 3.7 4.9 4.7 4.9
Insurance companies 2.0 1.8 2.1 1.9 2.0 2.3 2.4 2.4 2.7 33 33 4.2 43 4.3
Hospitals . .. 29 3.7 36 3.6
Hotels 2.6 1.9, 2.3 2.2
Miscellaneous nonmanufacturing industries 1.7 2.0 , 2.4 2.3 2.3 2.3 2.7 , 2.9 2.9 2.9 4.0 4.4 5.0 4.1
Data not shown separately for this industry group.
PAGENO="0182"
Average insurance payments as percent of payroll:
All companies . 1.4 1.8 2.0 2.2 2.3 2.7 2.9 3.0
Companies reporting insurance payments 1.5 i.9 2.1 2.3 2.3 2.8 2.9 3.0
Percent of companies reporting insurance payments 96 97 96 97 98 98 99 99 98 99 99 99 100 100 99 100
Average insurance payment as percent of payroll, all companies:
Life
Health .
Life and health**
Total
Percent of companies reporting payments for:
Life
Health
Life and health
Average for companies reporting specific type of insurance
payments:
Life
Health -
Life and health*~
Percent of companies reporting payroll deductions for insurance .. ... ... 87 80 81 80 75 75 74 74 73 70 70 65 68 68
Deductions for insurance as percent of payroll:
All companies 1.1 1.1 1.2 1.2 1.2 1.1
Companies reporting deductions 1.3 1.4 1.5 1.5 1.6 1.4
Thin item not shown separately.
Less than O.05y.
Companies reporting one payment for both life and health.
Distribution
of
Insurance
Payments
as
Percent
of
Payroll,
1951.79.
Item 1951 1953
1955
1957
1959
1961
1963
1965
1967
1969
1971
3.2 3.5 4.5 4.6 5.2 5.9 5.6 5.7
3.2 3.6 4.5 4.7 5.2 5.9 5.6 5.7
Percentage distribution of insurance payments:
0% 4 3 4 3 2 2 1
0.1-1.9% 74 64 53 45 41 35 30 28
2.0-3.9% 20 28 36 44 48 46 45 44
4.0-5.9% 2 4 6 7 8 14 19 22
6.0-7.9% 1 1 1 1 2 4 4
8.0-9.9% 0 * * 1 1 1
10.0-11.9% 0 o 0 o 0
12.0-13.9% 0 0 0 0 0 0 0
14.0% and over 0 0 0 0 0
Total 100 100 100 100 100 100 100 100
2 1 1 1 1 0
24 21 11 10 ,8 4 5 4
44 42 34 32 27 21 23 24
23 26 30 31 34 32 33 34
5 7 15 17 18 22 23 23
1 2 6 6 9 11 8 10
1 1 2 2 2 6 4 4
* 1 1 1 2 2 1
* 0 1 2 1
100 100 100 100 100 100 100 100
0.8 0.7 0.8 0.7 0.7 0.7
3.2 3.5 3.9 4.4 4.4 4.4
0.5 0.4 0.5 0.8 0.5 0.6
4.5 4.6 5.2 5.9 5.6 5.7
79 81 83 83 85 84
88 91 90 87 91 91
11 8 8 11 8 8
1.0 0.9 0.9 0.9 0.8 0.8
3.8 3.8 4.3 5.0 4.8 4.8
4.6 5.0 6.8 7.3 6.3 7.0
1.1 1.0 1.1 1.0 1.0 0.9 0.9 0.8
1.4 1.4 1.5 1.4 1.5 1.4 1.3 1.2
PAGENO="0183"
Table 19.
Payroll Deductions by Type of Deduction, 1955.79.
Item
Payroll deductions as percent of payroll
Old-Age, Survivors,Disability, and Health Insurance (FICA
taxes)
Railroad Retirement and state sickness benefits insurance taxes
Pension plan premiums or contributions
Life, hospital, surgical, medical, and major medical insurance
Payroll deductions as cents per payroll hour
Old-Age, Survivors, Disability, and Health Insurance (FICA
taxes)
Railroad Retirement and state sickness benefits insurance taxes
Pension plan premiums
Life, hospital, surgical, medical, and major medical insurance
Payroll deductions as dollars per year per employee
Old-Age, Survivors, Disability, and Health Insurance (FICA
taxes)
Railroad Retirement and state sickness beneits insurance taxes
Pension plan premiums or contributions
Life, hospital, surgical, medical, and major medical insurance
1973 1975 1977 1978 1979
6.7 7.1 6.6 6.8 7.0
5.3 5.7 5.4 5.6 5.8
0.1 0.1 0.1 0.1 0.1
0.3 0.3 0.2 0.2 0.3
1.0 1.0 0.9 0.9 0.8
31.6 38.8 - .41.0 45.6 50.1
25.1 30.9 33.4 37.6 42.3
0.4 0.6 0.6 0.6 0.6
1.4 1.7 1.5 1.4 1.4
4.7 5.6 5.5 6.0 5.8
664 800 850 949 1,042
527 636 693 783 877
9 11 13 14 14
29 36 26 27 30
99 117 118 125 121
1955 1957 1959
3.5 3.8 4.2
1.8 2.1 2.3
0.1 0.1 0.1
0.5 0.5 0.6
1.1 1.1 1.2
6.8 8.3 9.5
3.5 4.4 5.4
0.2 0.2 0.2
1.0 1.1 1.3
2.1 2.6 2.6
141 171 209
73 91 112
4 5 5
20 24 30
44 51 62
1961 1963 1965 1967 1969 1971
4.5 4.8 4.4 5.7 6.1 6.0
2.7 3.0 2.7 3.9 4.6 4.5
0.1 0.1 0.1 0.2 0.1 0.1
0.5 0.5 0.5 0.5 0.4 0.3
1.2 1.2 1.1 1.1 1.0 1.1
11.1 12.9 12.7 17.6 21.4 23.9
6.7 8.1 7.8 12.2 16.0 17.9
0.2 0.3 0.3 0.4 0.4 0.4
1.2 1.3 1.4 1.6 1.5 1.4
3.0 3.2 3.2 3.4 3.5 4.2
227 268 268 369 447 498
134 168 163 254 335 372
5 5 6 8 .7 8
25 28 31 33 30 25
63 67 68 . 74 75 93
PAGENO="0184"
Table 20
Wage Data, 1951.79.
Item 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1978 1979
As percent of total payroll:
Total payroll 1000 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Straight-lime pay 93.4 93.6 94.2 93.9 93.7 94.7 93.8 93.3 93.4 92.9 93.9 93.0 93.9 93.3 93.4 93,7
Overtime premium pay 3.5 3.5 3.0 2.8 3.0 2.5 3.0 3.6 3.6 4.0 3.3 4.2 3.1 3.6 3.7 3.6
Holiday premium pay 0.4 0.3 0.3 0.4 0.4 0.4 0.4 0.5 0.5 0.6 0.6 0.5 0.6 0.7 0.7 0.6
Shift differential 0.6 0.6 0.5 0.5 0.5 0.5 0.5 0.6 0.5 0.5 0.5 0.6 0.6 0.6 0.6 0.6
Earned incentive or production bonua 1.5 1.6 1.6 1.8 1.7 1.7 1.7 1.4 1.2 1.3 1.0 1.0 1.0 1.0 1.1 1.1
Other payroll llama 0.6 0.4 0.4 0.6 0.7 0.2 0.6 0.6 0.8 0.7 0.7 0.7 0.8 0.8 0.5 0.4
As canto per hour:
Total payroll 168.1 180.2 193.1 217.4 240.4 247.3 268.8 289.5 309.0 352.3 397.1 471.3 545.8 616.9 669.7 731.1
Straight-time pay 157.0 168.8 181.9 204.1 225.3 234.2 252.1 270.3 288.6 327.3 372.4 437.8 512.2 576.2 625.9 684.7
Overtime premium pay 5.9 6.2 5.8 6.1 7.2 6.2 8.1 10.3 11.1 14.1 13.2 20.0 17.0 21.9 24.6 26.4
Holiday premium pay 0.7 0.6 0.6 0.9 0.9 1.0 1.1 1.4 1.6 2.0 2.3 2.5 3.5 4,3 4.6 4.3
Shift differential 1.0 1.1 0.9 1.1 1.2 1.2 1.3 1.7 1.5 1.9 2.1 2.8 3.0 3.6 4.0 4.0
Earned incentive or production bonus 2.5 2.8 3.1 3.9 4.1 4.2 4.6 4.0 3.7 4.5 42 4.8 5.6 6.1 7.0 8.4
Other payroll items 1.0 0.7 0.8 1.3 1.7 0.5 1.6 1.8 2.5 2.5 2.9 3.4 4.5 4.8 3.6 3.3
As dollars per year per full-time employee:
Total payroll 3.437 3,750 4,034 4,500 4,965 5,036 5,591 6,081 6,465 7,355 8,260 9,878 11,254 12,785 13,924 15,191
Straight-time pay 3,210 3,510 3,800 4,225 4,652 4,769 5,244 5,674 6,042 6,835 7,747 9,187 10,561 11,929 13,014 14,227
Overtime premium pay 120 131 121 126 149 126 168 219 231 294 274 415 350 460 511 548
Holiday premium pay 14 11 12 18 20 20 22 31 33 42 49 49 72 89 95 90
Shift differential 21 23 20 23 25 25 28 36 31 40 44 59 62 77 83 84
Earned incentive or production bonus 51 60 65 81 84 86 95 85 77 93 86 99 115 128 146 174
Other payroll items 21 15 16 27 35 10 34 36 51 51 60 69 94 102 75 68
PAGENO="0185"
Table 21.
.
.
Estimated Employee Benefits,
Total
Uni
ted S
tate
s Ec
onom
y, b
y Type of Benefit, 1929.79.
Type of Payment
1929
1951
1953
1955
1957
1959
1961
1963 1965 1967 1969
1971
1973
1975
1977
1978
1979
1. Legally required
(Percent of wages and salaries)
9.2%
9.4%
0.6%
3.3%
3.2%
3.3%
3.7%
4.2%
5.1%
5.6% 5.3% 6.3% 6.6%
7.2%
8.1%
8.4%
9.0%
Old-Age, Survivors, Disability, and Health
Insurance (FICA taxes)
0
1.0
1.2
Unemployment Compensation
0
1.0
0.7
Workers' compensation
0.6
0.6
0.6
Govemment employee retirement
0.2
0.6
0.6
Other
0
0.1
0.1
2. Agreed-upon
0.4
2.7
3.2
1.7 2.1 2.4 2.3 32 3.5 3.7 4.4 4.6 4.5 4.6 4.8
0.9 1.1 1.2 1.0 0.8 0.7 0.7 1.0 0.8 1.2 1.3 1.2
0.6 0.7 0.7 0.7 1.0 1.0 1.0 0.9 1.0 1.0 1.0 1.0
0.8 1.0 1.0 1.0 1.0 1.1 1.5 1.5 1.7 2.0 2.0 2.1
0.2 0.2 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3
4.2 4.6 4.6 4.6 5.0 5.1 5.9 6.3 7.4 8.1 8.1 8.1
2.6 2.6 2.4 2.3 2.6 2.7 3.0 3.2 3.6 3.7 3.7 . 3.6
1.3 1.7 1.9 2.0 2.1 2.1 2.6 2.8 3.4 4.0 40 4.1
0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.4 0.4 0.4 0.4
3.0 32 3.3 3.1 3.3 3.3 3.6 3.6 3.7 3.8 3.8 3.8
6.6 7.1 7.4 7.3 .7.6 7.7 8.4 8.5 9.4 9.5 9.5 9.4
3.5 3.8 3.9 3.8 3.9 3.9 4.3. 4.3 4.8 4.9 4.9 4.8
22 2.4 2.5 2.5 2.6 2.7 2.9 2.9 32 32 3.2 32
0.8 0.8 0.8 0.8 0.9 0.9 1.0 1.1 12 1.2 12 12
0.1 0.1 02 02 0.2 02 0.2 02 02 02 02 02
5. Bonuses, protit-sharing, etc 0.1 1.0 1.1 1.2 1.0 1.0 1.0 1.1 1.2 1.3 1.3 0.9 1.0 1.1 1.1 1.1 1.1
Totat benetit payments 3.0% 15.0% 15.5% 17.0% 18.0% 19.0% 21.0% 22.0% 21.5% 23.5% 24.0% 26.0% 27.5% 30.0% 31.5% 31.7% 31.8%
(Billion dollars)
Wage and salaries $50.4 $171.1 $198.3 $210.4 $238.1 $258.2 $278.8 $312.1 $358.4 $423.4 $509.0 $573.4 $691.6 $806.6 $983.6 $1,103.5 $1,227.4
Total benetit payments $1.5 $26.0 $31.0 $36.0 $43.0 $49.0 $58.5 $68.0 $77.0 $100.0 $121.0 $150.0 $190.0 $240.0 $310.0 $350.0 $390.0
Sosrce: Wages and salaries from United States Department of Commerce. Benefits estimated by Chamber of Commerce of the United States.
Pensions 0.2
Insurance 0.1
Other 0.1
3. Rest penods 1.0
4. Time not worked 0.7
Vacation 0.3
Holidays 0.3
Sick leave 0.1
Other 0
1.4 1.5
0.7 0.8
0.5 0.5
0.5 0.7
0.2 0.2
3.6 3.9
2.0 22 2.4
0.9 1.1 1.2
0.3 0.3 0.3
2.3 3.0 3.0
5.7 5.9 6.4
3.0 3.0 3.3
1.9 2.0 2.2
0.7 0.8 0.8
0.1 0.1 0.1
1.8
0.7
0.2
2.5
5.5
3.0
1.8
0.6
0.1
PAGENO="0186"
Manufacturing . 72.1
Trade (wholeaale and retail) 9
Services 19.4
Construction 12.0
Finance, insurance, and real estate 8.8
Transportation 12.4
Utilities and communication 6.2
Mining 3.7
Agriculture 3.1
Private industry 174.5
Govemment federal, state, local) 35.9
Total, all industries 210.4
Manufacturing 16
Trade (wholesale and retail) 17
Services 11
Construction 12
Finance, Insurance, and real estate 24
Transportation . 20
Utilities and communication 22
Mining 25
Agriculture 10
Private industry 16
Government (federal, state, local) 21
Total,.all industries 17
Manufacturing 11.5
Trade (wholesale and retail) 6.3
Services 2.1
Construction 1.4
Finance, insurance, and real estate 2.1
Transportation 2.5
Utilities and communication 1.4
Mining 0.9
Agriculture 0.3
Private industry 28.5
Govemment (federal, state, local) 7.5
Total, all industries 36.0
Wages and salaries IBillion dollars)
80.6 84.8 87.5 98.0 115.5 134.1 157.5 159.5 196.6 211.7 266.3 298.3 330.9
42.1 46.3 50.0 55.7 59.2 69.0 82.5 96.1 113.2 136.2 165.5 186.4 206.8
22.4 25.7 29.9 34.4 41.4 50.2 63.0 75.4 92.8 116.8 148.5 169.5 190.9
13.9 15.2 15.9 17.8 21.1 24.3 30.6 35.0 42.3 44.7 53.4 62.2 72.4
10.2 11.7 13.5 15.0 16.8 19,8 24.7 29.6 35.3 4.3.1 51.6 59.3 66.9
13.9 14.2 14.4 15.4 17.2 19.6 22.9 25.9 30.9 34.2 42.5 47.8 54.4
7.2 7.7 8.4 9.2 10.3 11.9 14.4 17.4 21.0 25.2 31.1 35.2 39.7
4.3 3.8 3.7 3.8 4.3 4.7 5.4 6.1 7.4 10.7 14.0 16.3 19.6
3.4 3.5 3.7 3.6 3.4 3.5 3.9 4.7 5.6 8.2 9.9 10.5 12.3
198.0 212.9 227.0 252.9 289.2 337,1 404.9 449.7 545.1 630.8 782.8 885.5 993.9
40.1 45.3 51.8 59.2 692 86.3 104.1 123.7 146.5 175.8 200.8 218.0 233.5
238.1 258.2 278.8 ` 312.1 358.4 423.4 509.0 573.4 691.6 806.6 983.6 1,103.5 1,227.4
Benefit payments (Percent of wages and salariea)
17 21 23 23 22.5 25 26 29 30 33 34.5 35 35.5
18 15 17. 19 20 23 22 23 25 27 28 28.5 28
11 11 13 14 14 16 16 18 20 22 24 24.5 ` 24.5
12 15 17 18 17 19 18 22 24 25 26 26.5 26.5
25 26 29 30 30 32 33 35 37 37 39 39 39
20 21 23 25 25 27 27 29 31 35 38 38 38
22 ` 28 30 26 28 29 30 33 35 38 41 41.5 41.5
25 / 26 28 29 28 30 30 31 33 38 40 40.5 42
10 10 10 11 13 15 15 17 18 20 22 22 22
17 18.5 20.5 21 21 23.5 23.5 26 27 30 31.5 31.6 31.7
24 21 23 24 23 24 25 27 28 30 32 32 ` 32.1
18 19 21 22 21.5, 23.5 24 26 27.5 30 31.5 31.7 31.8
Benefit payments (Billion dollars)
13.5 17.8 20.1 23.0 26.0 33.7 41.0 46.5 58.5 70.0 92.5 104.5 117.0
7.5 6.9 8.5 10.5 11.8 16.0 18.0 22.0 28.5 37.0 46.5 53.0 58.0
2.5 2.8 4.0 4.8 5.8 8.0 10.0 13.5 18.5 25.5 36.0 41.5 47.0
1.7 2.3 2.7 3.2 3.6 4.6 5.5 7.6 10.0 11.2 14.0 16.5 19.0
2.5 3.1 4.0 4.5 5.0 6.3 8.1 10.5 13.0 16.0 20.0 23.0 26.0
2.8 3.0 3.3 3.9 4.3 5.3 6.1 7.5 9.7 12.0 16.0 18.0 20.5
1.6 2.2 2.5 2.4 2.9 3.5 4.3 5.7 7.4 9.6 12.7 14.6 16.5
1.1 1.0 1.0 1.1 1.2 1.4 1.6 1.9 2.4 4.1 5.6 6.6 8.3
0.3 0.4 0.4 0.4 0.5 0.5 0.6 0.8 1.0 1.6 2.2 2.3 2.7
33.5 39.5 46.5 53.8 61.1 79.3 95.2 116.0 149.0 187.0 245.5 280.0' 315.0
9.5 9.5 12.0 14.2 15.9 20.7. 25.8 34.0 41.0 53.0 64.5 70.0 75.0
43.0 49.0 58.5 68.0 77.0 100.0 121.0 150.0 190.0 240.0 310.0 350.0 390.0
.
.
0
Table 22.
.
Estimated Total Employee
Benefits,
Total
United
States
Economy,
by
Industry
Groups,
1955.79.
Industry group
1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1978 1979
Source: Wages and salaries from United States Department of Commerce. Benefits estimated by Chamber of Commerce of ihe United States.
PAGENO="0187"
Table 23.
Supplements to Wages and Salaries
, 1929.79.
(United States Department of Commerce Data.)
`
(Million dollars)
Type of Supplement 1929 1930
1931
1932
1933
1934 1935
1936
1937
1938
1939
1940
1941
1942
1943
1944
1945
Total supplements to wages and salaries .. 662 657
621
577
542
590 650
990
1,827
2,018
2,167
2,311
2,703
3,162
3,759
4,463
5,604
Employer contributions for social insurance . 101 106
111
126
133
147 171
418
1,234
1,423
1,540
1,624
1,983
2,302
2,677
2,937
3805
Federal social insurance funds 29 28
27
30
26
29 44
287
1,093
1,276
1,388
1,469
1,818
2,117
2,475
2,725
3,580
Old-Age, Survivors, and Disability
Insurance 0 . 1)
0
0
1)
0 0
0
288
261
291
329
419
532
625
648
.630
Hospital Insurance 0 0
0
0
0
0 0
0
0
0
0
0
0
0
0
0
0
State unemployment insurance 0 0
0
0
0
3 7
159
588
780
815
813
1,011
1,089
1,246
1,177
1,011
Federal unemployment tax 0 0
0
0
0
0 0
81
89
102
105
98
124 .
161
183
184
174
Federal civilianemployee retirement ... 21 21
22
22
22
22 32
45
63
77
84
93
102
109
147
192
227
Other items 8 7
5
8
4
4 5
2
65
56
93
136
162
226
274
524
1,538
State and local social insurance funds ... 72 78
84
96
107
118 127
131
141
147
152
155
165
185
202
212
225
State and local employee retirement ... 72 78
84
96
107
118 127
131
141
147
152
155
165
185
202
212
225
Otheritems 0 0
0
0
0
0 0
0
0
0
0
0
0
0
0
0
0
Other labor income 561 551
510
451
409
443 479
572
593
595
627
687
720
860
1,082
1,526
1,799
Employer contributions to private pension
and welfare funds 169 160
158
148
140
166 180
238
218
228
248
282
314
401
586
948
1,132
Pension and profit-uhanng
Group health insurance
Group life insurance
.
Workers' compensation
Supplemental unemployment 0 0
0
0
0
0 0
0
0
0
0
0
0
0
0
`0
0
Other items 392 391
352
303
269
277 299
334
375
367
379
405
406
459
496
578
667
Data not available.
PAGENO="0188"
Table 23-Continued.
Supplements to Wages and Salaries, 1929.79.
(United States Department of Commerce Data.)
(Million dollars)
Type of Supplement 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 19581959 1960 1961 1962
Total supplements to wages and salaries .. 6,047 6,077 5,903 0,599 7,818 9,659 10,364 11,024 tt,602 13,238 15,t64 17,227 17,746 20,644 23,000 24,106 27,055
Employer contributions for social insurance . 4,090 3,699 3,t88 3,661 4,164 5,033 5,177 5,148 5,487 6,216 7,tt6 8,t88 8,347 10,070 11,780 12,282 14,017
Federal social insurance funds 3,733 3,289 2,696 3,095 3,482 4,214 4,236 4,107 4,282 4,957 5,704 6,591 6,659 8,186 9,645 9,995 tt,636
Old.Age, Survivors, and Disability
Insurance 687 780 839 816 1,308 1,660 t,776 1,882 2,458 2,825 3,043 3,673 3,657 4,556 5,632 5,700 6,226
Hospital tnsuranco 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
State unemployment insurance 893 1,029 965 1,010 1,217 1,465 1,350 1,288 1,081 1,221 1,475 1,507 1,503 2,024 2,300 2,464 2,997
Federal unemployment tan 184 212 228 223 232 263 263 298 289 304 326 337 326 337 343 456 947
Federal civilian employee retirement ... 241 241 244 273 316 316 326 188 42 t44 393 599 726 755 838 875 943
Other items 1,728 1,027 420 773 409 510 52t 451 412 463 467 475 447 514 532 500 523
State and local social Insurance funds ... 357 410 492 566 682 8t9 941 1,041 1,205 1,259 1,412 1,597 1,688 1,884 2,135 2,287 2,381
State and local employee retirement ... 250 290 360 420 510 625 715 790 940 985 1,110 1,270 1,370 1,559 1,775 1,903 1,970
Other items 107 120 132 146 172 194 226 251 265 274 302 327 318 325 360 384 411
Other labor income 1,957 2,378 2,715 2,938 3,654 4,626 5,187 5,876 6,115- 7,022 8,048 9,039 9,399 10,574 11,220 11,824 13,038
Employer contributions to private pension . -
and welfare funds 1,231 1,555 2,614 2,828 3,534 4,499 5,049 5,726 5,951 6,845 7,856 8,839 9,185 10,344 10,969 11,555 12,752
Pension and profitsharing ... 1,196 1,262 1,713 2,262 2,543 2,861 2,903 3,377 3,757 4,153 4,134 4,771 4,866 4,966 5,442
Group health insurance 614 762 1 030 1 320 1 476 1 737 51,454 1,706 2,058 2,440 2,721 3,038 3,374 3,747 4,188
Group life insurance ... I ` ` ` ` 1 465 561 668 766 867 971 t,080 1,133 1,219
Workers' compensation ... 804 804 791 917 1,030 1,128 1,129 1,150 1,243 1,312 1,315 1,430 1,529 1,602 1,745
Supplemental unemployment 0 0 0 0 5 0 0 0 0 51 130 168 148 134 120 107 158
Other items 726 823 101 110 120 127 138 150 164 177 192 200 214 230 251 269 286
Data not available.
PAGENO="0189"
Table 23-Continued.
Supplements to Wages and Salaries, 1929.79.
(United States Department of Commerce Data.)
(Million dollars)
Type of Supplement 1963 1964 1965 1966 1967
1968 1969 1970 1971 1972 1973
1974
1975
1976
1977
1978
1979
Total supplemenls 10 wages and salaries .29,497 31,824 34,538 40,927 44,425
50,311 57,184 63,240 70,655 82,779 98,678
112,272
124,980
146,409
168,499
194,293
225,028
Employer contributions for social insurance .15,536 16,099 16,698 21,032 22,774
Federal social insurance funds 12,899 13,202 13,668 17,506 18,610
25,074 28,722 30,733 33,969 39,752 49,842
20,601 23,526 24,889 27,557 32,494 41,475
56,425
46,748
60,457
48,921
70,544
56,806
79,465
63,813
92,120
74,395
106,432
85,762
Old-Age, Survivors, and Disability
16,182 18,214 20,612 25,174
29,191
30,490
33,834
37,378
42,928
50,161
Insurance 7,464 7,846 8,330 11,033 11,866
13,138 15,621
5,375
5,610
6,225
6,875
8,594
10,487
Hospital Insurance 0 0 0 1,020 1,545
2,105 2,263 2,342 2,407 2,721
2,721 4,206 5,188
5,553
5,516
8,448
9,643
11,661
12,410
State unemployment insurance 3,034 3,059 3,076 3,014 2,614
2,536 2,529 2,493
669 854 853 1,182 1,511
1,289
1,294
1,504
2,270
2,884
3,300
Federal unemployment tax 847 619 558 597 601
3,779
4,353
4,866
5,466
6,013
6,785
Federal civilian employee retirement ... 1,034 1,138 1,146 1,244 1,339
1,501 1,719 2,215 2,520 2,872
687 725 803 842 901 1,130
1,561
1,658
1,929
2,181
2,315
2,619
Other items 520 540 558 598 645
State and local social insurance funds ... 2,637 2,897 3,030 3,526 4,164
4,473 5,196 5,844 6,412 7,258 8,367
7,326
9,677
8,482
11,536
10,170
13,738
12,059
15,652
13,500
17,725
15,011
20,670
17,425
State and local employee retirement ... 2,187 2,417 2,525 2,980 3,574
3,839 4,513 5,091 5,589 6,350
634 683 753 823 908 1,041
1,195
1,366
1,679
2,152
2,714
3,245
Other items 455 485 505 546
Other labor income 13,961 15,725 17,840 19,895 21,651
25,237 28,462 32,507 36,686 43,027 48,836
55,847
64,523
75,865
89,034
102,173
118,596
Employer contributions to private pension
36,047 42,311 48,042
54,996
63,595
74,822
87,892
100,823
117,015
and welfare funds 13,659 15,401 17,485 19,508 21,228
24,773 27,936
24,218
28,253
32,972
38,764
44,869
54,899
Pension and profit-sharing 5,760 6,591 7,646 8,675 9,456
10,717 11,823 13,050 15,108 17,903
16,163 18,014
20,725
24,043
28,835
33,745
37,878
41,574
`~ Group health insurance 4,551 5,182 5,890 6,410 6,869
8,408 9,931 12,099 13,661
3,127 3,573 3,673
3,946
4,368
4,418
4,795
5,495
6,009
Group life insurance 1,334 1,481 1,651 1,834 2,036
*
2,384 2,601
4,406 5,155
5,911
6,695
8,219
10,120
12,018
13,943
Workers' compensation 1,861 2,028 2,177 2,453 2,747
3,135 3,469 3,786
111 196 266 266
196
236
378
468
563
590
Supplemental unemployment 153 119 121 136 120
129
570 639 716 794
851
928
1,043
1,142
1,350
1,581
Other items 302 324 355 387 423
464
PAGENO="0190"
Table 24.
Supplements as Percent of Total Wages and Salaries, by Type of Supplement, 1929-79.
(Computed from United States Department of Commerce Data.)
Type of Supplement 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1839 1940 1941 1942 1943 1944 1945
Total supplements to wages and salaries 1.3 1.4 1.6 1.9 1.9 1.8 1.8 2,4 4.0 4.7 4.7 4.6 4.4 3.9 3.6 3.8 4.8
Employer contributions for social insurance 0.2 0.2 0.3 0.4 0.5 0.5 0.5 1.0 2.7 3.3 3.3 3.2 3.2 2.8 2.6 2.5 3.2
Other labor Income 1.1 1.2 1.3 1.5 1.4 1.3 1.3 1.4 1.3 1.4 1.4 1.4 1.2 1.1 1.0 1.3 1.6
Old-Age, Survivors, and Disability Insurance 0 0 0 0 0 0 0 0 0.6 0.6 0.6 0.7 0.7 0.6 0.6 0.6 0.5
Hospitallnsurance 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
State unemployment Insurance 0 0 0 0 0 0.4 1.3 1.8 1.8 1.6 1.6 1.3 1.2 1.0 0.9
Federal civilian employee retirement .......................... * 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.2 0.2 0.2 0.1 0.1 0.2 0.2
State and local employee retirement .......................... 0.1 0.2 0.2 0.3 0.4 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.2 0.2 0.2 0.2
Pension and profit-sharing
Group health insurance
Group life Insurance
Workers' compensation ....................................
Other supplements ......................................... 1.2 1.2 1.3 1.5 1.4 1.3 1.4 1.6 1.7 1.8 1.8 1.8 1.6 1.7 1.5 1.8 3.0
Type of Supplement 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962
Total supplements to wages and salaries ..................... 5.4 4.9 4.4 4.9 5.3 5.6 5.6 5.6 5.9 6.3 6.6 7.2 7.4 8.0 8.5 8.6 9.1
Employer contributions for social insurance .................... 3.7 3.0 2.4 2.7 2.8 2.9 2.8 2.6 2.8 3.0 3.1 3.4 3.5 3.9 4.4 4.4 4.7
Other labor Income 1.7 1.9 2.0 2.2 2.5 2.7 2.8 3.0 3.1 3.3 3.5 3.8 3.9 4.1 4.1 4.2 4.4
Data nut available.
* Less than 0.05%.
Includes federal, state, and local government workers' compensation, not shown separately in Table 23.
Old-Age, Survivors, and Disability Insurance
Hospital tnsurance
State unemployment insurance
Federal civilian employee retirement
State and local employee retirement
Pension and profIt-sharIng
Group health insurance
Group life Insurance
Workers' compensation~~
Other supplements
0.6 0.6 0.6 0.6 0.9 1.0 1.0 0.9 1.2 1.3 1.3 1.5 1.5 1.8 2.1 2.0 2.1
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
0.8 0.8 0.7 0.7 0.8 0.9 0.7 0.6 0.5 0.6 0.6 0.6 0.6 0.8 0.8 0.9 1.0
0.2 0.2 0.2 0.2 0.2 0.2 . 0.2 0.1 0.1 0.2 0.3 0.3 0.3 0.3 0.3 0.3
0.2 0.2 0.3 0.3 0.3 0.4 0.4 0.4 0.5 0.5 0.5 0.5 0.6 0.6 0.7 0.7 0.7
0.9 0.9 1.2 1.3 1.4 1.4 1.5 1.6 1.6 1.7 1.7 1.8 1.8 1.8 1.8
05 06 07 08 08 09 ~0.7 0.8 0.9 1.0 1.1 1.2 1.2 1.3 1.4
S ` ` ` ` ` ~ 0.2 0.3 0.3 0.3 0.4 0.4 0.4 0.4 0.4
0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 ~0.7 0.7
3.6 3.1 0.5 0.9 0.5 0.3 0.4 0.6 0.6 0.4 0.5 0.6 0.5 0.4 0.5 0.5 0.7
PAGENO="0191"
Table 24-Continued.
Supplements as Percent of Total Wages and Salaries, by Type of Supplement, 1929.79.
(Computed from United States Department of Commerce Data.)
Type of Supplement
Total supplements to wages and salaries
1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979
9.4 9.5 9.5 10.3 10.4 10.7 11.1 11.5 12.1 13.0 14.0 14.7 15.5 16.4 17.1 17.6 18.2
Employer contributions for social insurance 5.0 4.8 4.6 5.3 - 5.3 5.3 5.6 5.6 5.8 6.2 7.1 7.4 7.5 7.9 8.1 8.3 8.6
Other labor income 4.4 4.7 4.9 5.0 5.1 5.4 5.5 5.9 6.3 6.8 6.9 7.3 8.0 8.5 9.0 9.3 9.6
3.8 3.6 3.9 4.1
0.7 0.7 0.8 0.8
0.9 1.0 1.1 1.0
0.5 0.6 0.5 0.5
1.4 1.4 1.4 1.4
3.7 3.9 4.1 4.4
3.2 3.4 3.4 3.4
0.5 0.5 0.5 0.5
1.2 1.3 1.4 1.4
0.5 0.5 0.5 0.7
Old-Age, Survivors, and Disability Insurance
Hospital Insurance
Slate unemployment insurance
Federal civilian employee retirement
Stale and local employee retirement
Pension and profit-sharing
Group health insurance
Group life insurance
Workers' csmpensallon
Other supplemenls
Includes federal, state, andlscal government workers' compensation, not
straws separately in Table 23.
Table 25.
2.4 2.3 2.3 2.8 2.8 2.8 3.0 2.9 3.1 3.2 3.6 3.8 3.8
0 0 0 0.3 0.4 0.4 0.4 0.4 0.4 0.4 0.7 0.7 0.7
1.0 0.9 0.8 0.8 0.6 0.5 0.5 0.5 0.5 0.7 0.7 0.7 0.7
0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.4 0.4 0.5 0.5 0.5 0.5
0.7 0.7 0.7 0.7 0.8 0.8 0.9 0.9 1.0 1.0 1.0 1.1 1.3
1.8 2.0 2.1 2.2 2.2 2.3 2.3 2.4 2.6 2.8 3.0 3.2 3.5
1.5 1.5 1.6 1.6 1.6 1.8 1.9 2.2 2.3 2.5 2.6 2.7 3.0
0.4 0.4 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.6 0.5 0.5 0.5
0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.9 0.9 1.0 1.0
0.5 0.6 0.4 0.3 0.4 0.5 0.5 0.5 0.5 0.4 0.5 0.5 0.5
Supplements as Percent. of Wages and Salaries,
(Computed from United States Department of Commerce Data.)
industry group 1929 1930
by
1931
Industry
1932
1933
Groups,
1934
1935
1936
1929.79.
1937
1938
1939
1940
1941
1942
1943
1944
1945
All industries 1.3 1.4
1.6
1.9
1.9
1.8
1.8
2.4
4.0
4.7
4.7
4.6
4.4
3.9
3.6
3.8
4.8
Agriculture, forestry, and fisheries 0.4 0.4
0.5
0.7
0.6
0.5
0.5
0.4
0.5
0.6
0.6
0.6
0.4
0.4
0.3
0.4
0.4
Mining 1.6 1.7
1.8
2.2
2.0
1.8
1.7
2.6
4.8
6.3
5.9
5.7
5.3
4.9
4.5
4.0
4.0
Contract construction 2.3 2.7
3.5
4.9
4.6
3.8
3.5
3.8
5.8
7.1
6.7
6.6
6.0
5.5
5.1
5.2
5.3
Manufacturing 0.9 1.0
1.1
1.4
1.2
1.1
1.2
2.1
4.2
5.5
5.4
5.2
4.9
4.3
4.3
4.8
5.1
Transportation 2.0 2.2
2.6
3.0
3.3
4.0
2.7
3.7
6.0
6.3
6.3
6.2
6.2
6.4
6.1
5.9
6.0
Communication 2.1 2.0
2.2
2.6
4.4
4.1
4.4
4.9
6.9
8.1
7.9
8.8
9.5
9.2
9.1
9.1
8.9
Electric, gas, and sanitary services 1.7 1.8
1.9
1.8
1.6
1.5
2.2
3.3
5.3
6.7
6.7
6.2
5.6
4.9
5.3
8.1
9.4
Wholesale and retail trade 0.6 0.6
0.7
0.8
0.8
0.7
0.8
1.5
3.3
4.1
4.1
3.9
3.7
3.4
3.3
3.5
3.4
Finance, insurance, and real estate 2.4 2.4
2.4
2.5
2.3
2.2
2.6
3.4
4.9
5.9
6.0
6.0
5.9
5.6
6.3
6.0-
5.1
Services 0.4 0.5
0.5
0.~
0.6
0.6
0.6
1.1
2.1
2.7
2.5
2.4
2.5
2.3
2.2
2.2
2.2
Govemment and government enterprises 3.2 3.2
3.2
3.7
3.6
3.2
3.4
3.1
3.7
3.7
4.0
4.1
3.1
2.2
1.6
2.3
5.3
All pnvate enterpnses 1.1 1.2 1.3 15 1.5 1.4 1.4 2.2 4.0 4.9 4.9 4.8 4.6 4.2 4.2 4.4 4.5
PAGENO="0192"
186
3
0
0
0
(I'
0
.0
C)0
c~1.
~ 0
..E
0
0.0
CO
U).5
.2~
C5E
In!
~~0
C
U
0.
0
0
C
0 ~
E
0
0.
0.
in
~
PAGENO="0193"
Chart 6.
Supplements to Wages and Salaries as Percent of Wages and Salaries, I 929~79.
(United States Department of commerce Data.)
PAGENO="0194"
188
Chairman PICKLE. Does that complete your statement, Mr. Alex-
ander?
Mr. ALEXANDER. That completes my statement.
Mr. Romig and I will be glad to answer questions about the
chamber's questionnaire and will be glad to provide specific re-
sponses to your specific questions.
Chairman PICKLE. Let me ask Mr. Swain, are you prepared to
make your statement? If so, then proceed, and afterward we will
talk to the panel as a whole.
STATEMENT OF FRANK S. SWAIN, CHIEF COUNSEL, OFFICE OF
ADVOCACY, U.S. SMALL BUSINESS ADMINISTRATION
Mr. SWAIN. Yes, Mr. Chairman.
Chairman PICKLE. Mr. Swain is chief counsel, Office of Advocacy
of the U.S. Small Business Administration. We are glad to have
you, Mr. Swain.
Mr. SWAIN. Thank you, Mr. Chairman, members of the commit-
tee. I certainly appreciate the invitation to the Office of Advocacy
to participate in these very important hearings.
As you may know, the Office of Advocacy is statutorially charged
with being, within Government, policy spokesman for small busi-
ness responsible for assessing the impact of Federal policies and
proposals on the small business community.
With your permission, Mr. Chairman, I would like to very briefly
summarize my statement so that you may get to any questions.
Chairman PICKLE. Your entire statement will be included in the
record and that applies also to Mr. Alexander and any statement
you might want to make, also Mr. Romig.
Mr. SWAIN. I would like to discuss several issues. First of all, I
think it is important to make sure that it is on the record that em-
ployee benefits are important to small business owners. I think
sometimes in a discussion of employee benefits there is a percep-
tion that small businesses don't offer employee benefits, perhaps
because they are too stingy or uninterested. In my 3 years as chief
counsel for Advocacy and several other years working with the
small business community, I assure you that nothing could be fur-
ther from the truth.
Small business employers are very concerned about the ability to
offer employee benefits. Small businesses are the job creators. They
employ two out of three first-time workers in the work force. It is a
tremendous cost to hire a new worker, have him or her work for a
business for several months or a few years then move to some
other business that might have a larger or more lucrative employ-
ee benefit package. The ability of a small business employer to pro-
vide its employees and employees' families various fringe benefit
options is extraordinarily important.
Second, I would like to discuss the differing prevalence of fringe
benefits in large and small firms. Simply put, a large business is
very apt to have both health and pension coverage for their work-
ers; a small firm very much less so. Our statement provides some
specifics that generally track with the figures that were provided
by Mr. Salisbury of the Employee Benefit Research Institute. Basi-
cally, surveys indicate that if one works for a firm with fewer than
PAGENO="0195"
189
25 employees, one has about a one out of five chance of being cov-
ered by pension benefits, and about a one out of three chance of
being covered by health benefits.
If you work for a firm that has more than 500 employees, you
have about a 9 out of 10 chance of being covered by pension bene-
fits and about the same opportunity of being covered by health
benefits.
In other words, as figures in our testimony indicate, small busi-
ness employers are not nearly as likely as large employers to have
either pension coverage or health coverage, although small employ-
ers are more likely to provide health insurance than pension cover-
age.
Levels of health and pension coverage also vary significantly by
industry. Both pension and health care coverage is greatest in the
manufacturing and finance industries, while coverage is lowest in
the trade, service and construction sectors-all sectors, I might
add, that are rapidly growing in our economy.
The characteristics of pension and health care plans differ sig-
nificantly in large and small firms. Small firms are more likely to
have defined contributions than defined benefit plans. Pension ben-
efits tend to vest earlier for workers in small businesses largely
due to the greater likelihood that the small firm has established a
defined contribution plan.
In the area of health care cost containment, small businesses are
leading the way in attempts to cut down the costs containment,
small businesses of their plans. We noted in the testimony several
cost saving initiatives that we find very frequently in small busi-
ness health care plans.
What are the reasons for a lower level of coverage in small busi-
nesses as opposed to larger firms?
The first and foremost reason is less profitability in small firms.
Small firms can't afford many times very costly level of benefits
necessary to sustain pension and health care plans in particular.
Various surveys have continued to isolate this as the No. 1 basic
factor, small firm profitability. There are several other significant
factors.
In addition to the issue of profitability, I would like to mention
the fact that the benefit costs of health and pension plans are of-
tentimes very great for small firms. Small firms generally face
higher health insurance premiums than larger firms because they
are unable to spread the risks across as many employees.
Pension benefits also cost more per worker in small firms. For
example, pension costs per worker, in one survey that we have
cited in the testimony, average $1,080 per worker in firms with 10
or fewer employees; but in firms with between 500 and a thousand
employees the average cost per worker is $574. Clearly there are
some tremendous economies of scale in providing pension and
health care benefits.
Administrative costs and start-up costs, as a result of the com-
plexity of the law and the specific forms required to be filed, are
also a tremendous, largely fixed burden for small firms.
Various efforts to regulate the pension and benefit area I think
have been largely counterproductive in their attempts to enhance
the ability of small firms to offer more generous pension and
PAGENO="0196"
190
health care benefits. I cite simply the 1980 Multiemployer Pension
Plan Amendments Act which many people felt would solve some
significant problems in that particular category of benefit. I think,
that at least as far as the small business community is concerned,
in the 4 years since that act has been effective, the cure has been
far worse than the disease.
Finally, I think it bears mentioning that many times small busi-
nesses employ a large proportion of younger workers and part-time
workers and the workers themselves may well express a preference
for larger take-home pay rather than having a larger amount of
the compensation deferred in various benefit packages.
Finally, I would like to mention just one factor. We don't come
here as experts on tax or revenue losses. We are not responding in
our statement to any specific proposals that may be before the com-
mittee now or in the future. We are simply here to stress the fact
that the proposals to expand the taxable wage base by including
fringe benefits are likely to have a differential impact on smaller
firms as is almost any other proposal in the tax and fringe benefit
area.
It is likely to have very much of a differential impact on small
firms versus larger firms. This is because small firms are generally
more labor-intensive than large firms even within the same indus-
try, and increased taxes on labor will increase these firms' costs
over more capital intensive competitors.
I think it is clear that the Congress cannot legislate more cover-
age of workers in small firms since lack of sufficient profitability is
the major factor influencing an employer's decision to provide em-
ployee benefits.
I think it is equally clear that small business' ability to offer var-
ious pension and profit-sharing options can certainly be legislated
away by the Congress, either directly or indirectly deterred by in-
creasing cumbersome administrative and tax burdens.
Our bottom line is simply that we hope that the committee, in
looking at this very important issue this year and the future, pays
very specific attention to the relative costs and impact of various
policy proposals on small firms.
We think that this is tremendously important.
After all, small firms do represent over 4 million employers and
employ over half of the private sector work force. It is a key force
in our economy. Too many times the Congress takes action without
fully realizing its impact on the smaller business sector.
Thank you very much for your invitation, Mr. Chairman.
Chairman PIcKu~. Thank you, Mr. Swain.
[The prepared statement follows:]
STATEMENT OF FRANK S. SwAIN, CmEF COUNSEL FOR ADVOCACY, U.S. SMALL
Busrr~ss ADMINISTRATION
Thank you for providing me the opportunity to speak with you today. Employee
benefit programs are an important concern of small businesses. Today, I would like
to highlight their significance, as well as illustrate and explain the differences in
benefit coverage in small and large firms. I believe that an awareness of the differ-
ent picture for small and large businesses is essential to informed and rational deci-
sionmaking in this area.
PAGENO="0197"
191
I. THE SIGNIFICANCE OF EMPLOYEE BENEFITS TO SMALL EMPLOYERS
Fringe benefits and other payroll-related costs are of extreme importance to small
businesses due to the relative labor intensity of smaller firms. Payroll cost issues
were cited as one of the top 10 priorities in the June 1984 National Small Business
Issues Conference.
The importance of employee benefit plans to small business is obvious. A small
business's ability to offer a worker a package of compensation, including wages and
benefits, enables it to compete with larger firms for the most qualified employees.
Given two firms offering a prospective employee an equal wage but unequal benefit
plans, it is difficult to imagine a worker Selecting the job with the less attractive
benefit option. The ability of a small business to attract and maintain a quality
workforce enables it to effectively compete in the market place with larger enter-
prises in the production of goods and services.
However, there are dramatic differences in the level of benefits offered by small
and large firms. There are several explanations for this tendency, which I will dis-
cuss, but the unambiguous conclusion is that small business does not stand on equal
footing with large business in its ability to provide fringe benefits.
II. THE EXTENT AND NATURE OF EMPLOYEE BENEFIT PROGRAMS VARY GREATLY WITH
FIRM SIZE
Studies reveal that pension and health care coverage for workers increase dra-
matically with a business' size.' For example, in the area of pension benefits, in
1979, only 20% of workers in firms employing 1-24 employees had pension coverage,
as compared to 46% in firms employing 25-99 workers and 70% in firms employing
100-499 employees. In businesses employing over 500 employees, approximately 89%
of the workers were covered by pension plans (Table 1). In the very largest business-
es-those employing over 2500 employees-pension coverage approached 96% in
1977.
While most businesses are more likely to offer health care benefits than retire-
ment plans, the incidence of group health insurance also increases with establish-
ment size. Census data from 1979 indicates that coverage ranges from 36% in the
smallest firms (1-24 workers) to 86% in firms employing over 500 workers. For a
more detailed breakdown of firm size and health care coverage, I refer you to Table
2 which is appended to my statement.
Levels of health and pension coverage also vary significantly by industry. Both
pension and health care coverage is greatest in the manufacturing (durable goods)
and finance industries, while coverage is the lowest in the trade, services and con-
struction sectors. While a large proportion of the firms in low-coverage sectors are
small businesses, wage level and unionization affect the extent of benefit coverage
in different industries. Firms in low coverage sectors tend to be non-unionized and
employ a high proportion of low wage employees. Studies reveal that pension cover-
age is greater when an establishment is unionized, regardless of its size. Both health
and pension coverage increase with the level of wages. However, an analysis of the
confounding variables of size and wage level indicates that increases in establish-
ment size are more influential than increases in wage level in determining the
extent of pension coverage in different industries.2
The characteristics of pension and health care plans also differ significantly in
large and small businesses, Small firms are more likely to have defined contribution
than defined benefit plans. Pension benefits tend to vest earlier for workers in small
businesses largely due to the greater likelihood that the small firm has established
a defined contribution plan.3 Small firms are most likely to have retirement bene-
`See James Bell and Associates, Inc., "Coverage Characteristics, Administration and Costs of
Pension and Health Care Benefits in Small Business" (1984). This study was conducted for the
Office of Advocacy and provides detailed analysis of the extent and nature of employee benefits
in small firms. The study relies on findings from national aggregate data analysis, regional sur-
veys of small businesses, and on-site case studies and telephone discussions with small employ-
ers.
2 See Bell, "Coverage, Characteristics, Administration and Costs of Pension and Health Care
Benefits in Small Business," pp. 23-24.
In small firms, over 40 percent of workers with coverage need less than 5 years until the
vesting period is met. This is compared to 24 percent of covered workers in the larger firms. In
the smallest firms, 20 percent of the workers actually have benefits vested within one year of
employment.
PAGENO="0198"
192
fits funded by profit sharing plans. As might be expected, few small firms offer
more than one retirement plan. Long-term disability benefits are another rare fea-
ture in small business pensions.
The scope of health benefit coverage is also narrower in small businesses. Work-
ers covered by small health benefit plans are less likely to have family coverage
than workers covered by large plans. The types of benefits also tend to be less gen-
erous in small firms, particularly in the areas of dental and maternity benefits. Em-
ployee contributions to health plans are commonplace in small firms. Deductibles
and co-insurance provisions are also prevalent features in small business health
benefit plans.4
In. REASONS FOR LOWER BENEFIT LEVELS
Several factors contribute to the lower incidence and narrower scope of employee
benefits in small-sized businesses. Firm profitability, cost of benefits and plan ad-
ministration, regulatory complexity and employee preferences all influence small
firm's decision to establish a benefit program. A recent study of small employers
without pension plans reveals that lack of sufficient profitability is the dominant
reason for not establishing a pension plan.5 Corresponding to a small firms' lower
profits is the lesser value of the tax deduction available for qualified employer pen-
sion plans and group health insurance programs.
The benefit costs of health and pension plans are greater for small employers.
Smaller firms generally face higher health insurance premiums than larger firms
(for the same coverage) because they are unable to spread risk across as many em-
ployees. In small firms, a few very high claims in a given year will increase premi-
ums for the whole group, whereas larger firms can spread risk and avoid fluctua-
tions in price. Pension benefits also cost more per worker in small firms. For exam-
ple, in 1977 pension costs per worker averaged $1,080 in firms with less than 10 em-
ployees. This is compared to a cost of $574 per worker in firms employing between
500 and 1000 employees.6 A component of the cost differential is the cost of adminis-
tering the pension plan.
There is ample evidence of decreasing administrative costs as firm size increases.7
One study revealed that the administrative expenses per participant in small pen-
sion plans were seven times greater than for large plans. Research also indicates
that government regulation has increased the administrative costs of small plans. A
study of the effects of ERISA on administrative costs reveals an increase of 72% for
plans with less than 100 participants. Another study shows that the incremental
costs of ERISA for the smallest employers studied were nearly seven times as great
as the average incremental cost of the ten largest employers studied.
Start-up costs present a further impediment to the establishment of small busi-
ness benefit plans. Small employers must obtain out-of-house consultants to deter-
mine if a benefit program is advisable as well as to design a workable benefit plan.
Small firms report start-up costs in the $2,000 to $5,000 range. Many have estimated
costs of $1500 to amend retirement plans to comply with alternations in the law
subsequent to a plan's initiation.8
Government regulation is another factor influencing the provision of benefits in
small firms. As previously discussed, there is evidence that ERISA has increased ad-
ministrative costs and added further costs associated with amending plans to keep
pace with frequent changes in the law. The Multiemployer Pension Plan Amend-
ments Act of 1980 (MPPAA), which was intended to eliminate problems that imped-
ed the maintenance and growth of multiemployer plans, has had the unanticipated
effect of discouraging such plan formation. The Act's withdrawal liability provisions
pose a particular problem for small firms because the withdrawal assessments can
exceed the business' net worth. The events that can trigger withdrawal liabilities,
such as the sale of the business or loss of business lease, are commonplace among
small businesses. The Act has tended to impede the transferability of small busi-
nesses and discouraged small employers from participating in multiemployer plans.
~ This is particularly true in firms employing 26-100 workers. In 1982, 92 percent had deducti-
bles and 91 percent had coinsurance provisions.
See Bell, "Coverage, Characteristics, Administration and Costs of Pension and Health Care
Benefits in Small Business," p. 77, for a more detailed breakdown of pension costs per worker by
establishment size.
6 See Bell, "Coverage, Characteristics, Administration and Costs of Pension and Health Care
Benefits in Small Business," pp. 34-36.
See Bell, Ibid., pp. 2-4, reviewing a number of studies on the administrative costs of small
retirement plans and the effects of ERISA on the costs of small plans.
8 Ibid., p. 109 (discussing start-up costs) and p. 93 (discussing plan amendment costs).
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The composition of a small firm's workforce is a final factor influencing the
extent of benefit coverage. Compared to large businesses, small businesses hire more
younger workers, pay lower salaries to a larger proportion of workers, hire more
workers on a part-time basis, hire more "secondary workers" (i.e., second wage earn-
ers in a family with two or more workers). Younger workers, or those with low
wages, often prefer a higher salary to more comprehensive benefits. Relatively new
and part time workers may not be eligible under company benefit plans where they
exist. All of these factors tend to lower the proportion of total compensation going
to fringe benefits.
Conversely, large businesses hire a larger proportion of prime age workers, hire
more workers on a full-time basis, pay higher salaries to a greater proportion of
workers, and employ more "primary workers" (i.e., individuals who earn most of a
family income). Workers in higher tax brackets are more likely to prefer a greater
proportion of compensation in the form of fringe benefits. All of these factors tend
to increase the proportion of total compensation going to fringe benefits. Not sur-
prisingly, larger businesses, on average, put more dollars per worker into fringe
benefits packages, and pay a larger proportion of total compensation in the form of
fringe benefits.
IV. COSTS MAY INHIBIT FUTURE EXPANSION OF EMPLOYEE BENEFITS IN SMALL FIRMS
Due to the high levels of benefit coverage existing in large firms today, any signif-
icant expansion of benefit programs is likely to occur in small businesses. As small
employers continue to create a disproptionate share of new jobs,9 the growth of ben-
efit plans among small employers is likely to be even greater. However, because
small employers have cited insufficient profitability and cost as major factors in the
decision to establish pension benefits, the need to reduce the costs to small firms of
providing benefits may be necessary to stimulate benefit growth.
Rising health care costs present a significant impediment to the expansion of
health insurance coverage in small firms. Small employers have reported spiraling
premium costs as great as 15% to 30% a year, depending on the firm's size and loca-
tion. In response to increasing costs, small employers have been forced to change
insurance carriers and basic provisions of plans. Increasingly, firms are moving
away from high option coverage to standard coverage; asking employees to share in
the costs of coverage by making monthly contributions to the cost of coverage; ad-
justing plans to include higher deductibles; and instituting co-insurance features,
under which the employee pays some percentage of claims (e.g, 20% of cost above a
certain level).
Whether these measures will prove effective in curbing costs is still uncertain.
V. IMPLICATIONS OF TAXING EMPLOYEE BENEFITS TO SMALL BUSINESSES
There is no clear cut data indicating the effect of a tax cap on the health insur-
ance premiums of small firms. However, our knowledge of the small business com-
munity suggests both potential positive and negative consequences depending on
firm size, industry and the level at which the tax cap is placed. On one hand, a tax
cap that was uniform across all businesses, regardless of size, could discriminate
against smaller firms which are unable to get as much benefit coverage per dollar.
Small employers pay more than large firms to obtain the identical coverage and a
tax cap at a particular level might compel small employers to limit the comprehen-
siveness of existing health care packages. Employees may have to purchase supple-
mental health insurance with after-tax dollars. Supplemental insurance would be
most costly to low-wage workers who are found more frequently in small firms. Ad-
ditionally, the tax-cap could discourage small firms from hiring older workers,
whose health care costs are predictably higher and drive up costs for the entire
group.
On the other hand, taxing insurance payments above a certain level could reduce
the differential in health benefits provided by small and large businesses. Such a
limit could strengthen small firms' ability to complete with larger industries for
more productive workers. In addition, a tax-cap could result in a redistributive
effect in favor of lower income employees-who tend to work in small businesses-
as higher paid workers will be taxed on benefits at progressively higher rates. The
9A study conducted by David Birch reveals that firms with fewer than 20 employees, repre-
senting approximately 33 percent of total employment, created 66 percent of the net new jobs in
the United States from 1969-1976. In 1980-1982, firms employing less than 100 workers were
responsible for creating 100 percent of the net new jobs.
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Office of Advocacy will continue to review the proposed measure to determine the
most likely effects of a tax-cap on small business benefit programs.
Proposals to expand the taxable wage base by including fringe benefits are likely
to have a differential impact on smaller firms. This is because small firms are gen-
erally more labor intensive than large firms within the same industry, and in-
creased taxes on labor will increase these firms' costs over more capital intensive
competitors. In the manufacturing and mining industries, for example, small firms
rely more heavily on labor in production than do large firms.'°
The payroll tax burden on small firms in general will likely become even greater
as the workforce continues to shift from large industry into the service sector and
small businesses continue to provide an increased portion of our nation's new jobs.
The schedule of increased payroll tax rates established by the 1983 Social Security
Amendments will pose an additional payroll tax burden on small businesses in the
future.
I have highlighted some of the important differences between large and small
business in providing employment and compensation to workers. I believe that an
awareness of small businesses' impaired ability to provide employee benefits is
highly relevant to the development of policy and legislation in this area. I would be
pleased to answer any questions you may have.
`°A study conducted for the Office of Advocacy by Steven Lustgarten. "Firm Size and Produc-
tivity" (1982), found that the contribution of labor to total output in manufacturing firms, was
approximately 57 percent for firms with under 20 employees as compared to approximately 49
percent for firms with over 500 employees. Lustgarten relied on Bureau of the Census data from
1947-1972.
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I
I.
TABLE 2
Group Health Insurance Coverage of
Wage and Salary Workers
by Employment Size of Firm, 1979
Fim~ Size (Number of Employees)
Source: U.S. Department of Commerce. Bureau of the Census, Curtent Population Sun~y
data. March 1979 and May 1979.
TABLE 1
1-24 25-99 100-499 SOGi'
Firm Size (Number of Employees)
Source: U.S. Department of Commerce. Bureau of the Census, Current Population Swvr~'
data, March 1979 and May 1979..
1-24 25-99 100-499 500+'
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Chairman PICKLE. I appreciate the testimony of each of you. I
find it to be exceedingly helpful. Your charts and figures, your fac-
tual analyses, Mr. Salisbury, extremely important to our commit-
tee as we consider the overall approach.
Mr. Alexander, I appreciate your comments which were rolled
into a nice, pleasant package, but I want to read your testimony in
greater detail. I appreciate your statement about small business.
Let me ask you as a group, its true that employee benefits are
growing, perhaps as much as 3 percent up to around 17 or 18 per-
cent, or you can go even higher than that depending on the ap-
proach you take. Do you anticipate that employee benefits will con-
tinue to grow in a similar fashion in the next 5 years, 3 to 5 years?
Mr. ROMIG. Mr. Pickle, in our historical -survey, copies of which
we supplied the committee, if you will turn to page 23, you will see
that the cost data that we show for the period of 1951 through 1979
show that about 1977 or 1978 there was an apparent slowing-down
in what employers are spending for employee benefits, and that
this trend continues, so it appears from the data that we have col-
lected so far that the growth potential has slowed.
It is continuing but has slowed measurably. -
Mr. SALISBURY. Mr. Pickle, if I could add to that, I think you
have got a balance factor. For those employers who are spending
the most, they are now trying to spend no more or less. As a result,
pension contributions are dropping at the largest companies, and
they are going through major changes as described by the Depart-
ment of Health and Human Services yesterday, to reduce their
health care expenditures and all.
On the other hand, in terms of Mr. Swain's comment, there are
still many businesses that do not have employee benefits, and if
they go from having no employee benefits to next year spending 4
or 5 percent of wages and salaries on benefits, the total amount
that all of these numbers are going to show is going to be going up,
and so really I urge the staff and the committee to look at these
two different issues.
One issue is, Are those who are already spending a lot likely to
continue spending more? If you believe any of the surveys of labor
or management, the answer is no. -
On the other hand, will spending continue to grow if the tax in-
centives are effective in having employers that don't provide em-
ployee health now provide it and other things, the gross numbers
are going to grow, and if you will, in the terms of some of the spe-
cific questions of yesterday, the FICA tax base erosion, to that
degree, will continue, but it will be because of an expansion of the
protection more than it will be because those who already have are
spending more.
Chairman PICKLE. I take it that you are saying that the charts
and the trend shows that there is a leveling-off on employee bene-
fits, and therefore there is such a leveling-off that we don t need to
do anything.
The program, and the administration of it, will take care of
itself.
Mr. SALISBURY. I am not suggesting that. To take an example, if
you take the charts from the Social Security Administration yester-
day in their testimony, those charts, because they simply use aver-
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ages, would imply to you that everyone every year is spending
more on their benefit programs. That is not the case.
Even if tomorrow you were to take that chart and change the
law, and say we are going to put a cap, a percentage cap, on what
any one employer can spend, you are still going to see the line go
up because employers that currently don't have programs are
going to put them into effect.
The Social Security Administration chart yesterday indicated
that on the average all employers are spending approximately 16.8
percent of compensation on a combination of Social Security, pen-
sions, health and other fringe benefits. Let's say you were to cap it
and say nobody can ever spend more than 16.8 percent. There are
still hundreds of thousand of businesses out there that are spend-
ing so far less than 16.8 percent that your growth, the absolute
growth, is still going to continue.
Now, you get something for that. You get pension protection.
You get health protection. You get life insurance protection, but it
is that balance factor. It doesn't say you shouldn't do anything. It
does say that how you draw lines has to be done with great care.
Chairman PICKLE. I repeat again, you indicate to me that the
chart will not continue to go up if we just let things alone, but that
it will go up some.
Mr. SALISBURY. It will not go up as fast.
Chairman PICKLE. You don't think it will go up in the same per-
centage what it has over the last 20 years?
Mr. SALISBURY. Not as fast, no.
Chairman PICKLE. All right.
Now, is there any way to handle the equity issue? How would
you handle this, given the fact that, if there are two approaches to
take, as you say, Mr. Salisbury, there are already those who are
covered and receive the benefits, and then there are also all those
people out there that are not covered, who do not get employee
benefits; what is equity? Where is the equity?
How does the Congress address the problem to the small business
individual or the person not covered? How does he get relief or how
does he get something out of this?
Mr. SALISBURY. I will answer your question with a question.
The charts I showed you indicate that even when you include
small businesses, over 80 percent of all working Americans today
have employer-provided health insurance. Do we cut back on the
80 percent in order to provide equity for the 20 percent, if the
result of that is then that in order to provide for basic needs we
have to put into effect a national health insurance program or
something else?
Chairman PICKLE. You are not recommending that we cut back
on that 80 percent. My question is, what do you do for that 20 per-
cent? Your chart shows somewhere between 4 and 18 percent.
Mr. SALISBURY. I can direct you, for lack of a better example, to a
study that was mandated by the Carter administration, a Carter-
appointed President's Commission on Pension Policy.
The conclusion of that broadly-based Commission was that the
only way to really get broad-based usage in the small business
sector was to expand the tax incentive, to provide an employer
with the equivalent of a tax credit rather than simply a tax deduc-
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198
tion, if you wanted it to still be a voluntary system. That is expen-
sive.
Chairman PICKLE. That would be a loss to the Treasury?
Mr. SALISBURY. That is expensive.
Mr. ALEXANDER. That certainly would be a loss to the treasury.
Mr. Chairman, the Chamber doesn't quite agree with Dallas
Salisbury's prediction, qualified as it was, of further growth, and
perhaps an implication that further growth in the tax favored em-
ployee benefit area might be at the same rate in the future that it
has been in the past.
I am no statistician. It would just seem to be very difficult to
achieve, to me, if 80 percent were already covered at the optimum
level, and only 20 percent were left.
If all 20 percent immediately decided to obtain coverage at the
optimum level, perhaps there would be rather surprising growth in
the particular year, but there would be zero growth the following
year, so I don't quite understand the projection. That shows I am
no statistician, but I do understand reality and the realities are
that the Chamber's surveys show a definite decline in the growth
rate.
There has been an absolute decline in certain elements, as Mr.
Salisbury pointed out. But how are we going to help small busi-
ness? I think you have just ruled out making everybody equal by
reduction-making me the same height as Congressman Duncan by
cutting off his legs up to the knees.
A better way would be to give me elevator shoes, and I suggest
the better way is to help small business rather than hurt other
small business.
Mr. Swain can best speak to this.
Mr. SwAIN. Let me say, Mr. Chairman, that you basically have
two types of small businesses. Eighty percent of the businesses in
this country have static levels of employment. They will have 20
employees today. They may have 21 next year. They may have had
19 last year.
Whether they offer a pension or health plan I think has less to
do with anything else than how much money they are making. One
might ask how can you reconcile the fact that half of the workers
in the country work for small business, but Mr. Salisbury says that
80 percent of all American workers are covered by health plans.
It is very simple to reconcile. A lot of the people that work for
small business are so-called secondary or tertiary wage earners
who may be covered under a family member's plan, and so the fact
that a lot of small businesses don't offer various benefit levels is
not necessarily a bad thing.
I think it is more a reflection of the demography of the work
force and the amount of money that small businesses are making.
That is true for 80 percent of the small businesses.
All of the figures you hear about job generation, that small busi-
nesses are creating new jobs and creating innovations, are all quite
accurate. Almost all of those jobs, in any given year, are created by
a very small number of small businesses, maybe 15 or 20 percent of
the small businesses.
It is those businesses that are actively growing or shrinking; they
are competing for employees, frequently highly professional or
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highly technical employees. These small businesses are competing
for employees against large firms and large universities which
many times offer benefit levels that are very attractive.
Those small firms have to have the options to offer similar bene-
fit levels in order to sustain their growth which we all depend on? I
would suggest that there is very little that Congress can do to man-
date broader pension coverage from an employer who doesn't have
it now except by providing some incentive. Obviously, whether
those incentives are provided or not is a revenue question. On the
other hand, the Congress can do a whole lot to discourage those
quickly growing small firms from being able to compete by further
increasing the administrative or the regulatory--
Chairman PICKLE. The Congress has had no intention, so far as I
know, of taking away some of the employee benefits. You have,
each of you, both inferred the fact that you ought not to take away
in order to help this other group. We are not trying to take it. You
are just not going to put words in our mouth that we are going to
slow down or take away the benefits.
You raised the question, how far can it grow? You indicated it is
leveled off and won't grow any more. If that is so, should we try to
arrive at a cap or a percentage? I presume none of you want that,
but just trust to the Lord that it won't grow any, and we can all go
home happy. We could do that, but then that still leaves you in the
inequitable status of the person who gets none of these employee
benefits. The committee is simply trying to look at the overall
question.
Will it continue to grow? And I have to say that it will continue
to grow.
I hear what you tell me, but I look at the charts, and the prac-
tice of the employers of the country, the large employers, and I
think the average employer would go up to 20, 25, and 30 percent if
they thought they would get a tax deduction for him.
I don't think there would be any limit, almost. You could say
that such levels would be reasonable and realistic, but I have not
seen the growth slow down. I know that you like these credits, so I
have to say that we have to concern ourselves about their contin-
ued growth.
Also, we know if you try to help broaden benefit coverage, and
say we will give you a credit or a tax deduction to do it, that costs
the Treasury a bundle. We don't know what the answer is. But, I
don't think the answer lies in just blissfully saying that there is no
need to worry about imposing a cap, or controls, or some kind of
standards, because it is becoming a serious problem.
I was particularly impressed, Mr. Salisbury, with your com-
ments, and I want to give myself another minute.
You said if we did lose $50 billion in revenue this past year, that
that would be offset perhaps by the payment in future years of de-
ferrals of income.
Mr. SALISBURY. A major portion, 60 percent.
Chairman PICKLE. So you are saying that is not actually lost to
the Treasury. It is deferred and Treasury will get it in years to
come.
I found that interesting. I don't know whether I accept that anal-
ysis. I want to make one other point. I recognize that the Govern-
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200
ment ought not to take the position we are going to run these pro-
grams because quite often on these benefits we run them less effi-
ciently and effectively than private enterprise.
If we do not allow for employee benefits then Government in
turn-since the Government has this responsibility-will inherit
those responsibilities. This I think would cost us more. So you have
to ask yourself who can do it best. But there still has to be a level
of how often and how far could we go in this if we are going to
protect the tax base. So I appreciate your testimony and perhaps
we will have a chance to come back as we ask further questions on
it.
[The following was subsequently received for the record:]
ANSWERS TO QUESTIONS ASKED BY CONGRESSMAN PICKLE REGARDING EMPLOYEE BENE-
FITS AND THE TAx CODE, SUBMITTED BY THE EMPLOYEE BENEFIT RESEARCH INSTI-
TUTE
1. We need to understand the relationship between private pensions, Social Secu-
rity and individual effort plans such as IRAs. We need to understand what happens
to one of these when a change is made in one of the others.
Social Security, employer-sponsored pensions and Individual Retirement Accounts
(IRAs) are complementary, working together to assure retirement incomes. They are
not perfect substitutes in terms of benefit delivery, but change in one would effect
public pressures for, support for, and confidence in the others.
Social Security provides a floor of protection on a redistributional basis, with
lower earners receiving proportionally greater benefits. Many of those who rely
most heavily on Social Security do not have high enough incomes to allow savings,
and their work is such that they are unlikely to have employer sponsored retire-
ment plans. Social Security is a pay as you go program. Research indicates that it
has no effect, or a negative effect, on aggregate national savings.
Employer-sponsored plans provide another form of "forced" savings that repre-
sents a tier of income above Social Security. Among employers with more than 250
employees these programs are almost universal. Among smaller employers they are
not. For a significant portion of the population these advance funded programs rep-
resent their only real savings. As a result, research indicates that each dollar con-
tributed to a pension increases aggregate national savings by at least 35 cents.
IRAs are a vehicle for voluntary savings. They are used by 17 million persons as
compared to over 50 million with pension coverage. Over 13 million IRA holders
also have pension coverage.
There are also differences in what these programs provide, or must provide, under
current law. These differences affect the degree to which employer sponsored plans
and IRAs "compliment" Social Security in terms of retirement income provision.
Social Security only pays benefits as a stream of monthly benefits.
Employer sponsored plans are of two types: (1) those that only pay benefits as a
stream of monthly benefits-most defined benefit plans and some defined contribu-
tion plans such as TIAA-CREF--and (2) those that make one time "lump-sum" pay-
ments at change of employment or at retirement age and thus may or may not
produce retirement income-most defined contribution plans.
IRAs allow the money to be withdrawn at any time with the payment of a small
payment and after age 59 and ½ allow it to be removed as a lump-sum.
2. What is the relationship between private health plans and Medicare? If private
health plans are taxed to help finance Medicare now, will it eventually result in
greater demands on the Medicare system in the future?
Employer sponsored health programs provide risk production to most workers and
their dependents. Research indicates that taxation of these programs might lead to
a reduction in coverage. This in turn could produce significant pressure for a gov-
ernment program to complement present health programs for the poor (Medicaid)
and the elderly (Medicare). Employers also increasingly are providing health insur-
ance for retirees to supplement Medicare. Were these programs eliminated it could
increase long-term costs of Medicare due to a reduction in wellness.
Proposals for major tax reform therefore, need to be carefully scrutinized. To the
degree the full taxation of these programs as income rests on the assumption that
they will continue to exist, research indicates that for millions of workers, they will
not. Further, taxation could lead to an unintended age discrimination effect if
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health insurance were given an income value equal to the benefit provided, which
would increase dramatically with age.
3. What are the appropriate employee benefits that should enjoy favorable tax
treatment? What level of tax exempt or tax deferred benefits is acceptable in light
of the Federal Government's revenue needs?
Employee benefits should enjoy favorable tax treatment if they provide a benefit
that the government would otherwise be required by public sentiment to provide; if
it is provided more cost effectively by the employer than it could be by the govern-
ment; if it serves a human resources objective that is to the advantage of the gov-
ernment and can most effectively be achieved through the employer; if it serves an
economic advantage to the government that can be achieved most effectively
through the employer; if it achieves a social objective such as allowing women to
more readily enter the workforce and can most effectively be provided through the
employer; if it allows U.S. employers to more effectively compete internationally;
etc.
Different employee benefits test vary differently against these criteria. For an
analysis of such a question benefits should be clearly differentiated and can be class-
ified into at least nine categories:
(1) legally required benefits (including employer contributions to Social Security,
Medicare, unemployment insurance and workers' compensation insurance);
(2) discretionary benefits that are fully taxable (primarily, payment for time not
worked);
(3) discretionary benefits that provide retirement income as a stream of payments
and for which taxes are deferred until benefits are received (including employer
contributions to defined benefit pension plans and to defined contribution plans
which require payment in the form of an annuity);
(4) discretionary benefits that insure the employee against financial risks and are
tax exempt (including employer contributions to health, life, and disability insur-
ance plans);
(5) discretionary benefits that provide for the deferral of salary until termination
of employment, generally pay benefits as a lump sum, and for which taxes are de-
ferred until benefits are received (including contributions to some profit sharing
plans, to money purchase plans and ESOPs);
(6) discretionary benefits that provide for the deferral of salary until special needs
arise (loans and hardship), or until termination of employment, generally pay bene-
fits as a lump sum, and for which taxes are deferred until benefits are received (in-
cluding contributions to some profit sharing plans, thrift-savings plans, and salary
reduction plans);
(7) discretionary "reimbursement account" benefits programs that have been le-
gally allowed since 1978 which allow employees to have reimbursement accounts-
funded by the employer or through salary reduction-to pay expenses that fall into
"statutory benefit' areas and are tax exempt (including health care reimbursement,
child care reimbursement, etc.), with a further analytic break between those which
allow salary reduction and those which don't;
(8) discretionary benefits that help the employee meet special needs and are tax
exempt (including employer contributions to child care and legal plans); and
(9) discretionary benefits that have traditionally been called fringes and are in-
tended to meet employer needs and are tax exempt (including employer provision of
purchase discounts, job site cafeterias, special bonuses and awards, van pools, clubs,
and parking).
Only after the question is answered regarding which of these benefits meet the
criteria set above for justification of favorable tax treatment can the revenue level
issue be approached. All available evidence, for example, indicates that the retire-
ment, life, health and disability benefits now provided far exceed the value of the
government revenue loss. In other words, policy change should more readily be
based on the question of whether the programs are meeting objectives the Congress
supports, not on the revenue issue per-se.
4. If certain compensation is not taxed, does Congress have to increase the tax
rate on taxable compensation? Who benefits from that shifting of tax burdens?
If certain compensation is not taxed at all like tax exempt insurance costs or on a
deferred basis like retirement and savings programs, then to raise a given amount
of revenue tax rates would have to be higher if behavioral change is not involved.
This is the greatest problem with tax expenditure estimates, they assume no change
in behavior when a change in the tax law takes place. On the other hand, if taxing
otherwise non-taxed compensation-in this case exempt benefits-leads to larger
government programs, then tax rates might in fact be lower than they would other-
wise be were all compensation taxed.
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202
Were tax rates higher because of the exclusion or deferral of tax on benefits, how-
ever, a 1982 Treasury Department analysis undertaken for the Joint Economic Com-
mittee indicates that the burden would fall across the income spectrum on the same
relative basis if benefits were valued as they are today. It is important to note, how-
ever, that the valuation of health insurance would likely change if taxed. The effect
of this would fall most heavily on older workers at all income levels. This is because
the true value of health insurance increases significantly as an individual ages, as
evidenced by expenditure levels under the Medicare program.
5. How should we deal with tax-deferred compensation as opposed to tax-exempt
compensation?
All forms of benefits should be evaluated against their ability to meet policy
goals. Tax expenditure numbers for all programs should be considered in context of
the warnings contained in the budget, however, and tax-deferrals should be careful-
ly considered in terms of the amount of tax savings eventually repaid to the govern-
ment: over 80 percent in nominal dollar terms and over 70 percent in real dollar
terms. This means that long-term tax subsidies are much smaller than the current
year budget number implies for tax-deferred benefits.
Estimates assume no other changes in the tax laws and estimates assume no
change in taxpayer behavior if the law is changed-even if this is the only provision
changed.
Economists refer to this as "partial equilibrium" analysis. This means that most
behavioral change is assumed away so that rough estimates are possible. As a
result, these estimates suffer as guides to policy. Therefore, they must be used with
great care. Analysis cannot, for example, legitimately use the numbers to indicate
that elimination of favorable employee benefit tax provisions would produce $X of
additional revenue for the fiscal or $X for the use of such programs as Social Securi-
ty, health insurance for the unemployed, or Medicare.
6. Which income groups and what kind of employees benefit from different forms
fo employee benefits?
Benefits are now provided across the income distribution. In medium and large
establishments, coverage for major employee benefits such as retirement, health,
life and disability is nearly universal. Employee benefits are now a mainstay of the
middle-income worker's economic security, building savings as well as providing
hazard protection.
Employer pensions.-Of all full-time employees in medium and large establish-
ments, 82 percent are covered by a pension plan. Small firms, for numerous econom-
ic reasons, do not sponsor plans as uniformly. In 1981 the President's Commission
on Pension Policy concluded that this could only be changed by mandating plans or
by offering tax credits. As firms grow, however, they do add retirement programs.
Among employees in all establishments who were covered by pensions in 1983,
nearly 28 million (or 59.0 percent) earned less than $20,000.
Pensions redistribute wealth to favor those at the lower end of the income scale
who do not tend to save much out of current income. According to recent EBRI sup-
ported research, accumulated pension benefits constitute the major form of financial
savings for more than half of all persons with pension coverage. More than 40 per-
cent of the labor force reported no savings income in 1983. This group's average
income was $9,651, just under half the average income of those reporting some asset
income. Almost half of the group reporting little or no savings income were covered
by an employer pension. Not all retirement benefits exhibit the same income distri-
bution patterns, however. In particular, statutory provisions aimed at encouraging
individual provision for retirement differ considerably. While 59 percent of pension
participants earn less than $20,000, 46.5 percent of individual retirement account
(IRA) holders and 34.8 percent of those participating in Section 401(k) plans fell into
this income group. Section 401(k) plans in particular follow a different income distri-
bution from both IRAs and employer-sponsored plans. More than half of Section
401(k) plan participants earn between $20,000 and $50,000, compared with under 50
percent for both IRAs and employer-sponsored plans.
Health insurance-Of all full-time employees in medium and large establish-
ments, virtually all are covered by health and by life insurance plans. Among all
employees with employer-provided health coverage in 1982, 57.3 million (or 68.6 per-
cent) earned less than $20,000, and 28.6 percent earned between $20,000 and $50,000.
About 35 percent of all spending on health care that does not pass through govern-
ment programs is now made through employer-sponsored plans. Fewer than 3 per-
cent of pension and health insurance participants earn more than $50,000.
Increased Savings.-Pensions both increase and reallocate total savings. If pension
contributions were received as cash income, total saving would decrease. The drop,
moreover, would be reJatively greater among lower- and moderate-income employ-
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ees. While nonpension financial saving is concentrated among relatively high-
income individuals, pensions are distributed broadly among income groups.
Pensions also change the distribution of saving among investment vehicles. Non-
pension saving consists primarily of liquid saving deposits and investments in
owner-occupied homes or other consumer durables. Pension funds, in contrast, are
invested in securities that finance productive capacity and employment. Pension
funds have grown to be the single largest supplier of investment funds to financial
markets. At a time when unmet capital financing needs are emerging throughout
the economy, the fact that pension funds provide long-term capital gives them an
important role in economic policy.
Increased retirement income.-The availability of a pension often means the differ-
ence between subsistence and the ability to maintain pre-retirement living stand-
ards in retirement. Recent EBRI research projects that over the next forty years
real retirement incomes will more than double. The average annual retirement
income for those reaching age sixty-five in the 1980s is projected to be $13,376 per
household in 1983 dollars. It is expected to increase to $26,802 for those retiring be-
tween 2110 and 2019. Average employer pension benefits will increase from $5,315
for those retiring in the 1980s to $12,417 for those retiring between 2010 and 2019.
The proportion of new retiree households receiving pension income will grow from
37 percent in the 1980s to 71 percent by 2019.
Tax payments by retirees will reflect this income growth. Pension beneficiaries
retiring in the 1980s will pay an average of $15,808 in taxes (1983 dollars) on their
benefits over the course of their retirement. Pension beneficiaries retiring between
2010 and 2019, in contrast, will pay an average of $44,672 in taxes (1983 dollars) on
pension benefits during their retirement.
Retirees not only receive larger retirement incomes as a result of employer pen-
sions, but their benefits are more secure due to legally mandated advance funding.
This security is all the more important as debates over the fiscal stability of the
Social Security system continue. Social Security benefits and employer pension ben-
efits complement each other. As pension benefits increase, Social Security benefits
become a smaller share of retirement income. If public policy continues to encour-
age increased pension coverage and benefit levels, the pension system could reduce
the pressure for ever-increasing Social Security benefits.
7. What effect would the various tax reform or tax simplification plans such as
the flat tax or modified flat tax or the value added tax have on employee benefits?
The average taxpayer demanding tax reform because of a perception that the tax
system is unfair does not see basic employee benefits as a tax abuse. Rather, both
employers and employees see these benefits as part of the social contract that social
contract that defines how individuals provide for themselves, their families, and
their future. This social contract and related tax benefits includes the majority of
the U.S. labor force. The distribution of benefit-related tax benefits among income
groups reflects the distribution of coverage and participation. In 1981, employees
earning between $15,000 and $50,000 received 71.8 percent of all health-related tax
preferences, 64.5 percent of all pension-related tax preferences, and 67.5 percent of
all insurance-related preferences. This group pays 51 percent of total federal taxes.
By comparison, this income group received 64.2 percent of tax benefits related to
homeownership. Employee benefits are less of a luxury than owning your own
home.
One of the most important consequences of tax reform proposals that seek to re-
structure the tax system for the average taxpayer would be to change the tax treat-
ment of employer contributions for employee benefits.
For workers with employee benefits there would be many implementation and
transition issues in major tax reform. These could be formidable, and even predict-
ing them involves some uncertainty about the reactions of employers, employees, in-
surers and other providers of benefits. This uncertainty arises from the fact that the
availability of tax incentives for employee benefits has influenced how plans are
provided and designed. For example, because employee benefits are purchased on a
group basis, employers and employees can benefit from economies of scale. There-
fore, a dollar spent on employee benefits by an employer buys more than would the
same dollar spent by an individual. In the absence of tax incentives encouraging
employer provision, the administrative structures that make group purchases cost-
effective may never have been developed.
Alternative treatments for employee benefits that have been proposed include: In-
cluding benefit contributions in the employee's adjusted gross income; eliminating
employer deductions for benefit contributions; capping the share of total compensa-
tion that can be provided in the form of tax-favored employee benefits; imposing an
40-046 0 - 85 - 14
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excise tax on the employer's benefit contributions; and imposing a value-added or
national sales tax.
Including benefit contributions in the employee's adjusted gross income.-Most
plans do not determine the costs of employee benefits on the basis of the character-
istics of the individual for whom protection is being provided. These pricing struc-
tures are reasonable from employer's viewpoint given current tax treatment, since
the total cost of insuring the employer's work force is not affected by the allocation
of these costs among the members of the covered population. They are irrelevant to
the employee who cares only about the total amount of insurance provided, and not
about how the cost of this insurance is billed to the employer.
If employer contributions for benefits were taxed to the employee, the entire pric-
ing and cost allocation structure of benefit plans could have to be revised to allocate
contributions appropriately among individuals. While the average price of providing
employee benefits to various employees may be uniform, the underlying cost of ben-
efits differs widely according to the employee's age under all major benefits. Bene-
fits for younger employees are less costly because these employees generally have
lower health insurance claims, disability rates, and mortality rates. The adjust-
ments that would be required would vary across benefits.
Pensions.-Actuarial methods used in defined-benefit pension plans do not gener-
ally allocate contributions or projected benefits to individuals, determining them in-
stead for an employee cohort based on aggregate forecasts of that cohort's future
demographic and economic experience. If defined-benefit pension costs were allocat-
ed among individuals, it would become clear that financing a given retirement bene-
fit requires a low3r contribution for a younger employee than for one closer to re-
tirement age. The contribution for the younger employee can accrue interest over a
longer period of time, while the same benefit increment for an older employee has
to be financed primarily out of employer contributions.
Pension costs in a defined-benefit plan may therefore be ten times as high for an
employee at age sixty as at age thirty. Attributing an average pension contribution
to each employee would create serious inequities. Older employees would be under-
credited, while younger employees would be overcredited. To the extent that older
employees earn more and are taxed at a higher rate than younger employees, this
inequity would be compounded.
Health insurance.-Employer contributions to finance health insurance are simi-
larly based on the total cost of insuring a particular employee group. Underlying
costs for health insurance can be twice as high at age sixty as they are at age thirty.
Similarly, the underlying cost of providing health insurance for women of child-
bearing age is higher than the cost of insuring young, single men. In short, the aver-
age price of most employee benefits is much higher than the cost of providing bene-
fits to some individuals and much lower for others.
If employer contributions for benefits were included in the tax base, they might
be treated in the same way that the Internal Revenue Code now treats employer-
paid life insurance premiums for coverage in excess of $50,000. These premiums are
currently included in the tax base. The cost of life insurance varies according to the
individual's age. For example, at age thirty, the cost of providing life insurance
worth an individual's annual salary is 17 percent as large as it is at age forty-five,
while at age sixty this cost is nearly four times as large.
To avoid the inequities that would arise if all individuals were taxed on an aver-
age cost of insurance, Treasury regulations prescribe the amount of premiums to be
recognized as income for individuals on the basis of age (in five-year brackets) and
coverage levels. The Treasury tables use blended actuarial assumptions for men and
women based on the proportions of men and women in the group of employees with
coverage over $50,000 in value.
To achieve an equitable distribution of tax liability, a schedule like that governing
the tax treatment of life insurance would probably have to be developed for all em-
ployee benefits. Given the Supreme Court s decision in the Arizona v. Norris case,
such tables would probably not be differentiated by sex. Such tables could, however,
be differentiated by age, family status, or both. Family status could be used to pre-
dict health insurance claims plans that offer maternity or dependent's benefits.
Effects of taxing benefits.-The effects of taxing benefits would vary among bene-
fits and would depend on whether or not individuals chose to continue their cover-
age. If pension accruals were taxed on a current basis, saving would almost certain-
ly decline, and would decline disproportionately among those at lower income levels
who do not tend to save out of current income.
To avoid the added tax liability, many low- and moderate-income individuals
would choose to do without health and other types of insurance. Research conducted
by the Employee Benefit Research Institute (EBRI) and others indicates that income
PAGENO="0211"
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determines whether or not people without employer-provided health coverage pur-
chase such coverage themselves. If employers did not provide health coverage, most
low-income workers would not purchase private health insurance. Since most people
covered by an employer health plan are members of low- and middle-income fami-
lies, employer-provided health benefits probably substantially raise rates of private
health insurance coverage throughout the nonelderly population.
For those who chose to continue their insurance coverage, the impact of a tax on
health insurance premiums would be regressive. While Employer contributions for
health insurance are independent of employee earnings. As a result, the value of
employer-provided coverage is a larger share of total compensation at lower income
levels and the added tax payment of low-income workers would be a larger share of
their income than at higher income levels. EBRI tabulations of data produced by
the Congressional Budget Office (CEO) indicate that under the Administration's pro-
posal to cap the amount of health insurance premiums that an employee can re-
ceive tax-free, those with the lowest incomes would pay more than six times as
much tax as a percent of income as those with incomes above $50,000.
The flatter rate structure of some major tax reform proposals would exacerbate
this regressively. Under current-law rates, the progressivity of the tax schedule off-
sets the effect on tax liability of the declining share of health insurance in compen-
sation at higher income levels.
In short, whatever the criterion used for determining the cost of each employee's
cost of benefits, if it targeted those individuals likely to have the highest incidence
of claims, it would also target those most likely to need insurance. Since those most
likely to become sick, disabled, or die would face the highest tax liability, taxing
employer contributions for benefits would impose tax liability in inverse proportion
to ability to pay.
Another potential effect of taxing employee benefits to the individual could be to
increase the attractiveness of flexible compensation of cafeteria plans. Under flexi-
ble compensation plans, employees can elect various levels of coverage under the
major types of employee benefit plans. An employee choosing a less-generous health
insurance plan, for example, can "spend" the employer's cost savings on added life
insurance, vacation days, or other benefits. All employees-except for those who
chronically guessed wrong about their need for health insurance or other benefits-
would segregate themselves into plans according to the expected value of their
claims. While this is the fundamental principle behind flexible compensation plans,
many employers sponsoring these plans now price the high-cost insurance options at
less than the value of the claims expected under them to maintain a reasonable risk
pool of participants under each option. If employees were being taxed on the value
of employer contributions, however, such subsidies would probably have to stop,
since they would mean that low-risk employees would be paying the tax bill for
higher-risk persons. If all persons chose plans priced at the expected value of their
claims, the risk-sharing inherent in group insurance plans would be eliminated.
Eliminating employer deductions for employee benefits-Some of these distribu-
tional problems would not accompany major tax reform proposals that would in-
clude nonpension employee benefits in the tax base by eliminating employer tax de-
ductions for them. The value-added tax could have this effect, depending on how it
was designed, and some versions of the consumption tax would provide for this.
Faced with such a provision, employers who now offer benefits would probably cut
them back and those who do not would probably not institute them. Some employ-
ers who offer benefits might eliminate them or continue to offer them with full em-
ployee payment.
Others might forego improving their benefit packages, while still others might in-
stitute or increase employee contributions, deductibles, or copayments where appro-
priate. Employers are already working to reduce their benefit costs; including bene-
fits in the tax base would clearly accelerate this process but at a social cost.
The greatest impact of proposals to eliminate employer deductions for benefits
would probably be on those employees who are not now covered. Most employees
without benefit coverage tend to be in smaller firms and at lower income levels. As
small and new firms grow and become profitable, they are more likely to incur the
financial commitment involved in establishing employee benefit plans. Removing
the tax deductions for employee benefits would probably make this commitment un-
economical.
Capping employee benefits as a share of total compensation-Another alternative
that has received some attention in tax policy debates, though not necessarily in the
context of major tax reform, is establishing a limit on the share of total compensa-
tion that can be provided in the form of tax-favored employee benefits. Benefits pro-
vided in excess of this amount would be subject to payroll tax, income tax, or both.
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Under alternative proposals, the cap could cover contributions for all benefits, or
pensions, welfare benefits, and so-called "fringe" benefits could all be capped sepa-
rately.
Such an approach could raise its own set of problems. For example, an employer
with a mature, long-tenure work force could be put at a competitive disadvantage
compared with an employer with a younger work force, even if the benefits in the
two firms were identical. Furthermore, a cap could act as a target that firms with
less-generous benefit plans would feel compelled to meet to maintain their competi-
tive positions. The efforts of such employers to catch up could offset the effects on
employers who benefits exceeded the cap. Such a system could also be difficult to
implement for non-profit or public-sector employers, neither of which pay business
profit taxes.
An excise tax on benefits.-Rather than capping benefits as a share of compensa-
tion, the Treasury in 1983 proposed imposition of an excise tax on all tax-favored
benefits, whatever their level. This would avoid creating a target benefit level for
employers to reach. An excise tax, however, would have the same effect on benefits
as eliminating employer deductions for benefit contributions. Employers now offer-
ing benefits would cut them back, while those without benefits would probably not
institute them. The only difference between the two options would be in the tax
rates they would impose. If an excise tax carried lower rates than the corporate or
business taxes the firm might be paying, then the incentives to eliminate benefits
would not be as strong.
A value-added or national sales tax-Instituting a value-added tax would not
have the same effect as a tax levied specifically on benefits. Any tax levied at differ-
ent stages of production would be neutral between wages and benefits as a form of
compensation, assuming that both were subject to the tax, and thus would not
change employer and employee preferences.
8. Should the tax law encourage employers to provide employee benefits; and if so,
which benefits or services should be encouraged, and what type and level of tax in-
centive is appropriate?
The United States has always had a commitment to economic security for workers
and retirees. Social Security with its income, health and disability components com-
bines with workers compensation laws and unemployment compensation laws as an
expression of public commitment. These social programs work with employer-spon-
sored programs to protect workers against significant health and economic risks.
The government has established programs like Medicaid to take care of those with-
out the employer protection, and it has provided tax incentives to encourage em-
ployer provision for the rest of the population.
The tax incentive approach allows programs to be designed to accommodate very
different workforces, geographic conditions, and employee preferences, while still
carrying out the federal government's social support agenda. Unless the nation de-
cides to step back from its commitment to economic security, tax incentives will be
essential to benefit provision. The testimony sets out nine categories that now re-
ceive favorable tax treatment that can be evaluated.
9. What conditions or restrictions are appropriate on tax incentives to encourage
employers to provide employee benefits?
As a provider and encourager of benefits and economic security the government
takes steps to assure that promised benefits are delivered, that all workers have
access, and that expense is defined. This suggests funding requirements, nondiscrim-
ination provisions, and percentage or dollar limits on employee benefits to control
"tax subsidies or tax expenditures". It must be stressed, however, that the present
system of benefit delivery would change if tax treatment changed.
10. Are the existing rules concerning employee benefits sufficient to ensure that
all employees benefit fairly from the tax incentives?
The data presented in this testimony provides a clear yes to this question.
11. Are the existing tax incentives for benefits such as health care, life insurance,
day care, educational assistance, and cafeteria plans effective in encouraging em-
ployers to provide these benefits to a broad cross section of employees at a lower
total cost than if the Government provided the benefit directly, if employers provid-
ed the benefits on a taxable basis, or employees purchased these benefits on their
own?
The first half of the question is easy to answer: benefits are being made available
on a broad cross section basis. The second half of the question gets more complicat-
ed. And it is important that sound benefits be incorporated into this answer as well
as cost. Note: employee benefits can accommodate different workers uniquely and
can accommodate different geographic sections of the country; regressive taxation
would result from the taxation of benefits where benefit cost is the same across the
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income stream (health, etc.); coverage gaps would be created if the employer chose
to drop programs when taxed or also if employees chose to not purchase coverage.
Finally, all available research indicates that the present system is the most cost ef-
fective and equitable method available to deliver the form and level of benefits now
being provided.
12. How will tax laws that encourage employers to provide employee benefits
affect compensation planning?
Research and experience show that economic security benefits will be provided
more readily in the presence of tax incentives. The presence of these incentives,
along with qualification requirements, assures provision across the income spec-
trum. It encourages total compensation planning.
13. Will tax incentives for employer-provided employee benefits affect potential
employees' choice of employment?
The answer to this question is yes; the effect on behavior increases as workers
grow older.
ENDNOTES
Numerous research projects sponsored by EBRI deal with these issues in greater
detail. Examples are provided below.
For background on flexible benefits plans and their relevance to changing employ-
ee needs, see Dallas L. Salisbury, ed., "America in Transition: Implications for Em-
ployee Benefits" (Washington, D.C.: EBRI, 1982); Issue Brief "Flexible Compensation
and Public Policy," no. 24; and Chapter XXII, "Flexible Compensation Plans" in
"Fundamentals of Employee Benefit Programs" (Washington, D.C.: EBRI, 1983).
For further analysis of the tax treatment issues, see Sophie M. Korczyk, "Retire-
ment Security and Tax Policy" (Washington, D.C.: EBRI, forthcoming). See also
Issue Brief "Pension-Related Tax Benefits," no. 25 (December 1983) and Issue Brief
"Employee Benefits and the 1985 Reagan Budget," no. 27 (February 1984).
For discussion of the interrelationship of programs see Sylvester J. Schieber,
"Social Security: Perspectives on Preserving the System" (Washington, D.C.: EBRI,
1982).
Alternative tax systems would require detailed judgments about the treatment of
various sources and uses of income. Both would also create some formidable imple-
mentation and transition problems. These problems and issues are treated in detail
elsewhere. For a discussion of employer pensions in basic tax reform, see Sophie
Korczyk, "Retirement Security and Tax Policy" (Washington, D.C.: EBRI, forthcom-
ing) and "Basic Tax Reform: Implications for Employee Benefits," EBRI Issue Brief
no. 28, March 1984. For a wide-ranging discussion of theoretical and practical issues
in basic tax reform, see Dallas L. Salisbury, ed., "Why Tax Employee Benefits?"
(Washington, D.C.: EBRI, 1984).
In smaller plans, the cost of providing health insurance for the marginal employ-
ee is based on the average costs of insuring the insured population of that communi-
ty. In larger plans, the cost of insuring the marginal employee is based on the aver-
age cost of insuring the population represented by that employer's work force.
While these two methods would be likely to yield different insurance costs for any
given employee, under either method the cost of insuring that employee does not
represent the cost of that employee's expected claims.
For a thorough discussion of health insurance see Deborah J. Chollet, "Employer-
Provided Health Benefits: Coverage, Provisions, and Policy Issues" (Washington,
D.C.: Employee Benefit Research Institute, 1984), p. 94. An EBRI simulation of pri-
vate health insurance suggests that 56 to 87 percent of all covered workers with
1979 family income of less than $15,000 would not have purchased private health
insurance, if an employer had not offered and contributed to their health insurance
plan.
For a discussion of employer efforts to reduce health care cost, see "Controlling
the Cost of Health Care: Recent Trends in Employee Health Plan Design," EBRI
Issue Brief no. 23, October, 1983.
Chairman PICKLE. The Chair yields to Mr. Heftel.
Mr. HEFTEL. Do you really think we can assume that the percent-
age of income to the employee that is fringe benefit and nontaxable
will not increase because if I am negotiating for employees, and I
can negotiate a benefit that is nontaxable, I certainly will do so. So
we should assume that there is a high risk of continuing increase
in the amount of benefits which are tax exempt. And therefore
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would it be reasonable for us to assume that we have to come up
with a cap?
Now I don't know where the cap is going to be placed, but since
the smaller businesses that are trying to play catch-up certainly
will find it more difficult if the larger firms, as we have heard you
testify, keep moving up, would it not make better sense for both
the equity to the Treasury and to the smaller firms, to at least
place a cap on the percentage of total income that can be allocated
to what we call tax free fringe benefits?
Mr. SALISBURY. Congressman Heftel, if I might, I think there is
some evidence to be taken from the current unfortunate situation
in the auto industry of bargaining that is going more difficultly
than one might prefer and that one of the major issues there is the
question of will employee benefit expenditures, percentage of wages
and salaries, be allowed to continue to grow or not, in terms of the
health provisions and the nature of those provisions.
If one looks at industry bargaining of the last two years at least
increasingly, that is being renegotiated to limit that future growth.
Whether that is a panacea or not and what that means for the
future is the reason I am careful not to say that I think you will
see no future growth.
But I would refer you quickly to chart 5, which I apoligize if I
put words in the chairman's mouth or implied that. But I wouldn't
want him either to put them in mine. What chart 5 shows is very,
very, very significant variations on an industry-by-industry and
employer-by-employer basis of the amount they are currently
spending as a percentage of wages and salaries on benefits.
I do not tell this committee-I'm sure Mr. Alexander would
differ with me. I am not telling the committee that you should not
put a cap into effect. That is a political judgment and a policy judg-
ment that is in your realm to make. What chart 5 and I are indi-
cating is that if one were to decide they wanted a cap, determining
where to put it it would be a very, very difficult thing to do. And
this chart indicates if you did it at 20 percent, for lack of a better
number, a significant number of millions of Americans would sud-
denly have income taxable, while millions of others would not.
That is a decision you need to face, but I am simply saying, the
numbers from Social Security presented yesterday, because they
are purely averages, can lead one to feel-I can put a cap here and
no one will be affected until tomorrow. But nobody today will be
affected. And chart 5 is simply tended to indicate to you that that
is-it is not that simple.
You may still want to do it, but you will need to draw the line
very carefully. It is my own judgment that the overall percentage
of wage and salaries on an average basis will in fact continue to
grow, even though for those employers today spending the most,
that it will decrease or stay level, because of the types of things we
are now seeing in the auto industry and elsewhere.
International competition is a key component of this. And in
terms of competitiveness there is a tremendous pressure for those
benefit expenditures among the largest, the people at 15 and 14.1
and the two and the 29 on this chart, to try~ and keep these num-
bers from going higher.
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Mr. ALEXANDER. Mr. Heftel, there is one other point. From the
employer's itandpoint a dollar compensation is deductible and a
dollar put into employee health care is also deductible. From the
employee's standpoint, the employee certainly would like to have a
tax break, health care, to a point; only to the point necessary to
give reasonable assurance to that employee and his or her family
that they are going to be adequately covered.
Beyond that the employee would much rather have cash, even
though it is subject to withholding tax, because the cash even after
tax is a lot better than a fringe benefit, tax-favored, but unneces-
sary. So there is an economic cap in addition to the points Mr.
Salisbury was making.
Mr. HEFTEL. Would you agree, then, that we should be looking at
the maximums in determining whether or not at some point we
need a cap?
Mr. ALEXANDER. Mr. Heftel, I think that what this committee is
doing today is highly constructive. I think the committee should
look at this area. I am suggesting that I think that a cap, if set low,
would create more problems than it cures. And, if set high, would
produce little in the way of addition to our national revenues.
Mr. HEFTEL [presiding]. The chairman may not be with us for a
while. I have a final report submitted to the Office of Advocacy,
Mr. Swain, from James Bell and Associates.
Mr. SwAIN. Yes, sir.
Mr. HEFTEL. We will place that in the record.
Mr. SWAIN. Thank you.
Mr. HEFTEL. Are there any other comments from members of the
panel?
Mr. ROMIG. Many, but in the interest of the committee's time we
will thank you for your time.
Mr. HEFTEL. I want to thank you for your instructive testimony
and your understanding of the problem we face. We will look for-
ward to continuing the dialogue. Thank you.
Mr. SALISBURY. Thank you, Mr. Chairman.
[The report referred to follows. Testimony continues on p. 417.]
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COVERAGE, CHARACTERISTICS, ADMINISTRATION,
AND COSTS OF PENSION AND HEALTH CARE BENEFITS
IN SMALL BUSINESSES
FINAL REPORT
Submitted to
The Office of Advocacy
Small B usiness Administration
by
James Bell and Associates, Inc.
ICF Incorporated
March 1984
PAGENO="0217"
211
TABLE OF CONTENTS
EXECUTIVE SUMMARY ES-i
I. INTRODUCTION 1
A. Background
B. Purpose of the Study 7
C. Methodology 7
D. Organization of the Report 14
II. PENSION AND HEALTH COVERAGE 16
A. Overview 16
B. Findings from National Aggregate Data Analysis 18
C. Findings from Regional Surveys 29
1. Pension Benefits 29
2. Health Benefits 34
D. Findings from On-Site Case Studies and Telephone Discussions 34
1. Reasons for Not Offering Pension Benefits 34
2. Reasons for Offering Pension Benefits 37
3. Health Benefits 39
III. CHARACTERISTICS OF SMALL PENSION AND HEALTH PLANS 40
A. Overview 40
B. Pension Benefits 43
1. Findings from National Aggregate Data Analysis 43
2. Findings from Regional Surveys 51
3. Findings from On-Site Case Studies and Telephone 58
Discuss ions
C. Health Benefits 63
1. Findings from National Aggregate Data, Analysis 63
2. Findings from Regional Surveys 66
3. Findings from On-Site Case Studies and Telephone 69
Discuss ions
IV. ADMINISTRATION AND COSTS OF SMALL PENSION AND HEALTH PLANS 74
A. Overview 74
B. Pension Benefits 76
1. Findings from National Aggregate Data Analysis 76
2. Findings from Regional Surveys 80
3. Findings from On-Site Case Studies and Telephone 82
Discussions
C. Health Benefits 99
1. Findings from National Aggregate Data Analysis 99
2. Findings from Regional Surveys 101
3. Findings from On-Site Case Studies and Telephone 105
Discuss ions
V. IMPLICATIONS AND CONCLUSIONS 108
APPENDICES:
APPENDIX A: On-Site Case Studies of Three Small Businesses A-i
APPENDIX B: Two Case Studies of Actuarial Constfltants B-i
APPENDIX C: Telephone Interviews of Small Employers C-i
APPENDIX D: Description of SBANE and SMC Surveys D-i
APPENDIX E: Findings from Needs Specificat~on Interviews E-i
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EXECUTiVE SUMMARY
This study focuses on the extent of coverage, characteristics,
administrative practices, and costs of pension and health care benefit plans
in small businesses. This report also identifies some of the most burdensome
aspects of health and pension regulations as reported by small businesses.
A. APPROACH
To achieve the study's objectives, the research effort was organized
around five basic questions:
* First, to what extent is health and retirement plan coverage
lower for small businesses?
* Second, what types of pension and health coverage do small
businesses have?
* Third, to what extent do small firms spend more to provide
health and pension benefits to their employees than large firms?
* Fourth, are the regulatory costs of employee benefit plans the
reason that coverage rates are lower?
* Fifth, what are the key regulatory actions or policy changes
that would be most important to reduce the costs to small
businesses?
The research plan for answering these questions combined four types of
analyses: (1) analyses of representative, national data; (2) analyses of
non-representative, but more in-depth data on small businesses in certain
regions of the U.S.; (3) interviews of small employers; and (4) interviews
with benefit consultants who provide health and pension benefits to small
employers. This approach produces both (1) results that are statistically
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generalizable to all employers (from the aggregate data analyses) and (2) an
in-depth understanding of the characteristics and costs of small employers
(gained from on-site case studies of individual employers and the other
sources).
B. FINDINGS
Pension and Health Coverage
Chapter II indicates that pension and health plan coverage levels for
workers in small businesses are substantially lower than the average for all
firms. In 1977, 77 percent of employees in establishments with less than 100
employees were covered by health plans, as compared to 97 percent of workers
in establishments with 100 or more workers. The differences are even larger
for pension coverage: 47 percent of workers in establishments with less than
100 workers were covered in 1977, while 87 percent of workers in
establishments with 100 or more workers were covered by pension plans. Of
employees in establishments with less than 100 employees, 45 percent had both
health and pension coverage and 21 percent had neither type of coverage. We
also found that:
* The level of coverage for both health and pension benefits
rises steadily with the size of establishment.
* If firms provide only one type of coverage, they are much more
likely to offer health rather than pension plans. Firms
typically adopt health plans before pension coverage for their
workers is established.
* The manufacturing and finance industries have the highest
percentage of health and pension coverage while the retail
trade, construction, and services industries have the lowest.
This is true for both small and large establishments.
* Workers in unionized establishments are substantially more
likely to receive both health and pension benefits. Even the
smdllest unionized establishments have high levels of coverage:
for example, approximately 90 percent of workers in unionized
establishments with 1-24 workers have pension coverage.
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* There is a strong correlation between wage levels in art
establishment and health and pension coverage.
* Approximately 85 percent of the workers not covered by either
health or pension plans in 1977 were in either: (1)
establishments with average wage rates of less than $3 per hour
in 1977; or (2) establishments with 25 or fewer employees.
The analyses of survey data provided by regional business organizations
and interviews with small employers and pension consultants who serve small
businesses showed that:
* The most important factor influencing the decision to
establish pension benefits was firm profitability. Small
businesses with pension coverage identified this as the prime
reason for establishment of benefits, while small firms without
pension benefits identified a lack of sustained profitability as
a major reason for not forming benefit plans.
* Start-up costs, the need for expert assistance, the complexity
and rate of change of regulations, and the lack of expressed
interest on the part of employees discourages the tormation of
pension plans in small businesses.
Characteristics of Small Pension and Health Plans
Analyses of aggregate data show that:
* Small firms are more likely to have defined contribution plans
than defined benefit plans. For example, 73 percent of the
firms with fewer than 25 employees and 67 percent of the firms
with 25-99 employees had only defined contribution plans--
compared to just 7 percent of firms with 100 or more employees.
* Small firms are most likely to have profit sharing plans.
* Few firms with under 100 employees sponsor supplemental plans.
* The likelihood of integration of defined benefit plans
increases as firm size increases--about half of the defined
benefit plans in firms under 25 employees areintegrated, while
72 percent of the defined benefit plans in firms over 100
employees are integrated.
* Firms with under 100 employees with defined benefit plans are
less likely to have early retirement benefits.
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Aggregate data analysis of the ICF Health Plan Data Base identified
several characteristics of health plans sponsored by small businesses:
* Workers covered by small health plans are less likely to have
family coverage than workers covered by large plans.
* Small firms tend to have less generous coverage than large
firms--particularly in the areas of dental coverage and
maternity benefits.
* Small firms are more likely to require employee contributions
than large firms.
* Firms with less than 100 employees are most likely to have
deductibles and co-insurance provisions.
In addition, regional survey data and interviews with small employers and
pension consultants who serve small businesses showed that:
* Interviews with small employers and pension plan consultants
suggested that profit sharing plans are selected, in part,
because of their greater flexibility in terms of making
contributions to the pension fund, as well as ease of start-up
and on-going administration.
* The regional data bases indicated that the most frequently
used combination of age/service requirements for pension plan
participation among small firms is the ERISA maximum--25 years
of age with one year of service.
* The regional data bases indicated that small firms are most
likely to offer Blue Cross/Blue Shield health coverage. Health
Maintenance Organizations (HMO) coverage is provided in only
10-15 percent of small firms. Only a very small percentage of
small firms use self-insurance.
* Most firms--85 percent in one regional data base--had some
form of deductible--usually $100 per year. About 80 percent of
the firms within this same regional data base had
co-insurance- -under most plans the insurance paid 80 percent of
medical expenses and the employee paid the remaining 20 percent.
Administration and Costs of Small Pension and Health Plans
Analyses of aggregate data ~howed that per capita pension costs are
substantially higher fo~ small establishments than large establishments. For
example, per capita costs decline from $1,080 for establishments with 1-10
workers to $574 for establishments with 500-999 workers.
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A major reason for this difference is the cost of pension plan
administration. Administrative costs, on a per worker basis, are highest for
small firms and decrease as firm size increases. Other findings from the
analysis of national, aggregate data on retirement plans include:
* Costs differences in pension plans are due to several factors,
including: (1) administrative costs, (2) benefit generosity,
(3) wage levels.
* On the basis of discussions with plan administrators and
actuaries, minimum on-going administrative coats are typically
$400 for a defined contribution plan and $600 for a defined
benefit plan.
* Per capita administrative costs for defined benefit plans
exceed those for defined contribution plans regardless of firm
size.
Analyses of aggregate data on health benefits indicated that total per
capita costs for individual health care coverage are highest for firms under
50 employees--$4l in monthly premiums. However, per capita cost for family
coverage are highest for firms with 100 or more employees-$lol in monthly
premiums--and lowest for firms with 50-99 employees. Also the aggregate
analyses demonstrated that large employers (over 100 employees) pay the
highest percentage of health care premiums--95 percent of premiums for
individual coverage and 91 percent for family coverage. Small firms, in the
50-99 employee range, paid the lowest share of premiums--68 percent for
individual coverage and 51 percent for family coverage. Finally, across all
firm size groupings, employers pay a higher percentage of premiums for
individual coverage than family coverages.
The analyses of regional data and interviews with small employers and
pension consultants showed that:
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* One regional data base suggested that about one-half of the
small firms administer their pension plans themselves, about
one-third use outside plan administrations and about one-seventh
rely on insurance companies.
* In setting up pension plans, most small employers utilize
expert pension advisors--including actuaries, attorneys,
etc. --at considerable costs. Depending upon the size of the
firm and the type of plan selected, start-up costs are an
estimated $2,000-5,000 for small plans.
* According to pension consultants and small employers, on-going
administrative costs for small firms (under 100) are an
estimated $500-l,500 per year--depending upon the type of plan
and number of participants.
* Small employers and pension consultants indicated several
areas of regulation and reporting requirement that are
burdensome--including parts of the Form 5500, "controlled group
requirements", "percentage coverage requirements", some
regulations under Multiemployer Pension Plan Amendment Act
(MPPAA) and "merger and spinoff rules".
* * Many small employers observed that it was not so much the
regulations that were a burden, but rather the constant changes
* in laws and regulations--which often imposed substantial costs
on the firms when they made plan amendments.
C. IMPLICATIONS AND CONCLUSIONS
This study confirmed that small businesses are significantly less likely
to offer pension and heath care benefits to their employees. If pension and
health care coverage of workers in the United States is to expand in upcoming
years, the impetus for expansion is most likely to come from small firms
because nearly all firms with over 500 employees currently offer both health
and pension benefits to their employees.
Pension Benefits
On the basis of our analyses of aggregate data and interviews with small
employers and actuaries, several alternatives have been identified which would
facilitate and encourage formation of plans among small employers, including:
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1. reduction in the costs of establishing plans;
2. decrease in the complexity of establishing and maintaining plans;
3. provision of monetary incentives--e.g., in the form of tax credits--
to cover the costs of plan formation; and
4. reduction in the burden and complexity of complying with current and
future regulations governing pensions.
A major finding of this study is that costs of plan start-up for small
firms are substantial--typically, in the $2,000-5,000 range. A reduction in
start-up costs or a spreading of these costs over several years would
encourage many small firms to set up plans. One avenue for reducing start-up
costs would be the development of more flexible IRS prototype pension plan
documents with variable provisions which small firms could adopt without
expensive, expert consultation. Other possible methods for reducing start-up
costs for small businesses would be to offer tax credits to cover set-up costs
or to enable small firms to spread costs over the first 3 to 5 years of the
plan's existence.
Beside the costs of initially setting up plans, our analyses show
considerable concern among small employers over frequent changes in
regulations governing pensions. What many employers found excessively
burdensome and problematic was constantly changing and increasingly complex
pension rules and regulations. These changes were not only costly--some
businesses said they had to amend their plans nearly every year at substantial
costs--but also created a condition of excessive uncertainty about the
future. Some smaller owner-operators were reluctant to set up plans because
they were unsure about the impact of future regulatory developments. One
solution to this problem might be to give already established plans a longer
period to come into compliance.
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Health Care Benefits
This study shows, that the central issue with respect to health benefits
in small firms is the rising costs of these benefits. In recent years, with
health care premiums rising rapidly, small firms have begun to ask serious
questions about whether they can afford to fully cover employees and about the
types of coverage they can afford to offer. Increasingly, firms are
instituting the following changes to their plans:
* they are moving away from high option coverage to standard
coverage;
* employees are being asked to share in the costs of coverage by
making monthly contributions to the cost of coverage;
* employers are adjusting plans to include higher deductibles;
and
* firms are instituting co-insurance features.
In general, employers have attempted to shift costs of health coverage to
employees-both to make them aware of cost increases and to help in meeting
costs. Whether these measures will prove effective in curbing cost increases
is still uncertain.
40-046 0 - 85 - 15
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I. INTRODUCTiON
A. BACKGROUND
In its final report, the President's Commission on Pension Policy
recommended that all employers be required to establish a retirement plan for
their employees. They made this recommendation because they thought that,
under current policies, pension coverage was unlikely to increase
significantly. The major reason coverage was unlikely to increase was "the
lack of pension offerings in small businesses".
The Commission's repori~ discussed several possible reasons for the lack of
retirement plans in small business. The foremost reason cited by experts is
cost. Costs for fringe benefits are higher in small businesses for a number
of reasons. First, the after-tax cost of offering benefits is higher because
small businesses typically have lower net income than large businesses. As a
consequence of the graduated corporate tax rate, the tax advantage of offering
retirement and health benefits is less for small businesses than for large
businesses.
A second factor which makes the costs of retirement and health plans
greater for small businesses than large businesses is the cost of their
administration. For example, establishing a retirement plan involves
actuarial, accounting, insurance, and investment services. The cost of these
services is usually not a function of the number of participants, but rather a
function of the time involved in drafting the plan document, auditing the
plan's assets, selecting securities, etc. As a result, the costs are
relatively higher for small businesses than for large businesses.
The relatively higher administrative costs to small businesses have been
analyzed empirically in several studies. In a recent analysis of pension plan
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costs, Emily Andrews and Olivia Mitchell found that administrative expenses
per participant in small pension plans were seven times larger than for large
plans.1~ A 1980 survey conducted by the Profit Sharing Council of America
examined the investment costs of small profit sharing plans. It found that
for plans with less than $200,000 in assets, the average investment cost per
SlOO invested was $6.48. For plans with more than $10,000,000, however, the
cost was only ~1322J
Many of these cost differences stem not only from the higher per-unit
costs of adxninistering a.srnall pension or. health plan, but also from the
additional burden imposed by government regulations. Exhibit 1-1, for
example, shows some of the specific actions which were required by the
Employee Retirement Income Security Act (ERISA) for pension. The direct and
indirect incremental costs of the regulatory impacts of ERISA have been
studied by a number of groups. First, Arthur Andersen & Company conducted a
study in 1978 for the Business Round Table which found that the incremental
administrative costs of ERISA for the smallest employers studied were nearly
seven times as great as the average incremental cost of the ten largest
employers studied. 3J
~ Olivia S. Mitchell and Emily S. Andrews, "Scale Economies in Private
Multi-Employer Pension Systems", Industrial arid Labor Relations Review,
Vol. 34, No. 4, July 1981.
2J Cited in Herbert Liebenson, National Small Business Association,
"Retirement Policy and Small Business", 1980.
3J Arthur Andersen & Company, cost of Government Regulation Study,
Executive Suinma~y, 1978.
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Procedures to allow:
Statement to separated employees
Written explanation of joint
and survivor annuity option
Explanation of denial of claim
Availability of plan documents
For defined benefit plans:
Maintenance of a `funding standard
account:
Insurace Requirements
Fiduciary liability insurance
(optiona~l)
Bonding expense
Plan termination insurance premiums
(defined benefit plans)
Department of Labor
Plan description (Form EBS-l)
Summary Plan Description
Changes in plan description (Amended EBS-l)
Updated Summary Plan Description
Annual Report (Form 5500)
Terminal Reports if applicable
Sc~r~r-irc~
Annual Registration Statement (Schedule SSA
of Form 5500)
Notification of Change in Status
Annual Report (Form 5500)
Defined Benefit Plans Only:
Actuarial Information (Form 5500
Schedule B)
Actuarial Valuation (first year and
every third year thereafter)
Pension Benefit Guaranty Corporation
(Defined Benefit Plans Only)
Premium payment declaration and annual
report (Form PBGC-l)
Notice of plan termination
Reportable event notice
Summary plan description
Updated summary plan description (every
five years)
Summary of changes in the plan description
Summary annual report
Written notice of reason for denial of
abenef it claim
Statement of benefits (upon request)
Statement of terminated vested
participant `s benefits
Modified from U.S. Department of Labor, Assessment of the Impact of
ERISA on the Administrative Costs of Small Retirement Plans, prepared by
Price Waterhouse & Co., Office of Government Services, (Washington, D.C.,
1977).
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EXHIBIT I-i
SPECIFIC FUNCTIONS REQUIRED BY ERISA
Administrative Requirements Reporting and Disclosure Requirements
Plan amendments to satisfy the
provisions of ERISA __________________
Detailed recordkeeping requirements
to comply with rules relating to:
Record Retention
Eligibility
Breaks in Service
Vesting
Rehiring
Marital Status ~~t~eiit~i r~eveiiue
Disclosure to Participants
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A second study conducted for the Department of Labor in 1977 found that
as a result of ERISA, the average administrative costs for small plans (less
than 100 participants) increased by 72 percent.'-~
As we found in this study, added costs are only part of the story because
small businessmen in many instances also do not have the expertise or the time
necessary to complete all of the government forms accurately, whatever the
cost to do so.2-~
ICF Incorporated completed a study in 1980 for the Department of Labor
whichshowed that no~ only were the added administrative costs of ERISA for
small firms greater, but the added costs of complying with ERISA's
participation, vesting, joint and survivor, and benefit accrual provisions
were also higher for small plans.3-' The higher direct costs of complying
with ERISA's provisions stemmed both from the fact that small firms had newer,
less generous plans and because their workforces were, in general, younger
than those of larger firms.
The impact of these regulatory costs on the decision not to offer pension
and health plans by small businesses has also been.studied. A 1979 Department
of Labor study prepared by Abt Associates evaluated the effects of ERISA on
the decision to form a new pension plan. The study included 52 firms that had
seriously considered but decided against plan establishment. Seventeen of
these 52 firms indicated that ERISA was significant in their decision against
~ U.S. Department of Labor, Assessment of the Impact of ERISA on the
Administrative Costs of Small Retirement Plans, prepared by Price
Waterhouse & Co., Office of Government Services, (Washington, D.C., 1977).
2J ~ cit. Liebenson.
~ ICF Incorporated, An Analysis of Pension Plan Costs, 1972-76, prepared
for the Department of Labor (Washington, D.C., 1980).
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plan establishment.'-1 A Battelle study examined the effect of regulatory
costs on the decision to offer a health plan. Exhibit 1-2 shows that although
regulatory costs were the single most important factor for not offering a
group plan for only two percent of firms, over 25 percent of firms felt they
were an. important reason.
In spite of much of this research, there remain a number of unanswered
questions about the coverage and types of benefits offered in the health and
pension plans of small businesses. It is important that these unanswered
questions be addressea soon. The Congress has been considering major reforms
to the participation and vesting provisions of ERISA as well as changes in the
tax treatment of employer deductions for health care coverage and a variety of
proposals to increase health care competition. In the area of pension policy,
for example, one proposal would set up a separate pension plan termination
insurance program for small employers. However, Congress has been reluctant
to establish this type of program, in part, because not enough is known about
the characteristics of small plans relative to large plans. Also of interest
is which specific parts of ERISA's regulations impose the greatest burden on
small businesses and provide the greatest barriers to the adoption of new
health and retirement plans.
In the area of health care policy, unanswered questions exist about the
impact of various health care competition proposals on small businesses. For
example, it may be an unnecessary burden on small business to require them to
offer expensive HNO coverage options if only a small number of individuals are
likely to join these plans. It may also be unrealistic to expect to realize
`-~ Abt Associates, Inc., Evaluation Study of the Formation of New Pension
Plans. Volume I (Cambridge, Massachusetts, April, 1979), p. 3.
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EXHIBIT 1-2
REASONS FOR NOT PROVIDING A GROUP HEALTH PLAN
Single Most
Very Somewhat Not Too Refused or Important
Factor Important Important Important Don't Know Total Factor
Government reporting 11% 16% 65% 8% 100% 2%
requirements
General administra- 17% 18% 55% 10% 100% 4%
tion paper work
Costs of benefit or 50% 17% 23% 10% 100% 29%
insurance
Size of your company 59% 14% 17% 10% 100% 35%
Having workers already 20% 12% 57% 11% 100% 10%
covered under union
or other plan
Tax considerations 16% 18% 53% 13% 100% 3%
SOURCE: Battelle Human Affairs Research Centers, "Study to Develop Methods
of Encouraging the Growth and Maintenance of Employee Benefit Plans
Among Firms with No Such Plans", June 1980.
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significant cost savings from requiring small businesses to offer two health
options if most small businesses currently have "low option" plans.1-J
B. PURPOSE OF THIS STUDY
The central objective of the study is to assess the cost to small
employers of providing employee benefits relative to the cost to large
employers. This study focuses on the level of coverage and the types of
benefits offered by the pension and health benefit plans of small businesses,
as well as administrative practices and costs. In addition, we identify the
m~ost bui~densome' aspects of health and pension regulations to small business.
In order to achieve the study's objectives, we organized our research
efforts around five basic questions:
* First, to what extent is health and retirement plan coverage
lower for small businesses?
* Second, what types of pension and health coverage do small
businesses have?
* Third, to what extent do small firms spend more to provide
health and pension benefits to their employees than large firms?
* Fourth, are the regulatory costs of employee benefit plans the'
reason that coverage rates are lower?
* Fifth, what are the key regulatory actions or policy changes
that would be most important to reduce the costs to small
businesses?
C. METHODOLOGY
In developing the research plan, we determined that the research questions
could be answered most efficiently and effectively by combining the results of
four types of analyses: (1) analyses of representative, national data; (2)
1J See a discussion of this issue in ICF Incorporated, "Analysis of the
Short-Term Impacts of Selected Pro-Competition Measures on Private,
Employment-Related Health Plans", prepared for the Health Industry
Manufacturer's Association, 1981.
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analyses of non-representative, but more in-depth data on small businesses in
certain regions of the U.S.; (3) interviews of small employers; and (4)
interviews with benefit consultants who provide health and pension benefits to
small employers. This approach produces both (1) results that are
statistically generalizable to all employers (from the aggregate data
analyses) and (2) an in-depth understanding of the characteristics and costs
of small employers (gained from on-site case studies of individual employers
and the other sources).1~
The five major tasks of the study reflected the key research questions:
* Task 1 - - Needs Specification
* Task 2 - - Analyses of Coverage
* Task 3 - - Characteristics of Retirement and Health Plans
* Task 4 -- Administrative Practices~ and Costs
* Task 5 -- Analysis of Factors Affecting Costs and Coverage.
Needs Specification
It is often difficult to target data collection and analysis in the most
germane and potentially useful areas for policy makers. Consequently, in the
initial task of this project, we identified the information needs and research
products needed by key decision-makers in the policy process. This technique,
known as needs specification, helps to overcome this difficulty by (1)
identifying key individuals in the policy process and (2) interviewing them to
gain vital information on issues and gaps in existing data and knowledge.
1J Another possible approach could have been to conduct a large survey of
employers. We did not use this approach because of the large burden it
would have imposed on employers relative to its added value. We note
that the research plan did not involve 0MB forms clearance because no
more than nine employers were asked the same set of questions in the
interview process.
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With approval from the project officer, we interviewed nine individuals
from the government, congressional staffs, independent experts and
representatives of small business outside government. We asked them to review
the study questions, discuss priorities among questions, suggest additional
high priority questions and discuss potential uses of information resulting
from the study.
Interviews conducted with the government officials, congressional staff
members, independent experts, and representatives of small business stressed
the importance of direct contacts and detailed interviews of small businesses
to develop what one respondentreferred to as the "nuts and bolts" problems of
pension and health care plan administration and costs. Interviewees indicated
particular interest in evidence that would highlight the actual
characteristics of benefit plans, administrative practices and related costs,
and particularly, effects of regulation and problems that small firms face in
setting up and maintaining benefit plans. These interviewees also suggested
that greater emphasis be placed on examination of pension issues (versus
health benefits issues) because of lower rates of pension coverage among small
firms, greater complexity of regulations governing pensions, and the
likelihood of legislation affecting pension regulation in upcoming
Congressional sessions. Hence, in addition to examining aggregate national
data bases, we placed considerable emphasis on detailed discussions and case
studies of the retirement plans of small business firms. Appendix E describes
these interviews in detail.
Analysis of Coverage
In this second task, we analyzed the percentage of employers who sponsor
health and retirement plans. This task built upon previous research conducted
by ICF and others on the levels of health and pension plan coverage by
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employers of different sizes. In contrast to other studies which have
analyzed only pension or health coverage, however, JBA and ICF analyzed the
offering by employers of: (1) health benefits only (no pension benefits), (2)
pension benefits only (no health benefits), (3) neither health nor pension
benefits; and (4) both health and pension benefits.
To conduct these analyses, we used the Expenditures for Employee
Compensation (EEC) Survey conducted by the Bureau of Labor Statistics in
1977. The EEC data included employee benefit information for a representative
sample of over 6,000 employers during 1977. The data in the EEC survey
include information on employer expenditures for pensions, health coverage,
and other employee benefits.
In this task, we also conducted in-person and telephone interviews with
15 small employers--eight firms with pension and health plans and seven firms
with health plans but without pension plans. These interviews focused on the
reasons small employers did or did not have pension and/or health coverage.
The selection of employers for these interviews was guided by two small
business organizations: the Greater Cleveland Growth Association and the
Smaller Manufacturer's Council of Pittsburgh.
These interviews were intended to enrich and supplement the aggregate
data analyses undertaken during this task. For example, when the analysis of
existing data sources indicated that coverage by pension and health care
benefit plans was related to firm size, interviews were then aimed at
identifying factors that influenced the decision to offer benefits. In
addition, interviews with small businesses provided preliminary indications of
key factors--such as type of business, government regulation, administrative
costs and burdens, and firm profitability--which appeared to influence
directly decisions concerning the offering of employee benefits.
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We used two other sources of primary data during this task: (1) the
Small Business Association of New England's (SBANE) 1982 Survey of Fringe
Benefits, and (2) the Smaller Manufacturer's Council of Pittsburgh's (SMC)
1982 Wage and Fringe Benefit Survey. The SBANE Survey was conducted during
1982 with 176 small businesses in the Boston area. The SMC Survey was
conducted during 1982 with 242 small firms in the Greater Pittsburgh area. It
included detailed questions on wage rates, health care plans, retirement
plans, and a host of other fringe benefits. While neither of these surveys
used random sampling procedures, they provide rich, current data to supplement
and extend our aggregate data analyses. A more detailed discussion of these
two data bases and copies of the survey instruments appear in Appendix D.
Retirement and Health Plan Characteristics
In the third task, we analyzed the types of benefits offered by small
employers with health and/or pension plans. Using two data sources developed
by ICF, this task compared the different levels and types of benefits offered
by both large and small employers. Several other sources of data were also
used, including: telephone interviews with small firms, case studies of small
firms and pension consultants, and the SMC and SBANE data bases.
We used two aggregate data sources to analyze the characteristics of the
benefit plans in this task. For health plan benefits, we used the ICF Health
Plan Data Base which is a representative sample of over 2,100 employer
sponsored health plans. It is composed of data provided in both the l~77/l978
Battelle Survey of Employers and the 1977 BLS Survey of Health Plans. The
Battelle data on employers with less than 26 employees were included in the
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ICF data file because they are the most recent publicly available data on
health coverage for small employers. However, because the Battelle data have
an unacceptably low rate of response among larger employers, ICF obtained data
on larger employer-sponsored health plans from the 1977 Bureau of Labor
Statistics Health Plan Survey. This BLS survey provides data on a
representative group of plans with 25 or more participants. These merged data
from the Battelle and BLS surveys, called the ICF Health Plan Data Base,
contain the most extensive and recent data publicly available which .is
representative of all employer health plans.1~
Data on the characteristics of retirement plans came from the ICF
Retirement Plan Provisions Data Base. This representative plan sponsor data
base is stratified by industry, firm size, and multi/single employer status.
It provides plan provision data for both the primary and supplemental defined
benefit and defined contribution plans offered by public and private sector
sponsors. For each of these sponsora, ICF obtained Summary Plan Description
(SPD) data on their retirement p1ans.2~ The data base includes all relevant
plan provisions for participation, vesting, hours crediting, retirement,
death, disability, joint and survivors benefits and social security
integration.
1J It has been used in other published studies. See ICF Incorporated,
"Analysis of the Short-Term Impacts of Selected Pro-Competition Measures
on Private, Employment-Related Health Plans", prepared for the Health
Industry Manufacturer's Association, 1981.
2J The sample was originally developed in 1980 for the President's
Commission on Pension Policy. It was updated in 1982 under contract with
the Employee Benefit Research Institute.
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We also conducted telephone interviews, case studies and analyzed the
SBANE and SMC Surveys. Eight small firms were asked a series of questions
about the characteristics of their pension plan and fifteen small firms were
asked questions about the characteristics of their health plans. These
discussions were aimed at filling gaps in currently existing data and
extending the depth of analyses concerning the provisions and types of
employee benefits offered by small employers. Project staff also analyzed
questions pertaining to health and retirement benefits within the SBANE and
SMC data bases.
Pension and Health Plan Administrative Practices and Costs
In this task, we examined the differences in the level of expenditures
for pension and health benefit plans between small and large firms using the
1977 version of the Bureau ofLabor Statistics Survey of Employer Expenditures
for Employee Compensation (EEC). We analyzed the EEC data to calculate the
frequencies of health and pension plan expenditures in various industries,
size categories, and wage classes.
We used several other sources of data to analyze the administrative
practices and costs of small pension and health plans. These sources included
telephone interviews with small employers, case studies of small firms and
pension consultants, and the SBANE data base. The SBANE data base provided
data on administrative practices and some data on the percentage of the firms'
payroll spent on pension benefits and health care plans.
We also conducted case studies with three small employers in the
Cleveland area. These small firms--a steel wire manufacturer, a rigging and
moving firm, and a real estate developer--had both pension and health care
plans. These on-site case studies examined reasons for coverage and selection
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of particular plans, characteristics of plans, administrative practices, costs
and factors affecting costs, and impacts of government regulations. Appendix
A provides a detailed summary of each case study.
We also conducted two case studies of independent, actuarial pension plan
consultants during this task. These interviews were aimed particularly at the
analysis of administrative practices, costs, factors affecting costs, and
effects of regulations. Appendix B provides a detailed summary of each case
study.
Factors Affecting Costs and Coverage
The final task of the study focused directly on the factors which
affected costs of employer benefits plans. as well as the extent of coverage.
An important part of this task was identifying specific regulations that
increase the costs of benefits for small businesses.
During this task, we examined evidence from the telephone discussions
with fifteen small employers, the three on-site case studies, and the two
interviews with pension consultants. This task was instrumental in verifying
and extending project findings concerning regulatory actions and identifying
policy changes that would be most important in reducing the cost of health and
pension benefits for small businesses.
D. ORGANIZATION OF THE REPORT
This report is aimed at providing SBA with data analysis and information
to assist in the formation of policy positions. The report has been divided
into three major chapters. In Chapter II, we examine the extent of pension
and health plan coverage in small business firms. In Chapter III, we present
data on the characteristics of pension and health plan benefits in small
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business firms. Chapter IV then discusses our analysis of the administration
and factors affecting the costs of pension and health benefit plans in small
firms.
Within each of these chapters, we have provided a brief summary of
findings, followed by three levels of analysis to support these findings:,
* Findings from National Aggregate Data Analysis
* Findings from Regional Surveys of Small Business Firms
* Findings from On-Site Case Studies and Telephone Discussions.
A final chapter--Implications and Conclusions--examines the implications
of this study for the current policy debate concerni~ng employer pension and
health care benefits. Several appendices, following the final chapter,
provide more detailed description of the analyses.
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II. PENSION AND HEALTH COVERAGE
A. OVERVIEW
This section presents information about differences in health and pension
coverage among business establishments of varying sizes and the key factors
responsible for these differences.
In analyses of national aggregate data, we found that in 1977, 65.1
percent of all workers were covered by both health and pension plans, 21.8
percent by health benefit plans only, 1.5 percent by pension benefit plans
only, and 11.6 percent by neither type of plan.
Our analyses indicated that, as expected, coverage levels for workers in
small businesses are substantially lower than the average for all firms. We
found that in 1977, only 77 percent of employees in establishments with less
than 100 employees were covered by health plans, as compared to 97 percent of
workers in establishments with 100 or more workers. The differences are even
larger for pension coverage: only 47 percent of workers in small
establishments (less than 100 workers) were covered in 1977, while 87 percent
of workers in establishments with 100 or more workers were covered by pension
plans. In addition, we found that only 45 percent of employees in
establishments with less than 100 employees had both health and pension
coverage and that 21 percent had neither type of coverage. We also found that
in 1977:
* The level of coverage for both health and pension benefits
rises steadily with the size of establishment. For
establishments with fewer than 10 employees, only 30.9 percent
of workers are covered by both health and pension benefits,
while for establishments with more than 2,500 employees, 95.3
percent of workers are covered by both types of plans.
40-046 0 - 85
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-17-
* If firms provide only one type of coverage, they are much more
likely to offer health rather than pension plans. Our analyses
also indicate that firms typically adopt health plans before
they establish pension coverage for their workers.
* On an industry level, the manufacturing and finance industries
have the highest percentage of health and pension coverage while
the retail trade, construction, and services industries have the
lowest. This is true for both small and large establishments.
* 91.4 percent of workers in unionized establishments receive
both health and pension benefits compared to 55.6 percent of
workers in non-unionized establishments. Even the smallest
unionized establishments have high levels of coverage: for
example, approximately 90 percent of workers in unionized
establishments with 1-24 workers have pension coverage.
* There is a strong correlation between wage levels and health
and pension coverage. For employees in establishments with an
average hourly wage of less than $3 per hour in 1977, 49 percent
received both health and pension benefits while 84 percent of
* employees in establishments in which the average hourly wage
rate was $6 or more in 1977 did so.
* Approximately 85 percent of the workers not covered by either
health or pension plans in 1977 were in either: (1)
establishments with average wage rates of less than $3 per hour
in 1977; or (2) establishments with 25 or fewer employees.
From our analyses of regional data and interviews with small employers
and pension consultants who serve small businesses we found that:
* The two regional data bases confirm that pension benefit
coverage rises steadily with the size of establishments.
Overall, SBANE and SMC data show that 55-60 percent of the firms
with under 500 employees had pension coverage.
* The most important factor influencing the decision to
establish pension benefits was firm profitability. Small
businesses with pension coverage identified this as the prime
reason for establishment of benefits, while small firms without
pension benefits identified a lack of sustained profitability as
a major reason for not forming benefit plans.
* Other important reasons given in these interviews for
establishing pension plans included: a desire to offer
competitive levels of compensation, union negotiations, a desire
to share profits with employees, and a desire to provide for
employees' retirement.
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* Start-up costs, the need for expert assistance, complexity,
frequently changing regulations, and lack of expressed interest
on the part of employees discouraged formation of plans in small
businesses.
* Health benefits were regarded, in most cases, as an expected
benefit by both employers and employees--one that was generally
provided by firms to employees if they were to remain
competitive in the labor market.
B. FINDINGS FROM NATIONAL AGGREGATE DATA ANALYSIS
We used data from the 1977 Expenditures for Employee Compensation (EEC)
Survey, conducted by the Bureau of Labor Statistics, to analyze differences in
health and pension coverage among business establishments of varying
sizes.1~ The EEC data include information on employee benefit plan coverage
from a representative sample of over 6,000 private sector, non-agricultural
establishments in 1977.
Using the EEC data for 1977, we examined four categories of coverage:
(1) coverage for health benefits only (no pension plan), (2) coverage for
pension benefits only (no health plan), (3) coverage for both health and
pension benefits, and (4) neither health nor pension plan coverage. Pension
covered workers were defined as those workers whose employer made payments to
a pension plan for some or all of his employees. Similarly, workers covered
by a health plan were defined as those workers whose employer made
contributions for a health plan for some or all of his employees.
Exhibit 11-1 shows that coverage for both health and pension benefits
increases with establishment size. This exhibit shows that in 1977:
* Almost 87 percent of workers are in establishments with health
plans, while only 67 percent are in establishments covered by
pension plans.
1J BLS has not conducted the EEC survey since 1977.
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EXHIBIT Il-i
HEALTH AND PENSION COVERAGE,
BY ESTABLISHMENT SIZE, 1977
Establishment Size Health Coverage Pension Coverage
1-9 55.6% 33.6%
10-25 79.2 41.4
26-49 84.1 52.3
50-99 88.7 59.7
100-499 95.8 78.4
500-999 96.0 90.8
1,000-2,499 98.9 95.2
2,500+ 99.5 95.7
Total 86.9% 66.6%
SOURCE: 1977 Expenditures for Employee Compensation (EEC) Survey, Bureau of
Labor Statistics.
Only 77 percent of employees in establishments with less than
100 employees were covered by health plans, while 97 percent of
workers in large establishments (i.e., with more than 100
employees) were covered by health plans. A sharp distinction in
coverage for employer health plans is found between
establishments with less than 10 employees and establishments
with 10 or more employees: about one-half of employees in
establishments with fewer than 10 employees have health
coverage, while four-fifths of employees in establishments
larger than this size are covered.
* Only 47 percent of workers in establishments with less than
100 workers were covered by pension plans in 1977, while 87
percent of workers in large establishments were covered by
pension plans.
* The percentage of establishments in a size group with health
benefits always exceeds the percentage of establishments with
pension coverage.
* While almost 90 percent of workers in establishments with 50
or more employees have health coverage, the 90 percent coverage
level for pensions is not reached until establishments have 500
or more participants.
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Exhibit 11-2 shows that only about 31 percent of establishments
with less than 10 employees had both health and pension coverage in 1977 and
that about 42 percent of all establishments with fewer than 10 employees had
neither a health nor pension plan in 1977. This exhibit also shows the strong
correlation between health and pension coverage and establishment size. The
percentage of establishments with coverage for neither benefit drops quickly;
while over 40 percent of establishments with fewer than 10 employees had
neither health nor pension coverage in 1977, only 10 percent of establishments
with 50-99 employees had coverage for neither benefit.
Exhibit 11-2 also shows that if an establishment has only one type of~
benefit, it is most likely to have health coverage. For example, almost 25
percent of establishments with fewer than 10 employees have health coverage
only, while only three percent of establishments of this size have only
pension benefits. This also indicates that establishments are much more
likely to adopt health benefits before adopting pension coverage.
EXHIBIT 11-2
HEALTH AND PENSION COVERAGE BY
ESTABLISHMENT SIZE, 1977
Establish- Health Pension Both Health
ment Size 0nly~ Only and Pension Neither
1-9 24.7% 2.7% 30.9% 41.6%
10-25 40.2 2.3 39.1 18.4
26-49 34.5 2.6 49.6 13.3
50-99 30.0 1.0 58.7 10.3
100-499 18.5 1.1 77.4 3.1
500-999 6.7 1.4 89.3 2.5
1,000-2,499 4.1 0.3 94.9 0.8
2,500+ 4.2 0.4 95.3 0.1
Total 21.8% 1.5% 65.1% 11.6%
SOURCE: 1977 Expenditures for Employee Compensation (EEC) Survey,
Bureau of Labor Statistics.
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Exhibit 11-2 shows that, on average, establishments with 1-9 employees
are likely to have either no pension or health coverage (42 percent) or just
health benefits (25 percent). Somewhat larger establishments (10-25 workers)
are most likely to have health benefits, but not pension benefits.
Establishments with 25-49 workers are likely to have at least health benefits
(84 percent) or both health and pension benefits (50 percent). Almost all
establishments with more than 50 workers have health plans, and a majority of
these establishments have both health and pension coverage. When an
establishment has 500 or more employees, it is extremely likely that it will
have both health and pension benefits.
Health and pension coverage also vary significantly by industry. Exhibit
11-3 shows that the highest degree of both health and pension coverage is
provided by the manufacturing (durable goods) and finance industries, while
the trade, services, and construction industries have the lowest coverage
levels.
Many of these industry differences are found because the low coverage
industries have a higher proportion of small firms--many of which are new,
nonunionized, and have low wage level workers. In order to examine more
closely the factors influencing health and pension coverage, we first divided
the 10 industries in Exhibit 11-3 into four categories (1) Trade, (2)
Services, (3) Construction, and (4) Other. We note that the trade, services,
and construction industries employed 86.4 percent of workers not covered by
pension plans in 1977. We then examined the interrelationship between size
and industry in these four industry groupings. Exhibit 11-4 shows that, with
minor exceptions, small establishments in the trade, services, and
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EXHIBIT 11-3
HEALTH AND PENSION
COVERAGE, BY INDUSTRY, 1977
Finance
Manufacturing-Durable
Other
Transportation
Manufacturing Non-Durable
Mining
Wholesale Trade
Services
Construction
Retail Trade
SOURCE: 1977 Expenditures for Employee Compensation (EEC) Survey, Bureau of
Labor Statistics.
EXHIBIT 11-4
Establishment Size
1-25 26-99 100-499 500+ Total
Trade 27% 51% 71% 85% 49%
Services 33 34 68 96 57
Construction 35 72 68 NA 55
Other 51 66 84 95 80
35% 54% 77% 93% 65%
Indus~y
Health Pension Both Health
çj~ Only and Pens ion Neither
12.1% 1.0%
12.4 0.6
16.6 --
16.8
21.2
13.3
29.7
24. 1
26.2
29.2
84.0%
83.9
80.6
0.8 76.8
0.6 75.8
1.6 72.3
2.1 63.4
2.3 56.8
0.8 54.9
2.5 44.0
Total
2.9%
3.1
2.8
5.7
2.4
12.9
48
16.8
18.1
24.3
11.6%
21.8% 1.5% 65.1%
PERCENTAGE OF ESTABLISHMENTS WITH
BOTH HEALTH AND PENSION COVERAGE, BY INDUSTRY
AND ESTABLISHMENT SIZE, 1977
TOTAL
SOURCE: 1977 Expenditures for Employee Compensation (EEC) Survey, Bureau of
Labor Statistics.
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construction industries have lower coverage rates than small establishments of
the same size in the "other" industry groupings. Thus, these data indicate
that the trade, services, and construction industries do not have lower
coverage levels ~ because they have a relatively larger proportion of
small businesses.
Two other factors contributing to the lower coverage levels in these
industries are (1) the high proportion of lower wage employees and (2) the
high proportion of non-union employees. For example, 88.2 percent of workers
in the trade industry worked in establishments with average wage levels of
less than $6 per hour in 1977, and 86.0 percent of them worked in
non-unionized establishments. Similarly, in the services industry, there is a
high concentration of low wage and non-unionized workers, 74.3 percent and
86.0 percent respectively. The construction industry differs somewhat in its
characteristics: first, it is more unionized (34 percent of workers are
unionized compared to 14 percent in Services and Trade), and second, only 44
percent of its workers worked in establishments with average wage levels of
less than $6 per hour in 1977. In aggregate terms, for all the other
industries combined, 73 percent of workers worked in establishments with
average wage levels of less than $6 an hour (in 1977), and 61 percent were not
unionized.
We then examined coverage for pension benefits by establishment size and
wage level. Exhibit 11-5 shows that pension coverage increases both with wage
level and establishment size. We found that the increase is stronger with
respect to establishment size than it is to average wage levels. For example,
18.8 percent of employees in establishments with both (1) average wage levels
in 1977 of less than $3 an hour and (2) less than 10 workers were covered by
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EXHIBIT 11-5
PROPORTIONS OF WORKFORCE COVERED BY PENSION
PLANS, BY WAGE AND SIZE OF ESTABLISHMENT, 1977
Average Hourly Wage
Number of Employees ~ $3.00 S3.00-5.99 $6.00-8.99 ~
1-9 18.8% 25.5% 59.1% 69.2%
10-25 32.7 36.2 69.6 73.6
26-49 43.3 48.6 79.2 93.4
50-99 44.0 62.9 75.1 78.5
100-499 66.9 78.4 93.2 93.9
500-999 68.8 95.4 98.5 100.0
1,000-2,499 92.4 96.0 94.5 100.0
2,500+ 96.3 94.1 96.5 100.0
Total 50.7% 66.3% 85.2% 85.1%
S0URCE~ 1977 Expenditures for Employee Compensation (EEC) Survey, Bureau of
Labor Statistics.
pension plans compared to 69.2 percent of employees in establishments of the
same si~e but with average wage levels of more than $9 an hour in 1977. In
contrast, over 90 percent of employees in establishments with average wage
levels of less than $3 an hour in 1977 in the largest establishments had
pension coverage. For establishments with more than 1,000 employees, all wage
and size categories have more than 90 percent pension coverage.
Exhibit 11-6 provides even more detail on the relationship between
establishment size, industry, and the average wage level of establishments.
It shows that in 1977:
* Except for establishments in which the average hourly wage
level was less than $3 in 1977, 90 percent or more of all
workers in establishments with 500 or more workers were covered
by both pension and health plans in 1977.
* In establishments with 100-499 employees and high average
wage rates (over $6 per hour in 1977), coverage levels for both
health and pension benefits were 90 percent or more in all
industries except the trade industry.
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EXHIBIT 11-6
COVERAGE BY BOTH PENSION AND HEALTH PLANS,
BY INDUSTRY, WAGE LEVEL, AND ESTABLISHMENT SIZE
Industry/Average Size of Establishment
Hourly Wage Level (1977) 1-25 26-99 100-499 500+ Total
Trade
Less than $3 24% 39% 56% 66% 38%
$3-6 25 57 80 91 55
$6-9 49 68 76 100 65
36 75 100 N/A 63
Services
Less than $3 18% 30% 53% 89% 42%
$3-6 27 28 62 98 55
$6-9 * 42 50 93 98 78
62 70 92 100 74
Construction
Less than $3 17% 56% 73% N/A 41%
$3-6 12 45 43 N/A 30
$6-9 53 100 96 N/A 73
$9+ 100 99 100 N/A 100
"Other"
Less than $3 32% 53% 75% 90% 69%
$3-6 38 66 85 94 78
$6-9 66 79 96 97 92
$9+ 83 93 89 100 95
SOURCE: 1977 Expenditures for Employee Compensation (EEC) Survey, Bureau of
Labor Statistics.
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* Establishments with 100-499 employees and with average hourly
wage levels of less than $6 in 1977 in the trade and services
industries had substantially lower levels of coverage for both
types of benefits than gimilar establishments in other
industries.
* The levels of coverage in establishments with less than 100
employees were significantly lower for the trade and services
industries for all average wage rate levels.
We then examined the relationship between pension coverage, unionization
status, and establishment size. Exhibit 11-7 shows that unionization status
is extremely highly correlated with pension coverage: over 90 percent of
unionized establishments have pension coverage while only 57 percent of
non-unionized establishments have pension coverage. It also shows that 90
percent or more of unionized establishments in all establishment size groups
have pension coverage. This is in sharp contrast to non-unionized
establishments, in which coverage varies greatly by establishment size. One
reason for the high coverage rates of small, unionized establishments (and
firms) is that they are part of multiemployer plans.
We then examined the distribution of non-covered workers. This allows
one to understand the types of workers that are not covered and the
characteristics of the establishments in which they work. Exhibit 11-8 shows
that of the approximately eight million workers in establishments which had
neither pension nor health plan coverage in 1977:
* Almost ne-half (47.6 percent) of all uncovered workers were
in establishments with average wage levels of $3 or less in 1977.
* 65 percent of uncovered workers were in establishments with
less than 25 employees.
* Over 85 percent of the uncovered workers were in the trade,
services, and construction industries. And, almost 50 percent
were in trade and services establishments with 25 or fewer
employees.
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EXHIBIT 11-7
PENSION COVERAGE, BY UNIONIZATION
STATUS AND ESTABLISHMENT SIZE, 1977
Unionization Status of Establishment
Establishment Size Union Non-Union Total
1-25 91% 32% 37%
26-99 88 48 56
100-499 95 75 78
500+ 95 96 95
Total - 93% 57% 67%
SOURCE: 1977 Expenditures for Employee Compensation (EEC) Survey, Bureau of
Labor Statistics.
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EXHIBIT 11-8
DISTRIBUTION OF WORKERS NOT COVERED BY
E1THER PENSION OR HEALTH PLANS IN 1977
Industry/Average Hourly Size of Establishmen~
Wage Level (1977) 1-25. 26-99 100-499 500+ Total
Trade
Less than $3 17.8% 8.0% 0.8% 0.8% 27.4%
$3-6 12.6 3.7 0 0 16.3
$6+ 1.0 0.9 0 0 1.9
Services
Less than $3 6.9 5.3 1.9 0.8 14.8
$3-6 8.4 4.9 1.9 0 15.2
1.6 0.1 0 0 1.7
Construction
Less than $3 1.0 0 0 0 1.0
$3-6 5.1 0.4 0.7 0 6.2
$6+ 1.0 0 0.1 0.7 1.8
All Other Industries
Less than $3 2.5 1.7 0.3 0 4.4
$3-6 5.8 0.7 0.3 0 6.9
1.5 0.8 0 0 2.3
Total
Less than $3 28.2 15.0 2.9 1.5 47.6
$3-6 31.9 9.7 2.9 0 44.6
$6+ 5.1 1.8 0.1 0.7 7.8
Total 65.2% 26.5% 6.0% 2.3% 100.0%
SOURCE: 1977 Expenditures for Employee Compensation (EEC) Survey, Bureau of
Labor Statistics.
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Exhibit 11-9 shows the distribution of uncovered workers in two groups of
establishments: (1) establishments with neither health nor pension benefits;
and (2) establishments with health but no pension benefits. It shows that
these two groups have substantial differences:
* Workers not covered for either type of benefit are more likely
to be in low wage, small establishments.(28 percent versus 10
percent), or medium t~age, small establishments (32 percent
versus 19 percent) than workers covered by health plans but not
by pension plans.
* Workers with health but not pension coverage are more likely
to be found in low and medium wage, larger establishments (58
percent versus 32 percent) than workers not covered by either
type of benefit.
C. FINDINGS FROM REGIONAL SURVEYS
Examination of data from the two regional surveys of small businesses--the
SBANE and SMC surveys--provides further insight into the extent of pension and
health care coverage in small firms. This evidence, however, must be analyzed
with care because the data are not representative of all small businesses.
1. Pension Benefits
Exhibit 11-10 summarizes the frequency of pension coverage by firm size
from the SBANE and SMC data bases.'~ The exhibit shows that the proportion
of firms providing pension benefits to employees was comparable in both
surveys: 56 percent of the small firms surveyed by SBANE provided pension
benefits to their employees, while 59 percent of the SMC firms reported having
pension plans. The percentage of firms with pension benefits is very similar
to that found in the aggregate data analysis.
1~ All firms in these two surveys had less than 500 employees.
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EXHIBIT 11-9
DISTRIBUTION OF UNCOVERED WORKERS IN 1977 a!
Workers Covered by
Neither Health Nor Workers with Health,
Pension Plans But No Pension
(% of Total) Coverage (% of total)
Low Wago, Small Establishments
Trade, Services, Const. 2,000 ( 26%) 1,251 ( 9%)
Other 193 C 2%) 278 ( 2%)
Subtotal 2,193 C 28%) 1,528 C 10%)
Low Wage, Larger Establishments
Trade, Services, Const. 1,364 C 18%) 2,417 ( 17%)
Other 152 ( 2%) IJJI L~1
Subtotal 1,516 ( 19%) 3,534 C 24%)
Medium Wage, Small Establishments
Trade, ServIces, Const. 2,032 ( 26%) 2,075 C 14%)
Other 453 C 6%) 756 ( 5%)
Subtotal 2,485 ( 32%) 2,832 ( 19%)
Medium Wage, Larger Establishments
Trade, Services, Const. 903 ( 12%) 2,889 C 20%)
* Other 81 C 1%) ~ C 14%)
Subtotal 984 ( 13%) 5,009 C 34%)
Higher Wage Establishments
Trade, Services, Const. 425 C 5%) 1,309 ( 9%)
Other 180 C 2%) 416 ( 3%)
Subtotal 605 C 8%) * 1,725 C 12%)
TOTAL 7,783 (100%) 14,628 (100%)
a! Low wage defined as workers in establishments with average wage levels
of less than $3 per hour in 1977. Medium wage defined as between $3 and
$6 per hour in 1977 and higher wage defined as greater than $6. Small
establishments defined as 1-25 workers. Larger establishments include
all other establishments.
SOURCE: 1977 Expenditures for Employee Compensation (EEC) Survey, Bureau of
Labor Statistics.
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EXHIBIT 11-10
DISTRIBUTION OF PENSION COVERAGE BY FIRM SIZE,
SBANE AND SMC SURVEYS, 1982 a/
Firm Size
1-4
5-9
10-19
20-49
50-99
100-249
250-499
TOTAL
SBANE ( n175)
Pension No Pension
Coverage Coverage
1 (14%) 6 (86%)
4 (33%) 8 (67%)
l5~ (40%) 23 (60%)
29 (62%) 18 (38%)
23 (66%) 12 (34%)
19 (73%) 7 (27%)
5 (83%) 1 (17%)
98 (56%) 77 (44%)
SMC (n = 216)
Pension No Pension
Coverage Coverage
4 (36%) 7 (64%)
10 (37%) 17 (63%)
11 (35%) 20 (65%)
46 (59%) 32 (41%)
29 (76%) 9 (24%)
23 (92%) 2 (8%)
5 (83%) 1 (17%)
128 (59%) 88 (41%)
a/ Information not available for 24 firms in the SMC Survey.
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of
Fringe Benefits and the Smaller ?lanufacturers Council of
Pittsburgh's (SMC) 1982 Wage and Fringe Benefit Survey.
The SBANE and SMC data confirm the pattern of pension coverage by firm
size found in the aggregate data analysis: as the size of the firm increases,.
the likelihood of offering pension benefits increases. For example, 36
percent of the SMC firms with less than 20 employees offered retirement plans
to their employees, compared to 90 percent of those firms with 100 or more
employees. Similarly, the SBANE data show that 35 percent of the firms with
under 20 employees offered pension benefits, while 75 percent of the firms
with 100 or more employees offered pension benefits.
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On the basis of the two regional data bases, it appears pension coverage
increases rapidly after firms reach the size of 20 employees. For example, in
the SBANE survey, pension coverage jumps from 40 percent for firms in the size
range 10-19 employees to 62 percent coverage in the size range 20-49
employees. Similarly, SMC data show a rise of 24 percent between the two size
categories--from 35 percent coverage for the size group of 10-19 employees, to
59 percent coverage in the size group. of 20-49 employees.
Exhibit 11-11 presents evidence from the SMC regional survey on the
extent of coverage across various industries. Basic industrial
manufacturers--metal processors, metal fabricators, machine shops and
glass/ceramics manufacturers- -tended to have the highest proportion of
retirement pian coverage within the SNC data base. Similar to the aggregate
data analysis, the SMC data suggest that pension coverage in small firms
(under 500 employees) is closely linked to unionization. In fact, many of the
plans were instituted as part of a union contract. For example, 74 percent of
those firms surveyed by SMC reported that their pension plan was part of a
union contract.
The SMC survey indicates that most plans of small businesses cover both
salaried and hourly employees. Exhibit 11-12 shows that 77 percent of the
small businesses with pension plans covered both salaried and hourly
employees. A small proportion of firms within the SMC sample indicated that
their plan covered only hourly (16 percent) or only salaried (7 percent)
workers. Overall, SMC data indicate that pension plans in small firms tend to
cover all full-time salaried and hourly employees.
40-046 0 - 85 - 17
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EXHIBIT Il-il
DISTRIBUTION OF PENSION COVERAGE BY
INDUSTRY, SMC SURVEY, 1982
Pension No Pension
Industry Coverage Coverage
Glass/Ceramics 14 (78%) 4 (22%)
Metal processing 20 (69%) 9 (31%)
Natal fabricating 27 (63%) 16 (37%)
Machine shop 28 (61%) 18 (39%)
Processor of metals 12 (55%) 10 (45%)
Sales/Service 6 (30%) 6 (50%)
Electrical 5 (42%) 7 (58%)
Plastics/Chemicals 7 (39%) 11 (61%)
Other 9 (56%) 7 (44%)
Total 128 (59%) 88 (41%)
SOURCE: The Smaller Manufacturer's Council of Pittsburgh's
* (SMC) 1982 Wage and Fringe Benefit Survey.
EXHIBIT 11-12
ELIGIBILITY FOR PENSION BENEFITS BY TYPE
OF WORKERS, SMC SURVEY, 1982
Number
Type of Worker of Firms Percent
Both Salaried and Hourly 98 77%
Salaried Only 9 7
Hourly Only 21 16
Total * 128 100%
SOURCE: The Smaller Manufacturer's Council of Pittsburgh's (SMC) 1982 Wage
and Fringe Benefit Survey.
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2. Health Benefits
Virtually all firms questioned in the SBANE and SMC surveys had some type
of health benefits for their employees. For example, 174 of the 175 firms
with less than 500 employees in the SBANE survey had, some form of health
insurance. Hence, little can be said from the regional surveys about how firm
size affects whether firms offer health benefits.
However, the SBANE and SMC surveys indicate that firm size does appear to
affect the type of health benefits offered. For example, Exhibit 11-13 shows
that 43 percent of the firms in the SMC Survey and 32 percent of small firms
in the SBANE Survey offered dental benefits and that the proportion of firms
offering dental benefits increases as firm size increases.
D. FINDINGS FROM ON-SITE CASE STUDIES AND TELEPHONE DISCUSSIONS
We interviewed 18 employers about the reasons they did or did not provide
pension and health benefits. Of the fifteen small firms interviewed by
telephone, eight currently had pension plans. All 15 of these firms had
health care plans. The three firms selected for on-site case studies had both
pension and health care coverage.
1. Reasons for Not Offering Pension Benefits
During the telephone interviews, small employers without pension coverage
were asked questions in four general areas relating to their decision not to
offer plan coverage to identify:
* reasons that they did not have a pension plan;
* factors that would be most important in the firm's decision to
provide pension benefits in the future;
* whether (and how) government regulation or paperwork involved
in setting-up and administering a plan affects the firm's
decision; and.
* whether the firm currently had plans to establish a pension or
profit sharing plan during the upcoming year.
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EXHIBIT 11-13
DISTRIBUTION OF DENTAL COVERAGE BY FIRM SIZE,
SBANE AND SMC SURVEYS (1982)
SOURCE: The Small Business Association of New England's (SBANE) 1982 Survey
of Fringe Benefits and the Smaller Manufacturer's Council of
Pittsburgh's (SMC) 1982 Wage and Fringe Benefit Survey.
The seven employers without plans cited several reasons
this benefit. The most frequently cited reason was that the
sufficiently profitable to justify establishment of a plan.
three of the interviewees responded in the following manner:
* "We're not profitable enough on a yearly basis";
* "Haven't been highly profitable during recent years"; and
* "Money has not been available for setting up a plan".
In addition to the lack of firm profitability, interviewees cited several
other reasons for not having a retirement plan, including:
* demographic characteristics of employees, e.g., one
interviewee indicated that the firm's employees were relatively
young and therefore preferred to receive higher income (through
increased salary) than employee benefits;
* complexity and costs of setting up a plan, as well as the need
to obtain expert advice;
SBANE
SMC
No
Dental
No Dental
Firm Size
Dental
Coverage
Coverage
Dental
Coverage
Coverage
1-4
1
(i4'~)
6
(86%)
1
( 7%)
14 (93%)
5-9
3
(25%)
9
(75%)
13
(35%)
17 (65%)
10-19
8
(21%)
30
(79%)
8
(24%)
25 (76%)
20-49
15
(32%)
32
(68%)
37
(45%)
45 (55%)
50-99
14
(40%)
21
(60%)
17
(45%)
21 (55%)
100-249
10
(39%)
16
(61%)
17
(68%)
8 (32%)
250-500
4
(67%)
2
(33%)
5
(83%)
1 (16%)
TOTAL
56
(32%)
119
(68%)
98
(43%)
131 (57%)
for not providing
firm was not
For example,
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* lack of interest on the part of the employees;
* existence of bonuses for employees which could be placed in an
IRA by the employee;
* complexity of laws governing pension plan formation and
administration, e.g., one employer stated that he found it
difficult to stay up with and understand regulations governing
pensions under ERISA and that he had some concern about overhead
costs involved in filling out forms to comply with ERISA; and
* general financial and economic conditions, e.g., one
interviewee indicated that under the current inflationary trends
that he preferred to give the employees cash now rather than
later.
One interviewee formerly had a plan, but decided to terminate it when
ERISA came into existence. The owner-operator cited several factors for
terminating the plan:
* The employer found that ERISA's plan trustee provisions were
too rigorous. He noted that under these provisions that he (and
the plan trustees) no longer wanted responsibility for plan
administration.
* The company attorney estimated that it would cost $2,500 to
change the plan to conform with ERISA requirements. He felt
that this was excessive.
* He did not see any real benefit to having the plan- -commenting
that employees were no more loyal or hardworking because of the
plan and generally took the plan for granted.
* He found that the cost of the plan was getting greater as the
salaries of employees increased.
The most important factor governing the future decisions of these firms
to establish a retirement plan was financial considerations--specifically,
firm profitability. Several firms indicated that "no factor" would influence
their decision to establish a plan--they were not interested in setting up a
plan. One interviewee indicated that he would only initiate a plan that
required mandatory contributions by both the employer and the employee, and
that yielded equal benefits across all types of employees.
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Interviewees were split over whether government regulation or paperwork
involved in setting up a plan affected their decision not to offer pension
benefits. Those that felt that regulations were a factor (four of seven
interviewees) pointed to the complexity of the laws and the added paperwork
involved in on-going administration. For example, one employer indicated that
government regulation did not directly affect his decision to offer benefits,
but that he did not "clearly understand the regulations" and that these
regulations would "more than likely delay future decisions" to establish a
plan. Another interviewee noted that the advent of ERISA had made laws
governing pensions complex and that he was less likely to establish a plan
because he did not want to pay someone in his company to complete required
paperwork when he was trying to cut back on overhead. None of the seven firms
indicated that they had plans in the upcoming year to establish a retirement
plan. -
2. Reasons for Offering Pension Benefits
Telephone discussions with eight employers with pension plans, on-site
case studies of three small employers and interviews with two plan consultants
provided evidence on why small firms decide to provide pension benefits. The
eight telephone interviewees cited a variety of reasons for initiating their
pension plan, including:
* firm profitability at the time of plan formation and the
desire to avoid corporate taxes on profits;
* a desire to remain competitive in the labor market;
* that the plan was the result of union negotiations;
* to provide for the future of employees and protect them at the
time of retirement; and
* to share firm profits with employees.
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Similar reasons for plan establishment were identified du;ing the three
on-site case studies and interviews with plan consultants. For example, one
firm cited four major reasons for plan establishment:
* to provide for the owner-operator and employees in case of
future company bankruptcy;
* because the owner-operator (aged 48) and most employees (in
their 30's) were approaching the age at which they felt it was
important to set aside funds for retirement;
* because the company had recently become sufficiently
profitable to set aside funds; and,
* because of tax advantages (i.e., avoidance of corporate and
personal taxation) associated with retirement plans.
A representative of an actuarial firm involved in the administration of
retirement plans for thirty small business firms felt that the overriding
reason for the establishment of a plan by the firms he dealt with was to avoid
taxation by sheltering income (particularly for the owner-operator). Other,
secondary reasons for plan formation, include~ concern over providing for
employees' retirement, the desire to provide for the owner-operator's
retirement, and a desire to reward long-service employees. A second actuary
supported these assertions--indicating that small firms set up plans when they
became sufficiently profitable that they were concerned about the implications
of taxation. This actuary noted that firms generally set up plans during the
final month of their fiscal year, when they knew the level of profitability.
While tax considerations were the central consideration in setting up most
plans, the actuary identified several other reasons--including concerns on the
part of the owner about personal retirement income and concern over the long
term welfare of the employees.
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3. Health Benefits
All firms interviewed by telephone (fifteen) and the three on-site case
study firms offered health benefits to their employees. Reasons that were
cited by employers for originally establishing a health care plan were similar
to those given for offering retirement benefits:
* to be competitive in the market place, both in terms of
recruiting and retaining personnel;
* to take care of the family needs of the employees, as well as
the owner-operator;
* because health coverage is a tax deductible expense; and
* in response to employee/union negotiations.
In general, the provision of health benefits by the firm was a benefit that
the employer expected to provide and the employees expected to receive. For
example, one employer commented, "it's the sort of thing you do for
employees"; another owner-operator felt that employees were entitled to this
benefit which had become "almost a required perk".
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III. CHARACTERISTICS OF SMALL
PENSION AND HEALTH PLANS
A. OVERVIEW
This section presents information about the characteristics of pension
and health care benefits in small firms. Using aggregate and regional data
analysis, as well as interviews with small employers and pension plan experts,
we examined the provisions of benefit plans.
In analyses of aggregate data, we found that small firms are more likely
to have defined contribution plans than defined benefit plans.~-~ We found
that firms with under 100 employees are significantly more likely to have
defined contribution plans. For example, 73 percent of the firms with fewer
than 25 employees and 67 percent of the firms with 25-99 employees had only
defined contribution plans--compared to just seven percent. of firms with 100
or more employees. We also found that small firms are most likely to have
profit sharing plans. As might be expected, small firms are substantially
less likely than firms over 100 employees to have more than one retirement
plan.
In our aggregate data analysis of the ICF Retirement Plan Provisions Data
Base, we also found:
~ Defined contribution plans guarantee no specific benefit at retirement,
but rather provide whatever a participant's allocated portion of
accumulated sponsor contributions will purchase. The size of the
sponsor's annual contribution may vary depending on factors such as the
participant's salary, plan type, and contribution formula and, in certain
plans, how much each participant contributes and/or company profits.
Defined benefit plans provide a prespecified benefit at retirement. The
plan sponsor must contribute a sufficient amount each year to make sure
that sufficient funds are available when each participant retires.
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Few firms under 100 employees sponsor ESOP or TRASOP plans.'-'
In addition, small firms are unlikely to offer thrift/savings
plans. However, they were much more likely than large firms to
offer money purchase defined contribution plans.
* The likelihood of integration of defined benefit plans
increases as firm size increases--while about half of the
defined benéf it plans in firms under 25 employees are
integrated, 72 percent of defined benefit plans in firms over
100 employees are integrated. This is found because many small
firms contribute to multiemployer plans which are not integrated
with Social Security.'
* Firms under 100 employees with defined benefit plans are less
likely to have early retirement benefits.
Analysis of the ICF Health Plan Data Base revealed that:
* Workers covered by small health plans are less likely to have
family coverage than workers covered by large plans.
* Small firms tend to have less generous types of benefits than
large firms--particularly in areas of dental coverage and
maternity benefits.
* Small firms are more likely to require employee contributions
than large firms.
* Firms with 26-100 employees are most likely to have
deductibles and co-insurance provisions.
`~ ESOP5 are Employee Stock Ownership Plans. These are a special type of
defined contribution plan in which, instead of cash deposits, the
employer transfers a portion of the ownership of the company to the
employees, i.e., gives the trust fund for employees stock in the
company. The Tax Reduction Act of 1975 provided a tax credit to
employers who provide ESOPs. Plans qualifying under this law are called
Tax Reduction Act Stock Ownership Plans or TRASOPs. See Internal Revenue
Code Section 415(c)(6).
An "integrated" pension plan is one that is linked with social security
-- that is, plan benefits are reduced to take into account the portion of
retirement income that pensioners receive from social security.
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From our analyses of regional data and interviews with small employers
and pension consultants who serve small businesses we found the following:'~
* Confirmation that small firms are more likely than large firms
to have only one pension plan and that the most common type of
plan found in small firms is a profit sharing plan. For
example, SBANE data indicate that 60 percent of the firms with
under 500 employees offer a profit sharing plan by itself or in
combination with another plan.
* Interviews with small employers and pension plan consultants
suggested that selection of a profit sharing plan is, in part,
due to their greater flexibility in making contributions to the
pension fund, as well as ease of start-up and on-going
administration.
* About three-quarters of the firms interviewed by SBANE had a
minimum age requirement and 93 percent had some type of service
requirement for employee plan participation. The most
frequently used combination of age/service requirements among
small firms is the ERISA maximum--25 years of age with one year
of service.
* The most frequent type of vesting provision found in firms
under 500 employees--occurring in 21 percent of the firms
interviewed by SBANE- -begins at one year of service and is
completed after 10 years of service. Fifty-five percent of the
SBANE firms had plans that provided full vesting at 10 years.
* Both SBANE and SMC data indicate that small firms are most
likely to offer Blue Cross/Blue Shield health coverage.
1J Telephone interviews were conducted with 15 small firms in the
Cleveland and Pittsburgh areas; on-site case studies were conducted with
3 small employers in the Cleveland area; and telephone interviews were
conducted with representatives of two major pension consulting firms in
the Washington area. The Small Business Association of New England
(SBANE) surveyed 176 small business firms in the Boston area in 1982 and
the Smaller Manufacturing Council (SMC) interviewed 242 small firms in
the Pittsburgh area. For more details on methodology employed in this
study see Chapter I (Methodology) and Appendices A-D.
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* Health Maintenance Organization (HMO) coverage *is provided in
10 percent of the SBANE firms and 15 percent of the SMC firms.
Only a small percentage of firms use self-insurance.
* About 85 percent of the SBANE firms had some form of
deductible--usually $100. About 80 percent of the SBANE firms
had co-insurance--under most plans the insurance paid 80 percent
* of medical expenses and the employee paid the remaining 20
percent.
B. PENSION BENEFITS
1. Findings from National Aggregate Data Analysis
We analyzed the ICF Retirement Plan Provisions Data Base to ex.mine the
differences in the types of retirement plans between small firms and large
firms. The ICP Retirement Plan Provisions Data Base contains data on the
characteristics of a representative sample of retirement plans. It is
stratified by industry, firm size, and multi/single employer status. It
provides plan provision data for both the primary and supplemental defined
benefit and defined contribution plans offered by public and private sector
sponsors. For each of these sponsors, ICF obtained Summary Plan Description
(SPD) data on their retirement plans. The data base includes all relevant
plan provisions for participation, vesting, hours crediting, retirement,
death, disability, joint and survivors benefits and social security
integration.
Our examination of these data, as shown in Exhibit Ill-i, indicates that:
* First, small firms are more likely to have defined
contribution plans than defined benefit plans. Approximately,
70 percent of workers in small firms are covered by defined
contribution plans. In larger firms, approximately 60 percent
of workers are covered by defined contribution plans--although
most of the defined contribution plans in large firms are
supplemental to defined benefit plans. This preference by small
firms for defined contribution plans is due, in part, to their
desire to control the costs of the plan.
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EXHIBIT Ill-i
THE PERCENTAGE OF WORKERS COVERED BY DIFFERENT
TYPES OF PENSION PLANS, BY FIRM SIZE, 1982
Firm Size
________________ Less than 25 25-99 ___________
73% 67%
25 32
2 1
* Small firms are likely to have only one plan. In contrast, 54
percent of employees in large firms work for employers with both
a defined benefit and a defined contribution plan.
* The very smallest firms (1-24 employees) are more likely to
have defined contribution plans than firms with 25-99 employees.
Exhibit 111-2 provides data on the types of defined contribution plans
sponsored by small firms. It shows that of firms with some type of defined
contribution plan, small firms are most likely to have profit sharing plans.
This is in sharp contrast to the defined contribution plans of larger firms,
which are predominantly savings plans. This reflects the fact that most of
the defined contribution plans for large firms are supplemental plans, while
for small firms the defined contribution plans are the primary plan. It also
reflects the desire of small employers to have plans with controllable costs.
Profit sharing plans are especially appropriate because they allow an employer
to have low payments (or none at all) in years of low profitability and higher
contributions in years of greater profitability. Exhibit 111-2 also shows
that few small firms sponsor ESOPs or TRASOPs. Finally, it shows that about
263
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Type of Coverage
Defined Contribution Only
Defined Benefit Only
Both Defined Benefit and
Defined Contribution
100 Or More
7%.
38
54
TOTAL 100% 100% 100%
SOURCE: ICF Retirement Plan Provisions Data Base.
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EXHIBIT 111-2
PERCENTAGE DISTRIBUTION OF WORKERS IN DEFINED
CONTRIBUTION PLANS, BY TYPE OF DEFINED
CONTRIBUTION PLAN AND FIRM SIZE, 1982
Type of Defined Firm Size
Contribution Plan Less than 25 25-99 100 Or More
Profit Sharing 65% 56% 27%
Thrift/Savings 5 3 47
Profit Sharing/Savings 3 3 8
Money Purchase 26 38 2
ESOP/TRASOP _i~
TOTAL 100% 100% 100%
a! Less than 0.5 percent.
SOURCE: ICF Retirement Plan Provisions Data Base.
one-quarter of workers in the smallest firms have money purchase plans, while
38 percent of workers in firms with 25-99 employees are covered by money
purchase plans.1~
Exhibit 111-3 examines how defined benefit plans are integrated with
social security benefits. It shows that, surprisingly, the likelihood of
integration increases as plan size increases. This is found because many of
the small firms contribute to multiemployer plans- -the vast majority of which
~ A moneij~i~chase plan is an arrangement for allocating pension funds to
individual participants under defined contribution plans. Under a money
purchase plan, contributions are allocated through the maintenance of
individual employee accounts. Generally, contributions are expressed as
a percentage of covered payroll.
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EXHIBIT 111-3
PERCENTAGE DISTRIBUTION OF WORKERS IN DEFINED
BENEFIT PLANS, BY TYPE OF INTEGRATION
PROVISIONS AND FIRM SIZE, 1982
Firm Size
Less than 25 25-99 100 Or More
Not Integrated 51% 47% 28%
Integrated
Offset" 28 25 45
"Step-Up" 21 28 27
Subtotal 49 53 72
TOTAL 100% 100% 100%
SOURCE: ICF Retirement Plan Provisions Data Base.
are not integrated with social security. If we look only at single employer
plans, small firms are more likely to have integrated defined benefit plans
than large firms. This exhibit also shows that large, integrated plans are
more likely to be "offset" plans than "step-up" plans, while small plans are
almost equally split between these two methods of integration.1~
Exhibit 111-4 examines the types of plan formulas used in the defined
benefit plans. It shows that the plans of small employers are more likely to
be unit benefit plans than the plans of large employers.2~ This surprising.
U "Offset" and "step-up" represent two different methods for integrating
pension benefits with social security benefits. Under the "offset"
approach, an employees's benefit is reduced or offset by a stated
percentage of such employee's old-age insurance benefit under the Social
Security Act. Under the "step-up" approach theformula used to calculate
the pension benefits increases (or "steps-up") when a certain level of
income is reached.
2J Unit benefit plans provide a specific dollar benefit for each year of
service. Thus, the benefit is independent of pay but is a function of
service. For example, a plan may pay $200 annual benefit for each year
of service. In this case a retiree who has 30 years of service at
retirement would receive a benefit of $6,000 per year ($200 times 30
years).
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EXHIBIT 111-4
DISTRIBUTION OF WORKERS IN DEFINED BENEFIT PLANS,
BY TYPE OF BENEFiT FORMULA AND FIRM SIZE, 1982
Firm Size
Benefit Formula Less than 25 25-99 100 Or More
Salary Related 53% 55% 79%
Flat Dollar 3 a/ 1
Unit 44 45 20
TOTAL 100% 100% 100%
a! Less than 0.5 percent.
SOURCE: ICF Retirement Plan Provisions Data Base.
finding is explained by the fact that many small employers contribute to
multiemployer plans, which are overwhelmingly unit benefit plans. If we
examine only single employer plans, the vast majority of small plans are
salary-related plans. The exhibit also shows that few workers are covered by
flat benefit formulas.
Our analysis of defined benefit plans reveals that less than five percent
of the plans of small employers either require or allow employee
contributions. Exhibit 111-5 shows that the situation is quite different for
defined contribution plans. In small, defined contribution plans,
approximately 40-50 percent of workers are covered by plans which either
require or allow contributions. The situation is quite different for large
defined contribution plans, primarily because these plans are more likely to
be supplementary plans.
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EXHIBIT 111-5
DISTRIBUTION OF WORKERS IN DEFINED CONTRIBUTION
PLANS BY EMPLOYEE CONTRIBUTIONS AND FIRM SIZE, 1982
Firm Size
Employee Contributions Less than 25 25-99 100 Or More
None 50% 38% 10%
Required 6 9
Not Required, But No 5 12 69
Employer If No Employee
Optional 40 41 21
TOTAL 100% 100% 100%
a/ Less than 0.5 percent.
SOURCE: ICF Retirement Plan Provisions Data Base.
Exhibits 111-6 and 111-7 present the vesting provisions in defined
benefit and defined contribution plans respectively. These exhibits show that:
* About 70 percent of workers in small, defined benefit plans
are covered by plans with 10-year "cliff" vesting. U A higher
percentage (77 percent) of workers in large, defined benefit
plans are covered by 10 year "cliff" vesting provisions.
* The high percentage of small firms with ten year cliff vesting
is due to the fact that many small firms contribute to
multiemployer plans which use this type of vesting.
* Vesting provisions in defined contribution plans are more
generous than in defined benefit plans. In other words, defined
contribution plans generally provide for a higher vesting
percentage for any given number of years of service.
Participants become partially or fully vested sooner in defined
contribution plans than in defined benefit plans.
U Cliff vesting means there is a "cliff" in the graph of the percent
vested versus years of service. 10-year cliff vesting provides no
vesting prior to 10 years and 100 percent vesting thereafter. There is a
cliff at 10 years.
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EXHIBIT 111-6
DISTRIBUTION OF WORKERS IN DEFINED BENEFIT PLANS,
BY VESTING PROVISIONS AND FIRM SIZE, 1982
Vesting Type/Years Required Firm Size
To Fully Vest Less than 25 25-99 100 Or More
"Cliff" Vesting
1-4 Years 7% 4%
5-9 Years 5% 2% 4%
10 Years 70% 67% 77%
Graded Vesting .
10 Or Less 14% 20% 13%
More Than 10 3% 6% 6%
Total 100% 100% 100%
a/ Less than 0.5%.
SOURCE: ICF Retirement Plan Provisions Data Base.
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EXHIBIT Ill-i
DISTRIBUTION OF WORKERS IN DEFINED CONTRIBUTION
PLANS, BY VESTING PROVISIONS AND FIRM SIZE, 1982
Vesting Type/Years Required Firm Size
To Fully Vest Less than 25 25-99 100 Or More
"Cliff" Vesting
Immediate a/ a! 32%
1-9 Years 11% 10% 18%
10 Years 4% 6% a/
Graded Vesting
Less Than 10 17% 15% 20%
10 Years 35% 36% 4%
More Than 10 Years 33% 32% 10%
Other a/ a!. 17%
Total 100% 100% 100%
a! Less than 0.5%.
SOURCE: ICF Retirement Plan Provisions Data Base.
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The vesting provisions of small, defined contribution plans
are significantly less generous than those of larger, defined
contribution plans. This is primarily because the defined
contribution plans of large firms are more likely to be
supplemental plans, such as thrift or savings plans, which
typically have fast vesting.
We also used the ICF Retirement Plan Provisions Data Base to examine the
early retirement provisions of defined benefit plans. We found that
approximately 85-90 percent of workers in small firms with defined benefit
plans are covered by plans with early retirement provisions. In contrast,
almost 100 percent of large firms with defined benefit plans have early
retirement provisions.
2. Findings from Regional Surveys
The SBANE survey provides considerable detail on the characteristics of
pension plans in small firms and confirms the findings of the aggregate data
analysis in the previous section. Exhibit 111-8 shows that small firms were
most likely to have only one plan. It also shows that small firms are most
likely to have a profit sharing plan. Seventy-eight percent of the small
firms surveyed by SBANE had one plan; 22 percent had more than one plan.
Similar to the findings from our aggregate analysis, the most common type of
plan was a profit sharing plan--in 41 percent of the firms (and 52 percent of
firms with only one plan). Overall, nearly 60 percent of the firms offered a
* profit sharing plan by itself or in combination with another type of plan. A
single defined benefit plans was offered in 26 percent of the SBANE firms.
Other types of defined contribution plans were found in nine percent of the
firms; and just three percent of the small firms offered a thrift plan by
itself. None of the firms in this survey reported having stock bonus or
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EXHIBIT 111-8
TYPE OF PENSION PLAN,
SBANE SURVEY, 1982
Percentage
~ype oL~4~ Number of Firms of Firm~
Firms with One Plan 73 78%
Defined Contribution 49 52%
Profit Sharing 38 41%
Thrift Plan 3 3%
Other Defined Contribution 8 9%
Defined Benefit 24 26%
Firms with Hore Than One Plan 20 22%
Defined Benefit and Profit Sharing 8 9%
Defined Benefit and Other Defined 4 4%
Contribution
Two Defined Contribution 8 9%
Total 93 100%
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of
Fringe Benefits.
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target benefit plans. The most common combination of plans was a profit
sharing plan with either a defined benefit plan (nine percent of the firms) or
another defined contribution plan (nine percent of the plan firms).
Exhibit 111-9 shows that among the SBANE survey firms, firm size had
little impact on the typo of plan. One possible explanation for the lack of a
relationship between firm size and type of plan is that the sample of firms is
not representative and is small.
Exhibit 111-10 displays the various combinations of age and service
requirements used by firms within the SBANE survey. Looking first at minimum
age requirements (i.e., across the rows of the table), 73 percent of the firms
had an age requirement for participation. The most frequent type of age
requirement--occurring in 55 percent of the firms--was that employees be 25
years of age. Analyzing minimum service requirements (i.e., down the
columns), shows that 93 percent of the firms had some type of service
requirement. Most frequently--in two-thirds of the firms--this requirement
took the form of a one-year minimum service requirement. One year of service
was frequently defined by 1,000 hours of work for the firm. Finally, an
examination of the age and service requirements together reveals that just six
percent of the firms had neither an age nor service requirement. The most
frequently used combination of age/service requirements was the ERISA
maximum--that the employee be 25 years of age with one year of service.
Exhibit 111-11 provides evidence on the vesting provisions among firms in
the SBANE survey with pension plans. Looking at evidence on the start of
vesting (across the rows of the table), about 40 percent of plans had vesting
which either started immediately or after one year of service. About 90
percent of the firms started vesting after four years or less. Examining
evidence on the completion of vesting (looking down the columns), 55 percent
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EXHIBIT 111-9
DISTRIBUTION OF PENSION PLANS BY
FIRM SIZE, SBANE SURVEY, 1982 a!
Defined Defined Profit Thrift
Firm Size Benefit Contribution Sharing Plan Total
1-4 1 (50%) 0 1 (50%) 0 2 (100%)
5-9 1 (25%) 1 (25%) 2 (50%) 0 4 (100%)
10-19 7 (37%) 3 (16%) 9 (47%) 0 19 (100%)
20-49 7 (24%) 4 (14%) 16 (55%) 2 ( 7%) 29 (100%)
50-99 7 (25%) 4 (14%) 15 (54%) 2 ( 7%) 28 (100%)
100-249 9 (41%) 4 (18%) 8 (36%) 1 C 5%) 22 (100%)
250-499 4 (57%) 0 C 0%) 2 (29%) 1 (14%) 7 (100%)
36 (32%) 16 (14%) 53 (48%) 6 C 5%) 111 (100%)
a/ Information was not available for seven firms.
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of
Fringe Benefits.
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EXHIBIT 111-10
DISTRIBUTION OF PARTICIPATION
REQUIREMENTS, SBANE SURVEY, 1982 a!
Service Requirement (Years)
No Total
Age Requirement Requirement «=l 1 2 3 Firms %
No Requirement 5 5 10 1 3 24 27%
Agel8 0 0 3 0 0 3 3%
Age 21 0 2 5 1. 0 8 9%
Age23 0 0 3 0 0 3 3%
Age24 0 0 2 0 0 2 2%
Age 25 1 8 37 3 0 49 55%
Total Firms 6 15 59 5 3 89 N/A
Percent 7% 17% 67% 6% 3% N/A 100%
a/ Nine firms with pension plans did not indicate whether they did or did
not have age or service requirements.
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of
Fringe Benefits.
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EXHIBIT Ill-li
TYPES OF VESTING SCHEDULES, SBANE SURVEY, 1982 ~/
Comp let ion (j~~__
Number of
Start of Vesting Immediately 1-Li 5 6-9 10 11-111 15 Firms Percent
ImmediatelY 3 0 0 0 5 1 0 9 11%
1 Year -- 1 5 0 17 - 1 0 214 30%
2 Years -- 0 0 3 3 1 0 7 9%
3 Years -- 1 1 14 6 0 0 13 16%
ti Years -- 1 0 1 8 8 0 18 23%
5Years -- -- 1 0 3 0 3 7 9%
10 Years ~ Q 2
Total 3 3 7 8 Lili 11 Ii 80 N/A
Percent 14% 14% 9% 10% 55% 114% 5% N/A 100%
a/Information not available for 18 firms that had plans.
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of Fringe Benefits.
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of the firms had plans that provided full vesting at 10 years--although few had
10 year cliff vesting, the most common vesting provision among large plans.
Looking at the start and completion of vesting together, the most frequent
vesting provision among the SBANE firms--occurring in 21 percent of the firms--
began at one year of service and was completed after 10 years of service.
The SBANE survey also examined several other characteristics of pension
plans in small firms, including: Social Security integration; loan/withdrawal
provisions; and the method of benefit payment. As Exhibit 111-12 shows,
one-third of the firms in the SBANE pension survey had plans which were
integrated with Social Security. Other analyses of the SBANE data indicated
that firms under 100 employees in the SBANE survey were no more likely to
integrate benefits than firms with over 100 employees.
EXHIBIT 111-12
SOCIAL SECURITY INTEGRATION, LOAN/WITHDRAWAL,
AND PAYMENT OF BENEFITS, SBANE SURVEY, 1982
Number of Percentage of
Plan Characteristics Firms Firms
A. Socia~ Security Integration a!
Yes 29 33%
No 59 67%
B. Loan/Withdrawal Provision b/
Yes 27 32%
No 57 68%
C. Payment of Benefits c/
From Fund 55 64%
Purchase of Annuities 9 10%
Both 17 20%
Other 5 6%
a/ Information not available for 10 firms.
b/ Information not available for 14 firms.
Cl Information not available for 12 firms.
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of
Fringe Benefits.
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About one-third of the plans (32 percent) in the SBANE survey had
loan/withdrawal provisions.
The SBANE data also indicate that most firms within the SBANE survey made
payment of plan benefits to participants directly from the pension fund (64
percent of the firms). Twenty percent of these firms provided benefits both
directly from the fund and through the purchase of annuities. Examination of
the type of payment mechanism by plan type did not result in any significant
differences across plan types.
Exhibit 111-13 presents the types of investments made with plan assets.
Over half (52 percent) of the firms invested plan assets in two or more of the
types of investments listed in Exhibit 111-13. The three most frequent forms
of investments were: cash accounts (34 percent of firms); common stocks (31
percent) and bonds (31 percent).
3. Findings from On-Site Case Studies and Telephone Interviews
A major objective of the on-site case studies and telephone interviews
was to examine closely the nature of plans and reasons for establishment of
particular types of plans. Exhibit C-l, in Appendix C, details
characteristics of pension plans for eight firms that were part of the
telephone interviews. Exhibits A-l, A-2, A-3 in Appendix A, detail
characteristics of plans in the three on-site case studies.
Four of the eleven firms had two pension plans. Similar to the SBANE
survey findings, profit sharing plans were the most frequent type of plan-7
of 11 firms (63 percent) of the firms bad this type of plan. Interviewees
gave several reasons for selecting profit sharing plans. One major reason
given was that a profit sharing plan involved the least amount of reporting
and on-going administration of the major types of plans. For example:
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EXHtB~T 111-13
TYPES OF PLAN INVESTMENTS,
SBANE SURVEY, 1982 a!
Number of Percent of
Types of Investments Firms Firms
Life Insurance Contracts 14 17%
Insurance Company Investments 20 24%
Common Stocks 26 31%
Bonds 26 31%
Cash Accounts 34 40%
Real Estate 5 6%
Market Funds 19 23%
Other 23 27%
a! Information not available for 14 firms; percentages are based on 84
firms.
SOURCE: Small Business Association of New Englandts (SBANE) 1982 Survey of
Fringe Benefits.
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* One interviewee felt that in terms of administration and
reporting a profit sharing plan was the "least of evils".
* A second interviewee commented that a profit sharing plan
allowed his firm tn avoid the restrictions and reporting
requirements of ERISA to the greatest extent possible.
* A third interviewee stated that he formerly had two plans--a
defined benefit plan and a profit sharing plan--but dropped the
former plan when ERISA went into effect because of the cost of
meeting ERISA's requirements. He retained the profit sharing
plan because the costs of meeting ERISA's requirements for
defined contribution plans were substantially lower than for
defined benefit plans.
A second major set of reasons for adopting a profit sharing plan is that
this type of plan provides the greatest flexibility in terms of making
contributions to the pension fund. Several owner-operators stated that under
a profit sharing plan, they made a determination of the level of the
contribution (at the end of the year) based on the firm's profitability. If
the firm did not have a profitable year, then the owner-operator did not have
to make a contribution. For example, one owner-operator stated that he
selected a profit sharing plan over other types of plans so that he could
avoid "getting trapped" into bankruptcy by the plan during bad years.
A final reason given for the selection of a profit sharing plan was that
it was the best type of plan for the employees- -permitting the firm to easily
distribute profits during peak years to employees.
The next most common type of plan was a defined benefit plan--selected by
five of the eleven firms. Firms that chose this type of plan gave several
reasons, including:
* One interviewee felt that this type of plan was the least
"risky" from the employees point of view.
* A second interviewee stated that the defined benefit plan was
a result of union negotiations. The union felt that the
employees would benefit from knowing exactly what they would
receive at the time of retirement.
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A third owner-operator said that a financial planning study
had recommended the formation of a defined benefit plan. This
type of plan provided a more substantial benefit to the older,
more highly compensated owner-operator than other types of plans.
Finally, two firms interviewed selected a money purchase plan. A major
reason given by one firm for the selection of a defined contribution plan was
that this type of plan seemed to work to the advantage of young, salaried
employees (which was the majority of employees at the time of plan formation).
Just two of the fifteen plans represented were part of multiemployer
arrangements; the other plans were single employer plans. The two
multiemployer plans resulted from union negotiations. One firm made monthly
contributions on a "cents per hour basis" to various union plans, including
retirement plans for Operating Engineers, Iron Workers, Teamsters, and
Millwrights.
Plans used three major types of eligibility requirements: employee type
requirements, minimum age requirements, and minimum service requirements.
Firms with one pension plan--7 of 11 firms--allowed all employees to
participate in the plan (with the exception of one firm, which permitted all
employees to participate except commissioned sälespersons). Those firms with
two plans--the remaining four firms--had one plan for salaried and/or
non-union employees and a separate plan for hourly and/or union workers.
Most of the firms interviewed had age and service requirements. Seven of
thirteen plans (54 percent) had both age and servica requirements. Four plans
(31 percent) had only a service requirement. No plans had a minimum age
requirement by itself. Two plans had no minimum age or service requirement.
Similar to the SBANE survey findings, the most common minimum age requirement
was 25 years of age; the most common service requirement was one year of
employment (usually defined by the 1,000 hours rule).
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Most of the plans provided full vesting after ten years of service. Nine
of thirteen plans (69 percent) fully vested employees at ten years (i.e., 100
percent vesting after 10 years); three other plans had 100 percent vesting
after 15 years and one plan had a graded vesting which provided full vesting
after eight years of service. There was considerable variety in the starting
period for vesting, including: 10 percent after one year, 12.5 percent after
one year, 20 percent after two years, 25 percent after five years; 33 percent
after five years, and 50 percent after five years.
Few of the interviewees knew if their plans were integrated with social
security--just three interviewees responded affirmatively to this question.
None of the firms interviewed had supplemental plans, such as ESOPs,
TRASOPs, savings or thrift plans, or 40lK5.'~ Most were unaware of the
availability of these supplemental plans.
Most of the defined benefit plans had provisions for early retirement.
Some had both an age and service requirement for early retirement (e.g., 60
years of age and 15 years of service, 55 years of age and 15 years of service)
and others had only an age requirement (e.g., 62 years of age).
Five of twelve plans (41 percent) had participant loan/withdrawal
provisions. Most firms paid benefits directly from the pension fund (eight of
nine plans for which information was available); three plans had an option of
1J Section 401(K) of the Internal Revenue Code provides for a qualified
cash or deferred arrangement in a profit sharing or stock bonus plan
under which: (1) a covered employee may elect to have the employer make
payments as contributions to a trust under the plan on behalf of the
employee or to the employee directly in cash; (2) amounts held by the
trust may not be distributed to participants or other beneficiaries
earlier than upon retirement, death, disability, separation from service,
hardship, or the attainment of age 59-1/2, and (3) an employee's right to
his accrued benefit derived from employer contributions made to the trust
are nonforfeitable.
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payment directly from the fund or through the purchase of annuities. Finally,
similar to SBANE findings, most of the firms interviewed invested funds in
stocks, bonds and cash accounts.
C. HEALTH BENEFITS
1. Findings from National Aggregate Data Analysis
Limited data are available on the specific provisions of small health
plans. We used the ICF Health Plan Data Base to analyze the characteristics
of health benefit plans. This data base is a representative sample of over
2,100 employer sponsored health plans. It is composed of data provided in
both the 1977/1978 Battelle Survey of Employers and the 1977 BLS Survey of
Health Plans. The Battelle data on employers with less than 26 employees were
included in the ICF data file because they are the most recent publicly
available data on health coverage for small employers~ However, because the
Battelle data have an unacceptably low rate of respOnse among larger
employers, ICF obtained data on larger employer-sponsored health plans from
the 1977 Bureau of Labor Statistics Health Plan Survey. This BLS survey
provides data on a representative group of plans with 25 or more
participants. These merged data from the Battelle and BLS surveys, called the
ICF Health Plan Data Base, contain the most extensive and recent data publicly
available which is representative of all employer health plans.
We first examined differences in the types of health coverage offered by
small and large firms. As shown in Exhibit 111-14, workers covered by health
plans in small firms are less likely to have family coverage than workers in
larger firms. The lower rates of family coverage may be due to the fact that
fewer of these workers are married or have families. However, one reason for
the lower rates of family coverage is that individual coverage is less
expensive than family coverage.
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EXHIBIT 111-14
DISTRIBUTION OF WORKERS BY TYPE OF
HEALTH PLAN COVERAGE AND FIRM SIZE, 1982
Firm Size
1-25 26-100 101 Or More
Family Coverage 53~ 6O~ 62%
Individual Coverage 47 40 38
TOTAL lOO~, 100% 100%
SOURCE: ICF Health Plan Data Base.
Exhibit 111-15 shows that small plans are more likely to require employee
contributions than large plans, although the plans of firms with 1-25
employees are less likely to require employee contributions than the plans of
employers with 26-100 employees. Again, it is lik~ly that the small health
plans require contributions as a way to reduce the costs of the health plan.
In recent years, an increasing number of firms have instituted employee
contribution requirements as a method of controlling the costs of health plans.
EXHIBIT 111-15
PREVALENCE OF CONTRIBUTORY HEALTH PLANS,
BY FIRM SIZE, 1982
Firm Size
1-25 26-100 101 Or More
Percentage of Workers
in Plans Which Require
Contributions for:
Family Coverage 55% 70% 40%
Individual Coverage 30% 25% 24%
SOURCE: ICF Health Plan Data Base.
40-046 0 - 85 - 19
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We also used the ICF Health Plan Data Base to examine the types of
benefits offered by the health plans of small firms. Exhibit 111-16 shows
that, in general, small firms have less generous coverage than large firms.
This is most striking in the areas of dental insurance and maternity benefits.
EXHIBIT 111-16
-~ PERCENT OF WORKERS WITH COVERAGE FOR
DIFFERENT TYPES OF BENEFITS, BY FIRM SIZE, 1982
Firm Size
Type of Benefits 1-25 26-100 101 Or More
Hospital/Surgical 100% 100% 100%
Major Medical 88% 93% 90%
Dental 15% 13% 50%
Outpatient Drug 89% 90% 95%
Maternity 77% 74% 94%
Outpatient Mental Health 76% 84% 88%
SOURCE: ICF Health Plan Data Base.
We also used the ICF Health Plan Data Base to examine the extent of
cost-sharing through deductibles and coinsurance provisions. Exhibit 111-17
shows that medium size firms (26-100 employees) are most likely to have
deductibles and coinsurance provisions. About 85 percent of workers in both
the smallest and largest size firms have deductibles. Although almost 80
percent of small plans have coinsurance provisions, small plans are the least
likely to have these provisions.
EXHIBIT 111-17
PERCENTAGE OF WORKERS COVERED BY PLANS WITH
DEDUCTIBLES AND COINSURANCE, BY FIRM SIZE, 1982
Firm Size
1-25 26-100 101 Or More
Deductible 85% 92% 84%
Coinsurance 78% 91% 85%
SOURCE: ICF Health Plan Data Base.
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2. Findings from Regional Surveys
Both the SBANE and SMC Surveys asked questions about the characteristics
of the health benefits of small firms. Exhibit 111-18 shows that small firms
were most likely to use Blue Cross/Blue Shield Insurance as an insurance
carrier. However, there was considerable disparity between the SBANE and SMC
results--half of the SBANE firms interviewed used Blue Cross/Blue Shield,
while 80 percent of the small firms in the SMC sample offered this type of
coverage. Slightly less than half of the SBANE firms (46 percent) offered
coverage sponsored by a different insurance company than Blue Cross/Blue
Shield; compared to 18 percent of the firms in the SMC survey. Health
Maintenance Organization (HMO) coverage was provided in 10 percent of the
SBANE firms and 15 percent of the SMC firms; only a small percentage of firms
used self-insurance.
Exhibit 111-19 shows that 14 percent of the firms in t~ie SBANE survey
provided two types of health plans to their employees. SBANE firms that had
only one plan were as likely to have other insurance company sponsored plans
as they were to have Blue Cross/Blue Shield. About two-thirds of the plan
combinations involved an HMO option with another insurance sponsored
plan--overall 10 percent of the firms offered health insurance with the option
of HMO coverage. A distribution of type of health insurance coverage by firm
size revealed no discernible pattern among firms with less than 500
employees. It appears, as expected, that firms under 50 employees were less
likely to offer 1*10 or self-insurance than firms over 50 employees.
Two possible mechanisms for controlling health care costs are higher
deductibles and co-insurance. Deductibles are an initial amount usually paid
by the individual before the insurance begins to pay for medical expenses.
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EXHIBIT 111-18
TYPE OF INSURANCE, SBANE
AND SMC SURVEYS, 1982
SBANE
Percent of
All Firms
Type of Carrier ________ Using Plan
Blue Cross/Blue Shield (50%)
Other Insurance Co. (46%)
Self-Insurance ( 7%)
Health Maintenance (10%)
Organization (HMO)
Total Plans 204 --
Total Firms 174 --
SOURCE: Small Business Association of New England's
Fringe Benefits.
Number
of Plans
88
80
18
18
SMC
Percent of
Number All Firms
of Plans Using Plan
151 (80%)
35 (18%)
3 (2%)
28 (15%)
217 --
190 --
(SBANE) 1982 Survey of
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EXHIBIT 111-19
TYPES OF PLAN COMBINATIONS
BY CARRIER, SBANE DATA
Number Percent
Firms with One Plan
Blue Cross/Blue Shield 68 39%
Other Insurance Company 68 39%
Self Insured 12 7%
1*10 1 1%
Subtotal 149 86%
Firms with Two Plans
BC/BS and 1*10 12 7%
BC/BS and Insurance Company 8 5%
Other Insurance and HMO 4 * 2%
Self Insurance and HMO 1 1%
Subtotal 25 14%
Total Firms 174 100%
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of
Fringe Benefits.
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Co-insurance is a feature by which the insurance company and the individual
share the cost of medical expenses incurred during a given year. Exhibit
111-20 shows that 85 percent of the firms had a deductible and about
two-thirds of the firms (64 percent) had a deductible of $100. Fifteen
percent of the sample had no deductible, while just five percent of these
firms had deductible of over $100. Fifty-three percent of the firms applied
the deductible to all medical bills, while 47 percent applied the deductible
to out-of-hospital charges only.
Exhibit 111-20 also shows that about 80 percent of the firms surveyed by
SBANE had some form of co-insurance. Seventy-eight percent of the firms had
plans in which the insurance paid 80 percent of medical expenses after the
deductible and the employee paid the remaining 20 percent. In about one-fifth
of the firms, the insurance paid 100 percent of the expenses after the
deductible.
Finally, Exhibit 111-21 shows that a very high proportion (96 percent) of
the firms in the SMC survey covered the employee's dependents for both
hospitalization and surgery, and major medical expense.
3. Findings from On-Site Case Studies and Interviews
Telephone discussions with fifteen small firms and on-site case studies
of three firms provided further information on the characteristics of health
plans in small firms. Exhibit C-2, in Appendix C, summarizes key factors of
plans in the firms interviewed by telephone.
We found patterns of coverage similar to those found in the SBANE
Survey. For example:
* About half of the firms offered two or more health plans to
their employees.
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EXHiBIT 111-20
TYPES OF DEDUCTIBLE AND CO-iNSURANCE
PROVISIONS, SBANE SURVEY (1982)
# of Firms % of Firms
Amount of Deductible a!
No Deductible 25 15%
$25 10 6%
$50 16 10%
$100 101 64%
$150 1 1%
$200 2 1%
Greater than $200 4 3%
TOTAL 159 100%
Deductible Applies to: b/
All Medical Bills 66 53%
Out of Hospital Expenses Only 58
TOTAL . 124 100%
Coinsurance (Percentage Paid by
Insurance After Deductible) c/
100% 29 21%
90% 2 1%
80% 110 78%
TOTAL 141 100%
a! Information was not available for 15 firms.
b/ Information was not available for 50 firms.
cf Information was not available for 33 firms.
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of
Fringe Benefits.
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EXHIBIT 111-21
COVERAGE OF EMPLOYEE'S DEPENDENTS,
SMC SURVEY (1982)
Dependents
Type of Plan Coverage Covered Not Covered Total
Hospitalization and Surgery - 218 (96~) 8 (4%) 226
Major Medical 212 (96%) 9 (4%) 221
SOURCE: The Smaller Manufacturer's Council of Pittsburgh's (SMC) 1982 Wage
and Fringe Benefit Survey.
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* Two of the seven firms with multiple plans offered separate
plans to their hourly, union employees. The other five firms
with multiple plans offered their employees a choice--between an
insurance carrier (e.g., Blue Cross/Blue Shield or other
insurance company) or HealthMaintenance Organization (HMO)
coverage.
* As firm size increased (among the fifteen firms interviewed),
they were more likely to offer an optional hea~lth
plan--generally HMO coverage.
* About half of the firms interviewed (eight or fifteen) offered
Blue Cross/Blue Shield coverage; seven offered other types of
insurance company coverage; six offered HMO coverage; and two
firms were self-insured.
The general reason that firms gave for selecting a particular plan wa~
price--e.g., management felt that the insurer offered the set of benefits
desired for the lowest cost. Many of the firms interviewed indicated that
they had recently either changed carriers or reduced the level of coverage
(i.e., from high-option coverage to regular coverage). Most of these changes
in coverage resulted from a need to hold down health care costs. Other
reasons given for the selection of particular types of plans included: ease
of setting up the plan; convenience in on-going administration and claims
reimbursement; desire to cover a particular contingency, such as catastrophic
illness; government requirements for provision of optional health care plans
(HMOs); and union negotiations and employee input.
Two firms were self-insured, under which the firm paid directly for
medical bills of employees and paid monthly insurance premiums to cover
employee claims in excess of a set amount (e.g., above $10,000). The reasons
given for the establishment of a self-insured plan included: cost control and
savings; flexibility in writing the plans; and ease of administration.
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All interviewed firms offered major medical coverage and most (80
percent) offered coverage for physician services. Except for two firms that
covered specific types of employees by particular plans, firms made their
plans open to all employees that met certain minimum service requirements.
Only one of the fifteen firms had no minimum service or hours requirement.
Most firms had a minimum service requirement of 60 to 90 days, with the
longest period being 6 months. About half of the firms also had a minimum
hours requirement--generally requiring that an employee either work half-time
(20 hours/week) or full-time (40 hours/week). Finally, most firms (80
percent) had some form of deductible, which firms used to hold down the cost
of claims. The usual deductible was $100 per year for individuals and $200
per year for families.
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IV. ADMINISTRATION AND COSTS OF SMALL
PENSION AND HEALTH PLANS
A. OVERVIEW
This section presents information on the administrative practices and
costs of pension and health benefits in small firms. We present analyses
based on aggregate and regional data as well as findings from interviews with
small employers. In addition, this section focuses on some of the problems
faced by small employers with government regulations.
In analyses of aggregate data, we found that per dapita pension Costs are
substantially higher for small establishments than large establishments. For
example, per capita costs decline from $1,080 for establishments with 1-10
workers to $574 for establishments with 500-999 workers. In addition, per
capita pension administration costs, which are highest for very small firms
(1-10 employees), decrease as firm size increases. Other findings that
emerged from our analyses of national, aggregate data on retirement plans
included:
* Cost differences in pension plans are due to several factors,
including: (1) administrative costs, (2) benefit generosity,
and (3) wage levels.
* On the basis of discussions with plan administrators and
actuaries, minimum on-going annual administrative costs are
typically $400 for a defined contribution plan and $600 for a
defined benefit plan.
* Per capita administrative costs for defined benefit plans
exceed those for defined contribution plans regardless of firm
size.
Analysis of aggregate data on health benefits indicated that total per
capita costs for individual health care coverage are highest for firms under
50 employees--$4l in monthly premiums. However, per capita costs for family
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coverage are highest for firms with 100 or more employees--$lOl in monthly
premiums--and lowest for firms with 50-99 employees. We also found from our
aggregate analyses that large employers (over 100 employees) pay the highest
percentage of health care premiums--95 percent of premiums for individual
coverage and 91 percent for family coverage. Small firms, in the 50-99
employee range, paid the lowest share of premiums--68 percent for individual
coverage and 51 percent for family coverage. Finally, across all firm size
groupings, employers pay a higher percentage of premiums for individual
coverage than family coverage.
From our analyses of regional data and interviews with small employers
and pension consultants we also found:
* SBANE data indicated that about half of the small firms
administer their plans themselves, about one-third use outside
plan administrators and the remainder relied on insurance
companies.
* SBANE evidence indicated that, on average, small firms (under
500 employees) spent about eight percent of their payroll on
benefits. -
* In setting up pension plans, most small employers utilized
expert pension advisors, such as an actuary or an attorney.
Depending upon the size of the firm and the type of plan
selected, start-up costs were estimated at between $2-5,000 for
small plans.
* Most small firms stated that they did not feel particularly
burdened by government regulation at the time of start-up
because they utilized expert pension services. However,
regulation clearly affected the initial decision to form a plan
and the types of plan selected.
* According to pension consultants and small employers, on-going
administrative costs for small firms (under 100) are an
estimated $500-l,500 per year--depending upon the type of plan
and number of participants.
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* Small employers and pension consultants indicated several
areas of regulation and reporting requ~irements that are
burdensomeinclUding parts of the Form 5500, "controlled group
requirements", percentage coverage requirements, some
regulations under Multiemployer Pension Plan Amendment Act
(MPPAA), and "merger and spinoff rules".
* Many small employers observed that it was not so much the
regulations that were a burden, but rather the constant changes
in laws and regulations"which often imposed substantial costs
on the firms when they made plan amendments.
B. PENSION BENEFITS
1. Findings from National Aggregate Data Analysis
We used data from the 1977 Bureau of Labor Statistics Employer
Expenditures for Compensation (EEC) survey to analyze the differences in per
capita pension costs by establishment size. Exhibit IV-l shows that costs, on
a per worker basis, are substantially higher for small establishments than for
larger establishments. The exhibit also shows that the per worker costs
decline from $1,080 for establishments with 1-10 workers to $574 for
establishments with 500-999 workers. Establishments with 1,000 or more
workers had higher costs than all but the smallest establishments.
These cost differences are due to a number of factors: (1)
administrative costs, which are higher on a per capita basis for small firms
than large firms; (2) benefit levels, which are generally more generous for
large establishments than smaller ones--in part because of supplemental plans
in large firms; and (3) wage levels, which are generally higher in large
establishments.
We examined closely the administrative costs of small pension plans.
This is difficult, because most firms do not generally report their actual
administrative costs. For example, many firms do not report the costs of
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EXHIBIT IV-1
PER WORKER PENSION COSTS,
BY ESTABLISHMENT SIZE, 1977
Per Worker Pension
Establishment Size Costs in 1977
Less than 10 $1,080
10-25 813
26-49 626
50-99 641
100-499 580
500-999 574
1,000-2,499 646
2,500+ 737
$731
SOURCE: 1977 Expenditures for Employee Compensation (EEC) Survey, Bureau of
Labor Statistics.
their plans on their Form 5500 because they provide their own administrative
services. To estimate the actual costs of plan administration, we talked to a
number of plan administrators and actuaries. From these interviews, we were
able to develop a schedule of typical costs for plan administration services.
These administrative costs are shown in Exhibits IV-2 and IV-3.
Exhibit IV-2 shows that there is, as expected, a minimum annual cost to
administer a plan. This exhibit shows that this minimum cost is typically
$400 for a defined contribution plan and $600 for a defined benefit plan.
Exhibit IV-2 shows that this cost increases at approximately the same rate for
both defined benefit and defined contribution plans as the number of plan
participants increases.
Exhibit IV-3 shows these typical administrative costs on a per worker
basis. It shows that the per capita costs drop quickly for firms with less
than 50 participants. They also show that on a per capita basis, the costs
for a defined benefit plan always exceed those for a defined contribution plan.
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$2000
$1800
$1600
$1400
$1200
~ $1000
$800
$600
$ 400
$ 200
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EXHIBIT IV-2
`TYPICAL ON-GOING ADMINISTRATIVE COSTS FOR
DEFINED BENEFIT AND DEFINED CONTRIBUTION PLANS, 1983
SOURCE: ICF estimates.
/
/
/
*1
--
-
~,~,1'
I
/
/
/
/
,
`ft.
/
/
/
,
DEFINED BENEFIT
DEFINED CONTEIBUTION
NUMBER OF PARTICIPANTS
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U,
U)
8
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EXHIBIT IV-3
TYPICAL PER CAPITA ADMINISTRATIVE COSTS, 1983
$600
$500
$400
$300
- - - - - - DEFINED BENEFIT
DEFINED CONTRIBUTION
$200
$100
1 5
10 15 20 25 30 35 40 45 50
NUNEER OF PARTICIPANTS
SOURCE: ICF estimates.
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2. Findings from Regional Surveys
The SBANE survey provides evide~è-on the nature of on-going
administration and costs of pension plans in small firms. We first used the
SBANE data to examine the way in which plans were administered. Exhibit IV-4
shows that about half of the small firms in the SBANE survey administered -~the
plan themselves. One-third of the firms used an outside plan administrator
and 14 percent relied upon an insurance company.
Firms with profit sharing plans were asked how the profit sharing
contribution w~s made. Of the 55 firms responding to this question, 85
percent reported that the contribution was determined by management or the
board of directors and 15 percent reported that the contribution was set by
formula. Hence, firms with profit sharing plans appear to have left
themselves considerable flexibility in setting contribution levels. This ties
in with one of the major motivating factors for selecting a profit sharing
plan--flexibility on the part of the firm to make contributions to the fund.
The only cost data on pension plans from the SBANE data base concerns the
percent of the payroll spent on retirement benefits. On average, firms spent
about eight percent of their payroll on pension benefits. A breakdown of the
percent of payroll spent on retirement benefits, presented in Exhibit IV-5,
shows that no firm in the SBANE survey spent more than 15 percent of payroll
on pension benefits. It also shows that there was a fairly even distribution
of firms across the 1-15 percent of payroll range. A further breakdown of the
percent of payroll by firm size yielded no significant pattern as firm size
increases or decreases.
40-046 0 - 85 - 20
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EXHIBIT IV-4
ADMIN ISTRATION OF PENSION PLANS,
SBANE SURVEY, 1982
Plan Administration by: Number Percent
Company 47 52%
Independent Administration 32 34%
Insurance Company 13 14%
TOTAL 92 100%
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of
Fringe Benefits.
EXHIBIT IV-5
PERCENT OF PAYROLL SPENT ON PENSION BENEFITS,
SBANE SURVEY, 1982
Percent of Payroll Number Percent
1-3 Percent 14 23%
4-6 Percent 16 27%
7-9 Percent 9 15%
10-12 Percent 8 13%
12-15 Percent 13 22%
TOTAL 60 100%
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of
Fringe Benefits.
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3. Findings from On-Site Case Studies and Telephone Interviews
Discussions with small firms during on-site case studies and telephone
interviews provided extensive detail about administrative costs and factors
affecting costs. These findings are presented below in two sections: (1)
start-up costs; and (2) on-going administration and costs.
a. Start-Up Costs
The case studies of three small firms and discussions with pension plan
consultants and actuaries yielded detailed information about plan start-up
costs.
Administrative Activities and Costs
As was previously discussed, the impetus for plan formation in small
firms often comes from a period of sustained profitability. At a point when a
firm becomes profitable, the management/owner-operator becomes concerned about
corporate taxes. When this occurs, one option that a firm will generally
investigate is setting up a pension plan. During our discussions with
actuarial firms, one actuary identified the following steps that many firms
went through in setting up a plan:
* after reaching a point of sufficient profitability, the firm
will recognize that a tax problem exists (sometimes as a result
of professional financial advice);
* the firm will then seek professional financial advice (e.g.
from a financial planner, accountant, insurance agent or
attorney);
* discussions will be conducted between the management of the
firm (usually the owner-operator) and the financial advisor to
identify the type of plan that is desired;
* the financial advisor will then make actuarial valuations for
the major types of pension plans under consideration and review
these with the firm;
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* the firm will make a choice of a plan and the details of the
plan will be refined and formalized;
* the financial advisor will then write the plan document;
* the plan will be reviewed and approved by the firm;
* the financial advisor will initiate a formal valuation and
determine the company's initial contribution to the fund; and
* the plan will be filed with and approved by the Internal
Revenue Service.
The case studies provide two detailed examples of the process of plan
formation. Firm A, a small manufacturer of steel wire, closely followed the
major steps detailed above in plan formation. This firm initiated a defined
benefit plan at the time of company incorporation in 1978, four years after
the firm was established. At the time of plan formation, the firm had been
profitable for severalyears. In response to this profitability, the
owner-operator commissioned an outside financial planning firm to do a study
on all aspects of the company's operations. One recommendation that emerged
from this study was that the firm establish a pension plan. The financial
planning firm reviewed the major types of plan options with the
owner-operator. On the recommendation of the financial advisor, the
owner-operator selected a defined benefit plan. This plan provided the older,
more highly compensated owner-operator with a more substantial retirement
benefit than other types of available plans.
Once the type of plan was selected, the financial planning advisor
developed and proposed a plan document, which incorporated the major features
decided by the owner-operator. Then, the company's attorney reviewed the plan
document and Firm A adopted the plan. The financial advisor made a formal
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actuarial valuation and determination of initial contribution. The plan was
filed with the Internal Revenue Service. The owner-operator estimated that
plan formation was completed over a 6-8 month period.
In addition to the time spent by the owner-operator of Firm A, the major
costs involved in plan formation included fees for financial planning, legal,
and actuarial services. Within the firm, the owner-operator was the only
employee directly involved in setting up the plan. Major activities that the
owner-operator became involved in included: review of the financial
management study, discussions outlining major aspects of the plan, review of
the financial planner's recommendations, and review of the plan document and
initial valuation. The owner-operator estimated that he spent only about
eight hours during this process.
Outside of the firm, the owner-operator used financial planning, legal,
and actuarial services. The initial management study, conducted by a
financial planning firm in 1978, cost $700. This study also included
recommendations for many other aspects of his business. Costs resulting from~
the review of the plan document by the company's attorney were estimated at
several hundred dollars. The initial actuarial valuation and determination of
firm contribution (done by the financial planning firm) cost $350. Hence,
outside assistance in setting up the plan was in the $l,000-$l,500 range (in
1978).
The owner-operator of Firm A noted that the costs of setting up a plan
were a higher percentage of annual fund contributions for small firms compared
to. large firms. In addition, he noted that larger firms were more likely than
small firms to have staff with expertise to assist in the formation of a
plan. The owner-operator expressed concern that small firms, like his own,
generally needed to purchase "high priced advice" to establish a plan.
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Firm B, a moving and rigging firm established in the 1870's, established
its plan under a different set of conditions than Firm A, but went through a
similar process. Prior to 1976, the company's employees were covered by a
variety of pension plans, including the Teamster's, Operating Engineers, Iron
Workers, and Millwrights. During the next five years, several union employees
moved into management positions. In 1981, business conditions caused these
employees to withdraw from the unions (primarily the Teamster's) and their
respective pension plans.
Consequently, in 1981 Firm B established a p~ofit sharing plan for its
nonunion, salaried employees. The union employees at the firm continued to be
part of various multiemployer plans. At the time of plan formation, the
firm's management wanted to cover the non-union employees with a pension
plan. Another important consideration in selecting a plan was that the firm
not be required to make contributions during periods of low profitability.
Unlike many firms at the time of plan formation, Firm B had experienced low
profitability in the years preceding the establishment of the plan.
In setting up the plan, the firm president and two other management
employees (who eventually became plan trustees) initially met with a pension
attorney from the company's law firm. Six to eight meetings were held between
the pension attorney and the firm's representatives, during which various plan
options were discussed. Because the firm wanted to avoid making payments into
the fund during periods of low profitability, a profit sharing plan was
recommended by the attorney.
The details of the plan document were drawn up by the pension attorney,
in consultation with the firm's management. The lawyer also prepared
projections of the plan's costs. After a period of 6-8 months, the plan was
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adopted by the firm and filed with the Internal Revenue Service. Finally, a
local bank set up an account for the plan and was contracted with to provide
on-going administration of the plan.
Within Firm B, four employees--the president, two management employees
and a payroll officer--were involved in setting up the plan. The president
and two management employees attended 6-8 meetings with the pension attorney
and reviewed plan recommendations (2-3 hours per meeting). In addition, a
payroll officer provided necessary statistical information to the lawyer for
cost projectIons (3-5 hours). External to the firm, a pension attorney was
extensively involved in setting up the plan. It is estimated that this
attorney provided between 75 and 100 hours of consultation, at a cost under
$10,000.
Problems in Plan Formation
In the view of the president of Firm B, the most burdensome aspect of
setting up the plan involved understanding the many complex options
available. Similar to Firm A, the president of Firm B noted that it was
necessary for a small firm to seek costly expert advice during plan formation.
During telephone interviews with eight other firms with pension plans,
interviewees were asked about the types of barriers or obstacles that their
firm faced in setting up a pension plan. Most respondents said that they had
not faced major barriers in setting up their plan because they consulted
experts to guide them through the process.
Most firms indicated that government regulation had not posed a major
problem to them in setting up the plan. For example, several firms commented
that they were only given options which met government regulations.
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However, several small firms which did not currently offer pension
benefits, indicated that government regulation had an impact on their decision
not to offer benefits, although firm profitability was the most important
consideration for them. For example, one interviewee stated that "ERISA was a
problem, but not a determining factor". Another commented that ERISA had made
the laws governing pensions fairly complex and that he was less willing to
establish a plan because of the required paperwork. A third interviewee said
that he was aware of the strong regulation of pensions, but that this did not
directly affect his decision hot to offer benefits. He added that he did not
clearly understand these regulations and in future decisions about covering
employees this factor might keep him "on the fence".
While government regulation does not appear to pose a major problem or
obstacle to the formation of plans in small firms, it can affect the decision
to form a plan, the type of plan selected, and the cost of establishing a
plan. For example, the following types of regulations affected the decision
of one firm to establish a plan: (1) tax benefits, which allowed the firm to
shelter some of its profits; and (2) bankruptcy rules, which provided that
employees receive certain benefits set aside in the plan before other
creditors if bankruptcy should be declared.
Finally, a representative of an actuarial firm that sets up and
administers plans for small firms, identified three areas of regulation which
affected choices made during plan formation. First, and most important, were
tax regulations: most clients were interested in establishing a plan that
gave them the greatest tax shelter. Second, the Pension Benefit Guaranty
Corporation's (PBGC) regulations relating to the 30 percent of net worth
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liability that could be imposed in the case of plan termination often affected
the firm's choice of plans. Third, ERISA regulations were sometimes a factor,
particularly when clients asked for less generous vesting schedules or
stricter participation standards than required by ERISA. In cases such as
this, it was necessary to notify the client of the restrictions. Finally, for
very small plans (under 20 employees), particularly those established by
doctors and other small professional partnerships, Section 415 of the Internal
Revenue Code--which limits pension benefits--was a major concern. This
problem has become an even greater concern since the passage of Tax Equity and
Fiscal Responsibility Act of 1982 (TEFRA) which further restricts these
benefit limits and adds "top-heavy plan rules".1~
b. On-Going Administration and Costs
On-going administration of pension plans includes such tasks as decisions
about investment of plan funds, determination of annual contributions to the
fund, processing of loans/withdrawals from the plan, compilation of
statistical data (e.g., payroll data), filing of reports (e.g., Form 5500) and
forms (e.g., W-2 forms), and making deposits into the fund. Small firms
approached the administration of plans in several different ways depending
upon the particular expertise within the firm, type of pension plan, and size
of the fund. Some firms (such as Firm C), both administer the plan and manage
plan assets. Other firms (such as Firm B), delegate responsibility for plan
administration and asset management to other firms that specialize in plan
administration, such as a local bank, insurance company or actuarial firm.
~ For specific regulations of TEFRA relating to pension plans see:
Commercial Clearing House, Inc., Tax Equity and Fiscal Responsibility Act
of 1982: Law and Explanation, (Chicago, 1982).
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And some firms (such as Firm A), contracted with a consulting firm to do some
of the more difficult aspects of plan administration, but still retained an
active role in other aspects of administration and investment.
Internal Administration
The first model of plan administration--plan administration and asset
management. done by the firm- -was found in three of the eight firms interviewed
by telephone and in. Firm C of the case studies. Firm C provi4ed a detailed
example of this administrative model.
WitF~in Firm C, thr~e employees were primarily responsible for
administration of the plan and investment of plan assets: the president, a
plan administrator, and a secretary. In addition, this firm used a small
business microcomputer to assist in the compilation of statistical data. This
firm had a profit sharing plan, which generally entailed somewhat less complex
and time-consuming administration than other types of plans. The president
made most decisions with regard to the investment of funds, the annual
contribution to the fund, and loan/withdrawals from the plan. It was
estimated that, on average, the president spent about 6-8 hours per year on
these tasks. The plan administrator, with assistance from a microcomputer
programmed with a spread sheet type software, computed the annual allocation
(including contributions, forfeitures, and interest), compiled data for and
completed the Form 5500, made deposits to the fund, processed loans and
withdrawals, and completed the W-2 forms (as needed) for employees. The most
time-consuming of these tasks was making deposits to the fund--about six hours
per month--and the activities involved in the completion of the Form 5500--an
estimated 20 hours per year. Several hours per year were spent~ on processing
loans/withdrawals, and about seven hours per year were spent on~ filling out
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any needed W-2 forms and detailing pension allocations for each employee.
During these tasks, the plan administrator was assisted by a secretary who
spent about eight hours per year on pension-related tasks.
External to the firm, the plan administrator occasionally conferred with
the firm's attorney and/or accountant about administrative problems and
special circumstances, such as withdrawals, loans, enrollment of new employees
and changes in regulations. lie estimated that 6-8 contacts were made
annually, at a cost of about $200 per year.
A major problem area identified by the plan administrator under this
administrative model was the investment of plan funds. Firm C, with
approximately 20 employees, was too small to have anyone within the firm
providing well-informed investment advice and the size of the pension fund was
too small to justify contracting for outside investment expertise. As a
result, Firm C's pension funds remained relatively static. The firm felt that
because of this, investment opportunities were missed.
External Administration
A second administrative model--in which the firm delegates responsibility
for plan administration and investment of funds to another firm- -was found in
Firm B (a rigging and moving firm) and in two of the eight firms interviewed
by telephone. Firm B provided considerable detail on this type of plan
management.
By choice, Firm B did not take an active role in the plan administration
or investment decisions. It delegated nearly all of these tasks to a plan
administrator--which was a local bank. Within Firm C, the president and two
other plan trustees were occasionally involved in the approval of investment
decisions by the independent plan administrator. Several hours a year, the
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presidenf and plan trustees met with a representative of the local bank to
review recommendations for fund investments. The firm management preferred
third-party handling of investments, as well as the relatively conservative
(risk-free) investment choices made by the plan administrator, for two
reasons: (1) the management did not have the time or expertise to make good
investment decisions, and (2) the management wanted to avoid criticism and
controversy on the part of participating employees that might arise from poor
(or even good) investment choices.
In terms of on-going plan administration, Firm B provided the independent
administrator with necessary information for making the profit sharing distri-
bution and completing reporting requirements. For example, payroll data (W-2
forms) were provided to the administrator as well as statistical data for the
Form 5500. Overall, it was estimated that the firm's management spent no mor~
than 10 hours per year on pension plan administration and investment decisions.
Firm B relied extensively upon a local bank to administer the plan and
make investment recommendations. As plan administrator, the bank has been
delegated nearly all on-going administrative tasks, including: filing of the
Form 5500, handling deposits to the account, and maintaining statistical
data. Because there has been only one profit sharing distribution to the fund
and no one is fully vested, plan administration has been relatively
uncomplicated. For services rendered, the local bank charges a half-percent
per year investment fee.
In addition, the firm has occasionally referred any pension-related
problems to the firm's attorney. To date, there has been little need to
consult with the firm's attorney--on average not more than two hours a year.
Under this administrative model, the firm identified no major problems.
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Shared Administration
A third administrative model--sharing of on-going administration and
investment decisions between the firm and an independent administrator--was
found in three of eight firms interviewed by telephone and Firm A. Firm A, a
small manufacturer of steel wire, illustrates this type of plan administration.
Firm A, which has an integrated defined benefit plan, makes its own
investment decisions but contracts with an actuarial firm to do plan
administration. Under this administrative arrangement, the owner-operator of
the firm performed the following administrative activities: made decisions
concerning investment of pension plan assets (in consultation with his
stockbroker); coordinated activities of the plan administrator; notified the
plan administrator of changes in employee status; and compiled statistical
data for the plan administrator for the Form 5500. The owner-operator did not
characterize these tasks as particularly time-consuming or burdensome--
spending perhaps eight hours per year on administrative tasks, most of which
were related to making investment decisions. He has been assisted in these
tasks by a secretary.
At a cost of $600 per year, Firm A has contracted with an actuarial firm
to do most aspects of on-going plan administration. These tasks include:
valuation to determine the required contributions, preparation of employee
benefit statements, and compilation of data for and completion of the Form
5500. Use of legal and accounting services to resolve problems has been
negligible in recent years.
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ProbJems in Ongoing Administration
The owner-operator of Firm A commented that he had not experienced
problems in on-going plan administration in recent years. However, he noted
that the cost of on-going administration appears to be a higher percentage of
the annual contribution to the pension fund for a small firm compared to a
large firm. For example, the S600 that this firm pays in administrative
expense is 5.4 percent of the annual contribution made to the pension fund.
Firms interviewed by telephone and on-site identified several effects of
regulation on the on-going administration of plans. On the whole,
interviewees were supportive of ERISA and other more recent changes to pension
laws--feeling that these laws were necessary to protect employees. For
example, one employer stated that without the "burden of ERISA", there would
be "little protection". However, some firms observed that that passage of
ERISA had imposed substantial costs on their firm. Several firms pointed to
the costs--primarily attorney's fees--of re-writing plans to conform to ERISA
standards. The costs of changing plans to comply with ERISA were estimated at
about $1,500. Other firms indicated that they changed to another type of plan
in response to ERISA--e.g., one firm went from a defined benefit plan to a
profit sharing plan; another firm dropped its defined benefit plan, but
retained its profit sharing plan; a third firm terminated its plan and did not
establish a successor plan because of costs involved in rewriting the plan.
In-depth discussions during case studies with firms identified several
effects of pension plan regulation on business operations and decisions. One
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unique problem stems from the existence of "controlled group requirements".'~
Because of these requirements, a small firm may face considerable problems in
acquiring another firm. These requirements may force a company (with a
pension plan) that acquires another company to provide a pension plan to
employees of this purchased firm even if the profitability of this acquired
firm is not sufficient to sustain such a plan. Potential buyers who do not
have a pension plan are at a competitive advantage because they are not
required to provide a plan to employees of the acquired firm. In general, the
impact of the "controlled group requirement" appears to be greater for small
firms than large firms because of the "percent coverage r.equirement". Under
the percentage coverage requirement (sometimes referred to as the Arbitrary
Rule), either: (1) 70 percent or more of all employees, exclusive of short
service, seasodal and part-time employees, must be covered; or (2) at least 70
percent of the employees, similarly defined, must be eligible for coverage
under the plan and at least 80 percent of all eligible employees must actively
participate.
`~ ERISA section 210(d) indicates that all employees of businesses which
are under common control shall be treated as employed by a single
employer. Thus, if company "A" with a pension for its 20 employees
purchases company "B" which has 30 employees and does not provide a
pension for the new employees, its pension plan will no longer satisfy
IRS participation requirements. The controlled group is company "A" and
company "B" and only 40 percent of the employees of the controlled group
would be covered. As a result, the plan would lose its tax qualified
status since Section 410(b) of the Internal Revenue Code states that 70
percent of all employees who meet minimum age and service requirements
must be eligible to participate in the plan for the plan to be a tax
qualified plan.
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The greater impact on small firms can be seen in the following example:
A company with 10,000 employees could purchase a small firm with 10 employees
and not be required to provide pension benefits to employees of the small
firm. However, a firm with 20 employees could not meet percent coverage
requirements if they purchased the same firm (with 10 employees) without
including the new employees in their own plan.
Another problem identified during discussions with firms involved
regulations governing multiemployer plans--specifically, the Multiemployer
Pension Plan Amendment Act (MPPAA). Firm C, a rigging and moving firm,
indicated that MPPAA regulations had contributed to the failure of numerous
trucking firms and undermined the participation of new firms in multiemployer
plans. Two reasons were given. First, the imposition of withdrawal
liability, which was legislated by MFPAA, had placed heavy burdens on the
owners of established firms and made it very difficult for owners to sell
firms. Second, companies that negotiated contracts with unions did so on a
"cents per hour" basis for pension (and other types of) benefits. The
imposition of other types of additional pension liabilities by regulation
(such as by MPPAA) after these agreements had been negotiated made bidding on
multi-year contracts difficult.
In-depth interviews with pension experts at two actuarial firms.- -which
both set-up and administer plans for small firms--identified several other
impacts of regulation and problems faced by small firms. One actuary
indicated that her small business clients experience no major difficulties
with on-going administration as a result of. regulations since the actuarial
firm filled out most forms such as the 5500. However, this actuary felt that
the constant changing of laws and regulations that has taken place over the
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past five to ten years has added significantly to the cost of administering a
pension plan. Some problems in the completion of the Form 5500 were also
identified:
Question 15 requires unnecessary detail. Particularly
questions relating to the percentage of plan assets and
diversity of investments may have meaning for a larger plan but
not for a small plan.
* Question l6i and 18c are ambiguous in the case of a plan for
which the sponsor pays all administrative expenses outside of
the fund. What the employer pays for administration over and
above his pension contribution is irrelevant information.
* Question 18a, which requests an explanation of what a trustee
is charged, is unclear as to what type of explanation was needed.
* Question 19a requests unnecessary detail on transactions. If
a plan abides by regulations relating to loans, having to detail
all of the rather trivial transactions involved in loans causes
an excessive amount of administration especially for loans that
are no longer outstanding. For example, one plan filed a 5500C
every three years. Although it had only four lives covered
under the plan, numerous loans over that three year period of
duration of less than six months merit that records had to be
obtained on over 25 loans most of which were no longer
outstanding at the time of filing.
* Question 21d is ambiguous. It asks if any contribution has
been late under the terms of the plan. A plan may call for a
contribution "at the end of the plan year". Second 412 of ERISA
gives firms 8~ months after the end of the plan year to make a
contribution. A contribution that is in compliance with ERISA
may technically be "more than three months past due under the
terms of the plan".
In addition to problems with the Form 5500, the actuary indicated that the
plan termination Form 5310 is very burdensome on small plans. Supplying a 10
year salary average represents a considerable burden for a plan that is fully
funded and for which 10-year cutbacks do not apply.
Finally, the actuary indicated that merger and spin-offs rules
unnecessarily create special problems for small plans. There is a necessary
cost associated with filings that meet a required regulatory need, but the IRS
40-046 0 85 - 21
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adds unnecessary costs by specifying in its revenue rulings complicated
procedures, especially in the case of spin-offs that do not occur on the plan
year anniversary. IRS also requires From 6088 for a professional corporation
even if it is has no PBGC liability.
Aside from the inefficiencies of the Form 5500 discussed above, this
actuary indicated that major ongoing administrative problems generally related
to special situations. The biggest problem has been the constant state of
flux of regulations and laws. The adverse administrative impact of numerous
changes could be greatly decreased if implementation in existing plans could
be delayed for a few years so that numerous changes could be made at the same
time. For example, plans could be required to be amended only once every
three years to come into compliance with new legislation. At that time, all
required changes could be made. In most cases, there would be little or no
adverse impact on the intent of the law resulting from this delay in
implementation. Fewer plans might terminate and more plans might be formed if
sponsors did not fear the cost of constantly changing laws and regulations.
Interviews with a second actuarial firm identified several other effects
of regulation and problems faced by small firms in administering plans. An
actuary from the second actuarial firm felt that filing requirements are
needed and indicated that although the cost per covered employee is much
higher for small plans, it is, in fact, in the small plan area that there is
the greatest abuse of pension plans. He thought that relaxation of filing
requirements might be possible in the case of certain standard simplified
plans--such as non-integrated plans, permitting no loans, having a bank or
other financial institution as a trustee and having an enrolled actuary do all
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of the administration. More complicated plans and ones that fund toward
retirement at age 55 and in other ways stretch the limits of regulations need
to meet more extensive filing requirements.
Although this actuary agreed with the spirit of filing requirements, he
felt that certain aspects of reporting and disclosure are carried to a
burdensome extreme. The new Form 5500C is more time consuming than the old
one and filling it out only every third year is more of a burden than filing
the old Form 5500 every year was. In addition to the Form 5500, a plan has to
file joint and survivor notices nine months prior to when an employee is
eligible for eatly retirement, suspension of benefit notices after an employee
reaches age 65 in certain plans, summary annual reports, summary plan
descriptions, summary of material modification notices and PBGC premium
reports. He also feels that the Financial Accounting Standard Bureau (FASB)
proposal regarding how to expense pension contributions is an excessive burden
on pension plans.
The actuary and plan administrator found that one of the biggest problems
faced by small firms was that laws and regulations have changed so frequently
in recent years- -requiring employers to amend their plans almost every year;
This doubles or triples the annual administrative cost of maintaining a small
plan. In addition, TEFRA limits the benefits to the owner-operator of
maintaining a pension plan.
The actuary cited several specific areas of regulation that are
unnecessarily burdensome:
* The suspension of benefits notice is unnecessary. Employees
already receive a summary plan description and can always come
to the plan administrator to review their benefits. Many workers
who decide to work past age 65 research the issue thoroughly and
find out what the impact will be on their pension benefit
independent of receiving the suspension of benefits notice.
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* The requirement of providing retirement information nine
months prior to the employee's retirement date is unnecessary.
Exact figures are provided when the employee retires. Prior to
that, the employee receives or can request a benefit statement
on an annual basis.
* The requirement of an accountant audit in the case of insured
plans or plans trusteed by a bank is useless since there is
nothing to audit.
* PBGC requires that plans count as participants non-vested,
former employees who have terminated employment but who have not
yet incurred a break in service. The actuary estimates that
less than one percent of such workers ever return to
employment. Keeping track of all these incomplete breaks in
service creates an unnecessary record keeping burden.
* IRS requires a plan to obtain approval of a change of funding
method even when certain. minute details of the valuation are
changed. This can unnecessarily cost a plan several hundreds of
dollars and create unnecessary work for the IRS.
C. HEALTH BENEFITS
1. Findings from Aggregate Data Analysis
We used the ICF Health Plan Data Base to examine the costs of providing
health benefits in different size firms. Exhibit IV-6 shows the total
premiums paid by both employers and workers for health plan coverage. This
exhibit shows that the total per-capita costs for individual coverage are
highest for small firms. It also shows that individual monthly premiums do
not differ greatly by firm size. Exhibit IV-6 shows that per-capita premiums
for family coverage are highest for firms with 100 or more workers. The
exhibit also shows that for both individual and family coverage, per-capita
premiums are lowest for firms with 50-99 employees.
We then examined the level of monthly, per capita premiums paid by
employers. As with total premiums for individual coverage, small firms pay
the highest average premium although firms with 100 or more workers pay an
almost equal amount. Exhibit IV-7 also shows that, similar to total premiums,
employer premiums for family coverage are highest for large firms.
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EXHIBIT IV-6
AVERAGE PER CAPITA MONTHLY HEALTH
PREMIUMS, BY FIRM SIZE, 1980
Firm Size
50-99 100 Or More
$35 $38
~Z ~IQ~
$63 $77
1-49
$41
S92
$68
Plan Data Base.
Much of the differences in employer premiums are due to the relative
shares of costs borne by employers and workers. Exhibit IV-8 shows that large
employers pay the highest percentage of health care premiums. For example,
firms with 50-99 employees pay only 55 percent of total premiums--in part
because they pay only slightly more than one-half of the costs of family
coverage. Firms with less than 50 workers pay over three-quarters of the
total premiums for health coverage. The exhibit also shows that in all firm
size groups, employers pay a higher percentage of premiums for individual
coverage than family coverage.
319
Type of Coverage
Individual Coverage
Family Coverage
Total
SOURCE: ICF H&alth
Total
$39
~22
$74
EXHIBIT IV-7
AVERAGE EMPLOYER PER CAPITA MONTHLY
HEALTH PREMIUMS, BY FIRM SIZE, 1980
Firm Size
Type of Coverage 1-49 50-99 100 Or More
Individual Coverage $36 $24 $36
Family Coverage $68 $44
Total $53 $35 $71
SOURCE: ICF Health Plan Data Base.
Total
$36
$65
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EXHIBIT IV-8
AVERAGE PERCENTAGE OF HEALTH PREMIUMS
PAID BY EMPLOYERS, BY FIRM SIZE, 1980
Firm Size
Type of Coverage 1-49 50-99 100 Or More Total
Individual Coverage 87% 68% 95% 92%
Family Coverage 73% 51% 91% 87%
Total 77% 55% 92% 88%
SOURCE: ICF Health Plan Data Base.
2. Findings.from Regional Surveys
The SBANE data base provides some data on the current costs of health
care to small firms. Exhibits IV-9 and IV-lO provide a breakdown of the
monthly cost of health insurance coverage overall, and by employee and
employer. In over half of the firms (54 percent), single employees were not
required to make any contribution toward health insurance costs; 36 percent of
the family employees made no contribution. Total monthly costs for health
coverage of single employees were most frequently in the $60-$79 range (35
percent of the firms) and for family coverage in the $160-$l99 range (35
percent of the firms). Monthly costs to firms were most likely to be in the
$4O-$59 range for single employees and in the $8O-$ll9 range for family
employees.
Exhibit IV-ll summarizes available cost data from the SMC data base.
This regional data base shows a high percentage of firms paying the entire
cost of hospital and surgery (94 percent) and major medical (94 percent)
insurance.
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EXHIBIT IV-9
MONTHLY CONTRIBUTION OF EMPLOYEES/EMPLOYERS
FOR HEALTH INSURANCE (FAMILY EMPLOYEES)
MonthlyCost of Health Insurance Total
$0 $1-39 $11O79 $8o-119 $120-159 $16O-199 200+ Firms
Employee's (Family) lj7 (36%) 30 (23%) 3l~ (26%) 17 (13%) 2 ( 2%) 1 ( 1%) -- 131 (100%)
Contribution
Employer's (Family) 1 ( 1%) 3 ( 2%) 28 (21%) 118 (37%) 32 (211%) 12 ( 9%) 7 (5%) 131 (100%) ~
Contribution
Total (Family) Costs -- -- LI ( 3%) 30 (22%) 110 (30%) 48 (36%) 13 (10%) 135 (100%)
a/ Exhibit presents number of Firms that fall within each cost interval (e.g., 50 of 134 firms required no
contribution by family employees toward health insurance). Percentages figured on basis of each row total
number of firms.
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of Fringe Benefits.
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Employee's (Single)
Contribution
Employer's (Single)
Contribution
Total (Single) Costs
EXHIBIT IV-1O
MONTHLY CONTRIBUTION OF EMPLC
FOR HEALTH INSURANCF 1SIN~Ir
LOVERS
~ Al
72 (511%) 39 (29%)
3 ( 2%) I~ ( 3%)
Insurance
Total
15
(11%)
7
( 5%)
1
( 1%)
$oo~9~j~~
1 ( 1%)
--
13~i
firms
(11)0%)
35
(26%)
55
(111%)
29
(22%)
6 ( 5%)
2 (1%)
1311
(100%)
A/Exhi6i~~F~ents number of firms that fall within each cost interval (e.g., 72 of 131 firms require no
contribution by single employee toward health insurance).
SOURCE: Small Business Association of New England's (SBANE) 1982 Survey of Fringe Benefits.
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EXHIBIT IV-11
COMPANY CONTRIBUTION TOWARD
HEALTH CARE COVERAGE, SMC (1982)
Company
Contribution (%)
100%
90%
85%
80%
75%
66.7%
50%
TOTAL
Hospital + Surgery
212 (94%)
4 C 2%)
3 ( 1%)
1 (a!)
2 ( 1%)
1 (al)
3 ( 1%)
226 (100%)
Major Medical
211 (94%)
4 ( 2%)
3 C 1%)
l(a/)
3 C 1%)
224 (100%)
a/ Less than 0.5 percent.
SOURCE: The Smaller Manufacturer's Council of Pittsburgh's (SMC) 1982 Wage
and Fringe Benefit Survey.
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3. Findings from Telephone Discussions and On-Site Studies
Telephone discussions and on-site case studies uncovered considerable
concern among employers over the rising costs of health care coverage in
recent years. Exhibit IV-l2 displays health plan costs for the fifteen firms
interviewed by telephone. Average monthly costs for health benefits was about
$80 per month for single employees and $194 per month for family employees.
Health insurance costs ranged from $56 to $100 per month for coverage of
single employees and from $156 to S250 for coverage of family employees.
Firms absorbed most of the monthly costs of health insurance. Just
one-tenth of the firms indicated that single employees made a monthly
contribution toward health benefits (i.e., in 2 out of 20 plans for which cost
data were available). A slightly higher percentage of firm plans--l7
percent--required a contribution from employees toward health coverage of
their families. Monthly contributions ranged from $10 to $75 per employee.
No discernible pattern with respect to cost of health insurance and firm
size emerged from this small sample of firms. However, during other
discussions with representatives of small business organizations, considerable
concern was expressed over premiums paid by smaller employers. Smaller firms
often face a restricted choice of health benefit plans and, because they are
unable to pool risk across a large number of employees, face higher costs. In
addition, costs of coverage for a small firm may become prohibitively high
after a series of large claims.
Costs of plans played a central role in firm's decisions about the type
of plan coverage offered to employees. About one-third of the firms
interviewed, said they had recently changed their plans. In all cases,
changes were made in the insurance carrier in an attempt to control costs.
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Type of
Insurance
BC/BS
BC/B S
Ins. Co.
Ins. Co.
BC/BS
Ins. Co.
Ins. Co.
BC/BS
HMO
BC/BS
HMO
BC/BS
BC/BS
HMO
Self Ins.
Ins. Co.
Self Ins.
Ins. Co.
lIMO (1)
HMO (2)
BC/BS
Ins. Co.
HMO
Average Cost d/
~mpioyee tmpioyer
Contribution Contribution Total
N/A N/A N/A
o 90 90
N/A N/A N/A
0 117 117
0 N/A N/A
0 75 75
0 90 90
10 75 85
0 65 65
0 100 100
0 95 95
0 N/A N/A
0 84 811
N/A N/A N/A
0 a/
14 70 84
0 75b/ 75b/
0 66 66
0 67 67
0 62 62
0 c/ c/
0 56 56
$1.50 $78.00 $79.50
Coverage of Family Employees
Employee Employer Total
0 156 $156
0 188 S188
N/A N/A
44 117 $161
0 N/A N/A
0 225 $225
75 N/A N/A
25 225 $250
0 200 $200
0 225 $225
0 186 $186
0 212 $212
0 212 $212
N/A N/A N/A
0 a/ a/
36 180 $216
0 210b/ $2lob/
0 178 $178
0 180 $180
0 166 $166
0 c/ Cf
0 164 $1611
9 169 169
$6.18 $187.62 $1911
EXHIBIT IV-12
COST OF HEALTH PLAN COVERAGE FOR SINGLE AND
FAMILY EMPLOYEES, TELEPHONE DISCUSSION WITH FIFTEEN FIRMS
Firm Size
1 4
2 8
3 11
4 14
5 15
6 22
7 25
8 25
9 35
10 42
11 117
12 53
13 115
14 125
15 174
at Firm 11 was self-insured, the cost of self Insurance varied based on the number of claims and
amount of the claIms; the firm also had catastrophic insurance to cover Individual claims In
excess of $12,000.
b/ FIrm 13 was self-Insured; costs were estimated for an average month, but actual cost varied
based on the number of claims and amount of claims; the firm also paid a monthly premium to
cover Individual claims in excess of $10,000.
c/ Firm 15 had a cumulative monthly rate of $123 that covered both families and single employees.
d/ Average costs are figured across those firms that have reported employee, employer, and total
contributions. Average cost for single employee coverage was figured using 16 fIrms; average
cost for family employees coverage was figured using 17 firms.
SOURCE: JBA/ICF Telephone Interviews with Small Employers, 1983.
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For example, one firm recently made a switch (after 8 years) from a private
carrier to self-insurance in an attempt to reduce monthly insurance premiums.
This firm also capped liability for claims at the cost of $1 million and
introduced a deductible for "non-emergency" emergency room visits. Another
firm recently shifted from a high coverage plan (costing $298/month) to
120-day comprehensive/major medical wrap-around coverage (costing
$212/month). Two of the three case study firms also recently changed carriers
because of spiraling costs--both Firms B and C moved from larger carriers to
less expensive smaller insurers.
While nearly all employers cited rising monthly insurance premiums as a
problem, few offered ready solutions. Several felt that co-insurance and
higher deductibles might help control costs. For example, one owner-operator
felt that employees should pay part of the cost of health insurance so they
would be aware of cost increases and have more of an incentive to keep costs
down.
Others looked to lower levels of coverage of employees and capping of
claims as methods for controlling costs. Several firms noted that simplified
claims processing--in which the employees filled out claims rather than
company personnel--effectively held down some of the overhead costs of plans.
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V. IMPLICATIONS AND CONCLUSIONS
This study examined the extent of coverage, characteristics, -
administrative practices and costs of pension and health care plans in small
businesses. This chapter discusses the implications of the study's findings.
Pension Benefits
We found that small businesses are significantly less likely to offer
pension benefits to their employees than large firms. In addition, firms in
each size classification are substantially less likely to offer pension
benefits than health care benefits. Several reasons were given for the lower
provision of pension benefits in small firms, including:
* lack of sustained profitability;
* start-up costs;
* complexity of plans and the need for costly expert advice; and
* constantly changing regulations that create uncertainty about
future costs and benefits of retirement plans.
If pension coverage is to expand in upcoming years, the impetus for this
expansion is likely to come from small firms. As the aggregate data analyses
showed in Chapter II, nearly all firms with over 500 employees currently offer
pension benefits--hence, increased coverage is only likely to come through
expansion of benefits in firms with fewer than 500 employees.
Expanded coverage of pension and health care plans, however, will be
problematic given the current conditions faced by small firms. For example,
this study shows that the impetus for pension plan formation among small firms
is generally sustained profitability and the desire of owner-operators to
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avoid and/or defer tax payments. If this is the case, then it seems unlikely
that any new set of regulations--short of regulations mandating the
establishment of private pensions in firms--is likely to substantially expand
coverage for firms with low profitability.
However, several alternatives may be feasible which would facilitate and
encourage formation of plans for employers that are profitable. The most
promising alternatives include:
* a reduction in the costs of establishing plans;
* a decrease in the complexity of establishing and maintaining
plans;
the provision of monetary incentives--in the form of tax
credits--to cover costs of plan formation; and
* a reduction in the burden and complexity of complying with
current and future regulations governing private pensions.
As Chapter IV shows, the costs of plan start-up for small firms is
substantial--in the $2,000 to $5,000 range. Per employee costs of setting up
retirement plans are substantially higher for small businesses-particularly if
more complex defined benefit plans are selected. A reduction in start-up
costs or a spreading of these costs over several years would encourage many
small firms to set up plans.
One avenue for reducing start-up costs would be the development of more
flexible IRS prototype pension plan documents with variable provisions. Many
of the small businesses that were interviewed complained that it was necessary
to hire expensive, expert assistance to draft plan documents. Currently, the
alternatives for small firms are few: either use the IRS prototype plan,
which is a standard form allowing for no variation, or seek costly,
professional assistance from attorneys, insurance companies, actuarial firms,
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etc., to develop a plan. What many small firms are looking for is a middle
ground--one in which they can use a standard IRS form, but which provides
flexibility with respect to provisions of the plan. In essence, what is
needed is various IRS approved plan documents--along with detailed guide
books--which permit small businesses to choose a plan type, then tailor that
plan to the specific needs of their businesses.
Other possible methods for reducing start-up costs for small businesses
would be to offer tax credits to cover set-up costs or to enable small firms
to spread costs over the first 3 to 5 years of the plan's existence.
Currently, businesses fully absorb start-up costs of pension plan formation.
This includes both labor overhead costs and expert external assistance. A tax
credit--which would allow businesses to defray plan establishment costs
against corporate taxes--would provide considerable encouragement to small
firms to establish plans.
Another alternative which might prove effective in reducing the burden of
start-up costs would allow small businesses to spread costs over the first
several years of plan operation. The cost analysis showed that start-up costs
were substantial, but on-going maintenance costs of pension plans--which
generally range from $500-$l,500 per year--do not seem to pose a significant
problem to small businesses. If this is the case, the spreading of costs
across several years may effectively reduce cost barriers to setting up plans.
Reduction of costs faced by small businesses in setting up plans may not
be sufficient to increase substantially pension benefit coverage. As Chapter
IV shows, there is considerable concern among small businesses over the
frequent changes in regulations governing pensions. Despite the concern about
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-111-
ever changing regulations, small businesses generally supported regulation and
reporting requirements associated with pensions- -feeling that it was necessary
for the government to monitor plans to protect employees against abuse and to
ensure that benefits are available to participants at the time of retirement.
Constantly changing and increasingly complex rules and regulations
governing pensions are reported to be excessively burdensome and problematic.
These changes are not only costly--some businesses said they had to amend
their plans nearly every year at substantial costs--but also create a
condition of excessive uncertainty about the future. Some smaller
owner-operators were reluctant to set up plans because they were unsure about
the~ impact of future regulatory developments. In fact, about the only thing
they could be sure of was that the rules and regulations would soon be changed
(if the past was any indication of the future).
It seems unlikely that regulations governing pension plans will not
continue to change--e.g., at this time, Congress is again considering another
round of changes in pension laws. One solution to this problem, however,
might be to give already established plans in small firms a longer period to
come into compliance with new regulations. For example, plan sponsors could
be given a three (or five) year period to bring their plans into compliance- -
making it possible for them to make several changes in their plan at one time,
rather than continually amending their plan document.
Finally, during interviews with small employers and actuaries we found
numerous areas where regulations were particularly burdensome, complex and/or
costly for small employers, including:
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-1 12-
* "controlled group requirements" (ERISA Section 210(d) -
Internal Revenue Code, Section 1563(a)) and the "percentage
coverage requirement" (Internal Revenue Code, Section 410(b)),
which affect the ability of small businesses to acquire other
businesses;
* the Multiemployer Pension Plan Amendment Act (MPPAA), PL
96-364, which has imposed withdrawal liabilities that place
heavy burdens on small employers and make it difficult for
owners to sell firms;
* some parts of the Form 5500 (see 1982 Form 5500C), including:
plan assets and investments (Question 15); administrative
expenses (Question 16 and lBc); explanation of when a trustee is
changed (Question 18a); detail on transactions (Question 19a);
and detail on late contributions (Question 2ld);
* the plan termination Form 5310, in particular supplying a
ten-year salary average; when a plan is fully funded and 10 year
cut backs do not apply;
* merger and spinoff rules relating to pensions, which are
excessively complicated and necessitate expert assistance
(Revenue Ruling 81-212 and IRS Regulations 1.40l(a)-12 and
1.414(l)-l; -
* TEFRA sections 240 and 241 which impose limitations on
benefits to owner-operators, which decrease incentives for small
employers to establish plans;
* the suspension of benefits-notice and the requirement that
firms provide retirement information to employees nine months
before they retire (DOL Regulation 2530.203-3 and Revenue Ruling
81-140 and IRS Regulation 1.401(a)-li);
o the requirement of an accountant audit in the case of insured
plans or plans trusteed by a bank (ERISA Section l03(a)3);
* PBGC requirements on non-vested, former employees who have
terminated employment, but who have not yet incurred a break in
service (see definition of active participant on page 6 of 1983
Annual Premium Payment instructions); and
* IRS requirements for approval of a change of funding method
when only minor details of the valuation method or assumptions
have changed (ERISA Section 302(c)(6)).
Further investigation of the impacts of these type requirements on small firms
should be undertaken.
40-046 0 85 - 22
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Health Care Benefits
This study shows that the central issue with respect to health beffef its
in small firms is rising costs. Many of the small employers expressed concern
over the spiraling costs of health benefits in recent years. In response to
these increasing costs--which are estimated at eight to ten percent of pay--we
found that small employers are changing insurance carriers and basic
provisions of plans.
Overall, we found considerably higher rates of health benefit coverage
than pension benefit coverage in small firms. However, higher rates of health
care coverage still existed in larger firms compared to smaller firms. Both
employers and employees regarded health plan coverage as an almost required
benefit--one that is necessary if a firm is to attract and retain workers.
Cost containment was the overriding concern of the employers
interviewed. In recent years, with health care premiums rising rapidly, small
firms have begun to ask serious questions about whether they can afford to
fully cover employees and about the type of coverage they can afford to
offer. Increasingly, firms are instituting the following changes to their
plans:
* they are moving away from high option coverage to standard
coverage;
* employees are being asked to share in the costs of coverage by
making monthly contributions to the cost of coverage;
* employers are adjusting plans to include higher deductibles;
and
* firms are instituting co-insurance features, under which the
employee pays some percentage of claims (e.g., 20% of cost above
a certain level).
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In general, employers have attempted to shift the costs of health coverage to
employees--both to make them aware of cost increases and to help in meeting
costs. Whether these measures will prove effective in curbing cost increases
is still uncertain.
While cost containment is clearly the central issue facing small
employers, small employers also noted several other important issues. One
issue of concern is that smaller firms generally face higher premiums than
larger firms because they are unable to pool risk across as many employees.
In addition, if smaller firms have very high claims from several individuals
during a given year, they face potentially precipitous increases in the
upcoming year's premium. Larger firms, because they are able to pool risk
spread costs across greater number of employees, are able to avoid these
fluctuations in premiums. In addition, very small firms may find that they
face a more restrictive set of choices in establishing benefits. Again, this
is due to their inability to effectively pool risk. One way in which some
small firms have countered these problems of costs and insurance availability
is by joining small business organizations--~hich, in turn negotiate health
care plans to cover their membership. By doing this, small business pool risk
across employees in other small firms.
Finally, firms expressed some concern over administrative costs involved
in processing claims. Small employers in4icated that they could not afford
the overhead costs involved in processing employee claims (as larger firms
might be able to do). In response to this problem, small firms have selected
plans with simplified claims procedures--under which the employee c9mpletes
the claim forms and submits it directly to the insurance carrier.
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APPENDIX A
ON-SITE CASE STUDIES OF THREE SMALL BUSINESSES
INTRODUCTION
In on-site case studies of three small businesses, we examined closely
the administrative practices, costs, and effects of regulations on pensionand
health care plans. In these case studies, we placed particular attenti6n on
the activities and costs involved in setting up and maintaining benefit
plans. We then used the findings from these case studies to supplement and
extend the aggregate data analysis.
Using the Greater Cleveland Gro~rth Association--a business organization
located in the Cleveland, Ohio area- -we selected three firms for case
studies. Thesethree firms were not intended to be random or fully
representative of small businesses. In fact, we selected firms with different
types of plans, different reasons for establishment of plans, varying
administrative practices, and in different types of businesses.
Firm A is a small manufacturer of steel wire with about 15 employees,
which set up a defined benefit plan in 1978. The Owner-operator, who manages
the plan assets, utilizes a financial planning service to administer the plan.
Firm B is a small moving and rigging firm, which employs 20 salaried
management employees and up to 75 union employees. This firm established a
profit sharing plan in 1981 for its management employees, and makes
contributions to various pension plans set up for its union employees (e.g.,
Teamsters, Iron Workers, Operating Engineers and Millwrights). The firm
relies extensively upon an outside plan administrator (a local bank) to file
all forms and make investment recommendations.
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335
A-2
Firm C is a real estate developer with about 20 employees. This small
firm has a profit sharing plan which was established in 1973 and revised in
1977. The firm's president and a management employee are responsible for both
plan administration and investment decisions.
We conducted interviews with the presidents of Firms A and B and the plan
administrator of Firm C. A series of pre-planned questions, which appear in
Exhibit A-l, were used to guide these discussions. However, considerable
flexibility was permitted in the flow of conversations. We paid particular
attention (and time) to pension discussions because of the complexity of
pension regulations and administrative practices. In our interviews, we
placed substantial emphasis on the impact of regulations on (1) the decision
to offer plans and (2) the ongoing costs of the plans and any special problems.
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A-3
EXHIBIT A-i
DISCUSSION GUIDE FOR
ON-SITE CASE STUDIES
Pension Plan Questions
1. What type of pension plan do you have?
- Are all of your employees eligible for the plan?
- Is there a minimum age or service requirement?
- What is your vesting provision?
2. When did your plan go into effect?
3. How long did it take your firm to set up the plan?
4. What major steps did your firm go through in originally setting up the
plan?
5. Which of these steps was most burdensome? Why?
6. Who in your firm was involved in setting up the plan?
7. Who outside your firm was involved in setting up the plan?
8. What other costs were involved in setting up the plan?
9. Why did you select the type of plan that you did?
10. Did government regulation affect your decisions with regard to setting up
a plan? How?
11. Did government regulation impose any additional costs or burdens in your
firm when you were setting up your plan?
12. Who at your firm is involved in the on-going administration of your
pension plan?
13. Who outside your firm is involved in the on-going administration of your
pension plan?
14. What other costs are involved in the on-going administration of your
pension plan?
15. Over the course of a calendar year, what are the major activities
involved in administering the plan?
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A-4
EXHIBIT A-i
(Continued)
DISCUSSION GUIDE FOR
ON-SITE CASE STUDIES
16. What are the most burdensome aspects of the day-to-day management of the
pension plan?
17. What forms does your firm complete to report on your pension plan?
18. Which forms (or parts of forms) are the most burdensome to complete?
19. Does government regulation affect on-going costs of administering plans?
How? What is the most burdensome aspect of this regulation?
20. If you could change any one thing about pension plan administration, what
would it be?
Health Plan Questions
1. What type of health care coverage do you have?
2. Who at your firm was involved in setting up th8 plan? Did you receive
any outside assistance in setting up the plan?
3. What was the most burdensome aspect of setting up the plan?
4. Have you recently changed the type of coverage that you offer your
employees? If yes, why?
5. Who at your firm is involved in on-going administration of your health
plan? Does your firm receive any outside assistance in administering the
plan?
6. What are the most burdensome aspects of the day-to-day administration of
your plan? Does government regulation impose any burdens?
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CASE STUDY: FIRM A
Description of Firm A
Firm A is a small, owner-operated manufacturer of steel wire with about
15 employees. This firm was established in 1974. We interviewed the firm's
president, who set up the plan and currently manages its investments.
Description of the Pension Plan
Firm A has an integrated defined benefit plan. Currently, the firm's
annual contributions are approximately five percent of pay. The plan was
initiated in 1978, in the fourth year of the company's operation. The pension
benefit at retirement is 23.5 percent of compensation under social security
covered compensation plus 33 percent of the excess compensation. The plan is
funded completely by a trust fund,. with no life insurance involved.
Eligibility for plan participation is 25 years of age and one year of service
(where one year of service is defined by the 1,000 hours rule). The plan uses
graded vesting starting at 25 percent after five years of service, grading to
50 percent after 10 years, and 100 percent after 15 years of service. Early
retirement is permitted at age 60 with 15 years of service. Exhibit A-2
summarizes the plan characteristics.
Formation of the Pension Plan
Establishment of the Plan
The plan was established at the time of company incorporation (1978),
four years after the company was established by the owner-operator. According
to the company's president, who made the decision to establish the plan, the
plan was initiated for three major reasons:
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A-6
EXHIBIT A-2
PENSION PLAN CHARACTERISTICS OF FIRM A
Number of Employees 15
Product Manufacturing of Steel
Wire
Year Firm Established 1974
Type of Plan Defined Benefit
Single vs. Multiemployer Single
Reason for Selection of Particular Plan Defined benefit plan
provides a more
substantial retirement
benefit to the
owner-operator.
Type of Employee Eligibility All Employees
Minimum Age Requirements (Years) 25
Minimum Service Requirement (Years) 1
Vesting 25% after 5 years
50% after 10 years
100% after 15 years
Social Security Integration Yes
Supplemental Plans No
Early Retirement Yes
Earliest Age/Service 60 years old/15 years
Loan/Withdrawal Yes
Investments Stocks, Bonds, Money
Markets
Payment of Benefits Directly from Fund
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(1) The owner-operator wanted to provide protection for himself and his
employees in case catastrophic circumstances led to company
bankruptcy at some future time.
(2) The owner-operator (age 48) and most employees (in their 30's) were
approaching ages at which they felt it was important to start
setting aside funds for a pension plan.
(3) The company was then sufficiently profitable to set aside funds for
the pension plan and the owner-operator was aware of the tax
advantages of initiating a plan.
This firm initiated a defined benefit plan at the time of company
incorporation in 1978, four years after the firm was established. At the time
of formation, the firm had been profitable for several years. In response to
this profitability, the owner-operator commissioned a financial planning firm
to do a study on all aspects of the company's operations. One recommendation
that emerged from this study was that the firm establish a pension plan.
The financial planning firm reviewed the major types of plap options with
the owner-operator. On the recommendation of the fitlancial advisor, the
owner-operator selected a defined benefit plan because this plan would provide
him with a mor substantial retirement benefit than a defined contribution
plan.
Once the type of plan was selected, the financial planning advisor
developed a proposed plan document, which incorporated the major features
selected by the owner-operator. After the company's attorney reviewed the
plan document, Firm A adopted the plan. The financial advisor made a formal
actuarial valuation and determined the size of the initial contribution. The
plan document was then filed with the Internal Revenue Service. The
owner-operator estimated that this entire plan formation process was completed
over a 6-8 month period.
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A-8
Impact of Regulations on the Plan Formation
Pension plan regulations were not a particular problem or obstacle to the
owner-operator because he was only given choices by the pension consultant who
assisted in setting up the plan that satisfied the regulations. However,
government regulation clearly affected the owner-operator's decision to form a
pension plan and the type of plan he selected. For example, ~the owner stated
that favorable tax regulations- -under which his firm could avoid corporate
taxes and employees could defer personal income tax on payments made to their
pension--clearly affected the decision to form a plan. In addition, the owner
noted that regulations governing corporate bankruptcy- -which insured that
employees would receive pension benefits even if the firm went bankrupt--made
establishment of a pension plan attractive. He had seen other owner-operators
who had not established a plan, left with very little retirement income when
their businesses failed as they approached retirement age.
Costs of Plan Formation
Within the firm, the owner-operator was the only employee directly
involved in setting up the plan. Prior to plan initiation, numerous meetings
with insurance agents made him aware of the complexities and many of the
problems involved in setting up a retirement plan. When a management study
recommending the plan was initiated, he spent an estimated 6-8 hours reviewing
the study and the pension consultant's recommendations.
External to the firm, the owner-operator utilized financial planning,
legal, and actuarial services. The initial management study, conducted by a
financial planning firm, cost $700. This study included drafting a pension
plan document. The company's attorney reviewed the pension plan document at
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A-9
an estimated cost of a few hundred dollars. The initial actuarial valuation
and determination of firm contribu4on cost $350. Hence, expert assistance in
setting up the plan was in the $l,000-l,500 range.
The owner-operator expressed concern over the administrative costs
involved in setting up a plan, which he felt were a higher percentage of annual
contributions for small firms than large firms. In addition, he felt that
larger firms were more likely than smaller firms to have staff with expertise
to assist in the steps of setting up a pension plan. He thought that small
firms, like his own, generally needed to purchase "high priced advice" in
order to establish a plan.
Problems in Plan Formation
The greatest problem the owner-operator faced in setting up the plan was
conflicting advice offered by insurance agents. He commented that he was
"disconcerted by conflicting advice" offered by these agents. In addition,
the owner-operator felt uncomfortable being in an area of unfamiliarity- -
doubting that he could "make a good business decision" as he might make in
other operational areas. He also stated that he "feared locking into one type
of plan that would be unfavorable over the long term".
Ongoing Administration of the Pension Plan
Administrative Activities
Within the firm, the owner-operator performs the following administrative
tasks:
* decision making concerning investment of pension plan assets
(in consultation with his stockbroker);
* coordination of activities of the plan administrator;
* notification to the plan administrator about changes in
employee status;
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A-b
compilation of statistical data for the plan administrator to
prepare the Form 5500. He did not characterize these activities
as particularly burdensome or time-consuming.
Initially, he had some difficulty understanding regulations and reporting
requirements, but after a year he found on-going plan administration fairly
"cut and dried". A secretary assists him with typing and other clerical tasks.
An actuarial firm acts as the plan administrator. This firm values the
plan and estimates the required firm contributions. It also prepares employee
benefit statements, the Form 5500C, and other filings. A stockbroker advises
the owner-operator on investments at no charge. Use of legal and accounting
services to resolve problems has been negligible in recent years.
Administrative Costs
The owner-operator spends an estimated eight hours per year administering
the plan--most of which is spent on making investment decisions. He noted
that only the tangible cost of on-going plan administration is an actuarial
fee--which was initially $300 per year, but recently increased to $600 per
year. This fee represented 5.4 percent of the annual contribution to the fund
($11,000). This fee covers preparation of the valuation to determine firm
contributions as well as the preparation of employee benefit statements and
forms. The owner-operator noted that, in the past, he had also incurred
indirect costs in reviewing potential impacts of changed pension regulations,
such as TEFRA.
Impact of Regulation on Plan Administration
The impact of regulations and reporting is not fully apparent to this
owner-operator because most of the on-going administration is done by an
actuarial firm. At one time, the owner-operator completed the Form 5500, but
found it burdensome--particularly the portion relating to assets. Now, the
plan administrator fills out the Form 5500. Overall, the owner-operator does
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not object to the concept of the Form 5500 and other reporting requirements,
he only objects to unnecessary detail and the ordering of questions on the
forms.
Problems in Plan Administration
The owner-operator stated that a small firm with a pension plan could
face problems in acquiring another firm because of the "controlled group
requirements". These requirements may force that company to provide a pension
plan to employees in another purchased firm even though the profitability of
this newly acquired firm may not be sufficient to sustain the pension plan.
Potential buyers who do not have a pension plan are at a competitive advantage
because they are not required to provide a pension plan for the employees of
the purchased firm. The owner-operator stated that his firm had recently
faced this problem when they tried to acquire another firm.
The impact of this situation appears to be greater on a small firm than a
large firm because of the IRS's anti-discrimination rules on plan coverage.
For example, a company with 10,000 employees can purchase a small firm with 10
employees and not have to provide that acquired firm with a pension plan
because of the "percent coverage requirements". Under this provision, 70
percent or more of all employees, exclusive of short service, seasonal and
part-time employees, must be covered or at least 70 percent of the employees,
similarly defined must be eligible for coverage under the plan and at least 80
percent of all eligible employees must actively participate. A company with
20 employees could not meet participation requirements if they acquired this
same firm (with 10 employees) without including the employees in their pension
plan.
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The owner-operator also thought that it was important to have TEFRA's
"top heavy" restriction, but that this requirement may lead to unnecessary,
premature plan terminations both as a result of increased administrative costs
and the adverse impact on the owner-operator.
The owner-operator suggested changes in the Form 5500 that would enable
firms to complete the form without outside expert advice. Also, he stated
that while it was important to protect employees against employers who would
abuse their pension plan, that these protections should not penalize employers
who are not out to abuse the plan.
Health Plan Characteristics and Problems
For the first three years of the company's operation, health coverage was
provided on an individual policy basis--covering primarily catastrophic
illness. During the third year, a group comprehensive health coverage plan
was purchased. The insurance company underwriting this plan required purchase
of life insurance at the same time. This plan has a $100 deductible and 20
percent co-insurance.
This plan has a simplified claims administration package. Insured
employees fill out a form at the time of each claim, which is submitted
directly to the insurance underwriter. The cost of coverage for each employee
is about $1,500 per year, which represents about eight percent of pay. This
cost, however, includes both health and life insurance. Cost of health
insurance is estimated at seven percent of pay. The company has no long term
accident or disability coverage.
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A-13
CASE STUDY: FIRM B
Description of the Firm
Firm B is a moving and rigging company which employs 20 salaried
management employees and up to 75 union employees. The firm was established
in the 1870's. Prior to 1976, company employees were covered under union
pension plans (primarily the Teamster's plan). During the period from 1976 to
1981, several union employees moved into management positions. In 1981,
business considerations (not relating to the pension plan) caused these
salaried management employees to withdraw from their respective unions. We
interviewed the president of the firm, who holds no stock in the firm, but who
makes decisions regarding the benefit- plans and who was one of the employees
responsible for setting up the pension and health care plans.
Description of the Pension Plan
Nonunion employees of Firm B are covered by a profit sharing plan, for
which a formula percent of pay (0-15 percent) based on profits in excess of a
threshhold (approximately $200,000) are distributed each year. Although the
plan was established in 1981, only one distribution has been made. The plan
uses a "5-15" graded vesting schedule. Union employees are covered by several
multiemployer plans, including Operating Engineers, Iron Workers, Teamsters,
and Millwrights. Although regular contributions are made to these union plans
on a cents per hour basis, the firm's management had little knowledge of the
specific characteristics of these plans. Exhibit A-3 summarizes the major
characteristics of Firm B's pension plans.
Formation of the Pension Plan
Establishment of the Plan
The non-union profit sharing plan was established in 1981, when several
key employees moved into management positions and withdrew from their
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A- 14
EXHIBIT A-3
PENSION PLAN CHARACTERISTICS OF FIRM B
Plan A Plan B
Number of Employees 20 75
Product Moving and Rigging Moving and Rigging
Year Firm Established 1870's 1870's
Type of Plan Profit Sharing Several Multieznployer
Union Plans
Single vs. Multiemployer Single Multiemployer
Reason for Selection of Permitted distribution Negotiated by various
Particular Plan of firm profits to unions, including
employees; to avoid TeamsterS, Operating
making payment to Fund Engineers, Iron
when firm was not Workers, and Mill-
profitable wrights
Type of Employee Non-Union Employees Union Employees
Eligibility
Minimum Age Requirement None Varies by plan
(Years)
Minimum Service Require- None Varies by plan
ments (Years)
Vesting 33% after 5 years Varies by plan
100% after 15 years Varies by plan
Social Security No Varies by plan
Integration
Supplemental Plans No N.A.
Early Retirement N.A. Varies by plan
Earliest Age N.A. Varies by plan
Loan/Withdrawal Yes Varies by plan
Investments Stocks, Bonds Varies by plan
Payment of Benefits N.A. Varies by plan
I 4O~~O46 0 - 85 - 23
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A-15
respective unions (primarily the Teamster's Union). This plan was set up to
provide pension benefits for nonunion employees, who no longer were covered by
union retirement plans. At the time of plan formation, the overriding concern
was to provide coverage to non-union employees. Tax benefits for the firm and
employees, while important, were a secondary consideration.
A profit sharing plan was selected to avoid having to pay pension
benefits when the company was not profitable. This type of plan was desired
over a defined benefit plan because it did not require a contribution in years
when profits were below a threshhold. In addition, a profit sharing pian was
desired (rather than a bonus plan) because it permitted a distribution of
profits to employees that would be set aside for the employees' retirement.
Company profits distributed through a bonus plan would be subject to immediate
taxation, while profits placed into a pension plan would be subject to
taxation in the future (at a lower tax rate in all probability).
The plan was set up over a six to eight month period. The president and
two management employees (who eventually became plan trustees) met with a
pension lawyer from the company's law firm. It was estimated that six to
eight meetings were held with this lawyer, during which the lawyer provided
advice about possible plan provisions and projections of costs.
Impact of Regulations on Plan Formation
While regulation was not a significant problem or barrier to setting up
the profit sharing plan, it affected the decision to offer benefits, the type
of plan selected, and the costs of establishing the plan. In response to a
question as to whether pension regulations had been a problem in forming a
plan, the president stated that it had not been because the attorney hired to
establish the plan only set forth choices that met current regulations. The
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A- 16
complexity and frequent changes in regulations governing pension plans meant
that it was necessary for the firm to hire an attorney with expertise in
formation of private pensions. This attorney guided the president and several
management employees through the process of setting up the plan--proposing
various options and eventually writing the plan document.
Motivation for plan establishment was to a large extent a function of tax
benef its accrued to the firm and the employees. For example, the profit
sharing plan proved to be an effective mechanism for distributing company
profits to avoid corporate taxes, as well as to enable employees to defer
taxation on the contributions.
Costs of Plan Formation
Within the firm, four employees--the president, a payroll officer, and
two management employees--were involved in setting up the plan. The president.
and the two management employees had numerous (6-8) meetings with the
company's lawyer to discuss plan options. A payroll officer provided
necessary statistical information to the lawyer for projections of the plan
cost over the upcoming years.
Outside the firm, a pension attorney was extensively involved in setting
up the plan. It is estimated that he provided between 75 and 100 hours of
consultation (at a cost under $10,000). In addition, a local bank was
involved in setting up an account for the plan (at no cost to the firm).
Problems in Plan Formation
The most burdensome aspect of setting up the pension plan from the
president'spoint of view was understanding the many complex options
available. The president noted that it was necessary for a small firm to seek
costly, expert advice in order to set up a plan.
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A-17
Ongoing Administration of the Pension Plan
Administrative Activities
Since there has been only one distribution since plan formation in 1981,
and the five years required for vesting has not elapsed, the need for plan
administration has been slight. In general, the company does not (by choice)
take an active role in plan administration or investment decisions within the
firm.
The president estimated that plan trustees spend only several hours per
year reviewing investment decisions. The president and two other plan
trustees are occasionally involved in the approval of investment decisions by
the plan administrator (which is a local bank). The president preferred to
have a third party handle investment decisions because he did not have adequate
time to make good investment decisions and felt. that the "clear hindsight" of
participants makes even good investment decisions look bad.
Also, within the firm, a payroll officer provides the plan administrator
with payroll data (W-2 and related data) for the profit sharing distribution
and Form 5500.
The firm relies extensively upon a local bank to administer the plan and
make investment recommendations. This bank files all reporting forms,
including the Form 5500. Because there has been only one profit sharing
distribution and employees are not yet vested, there has been little need to
\4~scuss problems of on-going administration with the company's attorney.
Hence, nearly all major on-going administrative activities, except for final
decisions on investments, are delegated to the plan administrator (i.e., a
local bank).
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Administrative Costs
Since plan initiation, on-going administrative costs to the firms have
been negligible. It is estimated that less than 10 hours of company time is
spent on administration. As discussed above, the president and trustees
approve investment recommendations and a payroll officer provides necessary
data to the plan administrator. The plan administrator (i.e., a local bank)
charges a one-half of one percent per year investment fee, which covers the
cost of on-going administrative services (such as filling out the Form 5500).
The president estimated that consultation with the company attorney has been
less than two hours per year.
Impact of Regulation on Plan Administration
The president stated that his firm had not experienced difficulty with
the profit sharing plan for nonunion employees because the. plan was just two
years old and was administered by a local bank. However, for the various
multiemployer plans (covering the firm's union employees), he noted problems
in keeping up with ERISA regulations and the Multiemployer Pension Plan
Amendment Act (MPPAA). Because all reporting forms (e.g., Form 5500) are
completed by the plan administrator, he did not report any problems with
government forms.
Problems in Plan Administration
The president of the firm noted that regulations governing multiemployer
plans (i. e., the Multiemployer Pens ion Plan Amendment Act) had contributed
significantly to the failure of between 20-60 small trucking firms in the
Northeastern Ohio area. He also stated that MPPAA regulations had undermined
the formation of new trucking firms: he referred to regulations governing
multiemployer plans as "the single most significant impediment to the
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A-19
formation of small trucking businesses". He stressed that the financial
security of many owners of small firms had been undermined by MPPAA in that
owners who had built firms over many years were unable to sell their
businesses because of substantial increases in liability legislated by MPPAA.
Overall, he agreed with the concept of pension plan regulation, but
objected to having liabilities imposed "midstream" by government legislation
and regulation (particularly in reference to the MPPAA). For example,
companies, such as his own, negotiated with unions on a "cents per hour" basis
for plan contributions. The imposition of additional, undefined pension
liabilities (mandated by ERISA and the MPPAA) after these agreements had been
negotiated made it impossible to accurately bid contracts.
Health Plan Characteristics and Problems
The firm's president was keenly aware of increased health care costs. He
recently changed coverage from Blue Cross/Blue Shield to an insurance company
plan because of the increasing cost of coverage. He thought that employees
needed to share in the cost of coverage for health care costs to be brought
under control. Hence, he favored higher deductibles and co-insurance
provisions, which made the employees aware of the cost of health care. He
felt that there should be a social insurance which would spread the risk
associated with medical coverage. For example, he objected to insurance
companies charging higher rates to firms with higher claims costs.
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CASE STUDY: FIRM C
Description of the Firm
Firm C is a real estate developer, with approximately 20 employees. This
owner-operated establishment was purchased in 1959. We interviewed the
in-house plan administrator, who completes all forms and manages the plan.
Description of the Pension Plan
Firm C has a profit sharing plan, under which the employer's contribution
is entirely at the discretion of the company. There has been no contribution
in the last two years. Prior to that, since plan inception in 1973, an annual
distribution of 15 percent of compensation was made. Employees may also
contribute up to 10 percent of their compensation to the plan. Administrative
expenses and trustee's fees are paid by the emplQyer. Both investment and
certain legal expenses are paid out of the fund. Employees become
participants in the plan on the anniversary or half anniversary after
completing one year of service (based on the 1,000 hours rule). Vesting is
graded, starting at 10 percent after one year and increasing by 10 percent per
year. Under this schedule, employees become 100 percent vested after 10 years
of service. Upon demonstration of need and approval of the trustees,
employees may borrow against the vested portion of their account at the
prevailing interest rate. Exhibit A-4 summarizes the characteristics of Firm
C's pension plan.
Formation of the Pension Plan
The plan was established in 1973, when the firm had 12 employees. No
further information was available on the formation of the plan because
employees responsible for setting up the plan were no longer with the firm.
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EXHIBIT A-4
PENSION PLAN CHARACTERISTICS OF FIRM C
Number of Employees 20
Product . Real Estate Developer
Year Firm Established 1959
Type of Plan Profit Sharing
Single vs. Multiemployer Single
Reason for Selection of Particular Plan N.A.
Type of Employee Eligibility All Employees
Minimum Age Requirements (Years) None
Minimum Service Requirement (Years) 1
Vesting 10% after 1 year
100% .after 10 years
Social Security Integration No
Supplemental Plans No
Early Retirement N.A.
Earliest Age N.A.
Loan/Withdrawal Yes
Investments Bank Account
Payment of Benefits N.A.
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On-Going Administration of the Pension Plan
Administrative Activities
Within the firm, the president, a plan administrator, and secretary are
involved in on-going administration of the plan. The president makes
investment decisions, determines the size of the annual contribution (if any),
and makes decisions concerning loans/withdrawals from the plan. The plan
administrator calculates the annual allocation, completes the Form 5500,
oversees loans/withdrawals, and completes W-2 forms (when necessary) at the
end of each year. The secretary provides some. assistance"typing up the Form
5500, W-2 forms, and payroll data.
External to the firm, an accountant and lawyer occasionally review loans/
withdrawals and other special situations.
AdministratiVe Costs
The owner-operator spends an estimated 6-8 hours per year making
investment, distribution, and other types of decisions. The plan
administrator estimated that he spends:
* six hours per month making deposits and allocations;
* twenty hours per year completing the Form 5500 and performing
related calculations;
* seven hours per year filling out necessary W-2 forms and
detailing pension allocations for each employee;
* several hours, from time-to-time, administering loans and
withdrawals.
During these tasks, he is assisted by a secretary who spends less than eight
hours per year.
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Legal and accounting fees are each about $200 per year. The plan
administrator indicated that he contacted the firm lawyer and accountant 6-8
times per year about administrative problems and special circumstances, such
as withdrawals, loans, enrollment of new employees and changes in regulations.
Certain tasks were performed- -particularly related to generating the Form
5500--on one of the company's small business computers (TRS-80, Model II using
the VISICALC program). The plan administrator noted that Section 15 of Form
5500C, which covers assets and investments, accounted for a disproportionate
amount of the time spent on completing this form.
Impact of Regulation
The plan administrator indicated that Section 15 of Form 5500C was
excessively burdensome. He felt that some of the burden of reporting is
necessary for the protection of employees. He noted that the development of
the Form 5500R was a significant improvement over the Form 5500C. Because
there have been no contributions over the past 2 years, TEFRA has had no
impact. The plan administrator felt that ERISA was "long overdue" and that
"policing" of private pension plans was a necessity.
Problems in Plan Administration
The plan administrator identified plan investments as a major problem
area. He felt the company was too small (and busy) to have anyone in the firm
providing well-informed investment advice and that the size of the pension
fund was too small to justify hiring outside investment advice. As a result,
he feared that some investment opportunities were missed.
Health Plan Characteristics and Problems
Because of rising health care premiums, the firm recently solicited bids
for new health care coverage. This resulted in the replacement of a large
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insurance carrier by a small insurance carrier. The plan administrator noted
that employees occasionally experienced difficulties and delays during
hospital admission procedures because hospital administrators were not
familiar with the coverage of this small insurer. Because hospitals were
unsure of the extent of coverage under his firm's carrier, he said that his
employees were sometimes required to submit proof of ability to pay costs
prior to admission.
The plan administrator noted that there was very little government
regulation or reporting requirements related to health care plans. He
indicated that while his firm faced little paperwork or reporting with regard
to its health plan, employees occasionally complained of the difficulty of
having claims processed and confusion over types of treatment covered.
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APPENDIX B
TWO CASE STUDIES OF ACTUARIAL CONSULTANTS
INTRODUCTION
In these two case studies we examined the types of administrative
services provided to small firms by plan consultants and administrators. We
conducted these interviews because so many small businesses have outside
actuarial consultants and plan administrators. These consultants and
administrators are uniquely well qualified to discuss the problems faced by
small businesses in establishing and administering plans.
We emphasized the identification of the extent and types of services
performed during plan formation and on-going administration by independent
consultants. In addition, we interviewed consultants about the effects of
regulation and special problems that small firms may face in setting up or
administering plans. We interviewed representatives of two Washington area
actuarial firms.
CASE STUDY A
Description of the Firm and Its Clients
This firm is a small actuarial consulting firm originally set up to serve
the clients of an insurance agency, but which now serves approximately 800
pension and profit sharing plans. About 750 of these plans have under 100
participants. Over 500 have less than five participants, in many cases
covering incorporated professionals (often doctors). The firm has installed
approximately 150 plans in the past few years, of which over 115 have fewer
than five employees. We interviewed two enrolled actuaries: One is the
president of the firm and the other has the primary responsibility for all
plan administration done by the firm.
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B-2
Description of Pension Plans Administered
Most plans administered by this firm are defined benefit plans. However,
they also administer a large number of profit sharing and other defined
contribution plans. Although only defined benefit plans require the use of an
enrolled actuary, an equally important reason that this firm has so many
defined benefit plans is that this type of plan gives a more substantial
benefit to the key employees of professional firms and other corporations who
are responsible for setting up the plans. This firm provides a full range of
administrative services for most plans that it works on. However, in some
cases, the accountant for the plan sponsor does the Form 5500 and other
administration.
Formation of Pension Plans
Establishment of the Plans
The two interviewees indicated that typically a client establishes a
pension plan when the firm becomes sufficiently profitable for the owner to
become concerned about the impact of taxes on company profits. This is
particularly the case when company profits are passed onto the owner-operator
as earned income. Plan formation frequently occurs several years after firm
establishment--often at the time of incorporation. In fact, in the case of
many small professional firms, a primary reason for incorporation is to
establish a pension plan.
The interviewees have found that the initial impetus for formation of a
retirement plan usually comes from an advisor on financial matters--e.g., a
financial planner, accountant, insurance agent or attorney. They noted the
primary reasons for plan establishment include (in approximate order of
importance):
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* avoidance of corporate taxes on profits, as well as tax
deferral for the owner-operator and employees;
* desire of the owner to provide for his own personal retirement;
* desire of the firm to provide retirement benefits for
employees; and
* desire of the firm to reward long service employees.
The decision about the type of plan to establish is often closely related
to the age of the owner. Plans set up by owners under 35 years of age are
generally some form of defined contribution plan. This type of plan gives a
young owner a more substantial contribution than he would receive under a
defined benefit plan. This type of plan is usually integrated with social
security. For owners over the age of 35, an integrated defined benefit plan
is often more beneficial. This is especially the case for a married owner who
sets up his benefits based on assumed retirement at age 55 with a joint and
survivor option in effect.
The actuaries felt that there-is no fixed order of events involved in
setting up plans, but indicated a pattern that roughly exists:
* a firm recognizes that a tax problem exists (often as the
result of financial advice);
* discussions are conducted between the owner and an advisor to
develop basic criteria and an outline of the type of plan
desired;
* the advisor reviews a few numerical examples, including an
actuarial valuation or valuations for the types of plan(s) under
consideration;
* there is a formalizing of the plan (deciding on the details);
* the plan document is written;
* an initial formal actuarial valuation and company contribution
is calculated; and
* the initial contribution is made and the formal plan is filed
with the IRS.
PAGENO="0367"
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Impact of Regulations on Plan Formation
The interviewed actuaries felt that there were three areas of regulations
that affected choices made at time of plan formation. First, and most
important, were tax regulations. Generally, clients were-interested in having
the type of plan that gave them the greatest tax shelter. Second, were PBGC
regulations relating to the potential 30 percent of net worth liability that
could be imposed in the case of plan termination. Finally, other ERISA
regulations affected terms and characteristics of plans though were only a
secondary concern because plan advisors did not offer options that failed to
meet ERISA standards. For example, some clients asked for less generous
vesting schedules or stricter participation standards or other options not
permitted by ERISA. In these cases, the actuary simply stated that these
options were not permitted. For small plans, especially those for doctors,
Section 415 of the Internal Revenue Code which limits benefits and
contributions is a major concern. This has become an even greater concern now
that TEFRA has further restricted these limits. TEFRA's "top-heavy" rules are
also a consideration.
Costs of Plan Formation
Generally the owner, an actuary, and an attorney are involved in setting
up a plan. In addition, an accountant or other financial advisor may be
involved. An attorney usually draws up the plan document, though, in some
cases, an actuary may execute this task and a lawyer will review the plan
document.
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B-5
The interviewees estimate that- -depending upon services performed and the
complexity of the plan established and the number of employees (thus the
number of calculations involved)--actuarial fees to set up most plans range
from about $500 to $2,500. Legal fees generally range from $1,500 to $2,200.
Hence, total costs range from about $2,000-$4,700.
The actuary felt that costs on a per participant basis were definitely
higher for small plans. It costs essentially the same amount to set up a plan
for two or three persons asit does to set up a plan for 100 persons.
However, they noted that perhaps the important measure is cost per firm. That
remains roughly the same whether the firm has 2 or 10 employees.
Problems in Plan Formation
The interviewed actuaries cited two problems relating to plan formation.
First, they stated that there is no room for modification of standard plans
approved by the IRS. In one example, a standard IRS plan was used as the plan
document except that there was a minor change in vesting in the case of
disability. In this case, the entire plan document had to be filed and
reviewed by the IRS before the plan could be approved. These consultants
thought that it would have made sense and saved the client and the IRS
substantial time and expense if the one sentence that had been changed could
have been filed. They also thought that it would make even more sense to have
some flexible pre-approved plans available.
The two consultants identified TEFRA "top-heavy" rule and 415 limits as
substantial problems. These regulations are designed to specifically address
small plans to a greater extent than larger plans. However, the TEFRA imposed
limits are made even more burdensome because the intent of Congress is not
completely clear. The time involved in administering these new rules is a
burden on both the firm and the plan administrator.
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Ongoing Administration
Administrative Activities
This actuarial firm performs ongoing administration for most of its
clients. In some cases, a client's accountant fills out the Form 5500 and
related filings. Also, a client may rely on its lawyer to periodically review
pension matters and unusual circumstances.
Administrative activities vary somewhat depending on the needs of each
client. However, the following steps provide an approximate summary of major
on-going administrative tasks.
(1) If there is some discretion permitted in the employer's
contribution, the owner-operator (or other management employee)
contacts the actuary to provide statistical information.
(2) This data--on salary levels, company earnings, etc.,--is used to
develop preliminary projections of maximum and minimum contribution
levels.
(3) These projections are used to determine the split in distribution
levels between bonus and pension plans.
(4) After the board decides on the split, formal census and accounting
information is sent to the actuary.
(5) The actuary per~forms the formal valuation, fills out Form 5500 and
any related informatIOn, and provides information for individual
benefit statements.
(6) The actuary sends copies of these to the client, his attorney, and
in some cases, his accountant.
(7) Finally, the client reviews the information, makes any needed
contributions, and files the forms.
Administrative Costs
Annual administration for small plans is generally limited to the year
end processing (discussed above) relating to the annual contribution. The
actuarial firm does most of this. Annual fees are approximately $500
depending on plan complexity either in terms of plan provisions or number of
40-046 0 - 85 - 24
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lives. It was estimated that the client, including the firm's lawyer, would
not have to spend more than three of four hours each per year on pension
matters.
Other normal ongoing expenses related to participant loans, vested
benefit calculations for terminating employees, and retirement, death or other
benefit calculations. The time and cost involved in these tasks is
minimal--under a few hours per year by the client and less than a few hundred
dollars worth of the consultant's time. Except possibly for loans, these
transactions are infrequent. Often, no benefit payments occur in a given year.
Unusual events can increase pension ongoing administrative costs
considerably. Changes in regulations or legislation and changes in the
company make-up cause added administrative expenses. The actuary involved in
administration had been with an insurance company at the time when initial
ERISA regulations were enacted. She estimated that the administrative cost of
changing the plan to comply with ERISA was approximately $1,500 per plan. In
addition, the insurance company had to spend 50 to 60 hours to change its
prototypes to bring them into compliance with ERISA.. This represented an
indirect cost on top of the estimated $1,500 per plan. Changes in ERISA
regulations and tax laws in recent years have caused additional plan expenses
both in actuarial fees for plan administration and in legal fees relating to
document amendments. For example, changes in laws and regulations affecting
pensions have occurred in each of the last four years, causing some plans to
have to make amendments each year.
Another costly, unusual event is a merger or spin off. If small companies
which merge do not have the same type of pension plan, a comparability study
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showing that benefits are nondiscriminatory has to be performed and a decision
has to be made as to how plans will be changed to permit the merger. Asset
allocation calculations are required in the case of a spin off of a defined
benefit plan.
Impact of Regulations on Plan Administration
The two interviewed actuaries indicated that their clients' experience no
major difficulties with regular on-going administration as a result of
regulations since the actuarial firm fills out most forms such as the Form
5500. However, as discussed above, the actuaries indicated that frequent
changes in laws and regulations during the past ten years has added to the
costs of administering a pension plan. They also indicated the following
problems with Form 5500:
Question 15 - requires unnecessary detail. particularly questions
relating to the percentage of plan assets and diversity of
investments may have meaning for a larger plan but not for
a small plan.
Question 16i and l&c - are ambiguous in the case of a plan for which the
sponsor pays all administrative expenses outside of the
fund. What the employer pays for administration over and
above his pension contribution is irrelevant information.
Question l8a - request for an explanation of what a trustee, etc., was
charged are unclear as to what type of explanation is
needed.
Question l9a - requests detail on transactions which is unnecessary. If
a plan abides by regulations relating to loans, having
detail on all of the trivial transactions involved in
loans causes an excessive amount of administration,
especially for loans that are no longer outstanding. One
plan filed a Form 5500C every three years. Although it
had only four lives covered under the plan, numerous loans
over that three year period of duration of less than six
months meant that records had to be obtained on over 25
loans, most of which were no longer outstanding at the
time of filing.
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Question 21d - is ambiguous. It asks if any contribution has been late
under the terms of the plan. A plan may call for a
contribution "at the end of the plan year". Section 412
of ERISA gives 8~ months after the end of the plan year to
make a contribution. A contribution that is in compliance
with ERISA may technically be "more than three months past
due under the terms of the plan".
In addition to problems with the Form 5500, the actuaries indicated that the
plan termination Form 5310 is very burdensome on small plans. Supplying a 10
year salary average represents a considerable burden for a plan that is fully
funded and for which 10 year cutbacks do not apply.
Finally, the actuaries indicated that merger and spin-offs rules
unnecessarily create special problems for small plans. They indicated that
there is a necessary cost associated with filings that meet a required
regulatory need, but that the IRS adds unnecessary costs by specifying in its
revenue rulings complicated procedures, especially in the case of spin-offs
that do not occur on the plan year anniversary. U The IRS also requIres
Form 6088 for a professional corporation even if it is has no PBGC liability.
~ A spin-off occurs when a company sells a plant or other portion of its
employees. In the case of a small business, partners may decide to split
up, each taking with them a portion of the employees. This is considered
a spin-off. Revenue Ruling 81-212 specifies that pension plan assets and
liabilities must be valued as of the actual date of the spin-off. This
requires an additional full actuarial valuation even if the plan is fully
funded. A more reasonable approach would be to permit the use of the
most recent valuation and require the valuation as of the date of the
actual spin off only if one of the plans is terminated within a five year
period. A similar problem occurs when one person is transferred from one
plan to another within a controlled group. In this case if a portion of
one plan's assets are transferred a full spin-off valuation must be
performed. Again, the more reasonable approach would be to permit use of
the most recent valuation for the allocation and require the full
valuation only if one of the plans terminates within five years. The
more cumbersome approach is required by IRS Regulations l.401(a)-l2 and
l.414(l)-l and Revenue Ruling 81-212.
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Problems in Plan Administration
Aside from the inefficiencies discussed above, major on-going
administi~ative problems relate to special situations. The biggest problem
cited by the interviewees was the constant state of flux of regulations arid
laws. They felt that the adverse impact of numerous changes on plan
administration could be greatly decreased if implementation in existing plans
could be delayed for a few years so that numerous changes could be made at the
same time. For example, if plans only needed to be amended once every three
years to come into compliance with new legislation, at that time all required
changes would be made. In most cases, there would be little or no adverse
impact on the intent of the law resulting from this delay in implementation.
The positive effect would be that fewer plans would terminate and more would
be formed if sponsors did not fear the harassment of constantly changing laws
and regulations.
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B-il
CASE STUDY B
Description of the Firm and Its Clients
This firm is a medium sized actuarial consulting firm serving 1,500
clients, many of which have less than 100 employees. This firm has a
diversified clientele, including many small professional corporations. We
interviewed both a plan administrator and an enrolled actuary. The actuary
reviews approximately 100 pension plans for small companies (under 100
employees) and about 50 for larger companies.
Description of Pension Plans Administered
Most of the 150 plans administered by the interviewed actuary are
integrated, final average salary, defined benefit plans. Only about two
percent have formulas not related to final average salary, 80 percent are
integrated, 18 percent are based on a level percent of final average salary,
while the rest are based on final average salary and service. Most small
plans have 25 years of age and 1 year of service participation requirements
and "4/40" vesting. This actuarial firm performs all administrative services
as well as the actuarial valuations for most of its small clients.
Formation of Pension Plans
Establishment of the Plans
The actuary finds that most smaller plans are set up when the firm
becomes sufficiently profitable for the owner to be concerned about tax
implications of earnings. In fact, he indicated that most plans are not
formed until the last month before the end of a fiscal year, when the owner
knows what the firm's profitability will be for that year. In some cases, the
proximity of the owner to retirement age is a factor. Tax considerations are
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important in nearly all cases of new small plan formation-abOUt half are
formed for this reason alone. The owner's personal retirement income and/or
concern about employee welfare are often important considerations. The
actuary noted that many larger plans are formed either out of concern for
employee welfare or as a matter of meeting competition.
The actuary indicated that a plan is formed typically because an attorney
or accountant has made a plan sponsor aware of the tax benefits in setting up
a plan. The actuary indicated that insurance agents also are involved in
pension plan formation. However, he noted that plans set up by insurance
agents usually have their administration and actuarial work done by insurance
companies so he would not be apt to see these plans.
The actuary stated that the steps involve in setting up a plan are
typically:
* the company realizes a substantial profit,
* an accountant, actuary, insurance agent or lawyer recommends
the establishment of a plan because of tax advantages,
* the firm requests a study,
* an insurance company or actuary prepares a study outlining
costs of various plans,
* a plan is selected,
* final valuation is performed,
* a trust established and initial contributions made, and
* plan documents are drawn up and IRS filings completed.
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For small firms, usually only the president, assisted by an actuary and
attorney, is involved in the plan formation process. Because there is
generally u deadline for filing the contribution, the plan formation (i.e.,
through the point of making the first actual contribution) usually takes a
couple of months. The employer usually waits until the end of a plan year to
initiate the process and the contribution is due soon thereafter. The IRS
filing of the plan document need not be completed prior to the time of the
contribution.
Impact of Regulations on Plan Formation
The actuary felt that the forms and filings required in setting up a plan
were not unduly burdensome, but rather that they were required for protection
of plan participants. Generally, small plans choose those provisions which
provide the largest benefit for the owner. The actuary indicated that it was
not the regulations that were so much the problem, but rather how the
regulations had been implemented. As a result of the frequent changes in
pension rules, some potential plan sponsors have been hesitant to set up
plans, fearing further changes in laws. They are not greatly hindered by the
laws themselves, but rather with the uncertainty that constant change has
caused regarding future regulations. They feel that the costs of complying
are often not worth the benefits.
Costs of Plan Formation
Within a client company, usually the president is the only person
involved in setting up a pension plan. He will usually spend less than eight
hours- -a two hour meeting reviewing with the actuary and/or attorney the
objectives of the plan, a two hour meeting to choose the plan, a two hour
meeting deciding upon plan document provisions and one hour collecting census
data.
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The cost of outside professional assistance was estimated at about
$5,000. If the actuary drafts the plan document, performs needed valuations
and does an initial study, fees would be about $4,000. In addition, a
lawyer's fees for reviewing documents would be $500. If the attorney drafts
the document, the actuary's fees would be about $3,000 and the attorney's fees
about S2,000. Hence, total costs of assistance are in the $4,500-$5,000 range
for plan formation. Other costs might include trust fees, a fidelity bond for
the plan, PBGC premiums, and fees to accountants.
Problems in Plan Formation
The actuary did not identify any problems associated with setting up
pension plans. However, he noted that TEFRA and the uncertainty created by
repeated changes in pension laws have made the atmosphere less conducive to
the establishment of new plans.
Ongoing Administration of Pension Plans
Administrative Activities
This actuarial firm finds that only a few larger companies, generally
with well over 100 employees, do their own pension plan administration. In
some instances, the plan sponsor's accountant prepares the Form 5500.
However, for most clients, and all small clients, this actuarial firm performs
all plan administration. The primary person from the plan sponsor's company
involved is the president. The second-in-command rarely gets involved in
pension issues. The president makes decisions, provides data, and signs
documents for filing. External to the company, an attorney and an accountant
may be involved, mainly to review information and filings. Also, a bank or
some other financial institution may be involved in investing plan assets.
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Costs of Plan Administration
This actuarial firm estimated that for a plan involving less than 15
participants, on-going administration fees would be about $1,000. For larger
defined benefit plans, the fees would range from $1,500 to $2,500 for all
services including valuation, filings, individual benefit statements and all
plan record-keeping and about $500 less if record-keeping and individual
benefit statements are not provided. Administration for defined contribution
plans, where an actuarial valuation is not required, would be about $1,000 for
larger plans. The actuary estimated that less than five hours of time is
required by the plan sponsor. Usually the involvement of the company attorney
and accountant is minimal--probably less than a few hundred dollars per year
in fees. Other ongoing administrative expenses would be those related to
benefit pay-outs and plan changes due to regulatory or legislative changes.
The cost of benefit calculations is minimal. However, the amendment of a plan
document that may be required as a result of a change in the law can run as
much as $2,000.
Impact of Regulation on Plan Administration
The actuary thought that filing requirements are needed. He noted that
although the cost per covered employee is much higher for small plans, it is,
in fact, in the small plan area that there is the greatest abuse of pension
plans. He thought that relaxation of filing requirements might be possible in
the case of certain standard, very simple plans such as non-integrated plans
permitting no loans, having a bank or other financial institution as a trustee
and having an enrolled actuary do all of the administration. More complicated
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plans--for example, those that fund toward retirement at age 55 and in other
ways stretched the limits of regulations- -needed to meet more extensive filing
requirements.
Although the actuary agreed with the spirit of filing requirements, he
felt that certain aspects of reporting and disclosure are carried to a
burdensome extreme. The new Form 5500R is more time consuming than the old
form and filling it out only every third year is often more of a burden than
it was filing the old Form 5500C every year. In addition to the Form 5500, a
plan has to file:
* joint and survivor notices nine months before an employee is
eligible for early retirement,
* suspension of benefit notices after an employee reaches age 65
in certain plans,
* summary annual reports,
* summary plan descriptions, S
* summary of material modification notices, and
PBGC premium reports.
He also felt that the Financial Accounting Standard Bureau (FASB) proposal,
regarding how to expense pension contributions, may become an excessive burden
on pension plans.
Problems in Plan Administration
The actuary and plan administrator noted that one of the biggest problems
has been frequent changes in laws and regulations governing pensions--
requiring employers to amend their plans almost every year. Changes can
double or triple the annual administrative cost of maintaining a small plan.
In addition, changes can have substantial impacts on the extent of coverage
and benefit levels--e.g., TEFRA limits the benefits to the owner-operator.
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The actuary cited several specific areas of regulation that are
unnecessarily burdensome:
* The suspension of benefits notice is unnecessary. Employees
already receive a summary plan description and can always come
to the plan administrator to review their benefits. Workers who
decide to work past age 65 generally research the issue and
finds out what the impact is on pension benefits independent of
receiving the suspension of benefits notice.
* The requirement of providing retirement information nine
months prior to the employee's retirement date is unnecessary.
Exact figures are provided when the employee retires. Prior to
that, the employee receives or can request a benefit statement
on an annual basis.
* The requirement of an accountant audit in the case of insured
plans is useless since there is nothing to audit. This is also
true for plans trusteed by banks.
* PBGC requires that plans count as participants non-vested
former employees who have terminated employment but who have not
yet incurred a break in service. The actuary estimates that
less than one percent of these former employees ever return to
~ employment. Keeping track of all these incomplete breaks in
service creates an unnecessary record-keeping burden.
* The IRS requires a plan to obtain approval of a change of
funding method even when certain details of the valuation are
changed. This can unnecessarily cost a plan several hundred
dollars and create unnecessary work for the IRS.
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APPENDIX C
TELEPHONE INTERVIEWS OF SMALL EMPLOYERS
We conducted a number of telephone interviews to supplement the analyses
of aggregate data. In particular, these interviews were structured so that
they would provide the following types of information:
* reasons small firms did or did not have pension and/or health
benefit plans;
* characteristics of pension and/or health benefit plans; and
* costs and administrative practices involved in benefit plans.
We contacted two small business organizations"the Greater Cleveland
Growth Association and the Smaller Manufacturer's Council of Pittsburgh-
concerning the selection of interviews with small employers. Because the aim
of these interviews was to conduct detailed discussions about employee
benefits with a small number of firms, an effort was made to select firms that
varied across several key factors (e.g., size, type of product, year of
establishment, etc.).
Eight interviews were conducted with small firms with pension plans in
the Pittsburgh and Cleveland area. Another seven interviews were conducted
with small firms that did not have pension plans. In addition, each of the
fifteen firms--all of which had health plans--were interviewed about their
health plans.
Discussions were generally conducted with the president (or chief
executive officer) of the selected firms. Those firms who currently did not
have a pension plan were asked the following types of questions:
* Why do you not have a pension plan Ci. e., what factors have
affected your decision not to offer pension benefits)?
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C-2
* What would be the most important factor in your firm's
decision to provide pension benefits in the future?
* Did government regulation or paperwork involved in setting up
and administering a plan affect your decision? How?
* Do you currently have plans to establish a pension or profit
sharing plan during the upcoming year?
Those firms that currently had a pension plan were asked a different set
of questions that probed the characteristics of the plan, reasons for setting
up the plan, administrative practices, and problems associated with plan
administration. For example, some of the questions asked these firms included:
* Ate all of your employees eligible for the plan? If not, who
is not eligible?
* How many employees currently participate in your pension or
profit sharing plan?
* Is there a minimum age or service requirement for
participation? If yes, what is the minimum age or service
requirement?
* What is your vesting provision?.
* What type of pension plan do you have?
* Who manages the plan assets?
* How are the pension plan assets invested?
* Were there any particular reasons that you selected the plan
that you did?
* What obstacles or barriers did your firm face in setting up
the plan?
Finally, firms were asked a set of questions about their health care
plans. These questions probed characteristics, administrative practices,
costs, reasons for setting up the plan, and problems encountered in setting up
and administering health benefits.
Exhibit C-i provides a description of the basic characteristics of the
pension plans in the eight firms interviewed by telephone with plans. Exhibit
C-2 provides a description of the characteristics of health care plans in the
fifteen firms interviewed by telephone.
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377
EXHIBIT C-i
CHARACTERISTICS OF PENSION PLANS,
TELEPHONE INTERVIEWS
Firm 3
Number of Employees
Product
Year Firm Established
Type of Plan
Single vs. Multiemployer
Reason for Selection of Particular Plan
Type of Employee Eligibility
Minimum Age Requirements (Years)
Minimum Service Requirement (Years)
Vesting
Social Security Integration
Supplemental Plans
Early Retirement
Earliest Age
Loan/Withdrawal
Investments
11
Printing Services
1963
Prof it Sharing
Single
To avoid paperwork
and administrative
expense
All Employees
None
12.5% per year
100% after 8 years
N.A.
None
N.A.
N.A.
Yes
Common Stocks, Bonds
Directly from fund
Payment of Benefits
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378
EXHIBIT C-i
(Continued)
CHARACTERISTICS OF PENSiON PLANS,
TELEPHONE iNTERViEWS
Firm 7
Number of Employees
Product
Year Firm Established
Type of Plan
Single vs. Multiemployer
Reason for Selection of Particular Plan
Type of Employee Eligibility
Minimum Age Requirements (Years)
Minimum Service Requirement (Years)
Vesting
Social Security Integration
Supplemental Plans
Early Retirement
Earliest Age
Loan/Withdrawal
Investments
Payment of Benefits
Manufacturing Machinery
1953
* Defined Benefit
Single
Selected least risky
type of plan; wanted to
minimize involvement in
investment decisions.
All Employees
25
25
1
10% per year
100% after 10 years
Yes
None
Yes
N.A.
No
N.A.
Purchase of Annuities
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Plan A (Hou4y)
a!
Manufacturing Springs
1941
Defined Contribution
Single
Wanted plan to work
to advantage of young
salaried employees
1
50% after 5 years
100% after 10 years
Yes
No
Yes
62 years
Yes
Annuities
Directly from fund or
purchase of annuities
Plan B (Salaried)
Manufacturing Springs
1941
Defined Benefit
Single
Resulted from union
negotiations and union
concerned that
employees are able to
know what they will
receive at retirement
Hourly (Union)
Employees
None
379
C-6
EXHIBIT C-i
(Continued)
CHARACTERISTICS OF PENSION
TELEPHONE INTERVIEWS
Firm 9
PLANS,
Number of Employees
Product
Year Firm Established
Typeof Plan
Single vs. Multiemployer
Reason for Selection of
Particular Plan
Type of Employee
Eligibility
Minimum Age Requirement
(Years)
Minimum Service Require-
ments (Years)
Vesting
Social Security
Integration
Supplemental Plans
Early Retirement
Earliest Age
Loan/Withdrawal
Investments
Payment of Benefits
a/ 32 employees in the firm.
Salaried Employees
23
Non~\
50% ~fter 5 years
l00%~after 10 years
/
No2'
No
Yes
62 years
No
40 046 o - 85 - 25
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C-7
EXHIBIT C-i
(Continued)
CHARACTERISTICS OF PENSION PLANS,
TELEPHONE INTERVIEWS
Firm 10
Number of Employees 42
Product Chemical
Yea~r Firm Established 1964
Type of Plan Profit Sharing
Single vs. Multiemployer Single
Reason for Selection of Particular Plan Minimize administra-
tion and reporting
and too small at
plan initiation to
go with other type
of plan
Type of Employee Eligibility All employees
except commissioned
sales persons
Minimum Age Requirements (Years) None
Minimum Service Requirement (Years) 1
Vesting 10% after 1 year
100% after 10 years
Social Security Integration N.A.
Supplemental Plans No
Early Retirement N.A.
Earliest Age N.A.
Loan/Withdrawal No
Investments Common Stocks,
Money Markets
Payment of Benefits Directly from fund
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C-a
EXHIBIT C-i
(Continued)
CHARACTERISTICS OF PENSION PLANS,
TELEPHONE INTERVIEWS
Firm ii
Number of Employees 47
Product Quality Control Systems
Year Firm Established 1948
Type ~f Plan Profit Sharing
Single vs. Multiemployer Single
Reason for Selection of Particular Plan N.A.
Type of Employee Eligibility All Employees
Minimum Age Requirements (Years) None
Minimum Service Requirement (Years) 1
Vesting N.A.
100% after 10 years
Social Security Integration None
Supplemental Plans No
Early Retirement N.A.
Earliest Age N.A.
Loan/Withdrawal No
Investments Common Stocks, Bonds
Payment of Benefits Directly from Fund
PAGENO="0388"
382
c-9
EXHIBIT C-i
(Continued)
CHARACTERISTICS OF PENSION PLANS,
TELEPHONE INTERVIEWS
Firm 12
53
Equipment Distribution
1963
Profit Sharing
Single
To avoid ERISA to the
extent possible and to
avoid getting "trapped"
into bankruptcy by plan
All Employees
25
Number of Employees
Product
Year Firm Established
Type of Plan
Single vs. Multiemployer
Reason for Selection of Particular Plan
Type of Employee Eligibility
Minimum Age Requirements (Years)
Minimum Service Requirement (Years)
Vesting
Social Security Integration
Supplemental Plans
Early Retirement
Earliest Age
Loan/Withdrawal
Investments
10% after 5 years
100% after 10 years
N.A.
No, but looked into 401K
N.A.
N.A.
No
Insurance Co.
investments
Directly from Fund
Payment of Benefits
PAGENO="0389"
Number of Employees
Product
Year Firm Established
Type of Plan
Single vs. Nultiemployer
Reason for Selection of
Particular Plan
Type of Employee
Eligibility
Minimum Age Requirement
(Years)
Minimum Service Require-
ments (Years)
Vesting
Social Security
Integration
Supplemental Plans
Early Retirement
Earliest Age
Loan/Withdrawal
Investments
Firm 14
Plan A (Salaried)
25
Steel Lockers
1930
Profit Sharing
Single
N.A.
Salaried Employees
Plan B (Hourlyj
90
Steel Lockers
1930
Defined Benefit
Multiemployer
N.A.
Hourly (Union)
Employees
N.A.
383
C-10
EXHIBIT C-i
(Continued)
CHARACTERISTICS OF PENSION PLANS,
TELEPHONE INTERVIEWS
24
1/2
20% after 2 years
100% after 10 years
N.A.
No
N.A.
N.A.
No
Common stocks, Bonds,
General Assets
Directly from fund or
purchase of annuities
N.A.
100% after 10 years
N.A.
No
N.A.
N.A.
N.A.
N.A.
Payment of Benefits
N.A.
PAGENO="0390"
Plan A (Salaried)
99
1934
Defined Benefit
Single
Owner-operator felt
at the time that "a
defined benefit plan
was the best way to go
from the employee's
standpoint"
Salaried Employees
25 25
1
33% after 5 years
100% after 15 years
No
No No
Yes
55 years old; 15 years
of service
No
Bank Account, Short-
term G-Maes
Directly from fund or
purchase of annuities
384
C-li
EXHIBIT C-i
(Continued)
CHARACTERISTICS OF PENSION PLANS,
TELEPHONE INTERVIEWS
Firm 15
________________ Plan B (Hourly)
75
Combustion Equipment Combustion Equipment
Number of Employees
Product
Year Firm Established
:Type of Plan
Single vs. Multiemployer
Reason for Selection of
Particular Plan
Type of Employee
Eligibility
Minimum Age Requirement
(Years)
Minimum Service Require-
ments (Years)
Vesting
Social Security
Integration
Supplemental Plans
Early Retirement
Earliest Age
Loan/Withdrawal
Investments
1934
D&finèd Contribution
Single
N.A.
Hourly Employees
N.A.
100% after 10 years
No
N.A.
N.A.
N.A.
Payment of Benefits
N.A.
PAGENO="0391"
385
C-l2
EXHIBIT C-2
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 1
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
HMO Offered
Reasons for Establishing Coverage
Reason for Particular Plan
4.
Plastic Fabricating
1966
Blue Cross/Blue Shield
Major Medical/Physician Services
All employees
60 days
20 hours/week
$200/family
No
o owner-operator wanted to take
care of own needs
o give employees "peace of mind"
o offered by local business
association
o plan was easy to institute,
well-priced and easy to
administer
PAGENO="0392"
386
C-13
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE 1NTERVIEWS WITH FIFTEEN FIRMS
Firm 2
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
HNO Offered
Reasons for Establishing Coverage
8
Wiring Materials
1911
a) Blue Cross/Blue Shield
b) Insurance Cotnpany
Major Medical/Physician Services
Salaried employees/BC-BS
60 days
None
None
No
o management felt employees needed
coverage
o tried to match salaried plan to
medical coverage offered through
union
o convenience of setting up and
managing the plan
Reason for Particular Plan
PAGENO="0393"
387
C-14
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 3
Number of Employees 11
Product Printing Services
Year Established 1963
Type of Health Insurance Insurance Company
Type of Coverage Major Medical/Physician Services
Eligibility Requirements
a) Employee Status All employees
b) Service Requirements 60 days
c) Minimum Hours 20 hours/week
Deductible (per year) $100/individual
$200/family
lIMO Offered No
Reasons for Establishing Coverage o management felt employees needed
coverage
Reason for Particular Plan o former plan became too expensive
o carrier was a good customer
o wanted protection against
catastrophic claims
PAGENO="0394"
388
C-15
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 4
Number of Employees 14
Product Pipe Stoppers
Year Established 1973
Type of Health Insurance Blue Cross-Blue Shield
Type of Coverage Major Medical
Eligibility Requirements
a) Employee Status All employees
b) Service Requirements 90 days
c) Minimum Hours None
Deductible (per year) $100/individual
HMO Offered No
Reasons for Establishing Coverage N.A.
Reason for Particular Plan o former plan became too expensive
o easily procured through local
bus mess organization
PAGENO="0395"
389
C- 16
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 5
15
Air Valves
1974
Insurance Company
Major Medical/Physician Services
All employees
60 days
32 hours/week
$lOO/indivi4ual
$200/family
No S
o owner-operator wanted employees
to be covered
o less expensive and higher level
of coverage versus other plans
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c). Minimum Hours
Deductible (per year)
HMO Offered
Reasons for Establishing Coverage
Reason for Particular Plan
PAGENO="0396"
390
C-17
EXHIBIT C-2
(Continued)~
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 6
Number of Employees
Product
Year Established
* Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
HMO Offered
Reasons for Establishing Coverage
22
Certified Public Accountant/
Management Consultant
1973
Insurance Company
Major Medical/Physician Services
All employees
None
None
$200/family
No
o management felt employees were
entitled to health coverage
o to remain competitive in labor
market
o less expensive than other type
of plans
Reason for Particular Plan
PAGENO="0397"
391
C-18
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 7
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
25
Machinery
1953
a) Blue Cross-Blue Shield
b) HMO
Major Medical/Physician Services
All employees
30 days
1,000 hours/year
a) $200/individual, $400/family
(BC-BS)
b) None (lIMO)
Yes
o to remain competitive in the
labor market
o best coverage available at time
o government required provision of
lIMO option
lIMO Offered
Reasons for Establishing Coverage
Reason for Particular Plan
PAGENO="0398"
392
C-l9
EXHIBIT C-2
(Continued)
CHARACTER1ST1CS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 8
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
25
Pest Control Services
1908
a) Blue Cross-Blue Shield
b) HMO
Major Medical/Physician Services
All employees
90 days.
40 hours/week
a) $200/individual, $400/family
(BC-BS)
b) None (liMO)
Yes
N.A.
HMO Offered
Reasons for Establishing Coverage
Reason for Particular Plan
o recently changed from other
insurance company to reduce cost
arid red tape
PAGENO="0399"
392
C-20
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 9
32
Wire Springs
1941
Blue Cross-Blue Shield
Major Medical
All employees
60 days
None
No
o offered as a benefit to entice!
hold employees
o to remain competitive in labor
marketplace
o felt plan was most competitive
in area
o received very few complaints
from employees
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
HMO Offered
Reasons for Establishing Coverage
Reason for Particular Plan
PAGENO="0400"
394
C-21
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 10
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
HMO Offered
Reasons for Establishing Coverage
Reason for Particular Plan
42
Chemical Products
1964
a) Blue Cross-Blue Shield
b) HMO -
Major Medical/Physician Services
All employees
90 days
40 hours/week
a) $200/individual; $400/family
(BC-BS)
b) None (HMO)
Yes
N.A.
o cost was the overriding factor
PAGENO="0401"
395
C-22
-EXHIBIT C~2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 11
Number of Employees 47
Product Quality Control Systems
Year Established 1948
Type of Health Insurance Self-Insurance
Type of Coverage Major Medical
Eligibility Requirements
a) Employee Status All employees
b) Service Requirements 1-6 months
c) Minimum Hours None
Deductible (per year) $100/individual
HMO Offered No
Reasons for Establishing Coverage N.A.
Reason for Particular Plan o felt self-insurance would be a
money-saver
4O~-O46 0 - 85 - 26
PAGENO="0402"
396
C-23
EXHIBIT C-2
(Continued)
CHARACTERISTiCS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 12
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
HNO. Offered
Reasons for Establishing Coverage
Reason for Particular Plan
53
Distributors
1963
a) Insurance Company
b) HNO
Major Medical/Physician Services
All employees
6 months
None
$100/individual; $100/family
Yes
o to remain competitive in the
labor market.
o went to independent carrier
recently to save money
PAGENO="0403"
397
C-24
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 13
115
Electric Coils/Transit Equipment
1975
Self Insurance
Major Medical/Physician Services
All employees
90 days
40 hours/week
$100/individual
No
o employees wanted to be covered
o benefit was tax deductible
o selected self-insurance because:
- greatest cost-control and
flexibility
- could write own plan
- could administer own plan
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
HMO Offered
Reasons. for Establishing Coverage
Reason for Particular Plan
PAGENO="0404"
398
C-25
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WiTH FIFTEEN FIRMS
Firm 14
Number of Employees 125
Product Steel Lockers
Year Established 1930
Type of Health Insurance a) Insurance Company
b) 2HN0s
Type of Coverage Major Medical/Physician Services
Eligibility Requirements
a) Employee Status All employees
b) Service Requirements 60 days
c) Minimum Hours None
Deductible (per year) a) $100/individual; $200/family
(Insurance Company)
b) None (HMO)
HNO Offered Yes
Reasons for Establishing Coverage N.A.
Reason for Particular Plan o shopped around and found plan
was least expensive and met
basic service requirements
PAGENO="0405"
399
C-26
EXHIBIT C-2
(Continued)
CHARACTERISTICS OF HEALTH CARE PLANS,
TELEPHONE INTERVIEWS WITH FIFTEEN FIRMS
Firm 15
Number of Employees
Product
Year Established
Type of Health Insurance
Type of Coverage
Eligibility Requirements
a) Employee Status
b) Service Requirements
c) Minimum Hours
Deductible (per year)
HMO Offered
Reasons for Establishing Coverage
Reason for Particular Plan
174
Industrial Combustion Equipment
1934
a) Blue Cross-Blue Shield
b) Insurance Company
c) HMO
Major Medical/Physician Services
a) Hourly EmployeesBC/BS
b) Salaried Employees-Ins. Co./HNO
First of Month (Salaried)
None
None
Yes
o to remain competitive in the
labor marketplace
o hourly plan negotiated through
union
o salaried plan featured best
service for cost
o government required 1*10 option
PAGENO="0406"
400
APPENDIX D
DESCRIPTION OF SBANE AND SMC SURVEYS
We used data from two regional data bases during this project to extend
our aggregate data analyses: (1) a 1982 Survey of Employee Benefits,
conducted by the Small Business Association of New England (SBANE) and Griffin
Pension Services, Inc.; and (2) the 1982 SMC Survey of Wage and Fringe
Benefits, conducted by the Smaller Manufacturer's Council (SMC) of Pittsburgh.
The SBANE survey was conducted with 176 firms in the Greater Boston
area. All but one of these firms employed under 500 workers. The survey
included questions on the following types of employee benefits: health
insurance, dental insurance, group life insurance, paid vacations and
holidays, paid personal days, non-insured sick pay, short-term disability
insurance, long term disability insurance, retirement and savings plans,
educational reimbursement, special benefits, and bonus plans.
The SMC survey is conducted annually. It surveyed 242 firms in 1982 in
the Greater Pittsburgh area, 240 of which had fewer than 500 employees. This
survey asked questions about the wages, paid leave and vacations, pension
plans, bonus plans, group life insurance, sickness and accident insurance,
hospital and surgical insurance, major medical, dental insurance, and Health
Maintenance Organization coverage.
The SBANE and SMC Surveys did not use random sampling procedures. A copy
of the two survey instruments are included in Exhibit D-l.
PAGENO="0407"
401
APPENDIX E
SUMMARY OF NEEDS SPECIFICATION INTERVIEWS
INTRODUCTION
"Needs Specification" is designed to help target information collection
and analysis so that research products meet the needs and requirements of
policy decision-makers. It involves identifying key individuals in the
policy-making process, then holding discussions with them to gain information
concerning major policy issues, gaps in knowledge or data, priorities among
basic research questions and information about the schedule for future policy
decisions.
In this project, project staff conducted nine in-person and telephone
discussions with congressional staff members, independent experts, and
representatives of small business interests. The following agencies/
organizations were represented:
* Senate Finance Committee (Tax Counsel for the Minority);
* Senate Committee on Labor and Human Resources (Chief Counsel);
* Joint Committee on Taxation (Legislative Attorney);
* Employee Benefit Research Institute (EBRI), (Research
Director);
* Urban Institute (Director of the Income, Security and Pension
Policy Center);
* Griffin Pension Service (President);
* Greater Cleveland Growth Association (Director of the Council
on Smaller Enterprises);
* Smaller Manufacturers Council of Pittsburgh (Executive Vice
President);
* National Federation of Independent Business (Research Staff).
PAGENO="0408"
402
E-2
A non-representative sample of interviewees was selected on the basis of
expertise in the area of employee benefits, as well as an ability to offer
different perspectives on the major topics of this study. Five of the nine
interviews were conducted in-person; the other four were conducted by
telephone. The interviews, which lasted between 30 minutes and an hour, were
free-flowing discussions, loosely-structured around several topic areas,
including: current knowledge and data gaps; proposed scope and research
questions of this study; basic methodology of this study; proposed research
products and their uses; and the anticipated schedule for important policy
decisions affecting pension and health care regulations.
MAJOR FINDINGS
The need specification interviewees expressed strong support for the
basic scope and objectives of this study, particularly citing the need for
development of current and reliable information about employee benefits in
smaller firms.
Citing the lack of current and reliable data on employee benefits in
small firms, interviewees generally agreed that the study should focus on
issues of coverage, characteristics, costs, and factors affecting costs of
pension and health care plans in small firms. Respondents felt that the
methodology was sound--particularly, identifying the interviews and case
studies of small employers as valuable and cost-effective methods. They felt
that it was vital that the research project not be overly "academic" and that
it be closely linked to current legislative initiatives.
In discussions concerning the scope and ma3or research topics of this
study, interviewees expressed particular interest in the following areas:
* development of cost data related to the formation/administra-
tion of pension and health care benefits in smaller firms;
PAGENO="0409"
403
E-3
* analysis of the effect of recent legislation (e.g., effects of
the "top heavy" regulations in recent TEFRA legislation) and
proposed legislation (e.g., effects of taxing employee health
benefits) on the provision of employee benefits within small
firms;
* collection and analysis of current information on the extent
and characteristics of benefit plans within small firms;
* assessment of the "stages" that small business firms go
through in establishing a set of benefits and the factors that
seem to be most important during the decision-making process.
In reviewing the major research topics (i.e., extent of coverage,
characteristics, costs, and factors effecting costs of pension and health care
benefits), as well as the more detailed list of SBA research questions,
interviewees felt that the study addressed the most important issues. Most
respondents expressed greater interest in the pension area than the health
benefits area.
Interviewees were very responsive to the proposed research strategy of
combining analyses of large data bases, with iff-person and telephone
interviews and on-site case studies. Most respondents acknowledged the lack
of current and reliable information on benefit plans in small firms--noting
that, in part, the small business perspective was often underrepresented in
legislative hearings in the benefits area because of a lack of data and
analysis. Interviewees felt that the small sample, purposive interviews and
case-studies offered a valuable and effective research method for generating
much-needed data about formation and administration of benefit plans. In
addition, they felt that this approach might get at the "nuts and bolts"
problems faced by small firms. Finally, interviewees supported the staged
nature of the data collection and analysis plan--feeling that it was valuable
to develop successively more penetrating analysis by building upon prior
increments of descriptive analysis.
PAGENO="0410"
404
E-4
Respondents expressed interest in both the content and form of the
study's research products. Some indicated that products should not be "overly
academic". Others felt that products should be closely linked to the
development of policy positions on future legislative actions in the employee
benefits area. Finally, other respondents hoped that the final report would
give detailed treatment to the case studies and accurately reflect the
concerns and problems for the small businesses in forming/changing/
administering benefit plans.
Exhibit E-l provides a summary of the Needs Specification interviews.
The table briefly summarizes, by respondent, the major information needs and
anticipated uses of the information generated from this project, as well as
other comments that pertain to the scope, methodology or study questions of
this project. For example, an interviewee representing the congressional
perspective, felt that data and analysis were needed on the effect of a
"second round" of ERISA legislation on small business decisions to provide
pension benefits. This respondent intended to use products of this study to
assist in the review of proposed or recent legislation that was likely to
affect employee benefit regulations.
For purposes of assessing need, we divided interviews into three major
perspectives: congressional staff, representatives of small business
interests, and independent research experts in the area of employee benefits.
Across these three perspectives, we found general agreement over the need for
data development and analysis in the major research topic areas of this study
(i.e., coverage, characteristics, etc.). There was, however, considerable
variation in the specific issues mentioned by respondents in the three groups.
PAGENO="0411"
405
E-5
The three respondents that formed the "congressional" perspective seemed
to be most interested in the direct effects of recent and pending legislation,
benefit plan costs, administrative practices and factors affecting the cost of
plans. Interest in the extent of coverage and benefit plan characteristics
tended tQ be expressed in terms of how possible legislative initiatives might
affect these two issues. Respondents representing the congressional
perspective identified five issue areas where research activities and products
should be targeted:
* Analysis of the impact of recent legislative changes in the
rate of formation/termination of private pension plans in small
firms is needed. Some of the examples of legislation or
regulations were the following: effects of "prohibited
transactions", overall effects of MEPPA, and impacts of "top
heavy" rules.
* Analysis of the likely impacts of proposed changes in pension
legislation on the formation/termination and costs of operating
private pension plans in smaller firms is needed. Some examples
include: effects of further increase in the PBGC premium;
impacts of relaxation of the "prudent man" investment
restrictions; impacts of changes in "portability" rules; and
effects of rigorous enforcement. of non-discrimination rules in
the pension benefits area.
* More extensive data collection and analysis on the costs of
formation/ongoing operation of pension plans within smaller
firms, particularly start-up costs and regulatory costs, is
needed.
* Better understanding of the circumstances and problems faced
by small businessmen in setting up and administering employee
benefit plans based on actual experiences is needed. This would
include: steps a small firm went through in establishing a
plan, problems faced at different stages, general understanding
of federal regulations affecting pensions, and day-to-day
administrative costs and practices in managing a private pension
plan within a small firm.
* Data and analysis on the likely impact of a new legislative
proposal that would tax (some part) of employee health care
benefits is needed. This would include: reaction of smaller
PAGENO="0412"
406
E-6
firms to such legislation, methods by which such an initiative
could be administered, effects on the level of coverage of
health care benefits, employee reactions to such a~ tax and
whether they would reduce the level of coverage sought, and
types of firms/employees most hurt by such legislation.
As might be expected, the three interviewees representing the "small
business interest" perspective were particularly interested in the ways in
which regulation affected the decisions of small firms to offer benefit
plans. There was particular interest among this group over the costs
associated with different types of benefit packages. There was also
considerable interest in the types of plans and level of coverage currently
offered, as well as in the possible legislative alternatives that would
improve incentives for smaller firms to offer benefit plans. Respondents in
this group identified the following issues as representing important
information needs:
* Analysis of the effect of recent legislative changes on the
formation/termination of pension plan is needed.
* Information and analysis of the characteristics and types of
pension benefits selected by firms is needed. This would
include: information about the range of pension plans offered
by accounting and legal firms, ways employers use employee
benefits to attract and hold workers, and stages firms go
through in establishing benefit packages for employees.
* Data and analysis concerning the costs of establishing
employee benefits is needed. This would include: legal and
accounting fees associated with the formation of benefits, and
paperwork costs involved in forming/administering plans.
* Data, analysis and recommendations concerning the proposed
legislation that would tax employee health care benefits is
needed. This would include: costs of such taxation to
employees of smaller firms, whether firms would bear any of the
costs of the taxation, whether firms would be less likely to
offer such benefits.
PAGENO="0413"
407
E-7
* Data on the relative availability and costs of health care
benefits for smaller firms compared to larger firms is needed.
This would include: how much more smaller firms pay for a given
package of health care benefits (because of adverse "experience
rating"), types of health care benefit packages that are not
available to small firms, and recommendations concerning the
options available to small firms in providing health benefits.
Similar to the representatives of small business interests, the
respondents from the "independent expert" viewpoint were interested in the
factors that seemed to most effect the decision of small businesses to offer
pension and health care benefits to employees. These experts, as might be
expected, were concerned over the types and quality of data that would be
produced under the interviews and case studies. Several information need
issue areas were identified by this group:
* Analysis of the most important factors in the decisions of
small firms to offer pension benefits to employees is needed.
For example, this analysis should investigate: the basic
decision calculus that the small firm goes through in
establishing benefits; basic incentives (e.g., tax advantages)
that small businesses react to in setting up benefits; and major
changes that occur in the type and extent of coverage over the
lifetime of the firm.
* Data and analysis of the linkage between certain
characteristics of the firm and the selection of a particular
mix of employee benefits is needed. For example, this analysis
might examine the way in which age structure of employees
affects the type of pension benefits selected or analyze the way
in which product line or profitability affect the type of
benefits chosen.
* Data on the costs of offering different types of employee
benefits is needed. For example, these data should include
information about the types and costs of "packages" used to
establish employee benefits. In addition, a close examination
should be made of the higher costs of providing comparable
health benefit packages in smaller firms.
* Data and analysis on the effects of recent legislative changes
on the costs of forming/administering employee benefit plans in
small firms is needed. For example, cost impacts of ERISA
should be analyzed.
PAGENO="0414"
EXHIBIT E-1
INFORMATION NEEDS, ANTICIPATED USES AND OTHER
COMMENTS FROM NEEDS SPECIFICATION INTERVIEWS
CongressIonal Perspective
Information Needed ~itjcipated Use of Information
Impact of `second round' of ERISA Intended to use data and analysis to
Iegisla~ion on small business, assist in the review of proposed or
decIsions to offer pension benefits, recent legislation affecting employee
benefits regulation.
Effects of further Increases in
P8CC premium on private pension plans
in smaller businesses; impact of a
"rIsk related" premium on small
business pension plans,
Types of benefit plans offered by
different classes/types of small
businesses.
Factors effectIng the establishment
Employee Stock Ownership Plans
(ESOP5); specific reasons that ESOPs
are not, being set up.
Impacts of relaxation of "prudent
man" Investment restrictIons;
effects of relaxing restrictIons
on pension investment in mortgages.
Effects on taxing employee health
benefits on provision of such
benefits,
Breakdown of costs of formation/
ongoing management of health/
pensIon benefits within small fIrms.
Comments Relating to Study
~roduc~
Noted that smaller business interests
were generally underrepresented
during Congressional testimony on
pension/health care benefits.
Doesn't expect legislation which
would affect: the level of paperwork
In administering pensions, mandatory
private pensions in smaller firms, or
special government administering
agency for private pensions.
0
PAGENO="0415"
EXHIBIT E-1
(Continued)
Congress ions I Perspective
Comments Relating to Study
Information Needed Anticipated Use of Information ~c~I1prProdUc~S..
"Nuts and bolts" problems faced by Intended to use information to guide Strongly supported the use of case
small businesses in setting up and committees review of legislative studies to probe "nuts and bolts"
administering employee benefit proposals and recent changes in issues and problems faced by small
plans. legislation, employers with establishing and
maintaining employee benefits.
Effects of "prohibited transaC- Anticipates some legislative action
tions" on smaller plans. on ERISA in the Spring 1983. Stressed importance of talking with
actuarial firms to gain clearer
Effects of the MEPPA (i.e., understanding of costs associated
"Multiemployer Bill") on smaller with formation of pension benefit 0
businesses, plans in smaller firms.
Effects on taxing employee health Doesn't expect increase in PBGC
care benefits on provision of such premium to have much of an effect on
benefits within small firms. small business pension plans.
Identified small business firm's
"unawareness" of changes in pension
regulations as a key problem.
Doesn't feel that an "academic".
study would be very helpful,
particularly within legislative
hearings.
PAGENO="0416"
Congressional Perspective
EXHIBIT E-1
(Continued)
Informs tjgjijleedmd
Effects of changes in social
security "integration" rules.
Effects of changes in social
security policy on pension plans,
DRA.
Effects of "top heavy" rules in
TEFRA on the formation of private
pensions in small businesses.
Impact of changes in "portability"
rules on pensions in small
busInesses.
Effects of taxing employee health
benefits on the provision of such
benefits.
Effects of "non.discrimination" laws
on the types and characteristics
of' private pensions in small firms.
Impacts of "women's issues" on the
characteristics and formation of
pensions in small firms (e.g.,
vesting requirements, survivor
benefits, divorcee benefits).
Effects of increases in payroll
tax on the provision of pension
benefits in small firms.
Comments Relating to Study
"Integration" proposals most likely
fringe benefit tax proposal to be
addressed ir, 1983.
Expected huge ramifications on provi-
sion of pension plans if "flat tax"
legislation was adopted (e.g., it
would lead to removal of key tax
advantages currently in existence).
Anticipated difficult administrative
problems in attempting to tax health
care benefits.
Doesn't expect any legislation
effectIng level of paperwork in
meeting government regulatIons.
Anticioated ties of
Intended to use Information to guide
committee's review of legislative
proposals and recent changes in regu-
lat Ions.
`-a
*0
PAGENO="0417"
Independent Expert Perspective
Information_Needed
Analysis of stages and "time
horizons" in the establishment of
employee benefits (over lifetime
of the small firm).
Linkage between characteristics
of firms (partictilarly age
structure of workforce, firm
size, etc.) and the pattern of
employee benefi ts.
Assessment of incentives in current
legislation for extending benefits
to employees.
Data on the relative costs of
health care benefits for large
fl rms versus small firms.
Effects of the "top heavy" rule
on the formation of private
pension plans in small firms.
The "packaging" of employee benefit
plans and impact on costs of these
plans.
Ant ijp~Lp~_Use~fJj~fPQLEpfl
Intended to use information generated
in this study to better understand
trends in the formation of employee
benefits in smaller firms and to
shape policy recommendations.
Comments Relating to Study
F,,ture real private pension plan
growth is likely to occur within
small firms, if it occurs at all
(i.e., expanded coverage of employee
is likely to occur within small
f i rms).
Important to use careful selection
prucess when doing the interviews
and case studies of firms (difficult
to get a representative sample of
smaller firms).
Doesn't expect increase in the PBGC
premium to have much impact on small
firms.
Recent work in the area of health
care benefits indicates that an over-
wI,elmir,g majority of small firms
offer health care coverage.
Important issues that will be
examined in the near future: single
employer legislation, "integration"
of pension benefits with Social
Security benefits, and vesting
requi rements.
0
0
01
t'.)
`-~1
EXIIIBIT E-1
(Continued)
PAGENO="0418"
Independent Expert Perspective
EXlllI3iT E-l
(Continued)
Information Needed
Cost data and analysis on
establishing/maintaining private
pensions in small firms.
Analysis of the stages small
firms go through in establishing
a given set of employee benefits.
Effects of ER ISA on costs of forming
pension plans in small firms.
Types of employees that choose to
participate in pension/health care
plans offered by small firms.
Identification of gaps in health care
coverage..
Data on the formation/cutting back
of health care benefits in small
firms.
Intended to use study to extend know-
ledge of the basic issues confronting
small businesses in forming/main-
taining employee benefits.
Comments Relating to Study
Stresses importance of discussions
with actuarial cost accountants to
develop better information about
costs of establishing/maintaining
private pensions in small firms.
Expects that the issue of "port-
abilityt' of credits in private
pension plans will become
increasingly important.
Limits on medicare coverage in
future may affect health care
plans/pension plans in smaller firms.
PAGENO="0419"
Independent Expert Perspective
Information Needed
Start-tip costs involved in formation
of a priv?te pension plan.
Impacts of type and age of business
firm on the selection of a pension
plan (e.g., do small businesses
tend to start with a profit sharing
plan?).
Types of paperwork costs borne by
smaller firms in administering
employee benefits plans.
lypes of employers that use their
employee benefits to attract
wo rkfo rce.
Impacts of ERISA on the formation!
termination of pension plans in
small firms.
Impact of taxation of health care
benefits on the offering of such
plans In small firms.
Data on the cost and availability
of health care benefit plans for
small firms.
comments Relating 1.0 Study
~QPi~ ~PLQ~Q~-~--
Observed that it. is very difficult to
qtianti fy regulatory and paperwork
costs.
Noted that when NI 113 surveye& their
mumbers that they made instruments
short (1-2 pages), readable, and
asked for numbers. Warned that the
average small husinossman is
unlikely to be very knowledgeable
about pension regulations or the
specifics of his own plan.
Noted the importance of talking to
actuarial experts in tracking costs
of employee benefits.
Estimated that among their members
that there had been a slight growth
in recent year in the number of
private pension plans (estimated that
abotit 30 percent currently had some
form of pension coverage).
Noted that $23 billion is currently
deducted for employee health care
benefi ts.
Anticipated legislative action on
the "integration" issue in near
future.
EXHIBIT E-1
(coot i nued)
~!Lt icij~tedUseoflnfOrmatIQ0
Intended to use data and analysis
generated by this study to shape
basic policy recommendations of
NBRI concerning employee benefits
in small businesses.
PAGENO="0420"
Small Business Perspective
EXHIBIT E-1
(Cont nued)
Information Needed
Impacts of taxing health benefits
on the provision of such benefits
to employees.
Effects of ERISA on the formation!
termination of pensIon plans within
small firms.
Extent of ERISA on the formation/
termination of pension plans within
small firms vs. large firms; identi-
fication of policies that would
encourage the formation of pension/
health care plans in small firms
without such plans.
Anticjpated Use of InfojjQg
Intended to use data and analysis to
shape policy positions on various
pension/health care proposals and gain
support for legislative actions
beneficial to smaller businesses.
Comments Relating to Study
In setting up health care plans small
firms are typically at a relative
disadvantage to large firms both in
terms of availability and costs of
rlans. This is in large part due to
`experience rating".
Ilis organization planned to fight
any legislatIon which would levy
a tax on employee health
benefits.
Estimated that far less than half of
the 11000 member of his business
organization offered pension
benefits; estimated that nearly 90
percent of his members offered some
type of health benefit.
Felt that there was considerably
lower pension plan formation in
small firms since ERISA.
PAGENO="0421"
Small Business Perspective
EXhIBIT E-1
(Gout i nued)
I nfo rma t ion Needed
Data on impact of ERISA on the
termination/formation of pension
plans.
Data on legal and accounting
fees associated with formation of
employee benefits.
Impact of taxing health benefits on
the provision of such benefits in
small firms.
New types of pension plans offered
by accounting/legal firms.
Intended to use study to develop and
shape policy positions on issues
affecting employee benefits in small
firms.
Comments Relating to Study
p~pp~qd~c~
Estimated that 80-9(1 percent of his
members (1IIOI)-1500) currently had
some form of health care benefits.
Noted that when a firm reached about
11(0 employees that it was possible to
sustain a health benefit package at a
good rate.
PAGENO="0422"
Small l3uslness Perspective
EXhIBIT F-i
(Continued)
Information Needed
Effect of TEFRA legislation on
formation of pension plans in
small businesses, particularly Of
"top heavy" restrictions.
Analysis of small business firms
understanding of fede ra I regulations
governing employee benefit plans.
Types and level of coverage within
small firms.
Impacts of taxing health care
benefits on tile willingness of
smaller firms to offer such
benefits.
Intended to USO data and analysis to
better understand basic factors
effecting small business decisions in
the employee benefits area.
Comments Relating *to Study
Anticipates that small firms will end
up bearing much of the costs of any
tax on employee health benefits.
Expects that small firms will experl- ~
problems in, meeting TEFRA's "top ~
heavy' requirement, particularly as a
firm s workforce experiences transi-
t ions.
Estimates that i~ti% of SIIANE' s member-
ship (a sm;,l I business organization
located in New England) offered pen-
sion benefits and about 65% offered
health care benefits.
PAGENO="0423"
417
Mr. HEFTEL. Our next panel is Alicia H. Munnell, vice president
and economist, Federal Reserve Bank of Boston; Joseph Minarik,
senior research associate, the Urban Institute; Kenneth Simonson,
President's Commission on Industrial Competitiveness; Stephen
Woodbury, senior research economists, Upjohn Institute; Gail Wi-
lensky, director, Center for Health Affairs and vice president, Do-
mestic Division.
Though there is no rhyme or reason to the order in which I have
your names, so that at least I will be able to identify you by the
time you have testified, why don't we have you testify in the order
that you are on the panel sheet, starting with Alicia H. Munnell,
vice president, Federal Reserve Bank of Boston.
STATEMENT OF ALICIA H. MUNNELL, SENIOR VICE PRESIDENT
AND DIRECTOR OF RESEARCH, FEDERAL RESERVE BANK OF
BOSTON
Ms. MUNNELL. Thank you, Mr. Chairman, I am actually now
senior vice president and director of research of the Federal--
Mr. HEFTEL. See what a difference a day can make?
Ms. MUNNELL. I appear today on my own behalf. My views do
not necessarily represent the position of the Boston Fed or the Fed-
eral Reserve System.
I share the concern of the members of the subcommittees about
the growth in employer-provided fringe benefits and today would
like to argue for two major changes: the establishment of an over-
all limit on the share of compensation that can be received tax free
under the Federal personal income tax; and the full inclusion of
employer-provided fringe benefits in the payroll tax base for FICA
taxes.
In order to establish the case for reform, I will focus on four
major issues: one, the impact of the growth in fringe benefits on
the personal income and payroll tax bases and on the long run
costs of the Social Security Program; two, the impact of these bene-
fits on the equity of the tax structure; three, the outlook for the
future growth of fringe benefits; and four, the practicality of the
proposed reforms.
Between 1950 and 1984, employer-sponsored fringe benefits,
which allow employees either to avoid the payment of income and
payroll taxes altogether or to profit from the deferral of income tax
payments until retirement, have increased from 2.6 to 10.4 percent
of total compensation. These benefits, which consist primarily of
pensions, group health, and group life insurance, have significantly
eroded both the income and payroll tax bases and raised the long
run costs of the Social Security Program.
In terms of income tax calculations for 1984 indicate that the net
revenue loss for the three primary statutory benefits-group
health and life insurance and pensions-amounts to almost $70 bil-
lion, which represents approximately 22 percent of personal income
tax receipts in this year. In other words, personal income tax reve-
nues would have been almost 22 percent higher if employee bene-
fits were taxed in the same manner as wage and salary income, or
tax rates could have been reduced approximately 18 percent and
still have provided the same revenue.
PAGENO="0424"
418
Exclusions from the payroll tax base have never been considered
"tax expenditures," since the Treasury and the Congressional
Budget Office assume any reduction in contributions is reflected in
lower benefits. Nevertheless, since the benefit reductions associated
with a decline in payroll tax contributions do not appear for some
time, it is useful to consider the immediate revenue loss associated
with excluding fringe benefits from the payroll tax base.
Calculations indicate that 1984 payroll tax receipts would have
been $25 billion higher if employee benefits were included in the
payroll tax base. Alternatively, the 1984 Social Security payroll tax
rate for the retirement and disability portion of the program could
have been lowered from 5.7 percent each for the employer and em-
ployee to 5.2 percent, without any reduction in 1984 revenues.
Of course in the long run, broadening the payroll tax base to in-
clude employer-provided fringes will mean higher future Social Se-
curity benefits. The important point for our discussion, however, is
that the resulting benefit increases will be less than the additional
tax receipts produced by including fringes in the tax base. The
reason for this phenomenon is the weighted benefit formula, which
provides that a smaller percentage of wages are replaced at higher
earnings levels than at lower ones. Since most of the increase in
the payroll tax base would occur at higher earnings levels, benefit
payments would not~ be increased proportionately. Thus, the long-
range costs of the program would be reduced by including employ-
er-provided fringes in the payroll tax base.
Preliminary estimates by the Social Security actuaries indicate
that if the ratio of employer-provided fringe benefits to total com-
pensation stabilized at current levels, rather than continuing to in-
crease as projected in the official cost estimates, the projected pay-
roll tax rate required to finance the retirement and disability por-
tions of the Social Security Program over the next 75 years could
be reduced by roughly 0.4 percentage points.
That is instead of requiring revenues equal to 13.0 percent of tax-
able payrolls to cover promised benefits, the system could be fi-
nanced for the next 75 years at an average cost of 12.6 percent. Al-
ternatively, including employer-provided fringe benefits in full in
the payroll tax base would reduce long run costs by 0.6 percent of
taxable payrolls; that is, from 13.0 percent to 12.4 percent.
Including~fringe benefits in the income and payroll tax bases not
only would increase revenues, but also would improve the equity of
the tax structure. In the United States, it has generally been
agreed that income should be defined broadly for the purposes of
levying taxes, since this approach insures that taxpayers with
equal economic resources are assessed equal amounts of taxes and
those with different capabilities are assessed different amounts.
By excluding the value of fringe benefits from the tax base or de-
ferring taxation until the recipient faces lower marginal tax rates,
the current provisions create two types of inequities. First, exclud-
ing a major component of income from the tax base means that
two individuals, who are equally well off in an economic sense, will
pay different amounts of income and payroll tax over their life-
times.
Second, the exclusion has an adverse effect on the distribution of
income. Fringe benefits are concentrated among higher paid em-
PAGENO="0425"
419
ployees and under the income tax, although not the payroll tax,
the value of exclusion and deferral increases with a worker's mar-
ginal tax rate. Yet, all taxpayers must pay higher taxes to compen-
sate for the favorable tax treatment accorded employee benefits.
If the generous provisions associated with the fringe benefits are
allowed to continue for the growing array of new benefits, the pay-
roll and income tax bases will be reduced to the point where they
can no longer be considered even approximations of ability to pay.
What then is the outlook for the future of fringe benefits?
The social security trustees project that the ratio of benefits to
total compensation will increase by 0.3 percent annually. A decade
ago, such a forecast might have been viewed as somewhat high,
since the work force appeared fairly well saturated with the tradi-
tional statutory benefits. Recent developments, however, reveal
considerable interest on the part of both the employee and the em-
ployer in expanding the role of nontaxable compensation and a
willingness on the part of Congress to provide new mechanisms
with which to accomplish this goal.
The extension of statutory benefits began in 1974 with incentives
for employers to establish employee stock ownership plans [ESOP's]
for their employees. The next step in the expansion was a substan-
tial increase in the list of services that could be provided tax free
by employers for their employees. These include prepaid legal serv-
ices, employer-provided transporation by commuter van, education-
al assistance, and dependent care assistance.
A third innovation in employee benefit provision was the encour-
agement of so-called cafeteria plans that allow employees to select
from a menu of benefits and salary packages with a variety of
health, vacation, insurance, retirement and other benefits. The
same legislation also authorized so-called section 401(k) plans that
allow employees to reduce their salary by up to 15 percent of com-
pensation and invest the money tax free in a special account.
Finally, the most recent relevant legislation, the Deficit Reduc-
tion Act of 1984, awarded statutory standing to a list of benefits
that had generally been viewed as tax-exempt by the public. Al-
though early attempts were made to tighten up the rules for the
taxation of these nonstatutory benefits, the final legislation essen-
tially codified existing employer practices. In short, fringe benefits
will probably constitute an ever increasing portion of total compen-
sation.
Given that the growth in fringe benefits is likely to continue, the
question then becomes what should be done. Although Congress
and the Treasury have expressed concern about the trend towards
workers taking more compensation in tax-free benefits, Congress
has so far limited reforms to relatively minor actions, such as cur-
tailing benefit practices that are clearly aimed at tax avoidance.
I think that the time has come for more comprehensive approach
to tax reform, and that the reform should be logical and consistent
with the principles of the nation's tax policy.
Any economist will tell you that, for purposes of tax equity, the
theoretically pure solution would be to establish a comprehensive
definition of compensation for both income and payroll tax pur-
poses. Under such definition, the value of the employer's contribu-
tions for health and life insurance and the increase in the value of
PAGENO="0426"
420
accrued pension benefits would be included in the employee's
income. Employer contributions for dependent care, van pooling
and educational assistance would also be included in income, and
salary reduction schemes, such as 401(k) plans, would be repealed.
While such a reform would not be extraordinarily difficult to im-
plement for either the payroll or income tax, such a dramatic
change might have undesirable economic consequences. The basic
statutory benefits have been awarded preferential status under the
tax code precisely because it was deemed desirable to encourage
certain types of activities.
Almost everyone agrees that favorable tax treatment has con-
tributed significantly to the expansion of pension, health, and life
insurance plans. On the other hand, the existence of fringe benefits
cannot be attributed to tax policy alone. Pension plans, for exam-
ple, existed long before the income tax, reflecting employers' needs
for an impersonal and egalitarian mechanism to retire super an-
nuated workers. However, because the precise role played by tax
preferences in the growth of the basic statutory benefits is not
known, it would probably be unwise to dramatically alter the cur-
rent treatment and include the full value of these benefits in the
tax base for income tax purposes. On the other hand, it does seem
both desirable and feasible to include all fringe benefits in the defi-
nition of taxable wages under the payroll tax.
A precedent already exists in the taxation of 401(k) plans for
treating fringe benefits differently under the income and payroll
taxes. The codification of the Rowan decision provides that an ex-
clusion of income for income withholding shall not affect the treat-
ment of income for payroll tax purposes. As a result of the 1983
social security amendments, employee contributions to 401(k) plans
are included in the payroll tax base even though they are deducti-
ble under the income tax.
The 401(k) experience also seems to indicate that the application
of the payroll tax alone to an employee benefit does not have a se-
riously adverse impact on its adoption and growth. Recent surveys
indicate a dramatic expansion of 401(k) plans. Not only are they
continuing to expand among large companies, but are increasingly
being adopted by middle-sized firms, which is surprising since inno-
vations in benefits generally take some time to trickle down from
the largest employers.
Nevertheless, a recent survey indicates that half of the medium-
sized firms who responded to the survey, 256 firms in 38 States,
said they were taking positive action toward adopting 401(k) plans
or already have such a plan in place.
In short, it is theoretically desirable, administratively practical,
and economically feasible to include all fringe benefits in the pay-
roll tax base. This change will increase short-term revenues by
roughly $30 billion per year, and allow Congress to reduce the
scheduled 1988 and 1990 payroll tax increases by more than half
and reduce the longrun costs of the system by 0.6 percent of tax-
able payrolls. Moreover, the applicability of the employer's share of
the payroll tax to employee benefits removes the incentive for the
employer as well as the employee to prefer noncash payments.
While identical treatment of fringe benefits under the income
tax may not be desirable, some reforms are obviously necessary in
PAGENO="0427"
421
order to avoid becoming a society where workers receive half their
compensation in wages and half in fringes. The most obvious com-
promise is to place an overall limit on the amount of fringe bene-
fits-including pensions-that workers can receive tax free under
the income tax.
Setting such a limit must necessarily involve some degree of ar-
bitrariness, but would restrain the erosion of the tax base without
subjecting most of the work force to an immediate increase in their
tax liability. If a single number had to be selected, it should prob-
ably be slightly above the current benefits to compensation ratio of
12.5 percent that prevails in the manufacturing sector. Perhaps, 15
percent of total compensation might be reasonable. A preferable
approach, however, would be to allow a generous amount of non-
taxable benefits as a percentage of compensation at lower income
levels and reduce the percentage as income increases. For example,
nontaxable benefits could account for 25 percent of the first $40,000
of compensation, 15 percent of the next $40,000, and 5 percent of
any compensation over $80,000.
Thus, my recommendation is twofold: To tax fringe benefits in
full under the payroll tax and to establish an aggregate progressive
limit on tax free or tax deferred fringes under the income tax.
[The prepared statement follows:]
STATEMENT OF ALICIA H. MUNNELL,1 SENIOR VICE PRESIDENT AND DIRECTOR OF
RESEARCH, FEDERAL RESERVE BANK OF BOSTON
THE ECONOMIC EFFECTS OF THE GROWTH OF EMPLOYER-PROVIDED FRINGE BENEFITS
My name is Alicia Munnell. I am Senior Vice President and Director of Research
at the Federal Reserve Bank of Boston. I appear today on my own behalf; my views
do not necessarily represent the position of the Boston Fed or the Federal Reserve
System.
I share the concern of the members of the subcommittees about the growth in em-
ployer-provided fringe benefits and today would like to argue for two major changes:
(1) The establishment of an overall limit on the share of compensation that can be
received tax free under the federal personal income tax; and
(2) The full inclusion of employer-provided fringe benefits in the payroll tax base
for FICA and FUTA taxes.
In order to establish the case for reform, my testimony will focus on four major
issues: (1) the impact of the growth in fringe benefits on the personal income and
payroll tax bases and on the long-run costs of the social security program; (2) the
impact of these benefits on the equity of the tax structure; (3) the outlook for the
future growth of fringe benefits; and (4) the practicality of the proposed reforms.
I. The growth of employee benefits and its impact on the tax base
Between 1950 and 1984, employer-sponsored fringe benefits, which allow employ-
ees either to avoid the payment of income and payroll taxes altogether or to profit
from the deferral of income tax payments until retirement, have increased from 2.6
to 10.4 percent of total compensation (see Table 1). These benefits, which consist pri-
marily of pensions, group health, and group life insurance, have significantly eroded
both the income and payroll tax bases and raised the long-run costs of the social
security program.
1 The views expressed are solely those of the author and do not necessarily reflect the official
position of the Federal Reserve Bank of Boston or the Federal Reserve System.
PAGENO="0428"
422
TABLE 1.-EMPLOYER-PROVIDED FRINGE BENEFITS AS A PERCENT OF TOTAL COMPENSATION,
1950-84
[Percent]
Employer-provided benefit
1950
1960
1970
1980
1984 1
Group health insurance
Group life insurance
Pension and profit sharing:
0.5
2
1.1
1.1
.4
1.6
2.0
.5
2.1
3.1
.4
3.5
4.2
.4
3.7
Private pensions
Government pensions 2
7
1
1.2
.1
1.3
.1
1.8
.1
2.0
.1
Other
Total employer-provided benefits
2.6
4.4
6.0
8.9
10.4
1 Projections for total compensation were obtained from Data Resources, Inc. Percentages were estimated by author assuming rate of growth from
1983-1984 was the same as that from 1980-83.
2 Includes Federal Civilian Retirement System and State and local retirement systems; mittary pensions are not included. In 1971, the Treasury
Department began to transfer funds into the Fedenat Civilian Retirement System to pay the interest on unfunded liability and to amortize over a 30-
year period any increase in the onfunded liability. Since these transfers are not included in the National Income and Product Accounts, we did nut
nclode them in this table in order to maintain consistency. This results, however, in an understatement of the contributions to Government pensions
relative to private pensions and profit sharing.
Sources: Chamber of Commerce of the United States, "Employee Benefits Historical Data, 1951-1979" (Washington, D.C., 1981) and "Employee
Benefits, 1982" çWashingtoo, D.C., 1983); "The National Income and Product Accounts, 1929-76, Statistical Tables," Supplement tu the "Survey of
Current Business,' not. 61 (September 1981), Tables 1.11, 2.1, 6.15; "National Income and Product Accounts, 1976-79," Special Supplement to
the "Survey of Current Business," vol. 61 (July 1981), Tables 1.11, 2.1, 6.15 and "Survey of Current Business," voL 63 (July 1983), Tables,
1.11, 2.1, 6.15.
The impact of employee benefits on the income tax base
The effect of the exclusion of group health and life insurance on the income tax
base and on personal income tax receipts is straightforward. Gross income is low-
ered by the amount of the contributions and taxes are reduced by an amount equal
to the relevant marginal income tax rate times the excluded contributions. This re-
duction in receipts, commonly referred to as a "tax expenditure," is calculated an-
nually by the Treasury Department and included as a Special Analysis to the
Budget document.
The impact of the favorable tax treatment of pensions on the income tax base is
somewhat more complicated, since this employee benefit involves the deferral of
taxation rather than complete avoidance. For cash-based budget purposes, the reve-
nue effect in a given year is the net of two offsetting parts-the revenue loss from
exempting employer contributions and pension fund earnings from current taxation,
and the revenue gain from currently taxing private pension benefits.
In terms of the income tax calculations for 1984 indicate that the net revenue loss
for the three primary statutory benefits-group health and life insurance and pen-
sions-amounts to almost $70 billion, which represents approximately 22 percent of
personal income tax receipts in this year (see Table 2). In other words, personal
income tax revenues would have been almost 22 percent higher if employee benefits
were taxed in the same manner as wage and salary income, or tax rates could have
been reduced approximately 18 percent and still have provided the same revenue.
TABLE 2.-BENEFITS, 1950-84
[Dollars in billions]
Benefit 1 1950 1960 1970 1980 1984 2
Group health insurance: Exclusion of employer contributions -$0.2 -$0.8 -$2.8 -$12.9 -$22.9
Group life insurance: Exclusion of employer contributions' -.1 -.2 -.7 -1.7 -2.2
Pensions and profit shating:
Private plans:
Exclusion ef employer contributions -.4 -1.1 -2.8 -14.1 -20.2
Exclusion of fund earnings ° (4) -.4 -2.3 -13.5 -17.6
Inclusion of current benefits (4) +2 +8 +4.6 +8.8
Net
-.4 -1.3 -4.3 -23.0 29.0
PAGENO="0429"
423
TABLE 2.-BENEFITS, 1950-84-Continued
[Dollars in billions]
Benefit 1 1950 1960 1970 1980 1984 2
Government plans: 5
Exclusion of employer contributions -.2 -.6 -1.7 -6.9 -10.6
Exclusion of fund earnings ~ (4) -.2 -1.2 -8.1 -11.9
Inclusion of current benefits +1 +2 +7 +3.3 +6.8
Net revenue OIIC~L -.1 -.6 -2.2 -11.7 -15.7
Total revenue effect -.8 -2.9 -10.0 -49.3 -69.8
ADDENDUM
Revenue loss as a percent of personal income tax receipts 4.0 6.9 11.3 19.7 21.7
1 Revenue loss calculated by author using average marginal tax rates developed by Barro and Sahasakul-23 percent in 1950, 1960 and 1970
and 26 percent for 1980 and 1984. Revenue gain estimated assuming retirees face a marginal tax rate equal to one-half the average marginal rate.
2 Contributions, assets and benefits proiected by author assuming rate of growth from 1983-84 was the same as that from 1980-83.
Fund earnings calculated by author using asset information from "Flow of Funds Account" and assuming a rate of return on those assets equal
to the rate earned on 3-month Treasuries in that year.
Less than $0.05 bilion.
Includes Federal Civilian Retirement System and state and local retirement systems; the military retirement plan is not included.
Sources: Board of Governors of the Federal Reserve System, "Flow of Funds Accounts, 1949-1978: Annual Total Flows and Year.End Assets and
Liabilities" (1979) and "Assets and Liabitties 0otstandin~, 1959-1982" (1983); "The National Income and Product Accounts, 1929-76 Statistical
Tables," Supplement to the "Survey of Current Business, vol. 61 (September 1981), "National Income and Product Accounts, 1976-79," Special
Supplement to the "Survey of Current Business," vol. 61 (July 1981), and "Survey of Current Business," vol. 63 (July 1983), Tables 1.11, 3.4,
6.15 and 8.4; Robert J. Barro and Chaipat Sahasakul, "Measuring the Average Marginal Tan Rate from the Individual Income Tax," NBER Working
Paper No. 1060 (January 1983); Council of Economic Advisors, `Economic Report of the President" (Washington, D.C., 1984); American Council of
Life Insurance, "Pension Facts 1982, 1983 Update" (Washington, DC, 1984).
The impact of employee benefits on the payroll tax base
Exclusions from the payroll tax base have never been considered "tax expendi-
tures," since it has been generally assumed that any increase in contributions is re-
flected in higher benefits. Nevertheless, since the benefit increases associated with
an increase in payroll tax contributions do not appear for some time, it is useful to
consider the immediate revenue loss associated with excluding fringe benefits from
the payroll tax base. This calculation differs from that performed for the income tax
in two respects. First, employer contributions for all employee benefits represent
permanent reductions in the payroll tax base; even contributions to pension plans
escape tax completely, since no payroll tax is levied on pension benefits in retire-
ment. Second, revenue loss occurs on both the employees' and employers' side of the
transaction, since neither party is required to pay taxes on exempt employer-provid-
ed benefits. The calculations for 1984 indicate that payroll tax receipts would have
been $25 billion higher if employee benefits were included in the payroll tax base
(see Table 3). Alternatively, the 1984 social security payroll tax rate for the retire-
ment and disability portion of the program could have been lowered from 5.7 per-
cent each for the employer and employee to 5.2 percent, Mithout any reduction in
1984 revenues.
Of course in the long-run, broadening the payroll tax base to include employer
provided fringes will mean higher future social security benefits. The important
point for our discussion, however, is that the resulting benefit increases will be less
than the additional tax receipts produced by including fringes in the tax base. The
reason for this phenomenon is the weighted benefit formula, which provides that a
smaller percentage of wages are replaced at higher earnings levels than at lower
ones. Since most of the increase in the payroll tax base would occur at higher earn-
ings levels, benefit payments would not be increased proportionately. Thus, the
long-range costs of the program would be reduced by including employer provided
fringes in the payroll tax base.
PAGENO="0430"
424
TABLE 3.-IMMEDIATE REVENUE EFFECTS UNDER THE PAYROLL TAX FROM EMPLOYER-PROVIDED
BENEFITS, 1950-84
[Dollars in biltons]
Benefits
1950
1960
1970
1980
1984 1
Group health insurance
(2)
(2)
$02
-0.1
-$0.9
-0.3
-$5.4
-0.7
-$10.4
-1.0
Group life insurance
Pension and profit sharing:
-0.1
-0.2
-0.9
-5.9
-9.0
Private pensions
Government pensions
(2)
-0.2
-0.6
-2.9
-4.7
Total revenue effect
-0.1
-0.7
-2.7
-14.9
-25.1
ADDENDUM
Revenue loss as percent of payroll tax receipts
2.2
3.9
6.0
10.6
10.9
1 Contributions projected by author (see table 1, footnute 1).
2 Less than $0.5 billion.
Sources: "Social Security Bulletin," "Annual Statistical Supplement, 1983 (GPO, 1983), p~. 72, 200; 1984 Annual Report of the Board of
Trustees of the Federal Old Age and Survivors Insurance and Disahillty Insurance Trust Funds' (GPO, 1984); "The National Income and Product
Accounts, 1929-76 Statistical Tables," Supplement to the Survey of Current Business," vol. 61 (September 1981); "National Income and Product
Accounts, 1976-79," voL 61 (July 1981); "Revised Estimates of National Income and Product Accounts," vol. 63 (July 1983), table 8.4; and
Office of the Actuary, Harry C. Ballantyne," Long-Range Projections of Social Security Trust Fund Operations in Dollars," actuarial note 120 (May
1984).
Preliminary estimates by the social security actuaries indicates that if the ratio of
employer-provided fringe benefits to total compensation stabilized at current levels,
rather than continuing to increase as projected in the official cost estimates, the
projected payroll tax rate required to finance the retirement and disability portions
of the social security program over the next 75 years could be reduced by roughly
0.4 percentage points. That is, instead of requiring revenue equal to 13.0 percent of
taxable payrolls to cover promised benefits, the system could be financed for the
next 75 years at an average cost of 12.6 percent. Alternatively, including employer-
provided fringe benefits in full in the payroll tax base would reduce long-run costs
by 0.6 percent of taxable payrolls-that is, from 13.0 percent to 12.4 percent.
II. The impact of fringe benefits on tax equity
Including fringe benefits in the income and payroll tax bases not only would in-
crease revenues, but also would improve the equity of the tax structure. In the
United States, it has generally been agreed that income should be defined broadly
for the purposes of levying taxes, since this approach insures that taxpayers with
equal economic resources are assessed equal amounts of taxes and those with differ-
ent capabifities are assessed different amounts.
By excluding the value of fringe benefits from the tax base or deferring taxation
until the recipient faces lower marginal tax rates, the current provisions create two
types of inequities. First, excluding a major component of income from the tax base
means that two individuals, who are equally well off in an economic sense, will pay
different amounts of income and payroll tax over their lifetimes. Second, the exclu-
sion has an adverse effect on the distribution of income. Fringe benefits ar concen-
trated among higher paid employees and under the income tax, although not the
payroll tax, the value of exclusion and deferral increases with a worker's marginal
tax rate (see Table 4). Yet, all taxpayers must pay higher taxes to compensate for
the favorable tax retirement accorded employee benefits.
TABLE 4.-REVENUE EFFECTS `OF TAX EXPENDITURES, BY ADJUSTED GROSS INCOME CLASS, 1983
Total re
Adjusted gross income class
(t nusands) Number
turns filed
Cumulative
percent
distribution
Tax expenditures
Employer
Amount
(millions)
pension plans
Cumulative
percent
distnibu-
tion 2
Health insurance
Cumulative
Amount percent
(millions) distnibu.
tion 2
Life insurance
Cumulative
Amount percent
(miltions) distribu-
tion 2
Less than $10 34,366 100.0 -$1.1 100.0 -$1.3 100.0 -$0.1 100.0
$10 to $15 13,457 63.3 -1.6 96.0 -1.7 93.4 -.1 95.5
$15 to $20 10,936 48.9 -2.2 90.4 -2.1 84.7 -.2 89.4
PAGENO="0431"
425
TABLE 4.-REVENUE EFFECTS 1 OF TAX EXPENDITURES, BY ADJUSTED GROSS INCOME CLASS,
1983-Continued
.
Adjusted gross income class
(thousands)
Total netu
um r
ms filed
*
omu a ye
d~buti
~
Tax expenditures
Employer Pe
Amount
(millions)
nsion Plans
Cumulative
percent
distribu-
finn 2
Health Insurance
Cumulative
Amount percent
(millions) distribu-
finn 2
Life Insurance
Cumulative
Amount percent
(millions) distribu-
tion 2
$20 to $30
$30 to $50
$50 to $100
$100 to $200
$200 and over
17,254
13,538
3,384
549
116
37.2
18.8
4.3
.7
.1
-6.3
-9.6
-5.0
-1.7
-.6
82.6
60.0
25.9
8.1
.2
-5.5 74.0
-6.4 45.7
-2.1 12.9
-.4 2.2
-.1 .4
-.5
-.7
-.3
-.1
(3)
80.6
56.6
21.9
6.7
1.9
Total
93,600
NA
-28.1
NA
-19.6 NA
-2.0
NA
1 Revenue loss data derived from NIPA information presented in table 2. Distribution among adjusted gross income classes was calculated
according to information in Revising the Individual Income tax.
2 Percentages cannol be obtained from data due to rounding.
Less than $0.05 billion.
Nole.-NA=nof applicable.
Source: Congressional Oudgot Office, Revising the Individual Income Tax (July 1983), tables land 9, pp. 58, 60, and 61.
If the generous provisions associated with the fringe benefits are allowed to con-
tinue for the growing array of new benefits, the payroll and income tax bases will
be reduced to the point where they can no longer be considered even approxima-
tions of ability to pay. What then is the outlook for the future of fringe benefits?
III. The outlook for employee benefits
The social security trustees project that the ratio of benefits to total compensation
will increase by 0.3 percent annually. A decade ago such a forecast might have been
viewed as somewhat high, since the work force appeared fairly well saturated with
the traditional statutory benefits. Recent developments, however, reveal consider-
able interest on the part of both the employee and the employer in expanding the
role of nontaxable compensation and a willingness on the part of Congress to pro-
vide new mechanisms with which to accomplish this goal. In order to assess the rea-
sonableness of the social security projection, let us first examine the outlook for the
traditional statutory benefits and then turn to the likely development of the more
recently enacted forms of benefit plans.
Traditional statutory benefits
Coverage for any of the three major benefits-pensions, health, and life insur-
ance-is unlikely to expand much further. The percentage of the civilian work force
covered by these plans has remained almost constant since 1970 and a recent study
by the Bureau of Labor Statistics showed that coverage in medium and large firms,
the main providers of employee benefits, was nearly universal-97 percent of em~
ployees in these firms had health insurance, 96 percent had life insurance and 84
percent had retirement pensions. Moreover, the shifting industrial structure in the
United States tends to make further major increase in coverage unlikely. Industries
with traditionally higher benefit coverage, such as manufacturing, are expected to
employ a declining share of workers, while employment in industies with low bene-
fit coverage, such as retail trade and services, is projected to increase.
Some increase in the ratio of benefits to compensation should be expected, howev-
er, from benefit improvements and rising costs of the traditional fringe benefit
plans. In the case of private pension plans, pressure is almost certain to develop for
some form of post-retirement cost-of-living adjustments and in the health insurance
area, medical costs are likely to continue increasing at a more rapid pace than the
general price level. Thus, there will probably be a moderate expansion in the pro-
portion of compensation contributed to traditional employee benefits.
New types of benefits
The major source of growth in nontaxable employer-provided benefits, however,
will probably come from the proliferation of new types of plans. In the last ten
years a host of tax-favored employee benefit provisions have been introduced and
other benefits have been moved from the realm of administrative ruling to statutory
standing.
PAGENO="0432"
426
The extension of statutory benefits began in 1974 with incentives for employers to
establish employee stock ownership plans (ESOPs) for their employees (see Table 5).
The next step was a substantial increase in the list of services that could be provid-
ed tax free by employers for their employees. These include prepaid legal services,
employer-provided transportation by commuter van between home and work, educa-
tional assistance for tuition, books and supplies, and dependent care assistance for
children and incapacitated dependent adults. The only requirement imposed on
these benefits is that they be provided on a nondiscriminatory basis that does not
favor officers, shareholders, or highly compensated employees.
TABLE 5.-EXPANSION OF STATUTORY EMPLOYEE BENEFITS, 1974 TO THE PRESENT
Year Statutory benefit Legislation Provision1
1974-81 ESOP's Employee Retirement Singled out employee stock ownership plan (ESOP's) as only benefit
Income Security Act plans that could be used as a vehicle for corporate borrowing, by
of 1974. exempting ESOP's from certain fiduciary standards regarding
diversification and parties-in-interest transactions.
ESOP's Tax Reduction Act of Permitted corporations to take an additional 1 percent investment
1975. tax credit if the funds were invested in ESOP's.
ESOP's Economic Recovery Tax Revised the investment tax credit associated with ESOPs so that the
Act of 1981. additional allowable credit is based on the lesser of either the
total value of employer securities transferred to the ESOP or a
prescribed percentage of annual compensation of all employees
covered by the plan.2 The credit expires on ian. 1, 1988.
1976 Legal services ... Tax Reform Act of 1976.. Allowed employees to exclude from gross income the value of
employer contributions to qualified prepaid legal services plans, as
well as the value of any legal services provided. Applicable to
self-employed individuals. Expires ian. 1, 1985.
1978 Van pooling Revenue Act of 1978 Allowed employees to exclude from gross income the value of
employer provided transportation to and from work by commuter
van. Not applicable to self-employed individuals. Expires Jan. 1,
1986.
1978 Educational Revenue Act of 1978 Allowed employees to exclude from gross income the value of
assistance. employer provided educational assistance. Applicable to self.
employed individuals. Expired Jan. 1, 1984.
1978 Cafeteria plans.. Revenue Act of 1978 Eliminated the doctrine of "constructive receipt". Allowed employees
to exclude from taxable income the value of benefits chosen
under a qualified cafeteria plan if the benefit would have been
nontaxable in the absence of the plan.
1978-80 401(k) plans.... Revenue Act of 1978 Allowed employees to reduce their salary by up to 15 percent of
compensation and to invest money tax tree in a deferred
compensation account.
401 (k) plans.... Miscellaneous Revenue Allowed 401(k) plans to be included in cafeteria plans.
Act of 1980.
1981 Dependent Economy Recovery Tax Allowed employees to exclude from gross income the value of
care Act of 1981. employer provided dependent care assistance.
assistance.
1984 General Deficit Reduction Act of Allowed employees to exclude from gross income the value of 1)
guidelines. 1984. "no-additional-cost" benefits; 2) qualified employee discounts; 3)
"de minimis" benefits; 4) working condition benefits; 5) on-
premise athletic facilities, and 6) tuition reductions.
Limited inclusion in cafeteria plans to statutory nontaxable benefits
and cash.
Allowed the lending institution to exclude from gross income 50
percent of interest on loans made to [SOP's
1 to addition to these specific provisions, most statutory fringes must comply with nondiscrimination requirements in order to qualify as tax
exclusions. In general, statutory fringe benefit plans must be nondisctiminatory with respect to eligibility, contributions and benefits. It a plan is
determined to discriminate in favor of officers, shareholders or high!)' compensated emp!xyees, the otherwise applicable income exclusion is denied.
The Deficit Beduction Act of 1904, however, exempted "do rninimus' and "working condition" fringe benefits from nondiscrimination requirements.
2 The prescribed percentage is 0.5 for 1903 and 0.75 for 1905, 1906, and 1907.
Sources: Joint Committee on Taxation, "Pamphlet Prepared by Joint Committee on Taxation en Administration Proposal to Tax Employer Provided
Medical Insurance and Explanations of Tax Treatment of Benefits" (June 0903); Peter Henle and Jane G. Groweell, "Employee Stock Ownership
Plans: Current Status and Proposed Legislation," Congressional research Service Multilith No. 75-159E (Jo!) 1975); and "Analysis of the Employee
Benefit Provisions of the deficit Reductixn Act of 1904 (Public Law 90-369) and Text of Pertinent Sections of the Law," Special Supplement to
BNA Pension Reporter (Sept. 3, 1904).
PAGENO="0433"
427
A third innovation was the encouragement of so-called "cafeteria" plans that
allow employees to select from a menu of benefits and salary packages with a varie-
ty of health, vacation, insurance, retirement and other benefits. This development
became possible with the enactment of Section 125, which removed restrictions im-
posed by ERISA on cafeteria plans that offered the option of cash or a taxable bene-
fit. Essentially, ERISA said that the right to elect cash or a taxable benefit consti-
tuted "constructive receipt" even if the employee did not actually make such an
election. The 1978 legislation provided that the application of tax was to be based on
the actual election of taxable benefits, and thereby paved the way for the establish-
ment of cafeteria plans covering a wide range of taxable and nontaxable benefits.
The same legislation also authorized so-called section 401(k) plans that allow em-
ployees to reduce their salary by up to 15 percent of compensation and invest the
money tax free in a special account. As in the case of pension plans, interest is al-
lowed to accumulate tax free until the funds are distributed. Legislation passed in
1980 permits 401(k) plans to be part of a cafeteria plan.
Finally, the most recent relevant legislation, the Deficit Reduction Act of 1984
(DEFRA), awarded statutory standing to a list of benefits that had generally been
viewed as tax-exempt by the public. Although early attempts were made to tighten
up the rules for the taxation of those nonstatutory benefits, the final legislation es-
sentially codified existing employer practices. In the process of expanding statutory
nontaxable benefits, however, the act did impose restrictions on the types of benefits
that can be included in cafeteria plans. Beginning in 1985, choices under a qualified
cafeteria plan will be restricted to statutory nontaxable benefits and cash.
As a result of DEFRA, fringe benefits offered by the employer will be excluded
from taxable income if they qualified under any one of the following categories: 1)
Services provided at no additional cost to the employer, such as airline seats to air-
line personnel and their families; 2) Qualified employee discounts up to 20 percent
for goods sold in the normal course of the employer's business; 3) Benefits used in
the employee's work, such as a company car, if at least 85 percent of the benefit
would be classified as work related; 4) Other benefits that fall under a de minimis
exclusion such as picnics for company employees, small Christmas gifts, and subsi-
dized cafeterias. In addition, special exemptions will be allowed for qualified tuition
reductions, employee parking, and athletic facilities.
In short, new fringe benefits are constantly being introduced and will probably
constitute an ever increasing portion of total compensation.
IV. Proposal for reform
Given that the growth in fringe benefits is likely to continue, the question then
becomes what should be done. Although Congress and the Treasury have expressed
concern aout the trend towards workers taking more compensation in tax-free bene-
fits, Congress has so far limited reforms to relatively minor actions, such as curtail-
ing benefit practices that are clearly aimed at tax avoidance. I think that the time
has come for more comprehensive approach to tax reform, and that the reform
should be logical and consistent with the principles of the nation's tax policy rather
than an ad hoc response to looming federal deficits.
Any economist will tell you that, for purposes of tax equity, the theroretically
pure solution would be to establish a comprehensive definition of compensation for
both income and payroll tax purposes. Under such a definition, the value of the em-
ployer's contributions for health and life insurance and the increase in the value of
accrued pension benefits would be included in the employee's income. Employer con-
tributions for dependent care, van pooling and educational assistance would also be
included in income, and salary reduction schemes, such as 401(k) plans, would be
repealed.
While such a reform would not be extraordinarily difficult to implement for
either the payroll or income tax, such a dramatic change might have undesirable
economic consequences. The basic statutory benefits have been awarded preferential
status under the tax code precisely because it was deemed desirable to encourage
certain types of activities. Almost everyone agrees that the favorable tax treatment
has contributed significantly to the expansion of pension, health, and life insurance
plans. On the other hand, the existence of fringe benefits cannot be attributed to
tax policy alone. Pension plans, for example, have existed long before the income
tax, reflecting employers' needs for an impersonal and egalitarian mechanism to
retire super annuated workers. However, because the precise role played by tax
preferences in the growth of the .basic statutory benefits is not known, it would
probably be unwise to dramatically alter the current treatment and include the full
value of these benefits in the tax base for income tax purposes. On the other hand,
40-046 0 - 85 - 28
PAGENO="0434"
428
it does seem both desirable and feasible to include all fringe benefits in the defini-
tion of taxable wages under the payroll tax.
A precedent already exists in the taxation of 401(k) plans for treating fringe bene-
fits differently under the income and payroll taxes. The codification of the Rowan
decision provides that an exclusion of income for income withholding shall not
affect the treatment of income for payroll tax purposes. As a result of the 1983
Social Security Amendments, employee contributions to 401(k) plans are included in
the payroll tax bases even though they are deductible under the income tax.
The 401(k) experience also seems to indicate that the application of the payroll
tax alone to an employee benefit does not have a seriously adverse impact on its
adoption and growth. Recent surveys indicate a dramatic expansion of 401(k) plans.
Not only are they continuing to expand among large companies, but are increasing-
ly being adopted by middle-sized firms, which is surprising since innovations in ben-
efits generally take some time to trickle down from the largest employers.
Nevertheless, a recent survey by Meidinger, Inc. indicates that half of the medium-
sized firms who responded to the survey (256 firms in 38 states) said they were
taking positive action toward adopting 401(k) plans or already has such a plan in
place.
In short, it is theoretically desirable, administratively practical, and economically
feasible to include all fringe benefits in the payroll tax base. This change will in-
crease short-term revenues by roughly $30 billion per year, allow Congress to reduce
the scheduled 1988 and 1990 payroll tax increase by half and reduce the long-run
costs of the system by 0.5 percent of taxable payrolls. Moreover, the applicability of
the employer's share of the payroll tax to employee benefits removes the incentive
for the employer as well as the employee to prefer noncash payments.
While identical treatment of fringe benefits under the income tax may not be de-
sirable, some reforms are obviously necessary in order to avoid becoming a society
where workers receive half their compensation in wages and half in fringes. The
most obvious compromise is to place an overall limit on the amount of fringe bene-
fits-including pensions-that workers can receive tax free or tax deferred under
the income tax. Setting such a limit must necessarily involve some degree of arbi-
trariness, but would restrain the erosion of the tax base without subjecting most of
the work force to an immediate increase in their tax liability. If a single number
had to be selected it should probably be slightly above the current benefits to com-
pensation ratio of 12.5 percent that prevails in the manufacturing sector. Perhaps,
15 percent of total compensation might be reasonable. A preferable approach, how-
ever, would be to allow a generous amount of nontaxable benefits as a percentage of
compensation at lower income levels and reduce the percentage as income increases.
For example, nontaxable benefits could account for 25 percent of the first $40,000 of
compensation, 15 percent of the next $40,000 and 5 percent of any compensation
over $80,000.
Thus, my recommendation is twofold: to tax fringe benefits in full under the pay-
roll tax and to establish an aggregate progressive limit on tax free or tax deferred
fringes under the income tax.
Mr. HEFTEL. Next, Joseph Minarik, Urban Institute.
STATEMENT OF JOSEPH J. MINARIK, SENIOR RESEARCH
ASSOCIATE, THE URBAN INSTITUTE
Mr. MINARIK. Thank you, Mr. Chairman. I would like to empha-
size as Alicia did, that I am speaking for myself and not for the
Urban Institute. I would like to congratulate the chairmen of the
two subcommittees for holding these hearings. I think it is very im-
portant at this time, now that the Deficit Reduction Act has codi-
fied the treatment of tax-exempt fringe benefits, that we take a
look at what we have in the law.
Particularly, at this time when the deficit is such a pressing con-
cern, it is clearly very important that we look at any exclusions
from the tax base of this size to consider where we stand with re-
spect to the budget and what can be done to reduce the deficit.
I would like to just go into a few points, to emphasize some
things that Alicia said and disagree with her very slightly on her
conclusions. First of all, I think it is most important that we under-
PAGENO="0435"
429
stand that from the various sources of information that we can see,
coverage under fringe benefits does vary considerably from one in-
dustry to another, among different classes of workers and by
income levels.
So for example, we have professional workers in the economy,
half of whom are covered by both health insurance and pension
benefits. We have agricultural workers who are covered only in
proportion of about one in ten. We have service workers and con-
struction workers who are covered only about one in four. So clear-
ly we have tax-exempt fringe benefits going to particular classes of
workers, and not to others.
We have industry breakdowns where, in manufacturing as op-
posed to construction, for example, coverage of fringe benefits is
much more intensive. Now this raises two very important issues.
The most important one, I think, is the fairness issue. We are talk-
ing here not so much, I think, about an issue of what one income
group gets as opposed to another income group. I think the key
point is that at any given income level, there are workers who re-
ceive vastly different degrees of fringe benefit coverage, where in
some cases we have coverage of a quarter of payroll in tax-exempt
fringe benefits, and there are other workers, particularly those in
small firms, who receive no coverage whatsoever.
So as far as the equity concern is involved, it would be important
to make the tax base more comprehensive, so that most workers
who do not receive fringe benefits are not at a disadvantage com-
pared to others with the same cash compensation who receive more
in fringe benefits. Then I think there is an important issue of eco-
nomic efficiency. We have exclusions from the tax base. Those ex-
clusions reduce the amount of income subject to tax. And given
that the Federal Government has to raise a certain amount of reve-
nue in order to meet its needs, that means tax rates have to be
higher.
That is a double example for economic efficiency. One is that
they reduce incentives. Second, those taxpayers who do not receive
any tax-exempt fringes because the tax rates are driven up, have to
pay at those higher statutory rates. And so in both cases we have
concerns both on efficiency and also fairness with respect to the ex-
clusions we have for fringe benefits. Another thing is that fringe
benefit products become cut-priced goods in that workers will bar-
gain for tax-exempt fringe benefits to the extent that they can get
them, even though they may be valued at less than an equivalent
amount of cash.
So, for example, an employee in a 30-percent tax rate bracket
would prefer to receive 70 cents in subjective value worth of fringe
benefits to a dollar's worth of taxable compensation. I would con-
clude from these problems that the best way to deal .with the
equity issues and with the efficiency issues is to subject fringe ben-
efits to taxation, both under the income tax and under the payroll
tax.
The reason for that is that in order to provide equity for equally
situated taxpayers given that the income tax is the heavier tax,
income taxation would be the appropriate remedy for the inequi-
ties we have in the system right now. The caps that have been dis-
cussed do limit the overuse or abuse of the fringe benefit opportu-
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430
nities do not deal with the efficiency consideration where, under-
neath the cap, employees can still prefer to receive tax-exempt ben-
efits.
An excise tax has also been discussed as a remedy. This has a
benefit of dealing with the distortions, of providing some additional
cost to tax-exempt fringe benefits and therefore preventing their
expansion as completely tax free goods. However, it does not ad-
dress the equity issue to the extent that the excise tax is only a
partial substitute for the full taxation that would occur if these
fringe benefits were taxed under both the income and payroll
taxes. So I think it would be preferable to put fringe benefits in
both the income and the payroll tax bases.
The difficulty under the current income tax is that we have tax
rates that are high and we have exclusions that are perhaps inad-
equate, considering that some workers receive substantial amounts
of fringe benefits simply in the form of health insurance at low
income levels. So I think it would be important under these cir-
cumstances to consider the possibility that adjustment of the pro-
gram parameters of the income tax, including some of the tax
rates, and possibly the exemptions and zero brackets be considered,
as well.
Finally, I think it is important that we consider the effects that
taxation would have on benefit strategies. It is not, I think, a fair
statement that we have a choice of tax-exemption of fringe benefits
or no fringe benefits at all. In particular, health insurance is most
effectively and most efficiently provided thorough the private
market, and, in particular, health insurance is least expensive on a
group basis.
That suggests that employers will be the most logical sources of
health insurance coverage for employees. And so the issue here is
not so much choosing between fringe benefits and Government pro-
grams such as national health insurance. It is, rather, providing an
equitable and efficient means of taxation for compensation of em-
ployees. Thank you, Mr. Chairman.
[The prepared statement follows:]
STATEMENT OF JOSEPH J. MINARIK, STHI0R RESEARCH ASSOCIATE, THE URBAN
INSTITUTE
The Chairman of the Subcommittee on Social Security and the Subcommittee on
Select Revenue Measures are to be congratulated for holding these hearings on em-
ployer-provided fringe benefits. The fringe benefit issue has gained increasing im-
portance as fringes have grown, narrowing the tax base. With the Deficit Reduction
Act providing the tax treatment of fringe benefits, it is a good time to take stock of
the non-cash compensation paid in the economy, and its effect on employees and the
tax system.
In my statement today, I would like to discuss the proper tax treatment of em-
ployer-provided fringe benefits, and the characteristics of fringe benefits that are
important to the appropriate tax treatment. This approach will show why we want
a neutral and fair tax treatment of all forms of employee compensation, and how we
should achieve it.
TAX PRINCIPLES FOR EMPLOYEE COMPENSATION
The federal income tax starts from a principle of taxing income from whatever
source derived. The Social Security payroll tax, for programmatic reasons, starts
from a narrower base of employee cash compensation and self-employment income,
but it allows no deduction whatever from that base. So both of these taxes, in princi-
ple, seek a tax base that is as comprehensive as possible.
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431
There are two reasons for taxing broad measures of income, with minimal exclu-
sions permitted:
First, it is fairer. A taxpayer who may exclude some of his income excluded from
tax while others may not enjoys an unfair advantage. So, for example, no one would
argue on first principles that workers in the utilities and communications and
mining industries should pay less tax than those in services and agriculture; or that
professional and managerial workers should pay less than sales personnel and la-
borers; or that workers in large firms should pay less than those in small firms, all
else equal. But that is the effect of the current law. The utilities and communica-
tions and mining industries make benefit payments equal to more than 40 percent
of their wage and salary outlays, while the service and agriculture industries pay 25
percent or less (U.S. Chamber of Commerce, Employee Benefits 1982). More than
half of professional and managerial workers receive both health insurance and pen-
sions coverage, but only about 25 percent of sales personnel and laborers do (Timo-
thy M. Smeeding, "The Size Distribution of Wage and Nonwage Compensation: Em-
ployer Cost vs. Employee Values"). And workers in large- and medium-sized firms
are significantly more likely to receive employee benefits than those in smaller
firms (Statement of Dallas L. Salisbury before the Senate Finance Committee,
August 7 and 9, 1984). So some groups are systematically disadvantaged relatives to
others by the current exclusions for fringe benefits.
Second, a broad tax base is more efficient. A tax base that is broader can yield a
given revenue at lower rates; that reduces disincentives and distortions. Further, if
exceptions from a tax are granted, taxpayers will seek to receive their compensation
in the exempt form, reducing revenue and total income in the economy. Thus, exclu-
sions for employer-provided fringes are expected to cost the Treasury over $150 bil-
lion by 1988; that revenue loss forces tax rates up.
So in principle, employer-provided fringe benefits should not be excluded from our
tax bases.
Like all rules, the broad and uniform tax base has exceptions. Like all exceptions,
these are often claimed in vain to justify unjustifiable decisions. The conditions
under which these principles should be violated are strictly limited.
Some exclusions from our tax bases subsidize worthwhile activities that would not
be undertaken on their own. Some might argue that employer-paid health insurance
fits this description-that without a tax subsidy, workers would go without health
insurance, impoverishing themselves or leaving society holding the bag when they
became ill. Alternatively, it might be argued that the federal government would be
left to fill the gap with an expensive national health insurance program.
These arguments don't stand up. There is no evidence that employees would
choose to drop their employer-provided health insurance if the tax exclusion were
cut back or eliminated. Over recent years, as medical care and health insurance
have become more expensive and tax treatment has been constant, workers have
purchased more health insurance, not less. With the currrent cost of routine medi-
cal care and the possibility of catastrophic expenses, health insurance is a necessity,
and everyone knows it. Employer-provided insurance would continue to be popular
without the tax exclusion because group insurance is the most economical form.
With a continued healthy private insurance market, there would be no more
demand for national health insurance than there is now. Other insurance subsidies,
for dental and legal insurance, for example, have a much weaker rationale on their
own. These benefits might be dropped without the tax subsidy, but no important na-
tional purpose would be lost.
Pension subsidies, the other major tax-favored employer benefit, might be better
defended on these grounds. Young and middle-aged workers might well forgo saving
for retirement, which seems far away, while they would protect themselves against
medical bills, which are an immediate threat. Further, the availability of tax-de-
ferred IRAs for those not covered by employer plans makes the pension exclusion
less of an equity issue. (Of course, the availability of those same IRAs as a double-
dip for those who are covered by employer plans mitigates this argument some-
what.) One might argue with the generous upper limits for contributions to pension
plans, however, even after the cutback in the Tax Equity and Fiscal Responsibility
Act of 1982 (TEFRA). Employers can deposit in pension reserves each year free of
tax amounts roughly equal to the median family income, or can allow accrual of
annual pension rights equal to about three times the median income. Prudent prep-
aration for retirement is one thing, but we might wonder whether a public subsidy
is fitting for feathering a nest quite so luxuriously.
A second justification for tax exclusions is relief for hardship. This can hardly be
argued for employer-financed fringe benefits, because the working population receiv-
ing the fringe benefits are comparatively well-off. Further, the benefit of the tax ex-
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elusion is greatest for those with the highest incomes, because the tax savings are
greatest for those in the highest marginal tax brackets. So hardship or fairness are
no justification for the exclusion of employer-financed benefits.
A third possible justification would be administrative difficulty with measuring
and taxing the benefits. This justification, too, does not hold for the major fringe
benefits. Health and life insurance premiums are determinable for individual work-
ers, and can be reported to workers on their W-2 forms just like cash wages. Fully
vested contributions to defined contribution plans could be reported the same way;
partially vested contributions or accruals under defined benefit plans require actu-
arial assumptions, but those assumptions are far from complex for plan administra-
tions.
So the only real justification for continuing the fringe benefit exclusions at their
current generosity is inertia.
CHARACTERISTICS OF TAX-EXEMPT FRINGE BENEFITS
The use and distribution of the major employer-paid fringe benefits are partly de-
termined by the nature of the benefits themselves, and partly by the tax exemption.
Who gets what
Medical insurance.-Employer-paid medical insurance is widely received among
full-time employees in large- and medium-sized firms, but less so in smaller firms.
Medical insurance costs roughly approximate an equal per capita expense; while
more comprehensive coverage is more expensive, the difference between the most
and least generous plans is comparatively limited. More or less of that cost may be
paid by the employer and therefore be tax-exempt, according to the bargain struck
between employer and employee. In any given firm, the difference in the deal for
higher- as opposed to lower-wage workers is limited by anti-discrimination require-
ments. Thus, tax-free medical insurance premiums are distributed relatively equally
across the population; the tax benefit of the exemption is a function of the marginal
tax rate, and therefore greater for the more highly compensated employees.
Life insurance.-Employer-paid life insurance is the most widely received of the
major fringe benefits, and is nearly universal among full-time employees of large-
and medium-sized firms. The amount of employer-paid life insurance is generally
some multiple of annual income. Premiums increase with age, and older workers
tend to earn more. Thus, the amount of employer-paid premiums tends to increase
in proportion to income. The tax exemption is limited to $50,000 worth of life insur-
ance, however, and so the tax benefit is capped at some maximum amount.
Pensions.-Like life insurance premiums, pension contributions tend to a fraction
of income, and the maximum tax exemption is capped. Pension contributions are
much larger than life insurance premiums, however, and the maximum tax-exempt
contributions are quite large. Further, young and new employees, who tend to be
less highly compensated, can be excluded from pension plans for a time and subject-
ed to gradual vesting. Thus, pension contributions are the most exclusive of the
major employer-financed benefits. Anecdotal evidence suggests that a major benefit
to highly compensated employees has been arranging the maximum tax-exempt
pension contribution that the anti-discrimination laws allow. Thus, these contribu-
tions tend to be relatively heavily concentrated among highly paid workers, and the
tax benefits even more heavily concentrated because of the graduated tax rate
schedule.
Bargaining
Employers are indifferent between spending a marginal dollar on cash compensa-
tion or on fringe benefits, because both are tax deductible as legitimate business ex-
penses. Employees, on the other hand and all else equal, would prefer fringe bene-
fits, because they are tax deductible. Thus, tax-exempt employer contributions are a
kind of mad money, and are treated more lightly than taxable dollars. An employee
in the 30-percent bracket is indifferent between one dollar in wages and fringe bene-
fits that he would value at 70 cents.
The limit in employee bargaining for fringe benefits is determined by the declin-
ing marginal value of life and health insurance and pension contributions. Contrib-
uting to this declining value is the increasing number of two-worker couples, and
thus, duplicative employer-paid health insurance. One advantage to workers of lim-
iting the maximum employer contribution to a basic health insurance plan for
single people is that working spouses can choose this most limited coverage, which
they do not need anyway if the other spouses if fully covered, and take home more
cash.
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CONSEQUENCES OF TAXING FRINGE BENEFITS
Payroll tax
Subjecting these major fringe benefits to payroll taxation would augment the
total taxable wage base by about 10 percent of its current amount. Relatively small
amounts of life insurance premiums would be added, increasing with income across
the income scale; larger but more nearly equal amounts of health insurance premi-
ums would be added for most employees, with some, probably those with lower
wages, receiving none; and pension contributions of amounts increasing sharply
with income would be added as well. If the taxation of pension contributions were
restricted to the highest contributions of top-heavy plans, there would be virtually
no tax consequences.
Some of the augmentation of the tax base would be lost, because the benefits are
received by workers already exceeding the maximum taxable compensation. This
suggests that augmentation of the tax base should be accompanied by an increase of
the taxable maximum, to maintain full coverage of a high percentage of the work
force. Likewise, the payroll tax rate might be reduced, to lessen the additional tax
on low- and middle-wage workers who receive life and health insurance benefits.
The bottom line of payroll taxation of fringes, however, would be that the tax
would come closer to a levy on total compensation. This would be both more equita-
ble and more efficient.
Income tax
Taxation of fringe benefits would augment the income tax base by income group
in the same fashion as it would the payroll tax base; the only difference would be
that the taxable maximum would not apply. This means that the largest pension
contributions would be taxable, and in all probability would not be made. Employers
would tend to limit contributions to permissible tax-exempt amounts, and employees
would take any excess as cash compensation, and in all likelihood save it them-
selves.
Because the income tax rates are so much higher than the payroll tax rate,
income tax increase for fringe benefit recipients would be that much larger. So op-
position from recipients and their representatives would be that much more vigorus.
The appearance of such a change taken in isolation would be Uncle Sam singling
out wage and salary workers and drafting their money for the war on the budget
deficit.
This suggests that some compensating changes in the income tax might be made.
To protect low-income workers from substantial tax increases, the personal exemp-
tion and especially the zero-bracket amount, which are overdue for increases
anyway, might be raised. Alternatively, the tax rates at the low- and middle-income
level could be reduced. Because these changes are expensive, particularly the per-
sonal exemption increase, progress may be more likely in the context of a broader
tax restructuring bill than as an isolated reform of the handling of fringe benefits.
The bottom line should not be lost, however. It is that subjecting employer-paid
fringe benefits to the income tax would be more efficient, by treating different types
of income and expenditure alike, and fairer, by taxing workers with equal total com-
pensation the same way. It would not be an unfair burden on recipients, considering
other taxpayers who do not receive fringe beneifts. The distributional impact is not
an argument against taxing benefits, because standard deductions, exemptions and
tax rates can be adjusted to attain any distributional outcome desired.
Caps on tax-exempt benefits
Current law imposes caps on tax-exempt life insurance and pension contributions.
Anti-discrimination regulations might be seen as implicit caps on tax-exempt contri-
butions under different programs.
Individual benefit caps limit the use of particular tax-exempt benefits. To some
degree, this can be like capping one rabbit hole, merely increasing the flow through
other holes from a well-developed warren. There can be particularly important out-
lets, however, as in the cap on the contributions to pension plans. The Administra-
tion-proposed health insurance contribution cap may be similarly important, in that
the tax exemption has encouraged expensive first-dollar coverage, which can make
employees totally insensitive to the price of medical care.
Nonetheless, partial caps do not prevent extremes of overall use of tax-exempt
fringe benefits, nor do they necessarily impose their limits in any relationship to
the total compensation or income of the worker. Further, they do not make all
workers face the market price, rather than a tax-exempt "discounted" price, of
fringe benefits. Thus, item-by-item caps do not serve the overall purposes of tax
policy.
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An alternative would be an overall cap on tax-exempt fringe benefits from what-
ever source. That kind of a restriction would be more keyed to the total amount of
tax-exempt compensation, but not to total compensation (unless the cap were ex-
pressed as a percentage of total compensation). Further, a cap would not eliminate
the inequity of the relative treatment of taxpayers at any given income level with
more or less fringe benefits. Some of the effects of a total cap would depend on the
treatment of existing item caps. If item caps were lefted, more taxpayers and more
fringe benefits would go back to the zone where fringes are cut-price goods, thus
increasing distortions. If the item caps were not lifted, there might be a cry for ap-
plying unused fringe allowances to shelter cash compensation, narrowing the tax
base. So an overall cap would have an upside and a downside.
Excise tax on fringe benefits
Another option is an excise tax on fringe benefits, or on contributions above some
tax-free amount. Such an excise would prevent fringes from being quite so inexpen-
sive at the margin, and thus could slow the fringe benefit explosion.
Again, there is a question of how an excise on excess contributions would be co-
ordinated with existing item caps. If the caps were continued, contributions defined
as acceptable by a cap could be taxed by the excise. If the caps were lifted, use of
some fringes could expand beyond what is now considered an acceptable amount.
Unlike a general cap, an excise tax would not be likely to induce a campaign for tax
exemption of cash compensation for those with little or no fringe benefits.
Except for its limit on the amount of taxable compensation, the Social Security
payroll tax probably fits the description of an acceptable excise tax for otherwise
exempt fringe benefit contributions. Consideration might be given to using the pay-
roll tax in that role.
Nonetheless, the excise tax would likely be proportional, rather than progressive,
and so when compared to the income tax it would be relatively more rigorous for
low-wage than for high-wage workers. To eliminate the distortion of worker choices,
and to link the tax on fringe benefits to total compensation, income taxation would
be superior to an excise tax.
LIKELY TAXPAYER ADJUSTMENTS
If fringe benefits were subject to taxation, workers would want to adjust their mix
of compensation. This is a cost of transition, but it is not a significant disadvantage;
it says that workers' choices are distorted by the current tax treatment, a problem
that we should want to remedy.
One issue would be the terms of existing multi-year collective bargaining agree-
ments. Presumably, there should be a prospective effective date in the law to avoid
implicit changes in existing contracts. If grandfathering of existing contracts were
chosen with an immediate effective date, however, there would be a coordination
problem between the grandfathered tax exclusions and any compensating tax rate
cuts or tax allowance increases. Grandfathered workers could get the best of both
worlds-not having to pay tax on their fringe benefits for a time while enjoying a
general tax cut intended to compensate them for the added burden.
A second problem would be the health insurance coverage of two-earner couples.
Where one spouse has duplicative coverage under current law, the only disadvan-
tage is that that spouse would prefer to receive the cash that pays the premium
rather than the insurance. If that premium were taxable, however, there would be
an actual tax burden for insurance coverage that is neither wanted nor needed. Pre-
sumably, such a worker should be permitted to refuse the insurance coverage, and
possibly even allowed to take the premium money in cash. This requires institution-
al changes to give taxpayers more choice. It also raises problems of improvident tax-
payers circumventing the system to take cash compensation instead of health insur-
ance, and then dumping any catastrophic medical bills on society. Obviously, some
new institutional arrangements will be needed.
Mr. HEFTEL. Our next panelist is Kenneth Simonson, President's
Commission on Industrial Competitiveness.
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435
STATEMENT OF KENNETH D. SIMONSON, PRESIDENT'S COMMIS-
SION ON INDUSTRIAL COMPETITIVENESS, AND SPECIAL AS-
SISTANT TO THE CHAIRMAN, MILLIPORE CORP.
Mr. SIM0N50N. Thank you. I am speaking for myself only today
and no other organization. I would like to have my testimony sub-
mitted for the record and just to summarize a few principal points.
Mr. HEFTEL. So ordered.
Mr. SIMoNsoN. I will focus today on employer-paid health and
life insurance, mainly because I think that Members of Congress
have done a good job of dealing with the so-called nonstatutory
benefits this year, thanks to the leadership of Chairman Stark and
Mr. Conable, and because they have looked repeatedly at the pen-
sion area.
I don't think we have had the last word on either of those prob-
lems, by any means. But at least they have gotten close attention.
Therefore, I will focus on health insurance, the largest and fastest
growing area of fringe benefits and life insurance. In my opinion,
both belong in the tax base for income and Social Security tax pur-
poses.
Adding them to those bases would eliminate the strong bias that
now exists toward giving benefits and against cash compensation.
The static revenue gain from such a change would be large, but
that gain may evaporate as employers and workers adjust. The dis-
tributional effects also need to be taken into account, because
workers at various income levels would be affected differently. Fi-
nally, I will comment on the role of fringes in two broad income
tax restructuring bills that this committee may take up.
It is especially heartening to see the Social Security subcommit-
tee look at fringes. All of the tax restructuring bills that I have ex-
amined, and the current Treasury study, from what I hear of it,
ignore Social Security, as if neither the tax nor the benefits side
had any connection to income tax restructuring. Some economists
are guilty of encouraging such bifurcated thinking, by saying in
effect that "Social security revenues and outgo are projected to be
in balance (knock on wood), so there is no reason to examine that
part of the tax system." That advice sits well with many politicians
of all stripes, whose attitude seems to be, "If it ain't goin' broke
today, don't mention it, let alone fix it."
Yet Social Security is inevitably affected by decisions about the
income tax treatment of fringe benefits. The more broadly the
income tax is restructured, the more Social Security is likely to be
affected. They are intimately linked and I think it is essential you
look at the entire Tax Code when considering major tax restructur-
ing plans.
You have heard a lot of figures this morning and yesterday on
the magnitude of fringe benefits and their likely growth. As an
economist, I know how hazardous it is to project the growth of any
number. And I will not try to do that. I would like to point out,
though, that according to the national income accounts that were
released last month for 1983, group health insurance had grown 65
percent since 1980, while wages and salaries had grown only 22 per-
cent, or one-third as fast, over that span.
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436
Outlays for group health insurance totaled $82 billion last year.
Outlays for group life insurance another $7.6 billion. Together
these benefits accounted for 5.4 percent of wages and salaries that
year, up from 4.1 percent as recently as 1980, and more than
double the 2.6 percent rate of 1971.
So while I can't say how fast these benefits will continue to grow,
I think they have already reached a very substantial level and are
clearly growing much faster than wages and salaries. Therefore, I
think they merit your attention now. In particular they deserve at-
tention because they are unevenly distributed. A survey by the
U.S. Chamber of Commerce that you, I believe, are well aware of,
shows that premiums accounted for 6.7 percent of payroll in 1982
and by 1983 that figure had probably climbed to over 7 percent.
If you take out the firms that did not pay any benefits and also
adjust for the growth of premiums from 1982 to 1983, it appears
that the size of benefit per covered employee in 1983 was about
$1,500. That is a substantial amount of income to let out of either
the income or the payroll tax bases. I believe the principal justifica-
tion in most people's minds for exempting health insurance from
taxation is that it is a good thing to have broader health insurance
coverage.
That ought to lead to a healthier population. I have no quarrel
with the idea that we would like to have a population as healthy as
possible. However, I think that the current blanket exemption for
health insurance is a very inefficient way of achieving that goal. It
not only provides for many kinds of coverage that probably do little
to boost the overall health of the covered population. It leaves
many workers with inadequate coverage. Finally, by encouraging
those workers who are covered to make greater use of health serv-
ices, they tead to bid away those services from other persons who
may be needier, but do not have the same resources.
As a result the population as a whole may not be any better off
than they would be if we drastically revised the current tax treat-
ment of health insurance.
I think the case for exempting life insurance from taxation is
even weaker. Very few people would be left destitute if we removed
the exemption from employer-provided life insurance.
And finally, I think including both of these in the tax base would
not mean the end of employer-provided benefits in this way. Cer-
tainly, there are economies of scale to having employer-provided
group coverage, rather than for each individual to go out and pur-
chase coverage. And I think that employers would still be provid-
ing group coverage.
However, individuals would be buying that coverage out of after-
tax dollars, and, I think, would choose more carefully what level of
coverage was appropriate for them. So I believe that putting health
insurance in particular into the tax base would lead to a much
more rational choice of the amount of health care we want. While
that is not strictly the subject of today's hearing, I think is a major
concern of the committee which has so much of the health system
under its jurisdiction.
The incentive now from a worker's standpoint from leaving
health and life insurance and for that matter, other benefits, out of
the tax base, is substantial. The average marginal individual
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437
income tax rate is somewhat over 20 percent today. In addition the
combined employer and employee rate on Social Security tax is
13.7 percent this year and will be going up to 14.1 percent in a few
months.
Finally, State and local income taxes generally follow the defini-
tion of compensation used for the Federal income tax. Therefore,
even average income workers are facing a 35 to 40 percent tax rate
on wage income, if you include both employer and employee shares
of Social Security tax. And they have that large incentive to seek
exclusion of fringe benefits rather than taking cash compensation
even if the fringe benefit would not be worth nearly as much to
them as cash, in a nontax world, or in a world in which the tax
treatment was equal for both of those.
You have heard figures on the amount of revenue loss from ex-
cluding fringe benefits from income and Social Security tax.
The estimates for the Social Security base tend to vary widely. I
have one estimate in my testimony, and derived another estimate
from some Joint Committee on Taxation staff figures. I notice in
the pamphlet for this hearing that they have come up with a third
estimate. But I think all of those should be taken with a large dose
of salt because once you put the benefits under an income and pay-
roll tax system employers and workers would adapt.
These estimates all assume that there would be no change in the
level of benefits offered. Nevertheless, there should be significant
tax consequences for both the income and payroll tax basis. I agree
with Dr. Munnell that we would have been able to avoid some
Social Security tax increases in recent years, or upcoming ones, if
we had put these benefits into the payroll tax base. To put the ben-
efits into the income tax base would involve a number of distribu-
tional consequences.
As Joe Minarik and witnesses on the first panel pointed out, cov-
erage tends to be very uneven. Small businesses, for instance, pro-
vide less coverage. And in general, workers at the lower end of the
income scale get less benefit from fringes than do upper income
workers.
On the other hand, health insurance benefits, which as I men-
tioned are the largest category of employer-provided fringes now,
tend to be a flat dollar amount per person, more or less an excise
tax on each worker. Therefore, low income workers get, in propor-
tion to their wages, a larger benefit from health insurance cover-
age than upper income workers. Moving health insurance into the
income tax base would seem, then, to fall hardest on those workers
if employers adjusted by cutting back their benefits. Therefore, I
think that if you are considering taxation of health and life insur-
ance, and I realize you are probably very reluctant to do so because
of their broad popularity, you should do that in the context of a
general tax restructuring plan.
I have looked at two bills that do restructure the tax system. In
part, by including health and life insurance in the tax base. Those
are the Fair Tax Act of 1983 introduced by Representative Gep-
hardt and Senator Bradley and a bill proposed by Senator Quayle
called the SELF Tax Plan Act of 1985. He has not introduced that
yet, but has described it in the Congressional Record. And for that
bill he has made it explicit that his definition of fringe benefits
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438
would apply for Social Security tax purposes as well as income tax
purposes.
In contrast, the Bradley-Gephardt bill does not make that clear,
from my reading of it. However, I think that the static tax impacts
would be similar; namely, that you would get a tax increase of as
much as $13 billion in Social Security revenues. If these bills are
revenue neutral overall, that is, for income and payroll tax pur-
poses, as they purport to be, that employees that they have a large
income tax reduction and are making that up by adding substan-
tially to payroll tax receipts.
Now, the payroll tax falls much more heavily on lower to middle
income workers than does the income tax. And I think you need to
look carefully at those distributional effects of both taxes, if you
consider a broad-scale reform of the tax system.
Finally, let me comment briefly on two halfway measures to in-
cluding life and health insurance fully in the tax base. I think that
a cap on life and health insurance, or health insurance alone,
would be better than what we have now. However, it would not
avoid all of the administrative problems laid on employers by at-
tributing each dollar of health insurance to an employee. And it
would also create a perverse incentive to some extent to raise the
amount of health insurance that employees under the cap were
taking, so that the net effect on tax receipts might be quite small.
A second alternative is to put an excise tax on employers. If you
do this, you would avoid all the problems of trying to divide up
benefits for each employee. You wouldn't have to worry about
taxing employees on an income tax for which they may not have
had withholding take place. On the other hand, you would have to
be careful I think, if you really wanted to avoid an incentive for
taking extra fringe benefits, you would need quite a substantial
excise tax rate.
As I mentioned before, 35 to 40 percent would approximate the
average benefit that employees get now. And that rate would have
undesirable distributional consequences because low-income work-
ers now have a combined tax rate that is well below 35 to 40 per-
cent, and workers at the top a combined rate that is substantially
above that. So the excise tax would have the effect of encouraging
employers to hire more high-income workers, rather than low.
Thank you.
Chairman PICKLE. Thank you very much.
[The prepared statement follows:]
STATEMENT OF KENNETH D. SIMONSON, SPECIAL ASSISTANT TO THE CHAIRMAN,
MILLIPORE CORP.
Thank you for inviting me to testify today. Let me make clear at the outset that I
will be presenting my own views as an economist and not necessarily those of my
employer.
I wish to commend both of these subcommittees for exporing this topic today, just
before the full committee takes testimony on tax reform generally. Taxation of
fringe benefits poses some of the trickiest problems to resolve in redesigning the tax
system. Yet because total restructuring involves so many questions, the more com-
plex issues like how to tax fringes tend to be ignored or given a once-over-lightly.
To summarize briefly: I will focus today on employer-paid health and life insur-
ance. In my view, both of these items belong in the tax base for income and social
security tax purpose. Adding them to those bases would eliminate the bias toward
benefits and against cash compensation. The static revenue gain from such a change
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439
would be large, but that gain may evaporate as employers and workers adjust. The
distributional effects also need to be taken into account, because workers at various
income levels would be effectived differently. Finally, I will comment on the role of
fringes in two broad income tax restructuring bills.
It is especially heartening to see the social security subcommittee look at fringes.
All of the tax restructuring bills that I have examined, and the current Treasury
study, from what I hear of it, ignore social security, as if neither the tax nor the
benefits side had any connection to income tax restructuring. Some of economists
are guilty of encouraging such bifurcated thinking, by saying in effect that "Social
security revenues and outgo are projected to be in balance (knock on wood), so there
is no reason to examine that part of the tax system." That advice sits well with
many politicians of all stripes, whose attitude seems to be, "If it ain't goin' broke
today, don't mention it, let alone fix it."
Yet social security is inevitably affected by decisions about the income tax treat-
ment of fringe benefits. The more broadly the income tax is restructure, the more
social security is likely is to be affected.
This year Congress tackled a number of long-standing and vexations fringe bene-
fit problems, thanks in part to the leadership of Chairman Stark and Rep. Conable.
Taxation of retirement benefits, including pensions, has also been reviewed and
changed significantly in recent years. But two major categories of fringe benefits,
group health and life insurance, have been largely ignored.
MAGNITUDE OF BENEFITS
Group health insurance is the largest and fastest-growing category of compensa-
tion, totaling $82 billion in 1983, according to the National Income and Product Ac-
counts published by the Commerce Department. That figure is 65% higher than in
1980, while wages and salaries grew 22% over the same span. Outlays for group life
insurance totaled another $7.6 billion in 1983. Together these benefits accounted for
5.4% of wages and salaries that year, up from 4.1% as recently as 1980, and more
than double the 2.6% rate of 1971.
Even the 5.4% number is understated, because it compares premiums to wages
paid all employers, even ones that did not pay premiums. A survey by the U.S.
Chamber of Commerce of 1507 businesses, most of them large, shows that among
firms that paid premiums, the premiums accounted for 6.7% of payroll in 1982 (Em-
ployee Benefits, 1982, Table 12, p. 17). The 1983 figure probably exceeds 7%, given
the rapid growth of payments.
The same survey shows that combined payments for life and health insurance
premiums by all 1507 firms averaged $1274 per employee in 1982 (Table 8, p. 13)
Averaging this total just over firms that paid premiums and adjusting it for the
growth of premiums suggests that the cost in 1983 per covered employee was rough-
ly $1500. About 90% of that total was for health insurance.
WHY EXEMPT FRINGES
What justification is there for continuing to exempt fringes from taxation? It
might be argued that fringes do not fit under the definition of gross income, or of
compensation for FICA (social security) tax purposes. But that implies that workers
have not received anything of substantial value, an assumption that would be dis-
puted by any worker at the same cash income level who does not receive a fringe
benefit. It also suggests that all health and life insurance purchased by taxpayers
(employees or not) on their own behalf ought to be deductible. Such a deduction
would no doubt please insurance sellers, but it would hardly help the fisc. One is
forced to conclude that fringes are income, and to look elsewhere for a reason to
exempt them.
Two plausible reasons for exempting health insurance are to promote greater
health in the populaiton and to protect people from catastrophic medical costs. How-
ever, the current exclusion does not serve either of these rationales well. It is an
efficient means of spreading a safety net under people who might be bankrupted by
medical bills. The exclusion applies to many types of noncatastrophic medical cover-
age, and it does not assure that covered employees will be given coverage protecting
them from economic hardship.
Unfortunately, the exclusion does not necessarily lead to better overall health of
the population, either. It undoubtedly enables covered employees to purchase more
health care than they would pay for out of after-tax dollars, and presumably they
are healthier as a result. But their purchases drive up the cost of care, reducing the
amount purchased by the rest of the population, who may well need health care
more than covered workers and their families. (Where medical supplies or services
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440
are especially scarce, the quantity available to noncovered persons might be affected
more than the cost.) Moreover, removing the exclusion would not automatically lead
to wholesale abandonment of health insurance. Employees would still find employ-
er-provided group health insurance less expensive in many cases than individual
coverage.
The case for excluding life insurance from income is even shakier. The value of
the premiums is appropriately part of gross income. The exclusion induces workers
to buy more life insurance than they would buy out of after-tax dollars. Such a deci-
sion is not likely to benefit the rest of society enough to warrant the loss of revenue
unless the choice leaves less of a burden on society than would after-tax insurance
purchase.
Most of the premiums cover employees who would not place an added burden on
society even without the subsidy. Some of these employees have sufficient life insur-
ance, social security, pension, and other wealth to provide for their survivors; others
have no dependents; still others would purchase additional protection out of after-
tax dollars. Relatively few employees would gamble and lose in a way that would
cost society if the exclusion were abolished.
WHY TAX FRINGES
A worker who receives health and life insurance in addition to wages is clearly
better off than one who receives the same wages and no benefits. The first worker
has higher total compensation and disposable income. Therefore, employer-paid in-
surance properly belongs in the income and FICA (social security) tax bases.
Including premiums in income will reduce the tax bias against taxpayers who do
not receive benefits. It will encourage covered workers to choose between insurance
and other forms of compensation without basing their decision on tax consider-
ations. That in turn, should lead to workers selecting a more appropriate level of
insurance.
In the case of health insurance, such a choice is one vital step in allowing market
forces to set how much health care the nation can afford. Workers will select health
services more prudently if they directly pay additional tax when the amount of
health insurance they buy rises. Moreover, placing health insurance under FICA
implies that additional money flows to the medicare trust fund when workers buy
health insurance. This can be viewed as a way of compensating medicare recipients
for the costs imposed on them by employees who use more health services.
There is also an income redistribution argument for taxing fringes. In general,
workers who choose greater benefits must give up cash compensation, because em-
ployers (at least private-sector ones) will only send a given amount on labor services
for a given level of output, whether the payments take the form of salary, benefits,
or employers' payroll taxes. The workers who have the least incentive to seek addi-
tional fringe benefits are the ones in the lowest marginal tax bracket, and thus the
lowest income. They are also the ones who can least afford to give up cash income
in order to have their employers pay them in the form of benefits which are not
tradable for items they may need more urgently.
HOW SHOULD FRINGES BE TAXED
In principle, the full employer's full cost of providing the insurance should be at-
tributed to each employee and reflected on the annual W-2 wage statement. If this
attribution is made only at year end, many employees would owe substantial tax on
which no withholding had occurred. In addition, a retroactive statement of health
insurance costs would do little to make employees aware of how much they had
chosen. Thus, including the costs in each pay period would be better for workers.
However, employers may find it burdensome to calculate insurance-related costs on
a weekly or monthly basis, particularly for employers who self-insure or handle sub-
stantial administrative functions for insurers, such as claims processing.
Congress should take a comprehensive approach to allocable costs, so that there is
no bias for or against having employers subsidize health services by self-insuring or
providing services directly, for instance through in-house clinics. But employers and
employees should be given flexibility in finding ways of developing health-care op-
tions. For instance, some employers who process claims might decide to charge em-
ployees on a per-claim basis, whereas others may decide they can minimize total
costs by dividing claims among all covered employers without keeping track of indi-
vidual claims. There is no clear reason for Congress to prescribe or proscribe either
method.
If Congress decides that the administrative costs of allocating all employer-paid
health expenses to individual employees are excessive, there are two partial alterna-
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441
tives. One is the Administration's health insurance "cap" proposal, to allow costs up
to $70 per month for individuals and $175 for families to remain tax-exempt. This
cap would let employers avoid recordkeeping and tax collection for millions of work-
ers who choose lower-cost plans, and give workers and insurers a clear incentive to
choose plans that are under the cap. On the other hand, some employers would still
incur large administrative costs, and employees who now choose less than the maxi-
mum tax-free amount might decide to increase their health coverage up to the cap.
The second alternative is to put an excise tax on employers for the amount of
health-care costs rather than allocating the cost to employees. This spares employ-
ers from having to figure out how much to assign to each worker and avoids impos-
ing tax on workers for noncash income. (Congress could extend the tax base to other
benefits whose cost is identifiable at the employer level but hard to allocate individ-
ually, such as subsidized cafeterias.) If the excise tax rate is set equal to the sum of
the combined employer-employee FICA rate plus the marginal income tax rate for
the average employee, the revenue impact should be equal under this alternative.
Such a tax rate would be roughly 35-40% (14% for FICA and somewhat over 20%
for individual income tax). However, workers would not have as direct an incentive
to economize on insurance as they would if the cost and tax appeared on their pay
statements and tax returns. Furthermore, use of a single tax rate would mean that
low-income workers were taxed more heavily on benefits than on cash compensa-
tion, and high income workers the reverse, a result that does not fit most notions of
equity.
CONSEQUENCES OF TAXING HEALTH AND LIFE INSURANCE
The reason for taxing these benefits is to remove the bias that now exists for both
employers and workers to choose benefits over cash compensation and to improve
the price mechanism in the delivery of health care by making workers more aware
of the cost of those services. An added rationale that you may hear is that this
would be a potent revenue source.
At least in theory, a lot of revenue could be raised by including group insurance
premiums in taxable compensation. The "tax expenditure" for lost income tax re-
ceipts from excluding health insurance from individual returns totaled $15.3 billion
in fiscal 1983, with the amount estimated to grow to $20.0 billion by fiscal 1985, ac-
cording to Special Analysis G of the Fiscal 1985 Budget. The comparable figures for
life insurance are $2 billion in fiscal 1983, rising to $2.4 billion in fiscal 1985.
In addition, I estimate that, on a static basis, over $10 billion of FICA receipts
would have been collected in 1983 by including health and life insurance in the
social security tax base for employers and employees. (One of the many shortcom-
ings of the "tax expenditure" concept mentioned above is that it ignores all taxes
except corporate and individual income.) This estimate assumes that $80 billion of
the $89.6 billion spent by employers on premiums would have been allocated to em-
ployees whose income was below the FICA wage ceiling and thus would have been
taxed at the 13.4% employer-employee rate.
Before Congress decides to mine this lode, however, several cautionary notes
should be sounded. First, the potential revenue gain may not be all that it seems.
Employers and employees alike adjust their behavior in the face of rising taxes. If
employers must start paying FICA on health and life insurance, they will, over
time, cut back on those or other items-or do without some workers altogether.
Therefore, if employers must pay FICA on the health insurance they offer, they will
respond by reducing their total compensation costs by a like amount. Thus taxable
compensation will not rise by the full amount that intially is added to the tax base.
Even if employers do not bring total compensation back down to its previous level,
there will be some reduction in federal receipts because taxable employers will have
incurred an additional deductible expense.
The response to making fringes taxable will differ according to the employee's
wage rate. For highly paid employees, those above the maximum taxable level for
FICA ($37,800 in 1984, projected to be $39,300 in 1985), the employer will face no
additional cost from making fringes taxable. Conversely, the worker will be liable
for additional income tax, but not FICA.
At the other extreme, employers cannot react to additional costs by cutting wages
for workers earning the minimum wage. They can respond only by absorbing the
cost, cutting benefits, or eliminating the job. Thus workers at the low end of the
wage ladder are likely to bear the brunt of employer adjustments to this added tax,
by losing benefits or perhaps even their job. Even if their employer absorbs its share
of FICA on the benefits, the workers' already small after-tax wage income will be
reduced by the employee share of FICA and possibly income tax.
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A more severe consequence for low-income workers arises from the fact that
health benefits are basically a flat amount per employee and are not proportional to
income. Thus, putting social security tax on these benefits implies that workers at
all income levels would pay the same dollars amount of tax. This amount would
have been about $200 per worker in 1983 (assuming $1500 per worker in benefits
and a 13.4% tax rate that year.) Such an amount is obviously much easier for a
high-paid employee to absorb than for a minimum-wage worker. Conversely, em-
ployers will be more willing to absorb the $100 employers' share in the case of a
$35,000-per-year worker than a $10,000-year worker. Both of these effects suggest
that low-wage workers have the most to gain if employers substitute straight pay
for insurance.
The vast majority of workers fall between these two ends of the wage spectrum.
How will they be affected? They may face the largest additional tax burden, because
they would owe FICA (at a employer-employee rate of 13.4% in 1983 and 13.7% in
1984) as well as income tax, whereas employees who are above the wage ceiling
would own only income tax. Thus, a single worker receiving $24,500 of pay and tax-
able benefits in 1984 would face a combined federal income and payroll tax rate on
additional benefits of 43.7%. In contrast, a single worker receiving between $37,800
(the 1984 FICA wage ceiling) and $56,300 would pay no more than 42%.
Of course, this pattern of rates already applies to wages. Little wonder then that
workers increasingly show a preference for nontaxable fringes. This preference
should diminish if the fringes become taxable at the same rate as cash.
To sum up: An exclusion for health and life insurance does not serve a valid
social purpose and does distort workers' preferences between straight pay and bene-
fits. The overuse of health insurance in particular has harmful side effects in terms
of driving up the cost of health care for noncovered individuals (or for the taxpayers
who fund medicaid and medicare). Full taxation of these benefits would encourage
employers and employees alike to lessen their preference for benefits over wages.
Such a switch back to cash would help lowest-wage workers the most, although they
would pay a disproportionate share of the tax on benefits.
TAX RESTRUCTURING BILLS AND FRINGES
Most likely Congress would want to combine any such change with broader tax
restructuring. The best-known bifi that contains a combination of taxing fringes but
providing other forms of relief is the "Fair Tax Act of 1983" (HR. 3271/S. 1421),
introduced by Rep. Richard A. Gephardt (1)-Mo.) and Sen. Bill Bradley (D-N.J.). That
plan would include employer-provided health insurance, life insurance and other
statutory fringe benefits in individuals' gross income. The sponsors have never made
clear whether those items would also be included in the wage base for social securi-
ty (FICA) tax purposes, although I have been told that the staff of the Joint Com-
mittee on Taxation (JCT) did make such an assumption in doing revenue estimates
for the bill. You would do everyone concerned about tax reform a great service if
you could clarify and make public this information.
In contrast, Sen. Dan Quayle (R-Ind.) has shed some light on the static revenue
consequences (that is, assuming no employer or employee response) from including
fringes in the income and FICA tax bases. In a Senate floor statement (Congression-
al Record, June 12, 1984, pp. 6990-94), he provided data from the J~JT staff on the
effects by income class of his proposed "SELF-Tax Plan Act of 1985." That plan ex-
plicitly includes currently nontaxable fringes in the tax base for individual income
tax and for both employer and employee shares of the FICA tax.
Additional FICA receipts from the inclusion of health and life insurance and
other fringes would amount to $13.2 billion under the SELF-tax at 1984 rates and
1981 income levels, according to JCT estimates. The receipts under the Bradley-Gep-
hardt plan and other bills that add these items to the FICA base would be about the
same, irrespective of how their income tax rates differ. This is a large sum, equal to
well over 5% of the FICA receipts actually collected that year and possibly enough
to have averted the near-panic over social security's solvency that occurred in 1982.
(It is about 50% higher than my rough estimate, but both should be taken with a
large dose of salt, because the assumption of no response by employers and employ-
ees to reduce this tax load is clearly unwarranted.)
Even more startling is the effect on the distribution of tax liabilities from includ-
ing these receipts. Here the particular results apply only to the Quayle plan, but the
direction of change is just as applicable to any bill that attempts to keep overall
receipts by income class roughly the same as under present law (such as Bradley-
Gephardt). Under the Quayle proposal, only 20.6 million taxpayers would have
income tax increases, vs. 60.5 million who would receive income tax cuts. But the
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443
number with combined income and FICA tax increases (counting employer's share
of FICA as well as employee's share) jumps to 55.6 million, while the number receiv-
ing tax cuts drops to 54.6 million.
Nearly all of the taxpayers who are added to the tax-increase side of the ledger
have low expanded incomes. (Expanded income is adjusted gross income plus certain
tax preferences; it is the income measure generally used by the JCT staff to present
income distribution data.) To be specific, 36.4 million out of the 55.6 million tax-in-
crease cases have less than $10,000 of expanded income. Evidently, 29 million of
these taxpayers owe no income tax but do receive employer-paid fringes that would
be subject to social security tax under the plan. Many of these taxpayers are among
the working poor.
These effects are summarized in the following table.
EFFECTS OF "SELF-TAX ACT OF 1985" ON INCOME AND FICA RECEIPTS-COMPARED TO MARCH 1984
LAW, AT 1981 INCOME LEVELS
Expanded incume range (thousands)
Returns with tax decrease
(millions)
Income tax Income +
nnly RCA tax
Returns with tax increase
(millions)
Income tax Income +
only FICA tax
Net change
nam
e a
no y
(billions)
ncome +
ax
0(0 $10
15.0 14.4
5.9 36.4
-$1.8
$1.5
$10 to $20
21.3 9.5
13.1 11.6
3.1 5.0
4.1 5.6
-8.7
-6.3
-6.0
-3.1
$20 to $30
$30 to $40
5.9 5.1
2.2 2.0
3.4 4.2
1.9 2.1
-1.9
-.1
.2
.8
$40 to $50
$50 to $75
1.3 1.2
.4 .3
.4 .4
.1 .1
1.5 1.6
.4 .4
.3 .3
.1 .1
1.2
.5
-.5
-1.1
1.8
.6
-.4
-1.0
$75 to $100
$100 to $200
$200+
Total
60.5 54.6
20.6 55.6
-18.8
-5.6
Source: Compiled by the author (rum JCT stat simulations.
In the absence of data on the Bradley-Gephardt bill, it is impossible to verify the
sponsors' claim that that bill would leave each income class approximately as well
off as at present.
(For a fuller discussion of several tax restructuring bills and the impact that
changes in fringe benefits taxation and other features have on the distribution of
tax burdens, I hve attached my article, "The Not-So-Level Playing Field of Revenue
Neutrality," Tax Notes, August 13, 1984.)
In short, restructuring bills that attmept to maintain the current-law distribution
of tax burdens have very different effects, depending on whether they take social
security receipts into consideration. I urge you to look at the whole tax code when
you are considering proposals to restructure either fringe benefits or income tax-
ation generally.
40-046 0 - 85 - 29
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444
THE NOT-SO-LEVEL
PLAYING FIELD OF
REVENUE NEUTRALITY
by Kenneth D. Simonson
Sponsors `of recent ta_s restructuring plans deserve'
faint applause for professing to make their bills "revenue-
neutral." The applause is for attempting to separate the
issue of how much revenue to raise from how to raise it.
The faintness is for the lack of candor or clarity with
which they state what they mean by revenue neutrality.
Revenue neutrality sounds straightforward: merely
change the law so as to collect the same amount of tax as
under current law. Why make such a change? To make
the tax law fairer, simpler, or more efficient. A revenue-
neutral proposal lets people compare "apples and ap-
ples": without arguing about how much revenue should
be raised overall, they can decide whether present law or
the alternative satisfies these other aims better.
At least five tax restructuring plans currently receiving
attention purport to be revenue-neutral. These include
the "Fair Tax Act of 1983" (S. 1421/HR. 3271), introduced
by Sen. Bill Bradley (0-N.J.) and Rep. Richard Gephardt
(D-Mo.): the "Fair and Simple Tax Act of 1984" (HR.
5533/S. 2600), introduced by Rep. Jack Kemp (R-N.Y.)
and Sen. Bob Kasten (R-Wis.); the "SELF-Tax Plan Act of
1983" (5. 1040), introduced by Sen. Dan Quayle (R-lnd.);
a revised "SELF-tax" described by Quayle in a Senate
speech (Congressional Record, June 12, 1984, pp. 6990-
94); and the "Flat Tax Act of 1983" (5. 557), introduced by.
Sen. Dennis DeConcini (D-Ariz.). (Details of-the plans
were compared in David R. Burton's "Ma)or Tax Reform
Proposals at a Glance," Tax Notes, June 4, 1984, pp.
1095-1100.)
The sponsors, except DeConcini, çlâim not only that
their bills are revenue-neutral, but that they would keep
the revenue collected from each income group un-
changed. How welt do these claims stand up? Unfor-
tunately, no one, except possibly the sponsors. can say,
for two reasons. First, only one sponsor has offered proof
in the form of independently prepa'ed data. Second, the
authors have not made clear which revenues would be
kept even.
Where's the Proof?
Only Sen. Quayle has gone public with revenue esti-
mates from the staff of the Joint Committee on Taxation
(JCT). (See Barbara N. McLennan and Kenneth 0. Simon-
son, "Income Distribution Effects of Moving to a Broad-
Based, Low-Rate Individual income Tax," Tax Notes,
February 6, 1984, pp. 509-18, for estimates on S. 1040, the
"SELF-Tax Plan Act of 1983." See Sen. Ouayle'a floor
statement in the Congressional Record for estimates on
his revised propoat.)
Revenue neutrality is a static concept which
assumes no change in taxpayer behavior or
economic conditions as a result of the tax
change, an obvious impossibility.
Sen. Bradley and Rep. Gephardt have said the JCT
estimates for their bill show that it would be neutral, but
they have refused to make the figures public. Rep. Kemp
and Sen. Kasten say that their bill would be revenue-
neutral for most income classes and lose revenue for
upper-income groups, but they also have refused to
provide specifics. Sen. DeConcini evidently does not
have JCT data for hit bill. Still, he asserts that his bill
would be revenue-neutral, based on a calculation pre-
CIAL
Kenneth 0. Simonson, a Washington tax econo-
mist, is special assistant to the chairman of Millipore
Corporation. This article represents his views only.
In this article, Mr. Simonson notes that the Brad-
ley-Gephardt, Kemp-Kasten, Ouayle, and DeCon-
cmi tax restructuring proposals all profess to be
revenue neutral in (hat they would raise the same
amount of revenue in their first year as would be
raised under present law. The author finds that
except for Sen. Ouayle, the sponsors are either
unable or unwilling to state the actual revenue
effects of their bills. f-fe notes that the bills differ as
to which revenues would be held constant and that
the base-broadening encompassed within the bills
is likely to produce a substantial increase in payroll
tax liabilities for employers and employees.
The author suggests that the notion of revenue
neutrality is not a very useful guide to policy and
that revenue neutrality is possible only under very
artificial assumptions. I-fe suggests that using reve-
nue neutrality as a benchmark may lead to selection
of a tax restructuring plan that is undesirable on
both economic efficiency and deficit control
grounds.
PAGENO="0451"
445
SPECIAL REPORT
sented by Robert Hall and Alvin Rabushka in their book
Low Tax, Simple Tax, Flat Tax, That book estimates that
the bill would have been revenue-neutral in 1981, with
rapidly rising revenues thereafter, although their esti-
mation method differs from the JCT's method. -
The static approach may work well for marty
tax provisions that make only minor changes
in law, but it breaks down for large-scale re-
structuring bills.
Compared to What?
The federal government derives most of its revenue
from three main sources-individual income tax, corpo-
rate income tax, and social security payroll tax, which
includes taxes on employers, employees, and self-
employed. The restructuring plans all would explicitly
change the definition of taxable income and the rates for
the personal income tax. They all would change the
corporate tax but do not all spell out how. None specifies
changes in the payroll tax, but the Bradley-Gephardt and
Quayle plans would include in wage income employer-
paid fringe benefits such as health and life insurance.
Including fringe benefits in the definition of wages could
affect payroll tax receipts as well.
It is not always clear whether the sponsors intend that
the broader definition of wage income would apply for
social security payroll tax purposes as well. This point is
important, because at current payroll tax rates (a com-
bined employer-employee rate of 13.7 percent in 1984,
14.1 percent in 1985), adding roughly $100 billion of
fringe benefits to the tax base would produce a large
amount of added payroll tax receipts.
Only the 1984 Quayle proposal relies explicitly on
added social security payroll tax receipts to approach
revenue neutrality. That proposal is estimated to reduce
individual income tax receipts by $18.8 billion but add
$13.2 billion tg social secujity's coffers (counting em-
ployer and employee shares). The net impact is a revenue
loss of $5.6 billion, or 1.2percent of combined income
and payroll fax receipts for 1981.
Ouayle'a 1983 bill, S. 1040, apparently also would add
to social security receipts, but he did not state that
explicitly. That bill would have cut 1981 income tax
revenues by $7.4 billion, or 3.4 percent. Although Ouayle
considered this loss small enough to call the bill income
tax-neutral, it seems more accurate to call it income tax-
losing and income plus payroll tax-neutral, like his 1984
plan.
Bradley and Gephardt have not made clear whether
their broader definition of wage income would apply for
social security purposes. These effects would apparently
be similar to those in the 1984 Quayle plan: that is, a
revenue gain of 513 billion. Assuming their bill is revenue-
neutral with respect to income plus payroll taxes implies
trial tiie bill would cut income tax receipts by the same
amount.
In contrast. Kemp and Kaslen do not redefine taxable
i'.ace income. Thus their bill would apparently leave
social security receipts unchanged. Whether they leave
other receipts constant seems less likely. Their explana-
tory materials state that their plan would raise approxi-
mately as much as present law, but also that taxpayers
below $20,000 would get a small reduction on average, as
would taxpayers over $100,000. Corporate rates would be
cut as much as under Bradley-Gephardt (more for small
amounts of income), but Kemp-Kasten contains fewer
offsetting corporate revenue raisers. Thus, Kemp-Ka~en
appears to lose revenue in both its individual and corpo-
rate provisions, with no pickup from payroll receipts. In
other words, it is not actually revenue-neutral.
DeConcini would totally replace corporate and individ-
ual income taxes with a business tax and a compensation
tax. The latter would tax wages as currently defined and
thus would bring is less revenue than the current per-
sonal income tax. The business tax would apply to in-
come from capital, plus fringe benefits paid by business,
corporate and noncorporate. This tax would raise more
revenue than the current corporate tax. Together the
taxes are intended initially to equal the receipts from
today's income taxes. DeConcini evidently does not in-
tend to broaden the social security tax base, although.
making fringe benefits subject to business tax might also
open them up to payroll taxation. It is assumed in the
table below that his bill would match the sum of individ-
ual and corporate receipts in the first year and would not
change social security receipts.
In summary, it is unclear what revenues are being kept
neutral under most of these bills, because the authors
have not detailed their proposals sufficiently or have not
provided reliable revenue estimates. Nevertheless, if one
accepts the sometimes shaky assumptions above, the
following pattern emerges.
Table I
CHANGE IN RECEIPTS FROM PRESENT-LAW LEVELS
Plan Individual Payroll Corporate TaIaL.
Oueyle 184 planl down up neutral neutral
Ouayle (8. 1040) down up neutral neutral
Bradley-Gephardt down up neutral neutral
Kemp-Keslen down neutral down down
DeConcini down neutral up neutral
Neutral for Whom?
Although the plans (other than DeConcini's) claim to
be roughly revenue-neutral by income class as well as
overall, this type of revenue neutrality is much harder to
achieve. Qusyle's floor statement shows why.
He reproduces JCT figures showing that in 1981, over
50 million taxpayers had less than $10,000 of expanded
income (adjusted gross income plus tax preferences less
investment interest expense to the extent of investment
income).
Under Quayle'a proposals total income and payroll tax
receipts of that group would stay nearly constant, rising
by 2.9 percent from $53.1 billion to $54.7 billion. But this
is achieved by raising payroll taxes on 30 million individ-
uals. Counting employer and employee shares of the
social security tax along with income tax changes, over
36 million taxpayers would face increases: 14 million,
decreases. Looking just at income taxes, nearly 16 million
returns would have tax Cuts vs. only 6 million increases.
The net change in income tax receipts would be a decline
of 40 percent, from 54.4 billion to $2.6 billion. These
effects are shown in Table 2.
PAGENO="0452"
Table 2
TAX INCREASES AND DECREASES UNDER
1984 OUAYLE PLAN FOR UNDER-$1O,000
EXPANDED INCOME CLASS
Returns with Returns with All
Increases Decreeses Returns
No. Amt. No. Amt. No. AmI,
(mit. SI (bit. SI (mit. 9) (bit. 3) (mit. 5) (bit. 3)
Income tax
only
5.9
32.1
15.9
-3.9
21.8
-1.8
Income + pay-
roll tax
36.4
4.8
14.4
-3.3
50.8
1.5
Brad(ey-Gephardt would presumably have similar ef-
fects. if it uses higher social security receipts to offset
tower income tax receipts. In both cases, only taxpayers
whose wage income is below the social security ceiling
($37,800 of wages in 1984. projected to be $32,300 in
1985) face this combination of tower income taxes and
higher payroll taxes.
Quay(e's figures illustrate another point that applies to
alt restructuring bills. Even when there is no change in
aggregate liability for a group, many individuals in the
group face large increases or decreases. For instance,
Quayle's 1984 plan would raise the combined income and
payrott tax liability of the 530-40,000 expanded income
class by only $0.2 billion, or 0.2 percent. But the average
tax decrease for the 5.1 million returns with decreases in
that class would be S772. while the average increase for
the 4.2 million returns with increases would be $965.
Since these are averages, obviously some individuals
would have even larger shifts in liability.
Similarly, revenue neutrality for corporate taxation xp-
ples only on an aggregate basis. Any firm or industry is
likely to face large changes in its tax bill, depending on
the degree to which various corporate tax rates, credits,
deductions, and other terms are altered. But to the extent
the tax burden on one industrychanges, there will be
impacts on the customers, employees, and stockholders
of firms in that (and other) industries. These impacts
make the ultimate personal or corporate effects of a
restructuring plan still less predictable.
For instance, Bradley-Gephardt makes investment in
equipment less attractive by eliminating investment
credits and reducing the present value of depreciation
deductions. Industries that_use large amounts of machi' -
nery, equipment, or structures may suffer relative to ones
that now have high effective tax rates and small amounts
of depreciation or tax credits. Those industries would
gain from the bill's cut in the corporate tax rate from 46to
30 percent.
Does Low-Income Mean Poor?
(tis hard to maintain revenue neutrality for low-income
taxpayers because there are at least two types of them.
Low-wage taxpayers may have little or no income tax
liability, because either they have enough dependents to
eliminate tax, or they qualify for a second-earner deduc-
tion and earned-income or child-care credit. A couple
with two dependents can earn as much as $17,812 in 1984
(if they have equal salaries and $4,800 in dependent-care
costs) before paying income taxes.
Taxpayers below this income level do not necessarily
benefit from increases in the zero bracket amount (ZBA)
or personal exemption. two features of moat restructur-
ing plans. But they do pay more in social security, and
possibly income, tax if their wage base is redefined to
SPECIAL REPORT
include fringe benefits. They are also vulnerable to "sim-
plification" or base-brosdening" that cuts down on their
credits and second-earner deduction.
Other seemingly low-income taxpayers may be depen-
dents of wealthier families who must currently file be-
cause their parents have put some income from capital in
children's names to escape taxation at the parents' higher
rates. Arguably, they do not need tax relief on their own
account, but bills that raise the personal exemption do
grant them relief. Similarly, some taxpayers with low
expanded income (and many with low adjusted gross
income) may have large gross income from certain
sources offset by tosses. Whether these losses disappear
under a restructuring bill depends on the specific base-
broadening contained in the bill.
Table 3 shows how a moderate-income family and a
wealthy dependent would fare under present law and
each proposal. These taxpayers are not meant to be
repiesentative. Indeed, one point of the examples is that
each income class covers a wide range of tax situations.
The examples do illustrate the direction in which liabili-
ties would change for a number of taxpayers.
Taxpayer A is a family of four, Their income of $16,000
(less than 150 percent of the projected poverty line for.a
family of four in 1985) comes from wages. Both parents
work full-time at $4 an hour (15 percent above the
minimum wage) and receive a modest amount of em-
ployer-paid health insurance. They spend $3,600 on child
care. Under present law their income tax after child-care
credits is only $15. Under the alternatives, their income
tax would be anywhere from $308 to $1459. The Bradley-
Gephardl and Quayle plans would apparently also subject
their health insurance to payroll tax, adding $141 to the
combined employer-employee tax in 1985. Moreover, the
marginal rate is at least as high under all alternatives as
under present law, meaning that small amounts of addi-
tional income would be taxed at least as heavily under all
these proposals. Two-earner families with less income or
higher child-care expenses also would pay more tax
under all alternatives.
Even when there Is no change in aggregate
liability for a group, many Individuals In the
group face large Increases or decreases.
Taxpayer B is a minor whose wealthy parents claim
him as a dependent but have put assets in his name so
that $2,000 of in'come is taxed at his marginal rate rather
than theirs. His liability amounts to $110 under present
law, $55 under Bradley-Geptiardt and $0 under Kemp-
Kasten. (Individuals would not pay tax directly on capital
income under DeConcini, which is accordingly omitted
from this example.) For higher amounts of income, "poor
little rich kids" like Taxpayer B save even more under
Bradley-Gephardt, and at some levels under Ouayle.
although not under Kemp-Kasten.
In short, many taxpayers who are classified as having
low income on their tax returns are not poor but sttll
would benefit under some restructuring bills. Conversely,
some working poor and near-poor would face increases
in aggregate income tax )or income plus payroll tax)
burdens. The fact that a bill cuts some rates and broadens
446
PAGENO="0453"
447
SPECIAL REPORT
Table 3
TREATMENT OF TWO TAXPAYERS UNDER PRESENT LAW AND ALTERNATIVES
Presenl Bradley- Kemp- Ouayle Ouayle
Law Gephardt Kasten S. 1040 `84 Plan DeConcini
A. 2-earner family with 2 children. Each spouse receives $8,000 in wages. $500 in employer-paid health insurance. Child-care costs are
$3,600.
Wages $16,000 $16,000 $16,000 516.000 $16,000 $16,000
Taxable health insurance 1,000 1,000 1,000
Exclusion' -600 -3.200
Adjusted gross income 15,200 17,000 12,800 17,000 17,000 16,000
Personal exemptions -4,000 -5,200 -8,000 -4,000 -4,000 -1,620
Child-cure deduction 3,600
Zero-bracket amount -3,400 ,~,QQQ ~Q0 -10.000 -10,000 -6.700
Taxable income less ZBA 7,800 2,200 1,300 3.000 3,000 7,680
Tax before credits 987 308 325 420 450 1.459
Child-care credit ~ -
Taxaftercredits 15 308 325 420 450 1,459
Marginal rate' 14% 14% 25% 14% 15% 19%
B. Child who is a dependent on parents' return but receives $2,000 in interest income in own name.
Adjusted gross income $ 2,000 $ 2,000 $ 2,000 $ 2.000 S 2,000
Personal eoemption ,,,1220 ,,,j,&20 ~ "1.000 -`1.000
Taxable income less ZBA 1,000 400 0 1,000 1,000
Tax 110 56 0 140 150
Marginal rate 11% 14% 0% 14% 15%
UnOer present lxxi, second-earner exclusion cuts etlectixe marginal rate on earned income to 13.3 percent. UnOen Kemp'kesten, wage exclusion cuts
etlectioe marginal rate on earned income 1020 perxent.
the base does not assure that it helpo all thooe who are and DeConcini, with its one rate, single taxation of aft
truly moderate-income or hikes burdena for the "pseudo- income, and expensing.
poor." Moreover, eve;t if bitla happen to achieve revenue
Is Revenue Neutrafity Meaningful? neutrality for one year, they will not do so for future
Even it all restructuring billo used well-defined mea- years. This result is guaranteed not only by the differ-
sures of revenue neutrality and were accompanied by ences in revenue "feedbacks" that will occur over time,
publicly available data, the information would be of but by differences in how fast people become taxable or
limited use. The concept does help distinguish bills that move into higher brackets. The latter dIfferences are
are meant to keep revenu~s (however defined) at close to caused both by changes in the bracket and exemption
current levels from ones that make no such effort, such levels and by changes in indexing from present law,
as simple 10 percent flat-tax plans. But revenue neutrality These considerations make revenue neutrality still less
is a static concept which assumes no change in taxpayer useful a goal, if one assumes that the restructuring is
behavior or economic conditions as a result of the tax intended for the long haul and not a single year.
change, an obvious impossibility. In fact, one of the Still another problem with revenue neutrality is that it
purposes of these bills is to foster changes, such as gives an incomplete picture of effects on the deficit. For
greater work, saving, and investment at least in taxable instance, a bill that makes every dollar of unemployment
activities). benefits taxable may induce people to forego some
benefits, reducing government outlays. Conversely, a pro-
_________________________________________________ posal that raises the marginal coat of working by abolish-
ing earned-income and child-care credits, eliminating the
second-earner deduction, raising the bottom rate, and
Revenue neutrality for corporate taxation ap- subjecting fringe benef ifs as well as cash wages to in-
plies only on an aggregate basis. come and payroll taxation is likely to lead some people to
draw more in federal benefits ruther than to start or keep
working. The first bill thus might be revenue'losing but
deficit'neutral: the second, revenue-neutral but deficit'
increasing. The first bill would be preferable on either
The JCT staff is aware of this, but argues that it must economic efficiency or deficit control grounds, yet focus-
make static assumptions to provide a common basis for ing on revenue neutrality would lead to a preference for
comparison and to avoid argument over the nature and the second bill.
size of the changes that would be induced by the tax
revision. The static approach may work moderately well Conclusion
for many lax provisions that make only minor changes in Revenue neutrality soi.rids like an objective, unambigu-
law, but it breaks down for large~scate restructuring bills. ous, and desirable criterion tsr measuring tax restruc-
There would be large differences in actual receipts be- turing proposals. On closer inspection, hov.'ever, it is
i..ecri t3radley-Gephardt. with its multiple rates, double none of tt~e above, and `or nt.nterous reasons is hard to
laaation of some income, and extended depreciable lives, apply to ne ptans currer.:tv be~r.g advocated.
PAGENO="0454"
448
SPECIAL REPORT
The sponsors of current proposals have mostly tailed More generally, bills that keep revenues constant for
or refused to say what revenues they would hold constant lower-income groups may do so by penalizing those who
and have not presented evidence backing up their claims. are poor and benefitting the well-to-do who appear to
Bradley and Gephardt refuse to release data. Quayle's have low income for tax purposes. Even calculating that a
data show that his 1984 plan is neutral for payroll and bill is revenue-neutral requires making patently absurd
individual income taxes, but he fails to specify the nature assumptions about taxpayer behavior. Finally, choosing
of his corporate tax proposals, some of which bear on a revenue-neutral bill over one that loses revenue may
individual receipts also. Kemp and Kasten hint that their lead to perverse results for the deficit and the economy,
bill is actually a revenue loser but still call it revenue- even on a static basis.
neutral. The evidence on DeConcini suggests his bitt Perhaps that applause for revenue neutrality should be
could be either neutral or a large revenue gainer, still fainter.
Chairman PICKLE. Mr. Woodbury, with the Upjohn Institute.
STATEMENT OF STEPHEN A. WOODBURY, SENIOR RESEARCH
ECONOMIST, W.E. UPJOHN INSTITUTE FOR EMPLOYMENT RE-
SEARCH
Mr. WOODBURY. Thank you, Mr. Chairman. I am delighted to be
here. I should mention immediately that I speak for myself and not
necessarily for the Upjohn Institute or Michigan State University
with which I am also affiliated.
What I would like to do is simply summarize my written testimo-
ny and emphasize a few points. My comments will focus on three
issues. First, the growth of fringe benefits and reasons for that
growth. Second, fringe benefit coverage and the implications of
that pattern of coverage for income distribution. And third, equity
of the tax system and revenue losses that result from fringe benefit
exemption.
Everyone here is well aware of the dramatic growth of non-wage
benefits during the post-World War II years. The fact of fringe ben-
efit growth is simply not controversial. There is more controversy I
believe over the causes of that growth. Several studies listed in my
testimony have found convincing evidence that the favorable tax
treatment of fringe benefits, that is their exemption from Federal
income and payroll taxes has had a highly significant impact on
employer provision of benefits.
Many readers of these studies and even one or two of the re-
searchers themselves seem to have inferred from these studies that
favorable tax treatment is the major-or even the only-cause of
fringe benefit growth in recent years. I believe this is a serious
error and for two reasons. First, the same studies also find that a
variety of other factors have influenced fringe benefit growth; the
growth of real incomes and the aging of the labor force deserve
particular mention because they have increased right along with
the marginal income tax rate. Further, they seem to have a posi-
tive effect on benefits of the same order of magnitude as do in-
creases in the tax rate.
Second, I am less confident than some researchers that we have
successfully separated the effects of rising real incomes from the ef-
fects of rising tax rates. This is a statistical issue I comment on
more fully in my written testimony.
Why does all this matter? It matters I think because one of the
most frequently used arguments against taxing fringe benefits is
that by so doing employer-provided fringe benefits, health and re-
tirement plans in particular, would be reduced or even would dis-
PAGENO="0455"
449
appear. Statistical findings indicate this is simply not true. We
would blunt one incentive and one incentive only for further
growth of employer-provided benefits if we were to tax them.
The other forces behind fringe benefit growth would continue,
however. Insurance and pension plans would still be a better buy
when purchased through the employer. The work force would con-
tinue to age. Employers would still use deferred benefits as a
means of reducing turnover. Real incomes would continue to grow.
So we would not kill the goose that laid the golden egg and witness
the demise of the voluntary fringe benefit system if we tax fringe
benefits.
About the distribution of fringe benefits I want to make just one
point. Taken as a whole voluntarily provided benefits do increase
the inequality of the distribution of income. But there is one bene-
fit, health insurance, that seems to be roughly proportionally dis-
tributed. Health insurance it seems neither greatly increases nor
decreases the equality of the distribution of income.
Finally, a few words on the equity of the tax system and revenue
losses that result from fringe exemptions. It is quite clear that the
exemption of fringe benefits from taxation induces, introduces both
vertical and horizontal inequities into the tax system. That is,
those with greater ability to pay do not necessarily pay proportion-
ally greater taxes. This follows from the fact that higher paid em-
ployees also receive a higher proportion of their total compensation
as fringes on which they are not taxed. Also, two workers with the
same total compensation may pay quite different tax bills if one re-
ceives only wage income whereas the other receives some fringe
benefits. Finally, we are all acutely aware of the revenue losses re-
sulting from the exemption of fringes.
The pure solution to these inequities and the revenue losses that
result is the subjection of all employer contributions to Federal
payroll and personal income taxes. Because of the opposition such
proposals would likely meet, and have met, a variety of proposals
to tax one benefit, health insurance, have been put forward.
Taxing health insurance contributions is an alluring prospect
and represents a step in the right direction, but suffers from two
important defects I feel. First, if we want to improve the equity of
the tax system health contributions should be the last benefit to
fully or partially tax, not the first. The reason again is that health
contributions alone among voluntarily provided fringes are disjrib-
uted roughly proportionally.
The second defect of capping health contributions alone-or any
single contribution alone-is that such an approach opens the door
to tax avoidance by substitution away from the newly taxed benefit
and towards still untaxed benefits. Such substitution is more than
merely an academic matter. It means the existing estimates of rev-
enue gains resulting from taxing health contributions may be too
high. I should mention we have no microeconomic evidence at this
point on the degree to which pensions and health insurance are
substitutes. But developing such estimates should be a high priori-
ty for research.
In short, to mitigate inequities in the present system a uniform
tax treatment of all benefits is required. Also, based on my own re-
search and that of others I am unconvinced that taxation of em-
PAGENO="0456"
450
ployer contributions would result in disappearance or even reduc-
tion of fringe benefits.
I would therefore advocate a limit on the proportion of total com-
pensation that could be provided without Federal payroll or person-
al income taxation. This plan is similar to the second part of the
Munnell proposal, and it has three advantages. First, it is compre-
hensive. Second, it focuses on the proportion of total compensation,
and so would obviate the wrangling that has taken place over
dollar sum caps on tax-free contributions to health insurance. Fi-
nally, it would have a minimal effect on workers and their benefits
while it would forestall further erosion of the tax base.
Thank you.
Chairman PIcKu~. Thank you.
[The prepared statement follows:]
STATEMENT OF STEPHEN A. WOODBURY, SENIOR RESEARCH EcoNoMIST, W.E. UPJOHN
INSTITUTE FOR EMPLOYMENT RESEARCH*
THE TAX TREATMENT OF FRINGE BENEFITS: WHAT DO WE KNOW AND WHAT NEEDS TO BE
LEARNED?
The rather frivolous appelation that has been given to nonwage benefits-
"fringe" benefits-tends to mask both the importance of these benefits to workers
and the far-reaching implications of their favored tax status. For it is difficult to
think of health care or retirement income plans as merely decorative, peripheral, or
frilly parts of the compensation package in an age when health services account for
over five percent of national income and when over eleven percent of the population
is aged 65 or more. And further, the employer-provision of these benefits affects a
multitude of economic outcomes and behavior: the distribution of income and the
equity of that distribution; the size of the income and payroll tax bases and the
equity of the tax system; the use (or overuse) of the health-care system and the
timing of retirement.
What follows is a necessarily selective review of the burgeoning economic re-
search on nonwage benefits-specifically private pensions and he~ulth-insurance
plans-and an equally selective summary of the lacunae in that research. The focus
is on a few questions that are of immediate importance to policy: How much have
nonwage benefits grown and why? Who is covered and what are the implications of
the existing pattern of coverage for income distribution? What changes in the tax
treatment of nonwage benefits would yield significant revenue gains, and what are
the implications of these changes for the equity of the tax system? What are some of
the significant effects of employer-provision of benefits on workers' behavior and
how do these induced behaviors affect in turn other economic outcomes?
HOW MUCH, AND WHY, HAVE FRINGE BENEFITS GROWN?
It is by now a commonplace observation that nonwage benefits voluntarily provid-
ed by employers have grown dramatically in the post-World War II period. The
Bureau of Economic Analysis estimates that voluntary nonwage benefits (that is,
"other labor income," which includes employer contributions to all voluntary funds
such as pensions, profit-sharing, group health and life, workers' compensation, and
supplemental unemployment) rose from 2.3 percent of private sector total compensa-
tion in 1948 to 10.3 percent in 1982.' For the sample of companies surveyed by the
Chamber of Commerce, voluntary contributions to pensions, health insurance, and
* The views stated here are those of the author and do not necessarily represent the views of
the W.E. Upjohn Institute.
1 U.S. Bureau of Economic Analysis, The National Income and Produce Accounts of the
United States (Washington, D.C.: U.S. Government Printing Office, 1981), Tables 6.15 and 6.6B
and Survey of Current Business 63 (July 1983), Tables 6.15 and 6.6B. For these purposes, total
compensation is defined as the sum of wages and salaries and other labor income-that is, ex-
cluding contributions to social insurance. (Social insurance contributions are included in the
income and product accounts' measure of "compensation" in Table 6.5 of the accounts.)
PAGENO="0457"
451
other "agreed upon" items rose from about five percent of total compensation in
1951 to 11.6 percent in 1982.2
In large part, these increases have been in the form of contributions to retirement
and (particularly) health-insurance plans-whereas about 60 percent of voluntary
contributions were in the form of retirement and health benefits in 1948, nearly 84
percent of voluntary contributions were for retirement and health benefits in 1982.~
Although no one disputes the enormous of nonwage compensation, there is less
certainty about the causes of this growth. The litany of reasons for the provision of
fringe benefits includes: preferential treatment under the federal personal and cor-
porate tax codes; economies of scale in the provision of pensions and insurance; ef-
forts to improve workers' productivity and reduce turnover by deferring payment of
benefits; unionization; changing demographic composition of the labor force; and
rising real incomes.4
To what degree can each of these factors explain the growth of fringe-benefit pro-
vision? Although there is substantial evidence that unions and collective bargaining
exert a positive independent effect on the provision of nonwage benefits, the stagna-
tion of private-sector union growth since the 1950s makes unionism an unikely
source of the recent growth of fringes.5 Similarly, it is unclear that the "technolo-
gy," so to speak, of benefit provision has changed so as to yield scale economies of
benefit provision where none existed before. That is, it may well be that more em-
ployers are taking advantage of the lower costs that result from group purchases of
pensions and health benefits, and also that pension and insurance providers are re-
ducing overhead and administrative costs by expanding their asset or risk pools-
but these changes should probably be viewed as responses to an increasing demand
for benefits rather than as autonomous forces causing that increase.6
Deferral of income has been shown quite convincingly to reduce labor turnover,
and by reference, to improve productivity.7 But again it is unclear that the desire to
reduce turnover has been important to the growth of nonwage benefits. The only
existing study of this question concludes that considerations of productivity and
turnover are far less potent explanators of pension growth than is the tax treatment
of pension contributions.8
The most likely causes of fringe-benefits growth, then, are the aging of the labor
force, favorable tax treatment of benefits, and rising real incomes (that is, increases
in income apart from the implications such increases have for the tax rates faced by
households). Several studies have confirmed the influence of all three of these fac-
tors on fringe-benefit expenditures and the share of total compensation received as
fringe benefits.9 In particular, increases in the marginal tax rate on wage income
and increases in households' real incomes have been found to have strong positive
influences on the provision of health, life, and pension benefits.
That several independent researchers using various data sources and somewhat
varying techniques should all arrive at similar conclusions is fairly persuasive. But I
would like to sound at least one warning about the interpretation of these results,
lest they be misconstrued. It should not be inferred from these studies that rising
marginal tax rates are the only, or even the most important, cause of fringe-benefit
2 Chamber of Commerce of the United States, Fringe Benefits 1951 (Washington, D.C.: Cham-
ber of Commerce, 1952), Table 3, p. 9; and Chamber of Commerce of the United States, Employee
Benefits 1982 (Washington, D.C.: Chamber of Commerce, 1984), Table 4, p. 8. Figures in the text
equal "pension, insurance, and other agreed upon payments" as a percentage of gross payroll
plus pension, insurance and other agreed upon payments. Thus, legally required payments are
excluded, and rest periods and other payments for time not worked are included as part of the
wage. The Chamber of Commerce sample started out as a rather selective high-benefit sample,
and has become more representative over the years. Note that, unlike the National Income and
Product Accounts, profit-sharing is not lumped with pension contributions in the Chamber of
Commerce data.
Table 6.15 in the National Income and Product Accounts and in Survey of Current Business.
~ See Rice (1966), Lester (1967), and Long and Scott (1982) for general discussions. The issue of
improving productivity and reducing turnover-the so-called agency motive for providing do-
ferred benefits-have been treated by Logue (1979) and Lazear (1981).
See, among others, Freeman (1981), Alpert (1982), Rossiter and Taylor (1982), and Fosu
(1984), and Mincer (1981). Freeman and Mincer differ sharply on the underlying causes of the
union nonwage benefit effect.
6 Mitchell and Andrews (1981) offer an empirical treatment of scale economies of pension pro-
vision.
Schiller and Weiss (1979) and Wolf and Levy (1984).
8Mumy and Manson (1983).
~ Alpert (1983), Atrostic (1983), Leibowitz 1983), Long and Scott (1983), Sloan and Adamache
(1983), Taylor and Wilensky (1983), Turner (1981), Vroman and Anderson (1984), and Woodbury
(1983).
PAGENO="0458"
452
growth. Correspondingly, it should not be inferred that if the favorable tax treat-
ment of fringes were abolished then fringe-benefit plans would disappear. I feel it is
important to make these points because I am less confident than some that we have
successfully separated the effects of rising incomes from the effects of rising margin-
al tax rates on fringe provision. Not only have incomes and tax rates grown togeth-
er over time, but also in cross-section there is a close relation between the income
and the marginal tax rate faced by a household. This close relation poses problems
for econometric estimation. Although together, rising incomes and rising marginal
tax rates on wages income have surely accounted for most of the recent increases in
fringe benefits-my own estimate is that they account for nearly two-thirds of the
increase 10_it would be premature to say that rising marginal tax rates rather
than (pure) rises in income are the main factor.
Will pension and health contributions continue to grow as a proportion of total
compensation? My own conjecture is that they will, under the status quo or any
change in tax treatment that is under serious consideration. But the growth will
almost surely be less dramatic than it has been in the past. Although the calcula-
tions leading to this guess are best religated to a footnote," the intuition behind the
guess is straightforward: Consider two workers with equal total compensation. One
has some promised retirement income whereas the other has none. The worker who
already has some retirement income will be less willing to exchange additional
present income for more retirement benefits than will the other. Thus, as the cover-
age and level of pension plans (and social security) have increased, more workers
have become less willing to trade additional income today for additional retirement
income." The market for certain nonwage benefits is, in effect, becoming saturat-
ed."
FRINGE-BENEFIT COVERAGE AND INCOME DISTRIBUTION
Fringe benefit coverage and payments made by employers vary greatly by indus-
try, occupation, sex, and race. Transportation, manufacturing, and mining have
been historically high-benefit industries, whereas services, trade, and construction
have offered relatively low benefits.'4 Among occupations, the high-benefit occupa-
tions are as one might expect: managers and administrators, professional and tech-
nical, craft workers, and certain operatives. Service, sales, and clerical occupations
are, also expectedly, the low-benefit occupations. Even among full-time and full-year
workers, women receive lower benefits and are less likely to be covered than men.
As for black-white differentials, blacks are somewhat less likely to be covered by
health insurance and pension benefits (34.8 percent for blacks, 38.2 percent for
whites), and fringe benefits make up a smaller proportion of black than of white
workers' total compensation.'5
As a whole, voluntary employer-contributions to pensions and to health and life
insurance tend to make the distribution of income more unequal: High-wage work-
ers receive a larger share of their total compensation as deferred income and insur-
ance than do low-wage workers.'6 But it is important to decompose total compensa-
tion into health and life insurance, on the one hand, and pensions and other de-
ferred compensation, on the other. The reason is that health and life insurance ben-
efits are roughly proportionately distributed (Smeeding found that insurance bene-
10 See p. 180 of my 1983 paper.
11 The response to a change in the price of wage benefits can be decomposed by the Slutsky
equation as follows:e=(k,~Xs)-(k~Xs), where e is the elasticity of demand for fringes with respect
to a change in the price of wages, k~ is the share of compensation received as wages, s is the
eleasticity of substitution between wages and fringes, and e is the income elasticity of demand
for fringes. Estimates of s and e are such that as the wage share of total compensation (k~) falls,
e also falls. (See the estimates in my 1983 paper.)
12 Even if the terms of trade between present income and retirement income continue to im-
prove (through increasing marginal taxes on income, coupled with exemption of pension contri-
butions), given proportional improvements in those terms of trade will elicit ever smaller re-
sponses from workers.
~` Munnell (1984) comes to the same conclusion for pension and health benefits by a slightly
different route.
14 Calculations from The National Income and Product Accounts, op. cit.; and Survey of Cur-
rent Business (July 1983).
15 See Smeeding (1983), tables 6.2 and 6.3. This discussion depends heavily on Smeedings'
useful paper.
16 Again, see Smeeding (1983), Tables 6.6 and 6.7. Smeeding's fmdings are corroborated by the
findings of Taylor and Wilensky (1983) for health benefits, and of Kotlikoff and Smith (1983) for
pensions.
17 Munnel (1984), pp. 21-22.
PAGENO="0459"
453
fits ran from 3.7 percent of compensation for low-wage workers to 6.2 percent for a
middle-wage group, and then declined to 2.9 percent for the highest earnings group)
whereas deferred compensation is highly regressively distributed (0.4 percent of
compensation for the lowest earnings group to 7.2 percent for the highest).
In contrast, legally required contributions, such as social security, unemployment
insurance, and workers' compensation tend to be progressively distributed and bring
about greater equality.
In sum, voluntarily provided fringe benefits, unlike legally mandated contribu-
tions to social insurance, seem to have a disequalizing influence on income distribu-
tion. This naturally raises questions about the desirability of exempting these bene-
fits from federal payroll and personal income taxes.
EQUITY OF THE TAX SYSTEM AND REVENUE LOSSES RESULTING FROM FRINGE EXEMPTIONS
If a larger proportion of the total compensation of high-earnings workers is re-
ceived as nonwage benefits, as appears to be the case, then the exemption of those
benefits from payroll and personal income taxes is clearly a regressive aspect of the
tax system. That is, exemption of nonwage benefits violates the vertical equity pre-
cept that those with greater ability to pay for government services should do so.
In addition, exemption of nonwage benefits creates situations where horizontal in-
equities can-and undoubtedly do-arise. Consider two individuals, each with total
compensation (wages plus contributions to health insurance, life insurance, and pen-
sions) of $20,000. Suppose also that they are both single and declare one exemption
and the zero-bracket amount. If Smith receives $17,000 in wages, while Jones re-
ceives $18,500 in wages, then Jones pays more taxes and faces a higher marginal
tax than Smith. But this clearly violates the precept of horizontal equity-that
households equally situated should be taxed equally.
The "pure solution" to this problem, as Munnell has called it, is to include all
employer contribution for employee benefits in taxable gross income. (Increases in
accrued pension contributions would also be included in gross income, since such in-
creases constitute an increase in an individual's lifetime income.) The pure solution
is attractive both in principle-it would mitigate inequities in the tax system-and
in the practical sense that it would either raise federal revenues or permit federal
marginal income and payroll tax rates to be lowered.18 The practical difficulties of
implementing this pure approach are minimal. Indeed, those problems that exist
pale beside the political opposition such a proposal would almost certainly meet. In
view of this potent potential opposition, some workable alternative must be sought.
One alternative that has gained currency, and has been introduced in a variety of
guises in legislative proposals, is to limit the amount of the employer's contribution
to health insurance that is excluded from the worker's taxable gross income. 19 Such
an approach would stem what many observers believe to be an inefficient and exces-
sive use of the health care system which has led to inflation in that sector, and
would also raise considerable revenues.20
Placing a tax cap on health contributions has some alluring features, and repre-
sents a step in the right direction, but the approach also suffers from two important
defects. First, if we want to improve the equity of the income tax system, health
insurance contributions should be the last benefit to fully or partially tax, not the
first. As noted above, insurance contributions, alone among voluntarily provided
fringes, are distributed roughly proportionately. Thus, taxing them would not serve
to improve the vertical equity of the tax structure-in fact, calculations by Taylor
and Wilensky show that the effects of a tax ceiling on health contributions would be
felt disproportionately by lower-income groups.21
The second defect of placing a tax cap on health contributions alone (or on any
single benefit alone) is that such an approach still leaves contributions to other non-
wage benefits untaxed, and hence opens the door to tax avoidance by substitution
away from the newly-taxed benefit and toward other still-untaxed benefits. Such
substitution is more than an academic matter-it means that the estimates of reve-
nue gains that would result from taxing health contributions may be too high. It
should be emphasized that we have no knowledge of the degree to which substitu-
tion from health benefits into pension benefits would take place-no study has yet
18Munnell (1984, table 2) estimates the revenue gain from such a comprehensive tax to be
$64.3 billion in 1983.
19 and Gibson (1983) discuss the details of these proposals.
20 Taylor and Wilensky (1983) for some estimates of the potential revenue gains.
21 Taylor and Wilensky (1983), table 9-7, p. 177.
PAGENO="0460"
454
attempted such measurement.22 But it is clear that the appeal of a tax-cap on
health contributions would wane substantially if the possibilities for substitution be-
tween health and pension benefits are strong.
SUMMARY AND DISCUSSION
Several studies have found that the growth of fringe benefits is accounted for
largely by the favorable tax treatment they have received, by increases in real
income, and by the going of the labor force. Although most of these studies have
made much of the influence that favorable tax treatment and increasing marginal
tax rates have had on benefit growth, it would be a mistake to believe that tax
treatment is the only cause of fringe-benefit growth, and an even greater mistake to
believe that fringes would vanish if the favorable tax treatment were removed. In-
surance and pension plans are a better buy when purchased through the employer,
the institutions to provide benefits efficiently are in place, the work force will con-
tinue to age, employers will still make use of deferred benefits as a means of reduc-
ing turnover, and real income will continue to rise-for all these reasons, removing
the favorable tax treatment of benefits would not kill the goose that laid the golden
egg and lead to the demise of employer-provision of health and retirement benefits.
In addition, equity and fairness in the distribution of income and the distribution
of the tax burden suggest the expedience of taxing benefits. Pensions and other de-
ferred compensation in particular lessen the equality of the distribution of income,
so that the failure to tax employer contributions to pension plans violates the abili-
ty-to-pay or vertical equity principle of taxation. Also, since individuals with similar
levels of total compensation may receive quite different mixes of wage and nonwage
benefits, the failure to tax nonwage benefits introduces horizontal inequities into
the tax system.
Full or partial taxation of a single specific benefit (such as health-care contribu-
tions) is an unattractive alternative to full or partial taxation of all benefits, be-
cause of the possibility that employees could substitute away from the newly taxed
benefit and into still-untaxed benefits (such as pensions). Thus, taxation only of
health contributions would not greatly improve the equity of the tax system. Nei-
ther, it seems likely, would it raise the amounts of revenue that have been prom-
ised, as workers and employers would make adjustments in the benefits package so
as to avoid taxation. Finally, taxation of a single benefit would fail to correct fully
the resource misallocation that has resulted from sheltering fringes from taxation-
all have in effect been subsidized forms of compensation in the past, and an even-
handed approach to their taxation is needed to mitigate the distorting effects of the
current system.
Munnell (1984) has discussed several alternatives to comprehensive and full
income and payroll taxation of all employer contributions for fringes. Her suggested
"perhaps palatable" alternative, which would limit the proportion of total compen-
sation that an employer could contribute without taxation, has at least three advan-
tages. First, it is comprehensive, treating all benefits equally. Second, its focus on
the proportion of total compensation obviates the sort of wrangling over dollar-sum
caps than has accompanied proposals to limit tax-free contributions to health insur-
ance. And third, it would have a minimal (if any) immediate effect on workers and
their benefits, while forestalling further erosion of the tax base. Some such solution
is greatly needed to redress the resource misallocations and inequities that the fa-
vored tax status of fringe benefits have generated.
REFERENCES
Alpert, William T. "Manufacturing Workers' Private Wage Supplements: A Si-
multaneous Equations Approach." Applied Economics 15 (June 1983): Pp. 363-378.
Atrostic, B.K. "Comment of Leibowitz." In The Measurement of Labor Cost, edited
by Jack E. Triplett. Chicago: University of Chicago Press and NBER, 1983. Pp. 389-
394.
Chen, Yung Ping, "The Growth of Fringe Benefits: Implications for Social Securi-
ty." Monthly Labor Review 104 (November 1981): Pp. 3-10.
Chen, Yung Ping. "Employee Benefits and Social Security." Contemporary Policy
Studies, Number 3 (April 1983): Pp. 23-32.
Fosu, Augustin Kwasi. "Union and Fringe Benefits: Additional Evidence." Jour-
nal of Labor Research 5 (Summer 1984): Pp. 247-254.
22 Taylor and Wilensky are careful to point out the sensitivity of their revenue estimates to
the assumption of no substitution to still-untaxed benefits.
PAGENO="0461"
455
Freeman, Richard B. "The Effect of Unionism on Fringe Benefits." Industrial and
Labor Relations Review 34 (July 1981): Pp. 489-509.
Kotlifkoff, Laurence J. and Daniel E. Smith. Pensions in the American Economy.
Chicago: University of Chicago Press and NBER, 1983.
Lazear, Edward P. "Agency, Earnings Profiles, Productivity, and Hours Restric-
tions." American Economic Review 71 (September 1981): Pp. 606-620.
Leibowitz, Arlene. "Fringe Benefits in Employee Compensation." In The Measure-
ment of Labor Cost, edited by Jack E. Triplett. Chicago: University of Chicago Press
and NBER, 1983. Pp. 371-389.
Lester, Richard A. "Benefits as a Preferred Form of Compensation." Southern
Economic Journal 33 (April 1967): Pp. 488-495.
Logue, Dennis E. Legislative Influence on Corporate Pension Plans. Washington,
D.C.: American Enterprise Institute, 1979.
Long, James E. and Frank A. Scott. "The Income Tax and Nonwage Compensa-
tion." Review of Economics and Statistics 64 (May 1982): Pp. 211-219.
Long, James E. and Frank A. Scott. "The Impact of the 1981 Tax Act on Fringe
Benefits and Federal Tax Revenues." National Tax Journal 37 (June 1984): Pp. 185-
194.
Mincer, Jacob. "Union Effects: Wages, Turnover and Job Training." Working
Paper, Columbia University and NBER, November 1981.
Mitchell, Olivia S. and Emily S. Andrews. "Scale Economies in Private Multi-Em-
ployer Pension Systems." Industrial and Labor Relations Review 34 (July 1981): Pp.
522-530.
Mumy, Gene E. and William D. Manson. "The Relative Importance of Tax and
Agency Incentives to Offer Pensions: A Test Using ERISA." Public Finance Quarter-
ly: forthcoming.
Rice, Robert G. "Skill, Earnings, and the Growth of Wage Supplements." Ameri-
can Economic Review 56 (May 1966): Pp. 583-593.
Rossiter, Louis F. and Amy K. Taylor. "Union Effects on the Provision of Health
Insurance." Industrial Relations 21 (Spring 1982): Pp. 167-177.
Schiller, Bradley R. and Randall D. Weiss. "The Impact of Private Pensions on
Firm Attachment." Review of Economics and Statistics 61 (August 1979): Pp. 369-
380.
Sloan, Frank A. and Killard W. Adamache. "Taxation and the Growth of Non-
wage Compensation." Unpublished paper, Vanderbilt University, 1983.
Smeeding, Timothy M. "The Size Distribution of Wage and Nonwage Composition:
Employer Cost versus Employee Value." In The Measurement of Labor Cost, edited
by Jack E. Triplett. Chicago: University of Chicago Press and NBER, 1983. Pp. 237-
277.
Sullivan, Sean and Rosemary Gibson. "Tax-Related Issues in Health Care Market
Reform." In Market Reforms in Health Care, edited by Jack A. Meyer. Washington,
D.C.: American Enterprise Institute, 1983. Pp. 185-197.
Taylor, Amy K. and Gail R. Wilensky. "The Effect of Ta~ Policies on Expendi-
tures for Private Health Insurance." In Market Reforms in health Care, edited by
Jack A. Meyer. Washington, D.C.: American Enterprise Institute, 1983. Pp. 163-184.
Turner, John A. "Inflation and the Accumulation of Assets in Private Pension
Funds." Economic Inquiry 19 (July 1981): Pp. 410-425.
Vroman, Susan and Gerard Anderson. "The Effects of Income Taxation on the
Demand for Employer-Provided Health Insurance." Applied Economics 16 (February
1984): Pp. 33-43.
Wolf, Douglas A. and Frank Levy. "Pension Coverage, Pension Vesting, and the
Distribution of Job Tenures." In Retirement and Economic Behavior, edited by
Henry J. Aaron and Gary Burtless. Washington, D.C.: Brookings Institution, 1984.
Pp. 23-61.
Woodbury, Stephen A. "Substitution Between Wage and Nonwage Benefits."
American Economic Review 73 (March 1983): Pp. 166-182.
Chairman PICKLE. Our final panelist is Gail Wilensky, director,
Center for Heath Affairs, and vice president, Domestic Division,
Project HOPE.
STATEMENT OF GAIL R. WILENSKY, VICE PRESIDENT, DOMESTIC
DIVISION, PROJECT HOPE
Ms. WILENSKY. I am vice president of the Domestic Division of
Project HOPE. I am pleased to have this opportunity to speak to
PAGENO="0462"
456
you about the effects of statutory exclusions of certain fringe bene-
fits, particularly employment related health insurance. Much of
the information I will present is based on work done while I was at
the National Center for Health Services Research, which I have
continued at Project HOPE. I am, of course, speaking for myself
and not for either of these organizations. I would like to submit my
written testimony for the record.
We have been asked how large the subsidy is and how large the
fringe benefit is. I am focusing on employment related health bene-
fits and do have information about its growth. These contributions
have grown from about $36 billion in 1977 to almost $80 billion in
1983.
There have been two major concerns regarding the current tax
treatment of employer contributions to health benefits, and we
have been hearing them this morning. First, it has resulted in
large revenue losses to the Federal Treasury and government orga-
nizations at the State level. Related to these are certain equity
issues. Second, and of particular concern to health policy analysts,
the current tax treatment has provided an incentive to purchase
additional amounts of health insurance, which, in turn, results in
increased levels of health expenditures.
The loss in revenues to the Federal Government and to other
governmental levels which have resulted from this exclusion has
been estimated to be about $31 billion in 1983, up from about $12
billion in 1977. This includes losses to the Federal income tax, to
FICA, and also to the State income tax.
In answer to the question of who receives employee health bene-
fits, we have heard this morning that many people do. Approxi-
mately 85 percent of private health insurance is employment relat-
ed. The vast majority of employees, about 90 percent, work for
firms which offer health insurance plans. The most important
characteristics of firms which do not offer health insurance are
their small size and relatively large percentages of low wage em-
ployees on the payroll. Generally, firms that provide employment
related health insurance provide it to all of its employees.
Contributions by employers have also been increasing rapidly, up
from $623 in 1977, on average, to $1,126 in 1983. The share of the
premium paid by the employer is substantially higher for certain
employees, particularly those in firms with some union representa-
tion, and lower in firms which are in the South. While the share of
the premium paid by the employer does not vary with employee
income, the average contribution of the employer does in fact in-
crease slightly with employee income.
So, although we have heard this morning from several people
that treatment of employer contributions are not proportional to
income, there is in fact some slight correlation between the two. In
table 2, average employer contribution by income level is shown,
and in an appendix I have included information about the distribu-
tion of different amounts of employer contributions by family
income. So while it is correct that employer contributions are not
very influenced by income but there is some positive relationship
by income.
The question of who receives the subsidy, however, makes the re-
lationship with income much more important. That is, while the
PAGENO="0463"
457
premium itself only varies slightly with income, distribution of the
tax subsidy is much more unequal with respect to income. In gen-
eral, those in higher tax brackets receive a greater subsidy than
those in lower tax brackets and the reason is that the amount of
the current exclusion of the employer contribution depends on the
employee's income tax rate. The higher the income, the higher the
marginal tax rate. And these higher marginal tax rates produce
greater savings.
The average savings from Federal income tax in 1983 was esti-
mated to be $332 from this exclusion, but it varied substantially by
family income. And I have estimates provided in the paper in
Table 3. There are two basic reforms that have been mentioned
with respect to health insurance, and then a third reform which I
would like to touch on briefly.
The two major reforms which would make all or a portion of the
employer-provided health insurance subject to taxation involve
either a specific dollar tax cap or flat excise tax. There have been a
number of proposals, as you know, before Congress which have re-
quired employees to include all or a portion of the employer-provid-
ed health insurance in their taxable income. The Reagan adminis-
tration proposed a tax cap of $2,100 for family coverage and $840
for individual coverage. The number of employees affected and
amount of revenue at risk depends on where the cap is placed. Esti-
mates range from having as many as 62 million subscribers affect-
ed and bringing in $31 billion-if the full employer contribution
was taxed to raising $2.3 billion and affecting 11 million subscrib-
ers-if the tax cap was as high as $2,400 for families.
Additional information on the amount of revenue and number of
subscribers which would be affected is included in my paper. An-
other option in addition to the tax cap is the excise tax. The excise
tax could be imposed on employer payments for health insurance,
and it could be set as a variety of rates as we have just heard. One
attempt might be to set it to proxy the effect of the tax cap and to
set it at a rate which would provide revenue equal to that at 11
percent, the lowest income tax rate for individuals.
While this would mean that high-income individuals would re-
ceive a greater subsidy than low-income individuals, assuming-as
economists would-that the tax would be passed back to employees,
the difference would be not as great as it is under the current ex-
clusion. The third option, and one which we have heard about this
morning, is to place a tax cap or an excise tax on all fringe benefits
rather than attempting to limit expenditures on any specific fringe
benefit such as health insurance.
I would like to talk for a few minutes about the incentive and
equity effects of the current tax treatment.
The equity concern, as we have heard, is that the exclusion is
worth more, the higher the taxpayer's taxable income. Taxing all
or a portion of this fringe benefit would broaden the tax base, and
would remove at least some of the least desirable equity effects of
the income-related subsidy.
It should be noted, however, that because employer contributions
do not vary much with income, the additional taxed amount under
a tax cap would actually represent a somewhat larger percentage
of a low-income individual's income than that of a higher income
PAGENO="0464"
458
individual. That may sound somewhat contradictory to the state-
ment that the current subsidy is worth more the higher the indi-
vidual's income, but it happens because although the marginal tax
rate for low-income individuals is lower, the amount taxed under a
tax cap requests a higher percentage of total income.
Equally important, however, is the fact that the tax cap would
encourage employees and employers to choose efficient health care
plans, particularly the lower cost plans with high deductibles, and
co-insurance provisions. Individuals who wanted comprehensive
coverage would be encouraged to choose innovative health care de-
livery systems such as health maintenance organizations. The in-
centives to become much more cost conscious should result in lower
health care costs.
Estimating how a tax cap would actually affect health care ex-
penditures is much more difficult than estimating the revenue ef-
fects. Some estimates are provided in this paper, but I think we
have to understand that they are in fact not likely to be very pre-
cise. It should, however, make consumers more cost conscious in
their choice of providers and health care plans, and this is an im-
portant provision in health care and in health insurance, as op-
posed to the other fringe benefits which we have been considering.
The use of an excise tax to be paid by employers would make em-
ployers more cost conscious with respect to the health plans chosen
for their employees. Since we expect that the excise tax would be
shifted back to employees, it would have an incidence similar to
taxing all employees at exactly the same marginal tax rate. This
would improve equity but be less satisfactory in my view than in-
cluding the income in the employee's own taxable income.
There are, however, two appealing characteristics of an excise
tax. It does solve the problem of how to allocate employer pay-
ments to individual employees, particularly when the employee
self-insures, and it may be perceived as more of a tax on business
and less of a tax on employees, and therefore be politically appeal-
ing. Aside from these considerations, however, in my view the tax
cap represents a preferred option on both equity and efficiency
grounds
During the 1976's and 1970's most of the changes in employment-
related health insurance coverage were directed toward extending
coverage to new benefits and new beneficiaries. Two events have
contributed to a change in the direction of employee benefits over
the past few years.
First, the recession which began in the early 1980s has put a
squeeze on employer profits. Second, health care costs continue to
increase at a pace which far exceeded costs in other sectors of the
economy, even when other cost increases began to moderate. These
two events taken together have increased employers' awareness of
the effects which health care costs can have on their discretionary
expenditures. As a result, they have engaged in a variety of initia-
tives to contain health care costs, including forming coalitions,
helping to enact support of legislation, and redesigning health in-
surance benefits.
Because of the time it takes to collect nationally representative
data, it is difficult to know with any precision the scope and magni-
tude of the changes which have been taking place over the last two
PAGENO="0465"
459
years. It does appear, however, that employes are engaging in a va-
riety of activities which are lowering their health care costs. Ac-
cording to a survey of some 1,500 organizations including the For-
tune 1,000, conducted by the Health Research Institute in Califor-
nia, over 35 percent of the employers have increased the deductible
for family and individual coverage, and almost 19 percent had in-
creased employee co-insurance contributions.
In addition, 25 percent were insuring that the rates were applied
accurately, almost 20 percent were engaging in either concurrent
or retrospective utilization review, and about a third were requir-
ing second opinions.
While the nonrepresentative nature of the sample and the 40
percent response rate make it difficult to generalize these findings,
a report by Hewitt Associates of some 25 major U.S. employers,
suggests similar activities. They reported that between 1979 and
1983 there was a substantial decline in the number of companies
with deductibles as low as $100, and a substantial increase in the
number of companies with deductibles over $150.
Some employers have argued that since these initiatives have oc-
curred in the absence of a tax cap, tax caps are not needed to stim-
ulate cost-conscious behavior by employers and employees. I think
that this opinion may be overly optimistic. Aside from the revenue
and equity issues which are clearly important, it is not clear what
will happen to benefits as we continue to come out of the current
recession.
Employees who saw their benefits scaled back during the reces-
sion, with increased unemployment, may wish to recapture some of
the benefits they have given up. Even if that does not occur, it is
better to have both employers and employees more cost-conscious
about their choice of health plans than just the employers.
The conclusion of my testimony is that the effect of the current
tax treatment on employment-related health insurance has been to
erode the tax base, to cost the Treasury approximately $30 billion
in revenue, to provide a subsidy which is worth more as the tax-
payer's income increases, and which encourages the purchase of ad-
ditional health insurance.
The arguments for limiting the tax-free nature of employment-
related health insurance are even stronger for health benefits than
they are for other fringe benefits. Subsidizing the purchase of pen-
sion benefits and life insurance is now thought to exacerbate the
expenditures in these areas, whereas increased health insurance is
regarded as a major cause for increased spending in the health
area. Despite this fact, the tax cap has proven to be politically un-
attractive and has been roundly attacked by business, labor and
the insurance industry, as I know you have heard.
An alternative to limiting health insurance expenditures would
be to place a limit on the amount of fringe benefits which
employees can take tax-free. Having employees think of their
fringe benefits as a pool of benefits which can be taken tax-free up
to a specified limit would encourage them to be more aware of the
competing use of these tax-free funds. Since expenditures on em-
ployment-related health insurance are currently tax free, an over-
all limit could only reduce the amount currently spent on employ-
ment-related health insurance.
40 046 0 - 85 - 30
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460
[The prepared statement follows:]
STATEMENT OF GAIL R. WILENSKY, VICE PRESIDENT, DOMESTiC DIVISION, PROJECT
HOPE, MIu~wooD, VA*
Mr. Chairman and Members of the Subcommittee, I am pleased to have this op-
portunity to speak to you about the effects of statutory exclusions of certain fringe
benefits, particularly employment related health insurance. Much of the informa-
tion I will present is based on work done while I was at the National Center for
Health Services Research and continued at Project HOPE, where I am currently the
Vice-President of the Domestic Division and Director of its Center for Health Af-
fairs. The opinions I express, however, are my own and should not be attributed to
either of these organizations.
EMPLOYER PROVIDED HEALTH INSURANCE: INCENTIVE AND EQUITY ISSUES
Employment related health benefits: How large is the subsidy
There are several employee benefits which receives preferential treatment. These
include retirement, health, disability, and life insurance plans, as well as workers
compensation. The total amount of benefits has been rising over the past few years:
in 1981, employer contributions to such plans were estimated to equal 13.5 percent
of wages and salaries, up from 5.9 percent in 1970.(1) The focus of my comments,
however, is on employment related health benefits.
The total amount of employment related health benefits has also been rising over
the past few years. Employer contributions for health benefits were approximately
$77 billion in 1983, compared to about $36 billion in 1977. There are two major con-
cerns regarding the current tax subsidy of employer contributions to health bene-
fits. First, it has resulted in large revenue losses to the U.S. Treasury and, to a
lesser extent, state governments. Second-and of particular concern to health policy
analysts-the reduced price of health insurance via the subsidy has provided an in-
centive to purchase additional amounts of health insurance, which in turn results in
increased levels of health expenditures.
The tax treatment of employer contributions to health insurance coverage is pref-
erential because such contributions are excluded from employees taxable income
and the earnings to which payroll taxes are applied. The loss in government reve-
nues stemming from this exclusion was estimated to be approximately 31 billion dol-
lars in 1983, up from 12 billion in 1977.(2)
TABLE 1
1977
1983
Federal income tax
$8.5
2.0
1.5
12.0
$20.5
6.5
3.7
30.7
FICA
State income tax
Total taxes
Source: Wllensky and Taylor (1982), Taylor and Wilensky (1983).
Who receives employee health benefits?
Recent estimates indicate that almost 85 percent of private health insurance is
employment related. Furthermore, the vast majority (more than 88 percent) of em-
ployees work for firms which offer health insurance plans. The most important
characteristics of firms which do not offer health insurance is that they tend to be
small (less than 25 employees), and have a relatively large percentage of low wage
employees on the payroll. In firms that provide employment related health insur-
ance, almost all employees (94 percent) are eligible for such insurance. This percent-
age does not vary by employer characteristics(S)
The average employer contributions was $1126 in 1983, up from $623 in 1977. The
percent of the premium paid by the employer was substantially higher in firms with
some union representation, 89 percent versus 73 percent of the premium for firms
with no union representation. The percentage paid by employer was substantially
* The author would like to thank Steven Chapman, research assistant at Project HOPE, for
valuable assistance in preparing this testimony.
PAGENO="0467"
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lower in the South (72 percent) than it was for the country as a whole (80 percent).
Although the share of the premium paid by employer does not vary with employee
income, the average contribution by employer increases with subscriber family
income, as shown in Table 2. The relationship, however, between employer contribu-
tion and family income is not very strong. The distribution of employer contribu-
tions by family income is shown in Appendix Table A.
TABLE 2.-AVERAGE EMPLOYER CONTRIBUTIONS, EMPLOYEE CONTRIBUTIONS, AND TOTAL
PREMIUMS FOR GROUP SUBSCRIBERS, BY FAMILY INCOME, 1983
Total number
Family income ef subscribers
(thousands)
Average
contribution by
employer 1
Average
contribution by
employee
verage oa
premium
$1 to $9,999 $4,263
$10,000 to 14,999 5,665
$15,000 to $19,999 7,499
$20,000 to $29,999 17,045
$30,000 to $49,999 23,076
$50,000 or more 10,979
$763
855
1,025
1,098
1,287
1,188
$295
304
330
343
315
288
$1,071
1,170
1,371
1,466
1,626
1,443
Total 68,627
1,126
317
1,466
1 Includes those with zero empluyer contributions.
2 Employer and employee contributions do not add to total because of "other" contributions.
Includes persons with income less than $1.
Source: National Center for Health Services Research, National Medical Care Expenditure Survey, unpublished data.
Who receives the subsidy?
The distribution of the employment related health insurance tax subsidy is much
less equal with respect to income than is the distribution of employer contributions.
In general, those in higher tax brackets receive a greater subsidy than those in
lower tax brackets. The reason is that the amount of the current exclusion of the
employer contributions depends on the employees taxable income-higher incomes
are associated with higher tax rates, and higher marginal tax rates produce greater
savings. Most employees with employment related health insurance receive savings
from Federal or state income taxes, but only a small number of lower income em-
ployees also receive savings from Social Security taxes. The average savings from
federal income tax was $332 but the average varied substantially by family income.
The average savings in total tax was $467 but this average also varied substantially.
These figures are shown in Table 3.
TABLE 3.-NUMBER OF SUBSCRIBERS AFFECTED AND THE AVERAGE TAX SAVINGS FROM EXCLUDING
EMPLOYER CONTRIBUTIONS BY INCOME CLASS, 1983
Family income
Numbtr of
suh~cr~bejs
(thousands)
Average in
Federal income
tan 1 saving
Average in
total tax
saving 1 2
I. No exemptions:
$1 to $9,999
$10,000 to 14,999
$15,000 to $19,999
$20,000 to $29,999
$30,000 to $49,999
$50,000 or more
3,145
4,788
6,650
15,547
21,384
9,984
$105
161
213
277
420
464
$174
242
317
394
552
576
Total `
61,575
332
467
1 Excludes subscribers not affected by any tax change.
2 Excludes employers' shwe of FICA.
Includes persons with income less than $1.
Source: National Center for Health Services Research, National Medical Care Expenditure Survey, enpublished data.
PAGENO="0468"
462
Tax reform options
The major option for tax reform is to make all or a portion of the employer pro-
vided health insurance coverage subject to taxation. Two suggestions are a specific
dollar tax cap, and a flat excise tax.
Tax cap
There have been a number of proposals before Congress which required employees
to include all employer related health insurance above a specified amount in their
taxable income. The Reagan Administration proposed a tax cap of $2100 for family
coverage and $840 for individual coverage. The number of employees affected and
the amount of tax revenue at risk varies substantially according to where the tax
cap is placed. If, for example, all employment related insurance had been taxed in
1983 (i.e., the tax cap set at zero), then 62 million subscribers would have been af-
fected and the total revenue collected would have been $31 billion. A tax cap as
high as $2400 for family coverage and $975 for individual coverage would affect 11
million subscribers and, in 1983, raise $2.3 billion. The Administration's proposal
was projected to affect 16.5 million subscribers and raise approximately $3.1 billion.
Additional information on the number of subscribers affected and the increase in
tax revenue by type of tax is presented in Appendix B. Additional information on
the impact of various tax caps on employee income is available elselwhere.(4)
Excise tax
The second major option is to impose an excise tax on employer payments for
group health insurance. The excise tax could be set at a variety of rates depending
on the amount of revenue one wished to raise. It also could be set to proxy the effect
of a tax cap. For example, the rate might be set at 11 percent, which is the first
bracket rate for the individual income tax. While this would still mean that high
income individuals would receive a greater subsidy than low income individuals (as-
suming that the tax were passed back to employees), this difference would not be as
great as before.
An additional option would be to place the tax cap or the excise tax on total
fringe benefits rather than attempting to limit expenditures only on specific fringe
benefits such as health insurance.
Incentive and equity effects
Concern about the current tax treatment of health insurance benefits has in-
volved both the equity effects as well as the incentives it provides for the purchase
of additional health insurance. The equity concern is that the exclusion is worth
more as the taxpayer's taxable income increases, and is worth very little for employ-
ees at the lowest income levels. Taxing all or a portion of this fringe benefit would
broaden the tax base and remove at least some of the less desirable aspects of this
income related subsidy.
It should be noted, however, that because employer contributions do not vary
much with income, the additional tax would actually represent a somewhat larger
share of a low income individuals income than that of a higher income individual.
Equally important, the tax cap should encourage employees and employers to
choose efficient health care plans, particularly the lower cost plans with high deduc-
tibles and co-insurance provisions. Individuals who wanted comprehensive coverage
would be encouraged to choose innovative health care delivery systems such as
HMOs. The incentives to become more cost conscious should result in lower health
care costs.
Projecting the impact of a tax cap on health care expenditures is much more diffi-
cult than projecting the revenue effects of tax caps. In a 1983 study done with Amy
Taylor, we predicted a decline in total premiums ranging from $7.5 billion to $1.8
billion as a very conservative estimate and a decline of $16.7 billion to $3.6 billion as
a more likely estimate. The ranges reflect different limits which might be chosen for
the tax cap. While the precise reductions are difficult to estimate, a tax cap would
make consumers more cost-conscious in their choice of providers and health care
plans, which may result in greater reductions in health insurance expenditures
than we have projected. While the tax cap would send the strong signal to both con-
sumers and providers, it would take time for the system to respond to the increased
awareness of health care costs.
The use of an excise tax to be paid by employers would make them more cost-
conscious when choosing health plans for their employees. Since it could be expect-
ed that the excise tax would be shifted back to the employees, it would be similar to
taxing all employees at that marginal rate. This would improve equity, but be less
satisfactory than including the income in the employees own taxable income. There
are, however, two appealing characteristics of the excise tax. First, it solves the
PAGENO="0469"
463
problems of allocating employer payments to individual employees when the em-
ployer self-insures. Second, it may be perceived as more a tax on business and less
of a tax on employees, and therefore be more politically appealing. Aside from these
two considerations, however, the tax cap represents a preferred option on both
equity and efficiency grounds.
Recent employer initiatives
During the 1960s and 1970s, most of the changes in employment related health
insurance coverage extended coverage to new benefits and new beneficiaries. Since
then, two events occurred which contributed to the change in the direction of em-
ployee benefits which has been occurring over the past few years. First, the reces-
sion which began in the early 1980s put a squeeze on employer profits. Second,
health care costs continue to increase at a pace which far exceeded costs in other
sectors of the economy and show little sign of reaching any plateau, despite the fact
that other cost increases began to moderate. These two events taken together have
increased employers' awareness of the effects which health care costs can have on
discretionary expenditures. As a result, they have engaged in a variety of initiatives
to contain health care costs including forming coalitions, helping to enact support-
ive legislation and redesigning health insurance benefits.
Because of the time it takes to collect nationally representative data, it is difficult
to know with any precision the scope and magnitude of the changes which have
been taking place over the past two years. Most of the information which is avail-
able is ancedotal or based on selected groupings of industries. Nonetheless, it is
clear that employers are engaging a variety of activities which are designed to lower
their health care costs. According to a survey of 1500 organizations including the
Fortune 1000 conducted by the Health Research Institute in California, over 35 per-
cent of the employers have increased the deductible for family and individual cover-
age, and almost 19 percent had increased employee coinsurance contributions. In ad-
dition, 25 percent of the firms were ensuring that the coinsurance rates were accu-
rately applied, almost 20 percent were engaging in concurrent or retrospective
review, and approximately 35 percent were requiring second opinions. While the
nonrepresentative nature of the sample and the 40 percent response rate make it
difficult to generalize these findings, a report by Hewett Associates for some 250
major U.S. employers for the period 1979 through 1983 appears to suggest similar
activities. For example, they report a substantial decline in the number of compa-
flies having deductibles under $100 and a substantial increase in the number of
companies having deductibles over $150 per year. Simiarly, the use of a stop loss
feature (which limits the out-of-pocket expenses of an employee) increased from 57
percent in 1979 to 78 percent in 1983.
Some employers have argued that since these initiatives have occurred in the ab-
sence of a tax cap, tax caps are not needed in order to introduce additional cost con-
scious behavior on the part of employers and employees. I think this opinion may be
overly sanguine. Aside from the revenue and equity issues, it is not clear what will
happen to benefits as we continue to come out of the current recession. Employees
who were willing to see their benefits scaled back during a recession with increased
unemployment, may wish to recapture some of the benfits they have given up. Even
if that does not occur, it is better to have both employers and employees more cost
conscious about their choice of health plans than just employees.
CONCLUSION
The effect of the current tax treatment of employment related health insurance is
to erode the tax base, cost the Treasury approximately 30 billion dollars in revenue,
provide a subsidy which is worth more to the taxpayer as that taxpayer's income
increases, and encourage the purchase of additional health insurance. The argu-
ments for limiting the tax free nature of employment related health insurance are
even stronger for health benefits than they are for other fringe benefits. Subsidizing
the purchase of pension benefits and life insurance is not thought to exascerbate the
spending in these areas whereas increased health insurance is regarded as a major
cause of increased spending in the health area. Despite this fact, the tax cap has
proven to be politically unattractive and has been roundly attacked by business,
labor, and the insurance industry. An alternative to limiting health insurance ex-
penditures, per se, would be to place a limit on the amount of fringe benefits which
employees can take tax free. Having employees think of their fringe benefits as a
pooi of benefits which can be taken tax free up to a specified limit would encourage
employees to be more aware of competing uses for the tax free funds. Since expendi-
tures on employment related health insurance are currently tax free, an overall
limit could only reduce the funds currently going into employment related health
insurance.
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464
APPENDIX A-EMPLOYER INSURANCE CONTRIBUTIONS FOR FAMILY AND INDIVIDUAL GROUP
- INSURANCE COVERAGE, BY FAMILY INCOME, 1983
[Amounts in percent]
.
amiy income o ars
Total
subscribers
(thou.
sands)
Employer
insurance contributions
$0
$1-$399
$400 $799
$800-
$1,199
$1,200-
$1,799
$1,800-
$2,399
~-
$2,400 or
more
Family coverage:
$1 to $9,999
1,672
12.4
8.7
20.0
9.3
24.2
13.4
12.1
$10,000 to $14,999
2,743
9.1
11.6
18.3
15.7
26.7
12.1
6.5
$15,000 to $19,999
4,650
11.6
8.2
16.7
10.1
26.5
18.3
8.7
$20,000 to $29,999
11,802
9.5
6.8
15.3
13.1
28.6
15.9
10.9
$30,000 to $49,999
16,708
7.9
5.5
11.3
12.3
26.7
20.2
16.3
$50,000 or more
7,246
8.5
7.8
9.9
10.9
28.6
21.4
13.0
Total 1
44,854
9.1
7.0
13.4
12.1
27.4
18.3
12.8
Individual coverage:
$1 to $9,999
2,591
27.5
22.5
32.9
11.7
3.0
2.1
0.5
$10,000 to $14,999
2,922
20.0
19.1
39.3
13.9
4.2
1.8
1.6
$15,000 to $19,999
2,849
12.1
14.1
47.2
16.6
6.2
2.4
1.4
$20,000 to $29,999
5,242
11.9
22.5
39.5
17.4
6.7
1.5
0.6
$30,000 to $49,999
6,368
12.2
16.8
42.5
16.8
8.0
2.2
1.6
$50,000 or more
3,734
15.9
17.9
39.7
15.3
6.2
2.5
2.6
Total
23,773
15.3
18.8
40.5
15.7
6.2
2.1
1.4
1 Includes persons with income tess than $1.
Source: National Center Our Health Services Research, National Medical Care Expenditure Survey, unpublished data.
APPENDIX B.-NUMBER OF SUBSCRiBERS AFFECTED AND TOTAL INCREASE IN TOTAL TAX LIABILITY
FOR SPECIFIC LIMITATIONS ON TAX-FREE EMPLOYER CONTRIBUTIONS, 1983
Tax status of insuraoce premiums
Number of
subscribers
affected
(thou-
sands)
Total revenue
s increases
Federal
income
taxes
FtCA 1
State
income
taues
All taxes 1
I.
No exemptions
61,575
$20,443
$6,465
$3,818
$30,726
II.
$1,125 for family, $450 for individual policies exemption
44,431
7,998
2,488
1,511
11,996
Ill.
$1,800 fur family, $720 for individual policies exemption
23,497
3,454
1,057
658
5,169
IV.
$2,400 for family, $975 for individual policies exemption
10,786
1,564
464
302
2,330
1 Includes employers' share of FICA.
Source: National Center for Health Services Research, National Medical Care Expenditure Survey, unpublished data.
ENDNOTES
1. Emil Sunley. "Tax Policy Options" in Budget and Policy Choices 1983: Tax De-
fense Entitlements, Washington, D.C., Center for National Policy, 1983.
2. Gail Wilensky and Amy Taylor, "Tax Expenditures and Health Insurance: Em-
ployer Paid Premiums", Public Health Reports, Sept./Oct. 1982, Vol. 97, No. 5, and
Amy Taylor and Gail Wilensky, "The Effect of Tax Policy on Expenditures for Pri-
vate Health Insurance," in Market Reforms in Health Care, Jack Meyer, editor,
Washington, D.C., American Enterprise Institute, 1983.
3. Amy Taylor and Walter Lawson, "Employer and Employee Expenditures for
Private Health Insurance," National Center for Health Services Research, DHHS
Publication No. (PHS) 81-3297, 1981.
4. Wilensky and Taylor, Taylor and Wilensky, op. cit.
Mr. HEFTEL. In your absence, Mr. Chairman, all of the panelists
eloquently expressed the reasons why there is inequity, a loss of
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revenue and the need for remedy in the uncontrolled use of tax-
exempt fringe benefits. I would have no questions except to compli-
ment the panel, and to indicate that if we wanted that kind of tes-
timony to support legislative action, this panel has certainly pro-
vided us with it. Thank you very much.
Chairman PICKLE. I am pleased to hear that. I apologize to the
panel that I wasn't able to hear all the testimony. We had a press
conference in the Senate announcing unanimous agreement on the
disability reform bill. I certainly wanted to be there for that.
Therefore, I missed some of your testimony. Let me, though,
impose on you just a second. We have other panelists. We are going
through lunch period so we can complete all of the panelists' testi-
mony.
I want to observe, Ms. Munnell, that I am pleased to receive your
testimony, and I have read part of it. I have enjoyed reading some
of the commentaries and articles that you have written in various
publications. I and our staff are impressed with them, so we are
glad to have you here personally.
Ms. MUNNELL. Thank you.
Chairman PICKLE. Let me ask you two or three questions because
they pertain to the approach we are trying to take. Earlier this
morning a representative of the U.S. Chamber of Commerce chal-
lenged the assumption used by the Social Security trustees in their
1984 annual report, in projecting a straight-line decline in total
compensation subject to FICA.
They seemed to indicate that the Social Security trustees have
said there would be a straight-line decline on it. The chamber of
commerce was saying they didn't believe that would happen. Do
you agree with the trustees' report that there will be a decline in
the wage base as a result of continued growth in employees' bene-
fits? That is the first question. Do you agree with the trustees'
report or with the chamber of commerce report?
Ms. MUNNELL. Before I answer, can I just congratulate you on
the disability legislation compromise. I am delighted. That is won-
derful.
Chairman PICKLE. Thank you.
Ms. MUNNELL. In terms of the Social Security trustees' projec-
tions, they project that fringe benefits will increase by 0.3 of 1 per-
cent each year into the future, and that is incorporated into the
long-run cost estimate. At first I thought that might have been too
high, but after looking closely at the growth in fringe benefits, I
think that is a reasonable projection. In the traditional benefits, I
think pressure will develop in the pension area for some kinds of
cost-of-living adjustment, and there are going to be increases in the
health care area. In addition we have this new array of benefits
that have been introduced. I think that Social Security actuaries
are probably correct.
Chairman PICKLE. I will read your testimony. I want to make ref-
erence to one other part of your testimony for just a minute. Have
cafeteria plans affected the growth and the distribution of employ-
ee benefits, and if they have, in what way have they?
Ms. MUNNELL. I am not sure that they have caught on quite as
rapidly as I would have expected. I think that Congress's move of
taking the taxable benefits out of cafeteria plans was excellent and
PAGENO="0472"
466
desirable. I think the area where you have just seen astounding
growth is 401(k) plans, which don't harm the payroll tax base but
certainly erodes the income tax base.
Chairman PIcKu~. Do you agree or how do you respond to the ar-
gument that including fringe benefits in the payroll tax discrimi-
nates against lower paid workers, anywhere below the $37,800
level?
Ms. MUNNELL. If you don't put them in the tax base, you are
going to have to raise the payroll tax, and that is much more re-
gressive than taxing fringe benefits.
Chairman PICKLE. One more question. I notice in your statement
on page 8 you said that "We have made some curtailment" on
fringe benefits, but most of it has been in closing loopholes of a tax
avoidance nature. You said:
I think the time has come for a more comprehensive approach to tax reform, that
the reforms should be consistent with the nation's tax policies rather than an ad
hoc response to losing federal dollars.
I presume you go on to make some outline. Would you want to
comment further on what you would do?
Ms. MUNNELL. I would do two things. I would include all fringe
benefits including pensions in the payroll tax base.
Chairman PICKLE. Under what?
Ms. MUNNELL. In the payroll tax base immediately. And in the
case of the income tax, my proposal is more moderate, and that is
to put a progressive cap on the amount of compensation that indi-
viduals can receive either tax-free or on a tax-deferred basis.
Chairman PICKLE. Is that recommendation in your testimony?
Ms. MUNNELL. Yes, sir.
Chairman PICKLE. Very interesting. I am glad to have your com-
ment.
Do any of the other witnesses want to make further comments
based on the testimony you have heard, or add anything to the tes-
timony we have had?
Mr. :SIMONSON. With respect to the first panel you heard from
this morning, I would say the message was largely that the system
works and you don't need to do much about it, that it is ridiculous
to think that benefits are going to expand indefinitely at the same
rate as you have seen in the past, and I would say that first of all
there is a strong incentive for workers to seek more benefits.
I don't know if they will increase at the same rate, but when you
look at combined income and employer-employee payroll tax of 35
to 40 percent that workers are able to avoid by taking tax-free
fringe benefits, they will certainly want to see further expansion of
fringe benefits. Congress did well to put a fence around some bene-
fits this year, but you saw the enormous difficulty and the com-
plexity in some cases of doing that. I think those struggles will con-
tinue, unless you work toward putting all fringe benefits in the tax
base.
Chairman PICKLE. You may be right. That is a nice way to agree
with you.
We thank all of you for your testimony. You have been very
helpful to us. We appreciate your presence.
PAGENO="0473"
467
The next panel will consist of Susan Koralik; Carson E. Beadle,
accompanied by Lloyd Kaye; and Manuel Castells.
Chairman STARK. I want to welcome the witnesses to the hear-
ing, and thank you for coming. All of you have extensive prepared
statements which, as you know, will appear in the record in their
entirety. You can read your statements or you can summarize your
statements. It will be your choice, because you have been invited,
and some of you may feel, for certain reasons, that you would like
to read the entire statement into the record. It is certainly your
privilege to do so.
Having said that, I will just call on you in the order you appear
on our witness list, which would put Susan Koralik of Hewitt Asso-
ciates as the first witness. Proceed.
STATEMENT OF SUSAN KORALIK, PARTNER, HEWITT
ASSOCIATES
Ms. KORALIK. I would be happy to try and summarize my state-
ment. I would also like to take a minute afterwards, if I could, to
respond to some of the issues that others have raised this morning.
Chairman STARK. That would be swell with me.
Ms. KORALIK. Much of the discussion that we have been hearing
yesterday and today suggests that the benefits are offered for tax
reasons, or alternatively, to allow the employer to push employees
into retirement. Everybody seems to be ignoring the fact that bene-
fits play a role in our society for the employees.
I would like to start by summarizing the major roles that bene-
fits are playing. First, they do provide a mechanism for setting
aside assets to provide a source of income for the elderly.
Second, they protect against the financial hazards of unexpected
expenses due to health problems, disability or death.
Finally, benefits can be used to meet certain social objectives
such as allowing women to more readily return to the work force.
But again, listening to the recent discussions, we seem to be just
calling these loopholes now, and we are looking at employer-spon-
sored health plans as a $21 billion drain on the revenues.
But with hospital costs rising at 12.5 percent per year, we should
be looking at these plans as a system that allows access to quality
medical care without a need for socialized medicine, national
health insurance or the expansion of medicare and medicaid.
We should look at the employer-sponsored plans as a way of pro-
viding adequate income for the elderly. A number of people have
already commented on how well we have done in terms of expand-
ing the coverage to the majority of the work force, and one of the
issues that has been raised is,"But we still have this inequity."
I agree that there is an inequity there, but perhaps we should
solve the inequity, not by taking away from those who have the
coverage, but by finding a way to give coverage to the have-nots. So
let's applaud ourselves for providing coverage for 80 percent of the
workers, and try to find some solution for the other 20 percent.
One question that has been raised is to what extent do the tax
incentives affect the employer's decision to offer benefits? The
answer is very little.
PAGENO="0474"
468
The reason for that is that you are really focusing on the wrong
question. The employer will get the tax deduction if he pays the
employee in cash or if he pays the employee with benefits.
The question to consider is to what degree does the tax status
affect the employee's decision to demand a benefit or to even
accept a benefit as part of the compensation package. And there,
we think the tax status has a great influence.
We believe that if benefits were not nontaxable or tax deferred
employees would likely demand a cash option for each benefit.
Let's just consider the two major benefit areas, retirement and
medical. If employer contributions to retirement benefits were cur-
rently taxable, the employee would have no incentive to allow the
employer to have control over the assets.
The employee would say, "Give me the money. I will pay my
taxes and I will save the rest." So what we would see would be a
tremendous drop in the participation in employer plans, if there
was a choice, and eventually a drop in the provision of employer
plans to the employees.
The employees would not be willing to pay increased taxes now
for something that they might receive later. They would want cash
instead of the employer contribution to retirement.
On the medical side, we would again predict a change in the em-
ployee behavior if the tax incentives were altered. Employees
impute a value for their medical coverage based on their actual or
expected personal usage of the plans.
Employees who repeatedly face large medical expenses assign a
great value to the plan, but employees who tend to be healthy
value the plan much lower. They see it as protection for rare occa-
sions.
Many employers today are trying to make employees appreciate
the value of the plan, but what they are communicating is the av-
erage value, or the value after pooling the high and low risks. They
communicate the premium that they pay to the insurance compa-
ny.
Employees accept this pooling as long as it doesn't appear to cost
them anything. But when employers require that employees con-
tribute something to be covered under the plan, we do see a change
in behavior.
The studies indicate that as employee contributions go up, the
number of employees dropping coverage increases. Companies with
flexible benefit programs, where they have had them in place for a
few years, have seen a pattern in which the lowest risk employees
choose the least costly plans.
And the highest risk employees stay in the most expensive plan.
So, as the price of the richest plans go up, the number of employees
opting down increases.
Taxing employees benefits on part or all of the value of the medi-
cal values would produce the same behavior patterns. If we used a
pooi, the average value, which all of the proposals have suggested,
what we would have is the best risks would begin to demand cash
equal to the average value of the medical plan.
Some of the people have suggested we take the entire $2,000 cost
of a medical plan and make that taxable income to the employee.
The employee who never files a claim would come in and say,
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469
"Thank you very much, but I will just take the $2,000 and then I
will pay my taxes. I don't want just an extra $500 in taxes to be
paid."
One further complication would be that the taxable value would
be a greater percentage of pay for the lower paid than for the
higher paid employee, so what we would probably see are more
changes in behavior, dropping coverage, among the people least
likely to accept the risk.
If the taxes were imposed only on the average value in excess of
a stated amount, some sort of cap, employers could respond by of-
fering a lower value plan.
However, this would not be popular with the employees who
want the better protection, so the ideal solution would be the flexi-
ble approach, in which the low risk employees could choose lower
priced plans without opting out of coverage altogether.
But at this point, it should be noted that only about 200 employ-
ers are offering flexible programs, and there seems to be a lot of
concern as to whether flexible programs are good or not.
It looks like it might be the only solution, if you are talking
about a cap, so let's at least not kill the only solution that we have.
Just to summarize, we see the major factors being: First, the
need for financial protection is still there, second, the employer is
in the best position to provide that financial protection, third, the
employer's decision on how he structures the program is largely a
response to the employee's demands, and fourth, the employee's de-
mands, or behavior, are likely to change if some or all of the value
of the benefits become taxable.
The nature of the change will likely result in lower paid persons
opting for less or no coverage.
We would conclude that taxing employee benefits should not be
seen as just an issue of raising revenue. It will change behavior.
Taxing employee benefits would reduce the level of protection that
we have in this country today.
[The prepared statement follows:]
STATEMENT OF SUSAN KORALIK, PARTNER, HEWITT ASSOCIATES
Hewitt Associates is a consulting firm specializing in employee benefits and com-
pensation. Since the company was founded in 1940 we have worked with over 3,500
employers and our research staff has routinely collected and analyzed benefit data
to identify common practice and trends. We would like to comment on the appro-
priations of providing tax-favored status for employee benefits in 1984 and the
future.
Employee benefits play an important role in our society.
(1) They provide a mechanism for setting aside assets to provide a source of
income for the elderly. Retirement plans can prevent dependency on welfare sys-
tems, and provide a supplement to Social Security to permit a more realistic re-
placement of preretirement living standards.
(2) Benefits protect against the financial hazards of unexpected expenses due to
health problems, disabilities and death. By encouraging the pooling of these risks,
individuals can be protected without depending on welfare.
(3) Benefits can be used to meet certain social objectives such as allowing women
to more readily return to the workforce.
Listening to recent discussions about employee benefits, it appears that some have
lost sight of these objectives. The discussions now suggest that benefits are tax loop-
holes. There are those who look at the cost of employer sponsored health plans as a
$21.3 billion drain on revenues. With hospital costs rising at 12.5% per year, we
should look at these plans as a system that allows access to quality medical care
without a need for socialized medicine, national health insurance or the expansion
PAGENO="0476"
470
of Medicare and Medicaid. Similarly, we should look at employer sponsored retire-
ment plans as a means of providing adequate income for the elderly without putting
further demands on Social Security.
As we consider employer sponsored programs here in the United States, we can
be proud of our accomplishments. Over 70 million workers are covered under quali-
fied retirement plans and over 100 million are covered under medical programs.
These are not programs that help only the highly paid. We have achieved broad-
based participation covering most employed workers at a cost in government reve-
nues that is less than if this protection were delivered through federally sponsored
plans. Therefore, we see a need to continue to provide protection through employer
sponsored plans.
However, a question has been raised regarding the continuing need for tax incen-
tives. Since employee benefits are now an expected part of total compensation pack-
ages, would employers maintain the programs if the tax incentives were removed?
In other words, to what extent do tax incentives influence an employer's decision to
offer various employee benefits? We believe the answer is, "very little."
The employer has no tax incentive to offer or not offer a benefit. The employer
will get a tax deduction whether compensation is paid in cash or in benefits.
So, what influences the employer's design of a total compensation package?
(1) Employers try to create an atmosphere of security. They want the company to
be seen as a good place to work. And if employees aren't concerned with their finan-
cial security, they can focus on higher productivity.
(2) Management may want to provide retirement benefits to ease people out of the
workforce in a graceful manner and to open up jobs for younger employees.
(3) The most influential factor is probably employee demand. To attract and
retain the best workers, an employer must offer a competitive total compensation
program. It must be generally competitive in total dollar value. But it must also be
structured to suit the preferences of the employees.
It's at this point that the tax incentives begin to have influence. The question to
consider is to what degree does the tax status of benefits influence the employee's
decision to demand or even accept a benefit as part of the compensation package.
We think it has a great influence.
If benefits were not nontaxable or tax deferred, employees would likely demand a
cash option for each benefit. Consider the two major benefit areas-retirement and
medical.
If employer contributions to retirement plans were currently taxable, the employ-
ee would have no incentive to allow the employer to have control over the assets.
The employee would say, "Give me the money so I can pay my taxes, and I'll save
the rest." We would see a tremendous drop in employer sponsored retirement plans.
Employees would not be willing to pay increased taxes now for something they
might receive later.
Would employees save after-tax dollars independently? If they would, we could
meet our social goals without deferring the tax revenues. But we don't think this is
a realistic goal. Research indicates that for a significant portion of the population,
employer sponsored plans represent their only real savings. Even with tax incen-
tives, individuals don't save independently for retirement. Less than 17 percent of
the workforce has established an IRA. And among those who have IRAs, over 50
percent reported that the source of funds was accumulated savings rather than cur-
rent income. Money is just being shifted from one account to another, with little
increase in real savings. Therefore, if having income to supplement Social Security
for the elderly is an important social objective, we need the tax incentive to main-
tain employer sponsored plans, otherwise the impact is less retirement security.
As we look at medical benefits, we again would predict a change in employee be-
havior if the tax incentives were altered. Employees impute a value for their medi-
cal coverage, based on their actual or expected personal usage of the plan. Employ-
ees who repeatedly face large medical expenses assign a great value to the plan. But
employees who tend to be healthy value the plan much lower, as protection for rare
occasions. Many employers today are trying to make employers appreciate the value
of these plans. But what they communicate is the average value-or the premium
after pooling the high and low risks. Employees accept this pooling as long as the
plan doesn't appear to cost them anything. But when employers require that an em-
ployer contribute some amount to be covered under the plan, we see a change in
behavior. Studies indicate that as employee contributions increase, the number of
employees dropping coverage increases. Companies with flexible benefit programs in
place for a few years have seen a pattern in which the lowest risk employees choose
the least costly plans. And as the price of the richest plans go up, the number of
employees opting down increases.
PAGENO="0477"
471
Taxing employees on part or all of the value of medical benefits would produce
the same behavior patterns. If we used a pooled or average value, which all of the
proposals have suggested, the better risks would begin to demand cash equal to the
average value of the medical plan. Can you imagine the reaction of a healthy em-
ployee who is given an annual tax bill of $500 for medical coverage he hasn't used.
One further complication would be that the taxable value would be a greater per-
centage of pay for the lower paid than for the higher paid employee. Therefore, we
would probably see more changes in behavior-dropping coverage-among the
people least able to accept the risk.
If taxes were imposed only on the average value in excess of a stated amount,
employers could respond by offering a lower value plan. However, this would not be
popular with employees who wanted the better protection. The ideal solution would
be the flexible approach in which low risk employees could choose lower prices
plans without opting out of all coverage. At this point, however, only about 200 em-
ployers are offering employers choices through flexible plans.
CONCLUSIONS
Looking at the available data and the trends we have also been able to identify
over the years, we can draw some conclusions about the appropriateness and the
impact of taxing employee benefits. First, here is a summary of the major factors:
(1) The need for financial protection for unexpected expenses and savings for re-
tirement has not changed. And, the employer is in the best position to offer cover-
ages the individual cannot get on his own, to pool the risks among employers, and to
make prudent investments on plan assets. So, employer sponsored plans are a neces-
sity.
(2) The employer's decision on how to structure the total compensation package is
largely a response to employee demand.
(3) Employee demand or behavior is likely to change if some or all of the value of
benefits becomes taxable. The nature of that change will likely result in lower paid
persons opting for less or no coverage.
Therefore, we would conclude that taxing employee benefits is not just an issue of
raising revenue. Taxing employee benefits would reduce the level of protection that
we have in this country today.
Chairman STARK. Flow do you deal with the suggestions that you
make the plan progressive, one suggestion which was 25 percent of
the first $40,000, so the low paid employees are going to get all of
theirs tax free? That would obviously answer that.
They would take it then, right?
Ms. KORALIK. Yes, that wouldn't be a problem. If the low-paid
employees did not face a tax, then they probably wouldn't change
their behavior.
Chairman STARK. By definition, the high-paid employees are so
intellectually alert that they would not follow emotion.
Ms. KORALIK. Hopefully.
Chairman STARK. But sound economic choice.
Ms. KORALIK. Yes.
Chairman STARK. Thank you.
Carson Beadle and Lloyd Kaye on here as a team. Do you each
have separate testimony?
STATEMENTS OF CARSON E. BEADLE, MANAGING DIRECTOR,
AND LLOYD S. KAYE, VICE PRESIDENT, WILLIAM M. MERCER-
MEIDINGER, INC.
Mr. BEADLE. No, we just have one testimony. Lloyd Kaye has also
made himself available to answer questions.
Chairman STARK. Fine. Why don't you proceed, then?
Mr. BEADLE. Mr. Chairman, you pose questions in your frame-
work for these hearings that we think go right to the heart of the
taxation and fringe benefits issues.
PAGENO="0478"
472
They are precisely the questions on which we wanted answers
when we began our annual survey last spring, to which over 500
CE's have now responded. The survey results are attached to our
written testimony, and I think should be quite helpful to your com-
mittee in its deliberations.
I thought I would take just a few minutes to summarize those
findings that address your questions particularly, and then offer
some observations based on our own experience.
I would like to emphasize from the outset that it has been our
experience that the broadening of income security benefits that has
evolved over the last 35 years has been significantly influenced by
the special tax status afforded to these benefits, and as Susan has
just said, any significant change in that status will reverse the
trend.
Employee benefits have been different from fully taxable com-
pensation, and though their tax favored treatment has not been
the basic reason for the existence of benefit plans, it has played a
significant role as distinguishing characteristic in encouraging
their growth by making these benefits more affordable to employ-
ees.
You asked about the effect of tax favored treatment on the selec-
tion of fringe benefits. The CEO's that answered our survey were
asked if Congress were to eliminate many of the tax preferences
from employee benefits, how do you believe U.S. companies would
generally react?
Sixty-six percent believe that companies would cut their benefits.
We asked the question in different ways. For example, we asked if
tax preferences had encouraged companies to sponsor employee
plans, 69 percent said yes.
We asked if the current policies of providing the preferences
should remain intact; 87 percent said yes.
We asked if eliminating some of the preferences would be a sen-
sible approach to reducing the deficit; 81 percent said no; 72 per-
cent of these went on to say that reducing benefits will put pres-
sure on government to increase social security and provide addi-
tional welfare benefits.
When we asked them well, why company-sponsored benefit plans
in the first place, the answer did not affect taxes. In fact, that
ranged only for such reasons as remaining competitive for labor,
concern for employees' economic security, and desire for good em-
ployee relations.
The essential conclusion that permeated the responses is that the
tax favoring of benefits has played a very large role in encouraging
employers and employees alike to provide for their own income se-
curity and health benefits.
Chairman STARK. Excuse me, let me go through that again. You
say in the survey, the employers said it wasn't very important, the
tax considerations.
Mr. BEADLE. It is a very important point to distinguish here. It
has not influenced the selection of specific benefits, but the fact
that it has made benefits more attainable by employees through
lower cost, tax favoring lower costs, has encouraged employees-----
Chairman STARK. Employers?
PAGENO="0479"
473
Mr. BEADLE. No, encouraged employees to be ready to have em-
ployer sponsored benefit plans, to in fact demand them, ask for
them, or be sold on them, because there was an incentive.
Chairman STARK. But the employers are indifferent?
Mr. BEADLE. As Susan has said, for the employer it doesn't make
much difference whether it goes into cash or into benefits.
Chairman STARK. Right. The employer has an eleemosynary sort
of thing, he wants to be a nice person.
Mr. BEADLE. It must be a good place to work. I was going on to
say that the tax preferences are not the reason benefit plans are
implemented, but they are certainly a facilitator insofar as the em-
ployees are concerned.
You had a question about horizontal and vertical equity of the
income tax system. Regarding vertical equity, our survey group felt
that our employees would be affected most by the elimination of
tax favored status of benefits.
The next group would be the administrative clerical, and then
middle and top management. On the subject of horizontal equity,
and this is a personal opinion, we have 150 million American em-
ployees and their families to attest to the fact that well-placed tax
incentives entice people to acquire their own necessary protection,
and those that have been denied these incentives tend not to take
out adequate coverage to protect themselves, and I believe that is a
group that the committee has been concerned about.
The question was also asked what shift might occur in the inci-
dence of income tax if benefits were to become taxable. It is our
opinion that little shift would occur between higher and lower paid
employees, because the caps and the discrimination rules already
in effect covers most employee benefit situations.
There would, though, be a wrenching shift in the form of tax-
ation that would become payable by all taxpayers.
Since benefits were first introduced, they were understood by em-
ployees to be for the most part without taxation, or more correctly,
according to our survey, 85 percent of the respondents believe em-
ployees don't even realize they have a tax advantage, but they do
know what their current tax subsidized costs are, and any major
shift of tax benefits would be seen to be a tax increase to every em-
ployee in the country.
In fact, the cost of benefits such as health insurance tend to be
level regardless of income, so that they might well be considered a
regressive form of taxation.
When you think abOut it, the benefits are very personal to em-
ployees, and any benefits reductions brought about in response to
taxing them would likely be seen by taxpayers to have a greater
dollar effect than the taxes actually assessed.
Susan addressed the question of whether employees would buy
benefits indepedently even if they were tax-free. In our survey, 88
percent of the CEO's said they don't believe employees would buy
pension benefits even if their salaries were increased to make up
for reduced benefits; 84 percent think employees wouldn't replace
reduced health benefits.
Your next question concerned caps. In our survey, we asked,
would you favor--
PAGENO="0480"
474
Chairman STARK. Could I interrupt there? When you say the em-
ployees wouldn't want benefits, did you take into account those em-
ployees who are represented by bargaining units?
Mr. BEADLE. We posed that question separately, and the unions
expressed, at least the CEO's believe that the unions would press
very hard to retain benefits. Of course, they would attempt to
retain them without any reduction in cost so that would represent
an increase in payroll costs, you might say.
Chairman STARK. Thank you.
Mr. BEADLE. On the question of caps, the question we posed was
would you favor or oppose proposals to place a cap on employer
paid health insurance premiums. The majority of respondents be-
lieve that caps would cause internal inequities between employees,
that is, between older and younger employees as well as geographic
inequities and would not contain the rising costs of health care.
On the other hand, though, a significant number felt that a cap
on health insurance premiums would lead to more cost-effective
medical care, and would increase employees' awareness of the costs
of benefits incurred by the employees, so we found a difference of
opinion even by the CEO's on the question of caps.
But 70 percent of them believe that limiting the amount of tax-
free employer contributions to pensions and profit-sharing plans
would be unfair to lower-paid and long-term employees, because
the relative cost is higher there.
Personally, I would be concerned that any cap that would treat
with reasonable fairness and equality the wide demographic range
in the work force, for example, from a young, two-parent manufac-
turing family in New York, to a near-retirement electronics worker
in Spokane, in a system that could monitor its application, would
add a complex layer of regulation in an already heavily legislated
area, and all this would accomplish is to add virtually equal tax
income at all income levels.
The point is that tax increases in this form would create serious
inequities for employees. Since benefits are deferred income, and
employees want to spend their money now, benefit expenditures
will control themselves, except possibly for the higher paid, where
pension and discrimination limitations already provide caps.
We wondered in our survey whether a change in the tax prefer-
ences would have any effect on U.S. capital markets and capital
formation, given that there are currently about, I think, $900 bil-
lion in pension assets.
Eighty-seven percent of the CEO's said there would be an effect,
with 41 percent believing the extent would be great.
On another point, discussion of employer-paid costs, has centered
on there being an alternative form of compensation, and there are
some good arguments for this.
However, the vast majority of benefits enhance the work envi-
ronment, just as surely as safety equipment or workers' compensa-
tion. These benefits then might be considered not only in the sim-
plistic sense of being a form of compensation, but also as a noncom-
pensation cost of doing business that contributes to a more secure
attractive work environment, and any shift away from the provid-
ing of benefits by employers can also have a lessening effect on em-
PAGENO="0481"
475
ployees' attitudes to the workplace, and employers' concern for
their security.
I have also noticed that the vast majority of employees are not
using today's spendable cash which they need for rent and food or
want for cars and TV's, to buy unneeded benefits or to save for ex-
cessive pensions just because they are tax-free.
Some may want more or less protection, because as individuals
they are more or less insecure, but they don't seem ready to waste
their valuable spendable income.
You asked about the most efficient use of resources either by en-
couraging employers to provide benefits through tax treatments or
by providing them directly through directly funded public pro-
grams.
We know from experience of other countries, Britain, Denmark,
Canada, that governments can provide benefits directly. We also
know that these countries have their own serious financial and po-
litical problems in controlling costs.
Foremost is the difficulty in cutting benefits under universal pro-
grams, even in areas where we find there is no need, and that is a
problem we have already experienced under our relatively limited
programs here in the United States.
Health care is a current example--
Chairman STARK. Which programs were those?
Mr. BEADLE. I think in the case of Social Security, we have won-
dered whether everybody needs the universal benefit. You certain-
ly can't afford to take it away from anyone because it is a univer-
sal program.
It is very difficult for government to be selective about who
should receive a benefit it is sponsoring.
Chairman STARK. Once it is started.
Mr. BEADLE. Right, precisely. Health care costs are a good exam-
ple. What we are seeing in the private sector right now is a scram-
ble to bring health care costs under control, and to increasingly in-
volve employees as individuals in the decisionmaking on how that
money is spent.
The entire community, employers, union, employees, hospitals,
doctors and others, like consultants, like us, are all addressing the
issue of rising health care costs, each from its own perspective,
each searching for the right answer in its own area, and unencum-
bered by any overall singular scheme that has had to be imposed
on a nationwide or industry-wide basis.
That approach does produce some turmoil and pain during the
search for the right answers, but I believe that is still the system
that will produce the most cost-effective solutions once it has run
its course.
I do fear though that the rule assumed by the private sector may
be more fragile than is commonly believed. In the equation we are
now studying, we need to consider with care that any reversal in
this tax favored treatment runs the danger of reversing the trend
of employer support, and possibly even abdication of the role, and
that is particularly true in respect to smaller employers who al-
ready find the costs difficult to absorb.
I agree there is a limit to the amount of tax-favored treatment
we can afford to give to non-cash compensation, but we have all
4O~O46O-8531
PAGENO="0482"
476
seen that when it is used judiciously as an incentive to achieve
social objectives, it has been extremely effective.
I believe then that the benefits to which we accord tax-favored
treatment should be only those which support the country's social
policy, and limits should be applied only where abuse is a signifi-
cant factor.
I think, Mr. Chairman, it is a tribute to the system that commit-
tees such as yours are examining this important subject with such
care and we at Mercer-Meidinger are dedicated to assisting you in
any way we can.
Thank you.
Chairman PIcKI~. Thank you very much.
[The prepared statement follows:]
STATEMENT OF CARSON E. BEADLE, MANAGING DIRECTOR, WILLIAM M. MERCER-
MEIDINGER, INC.
Mr. Chairman and distinguished members of the Subcommittee, I am Carson E.
Beadle, Managing Director of William M. Mercer-Meiclinger, Incorporated, a bene-
fits and compensation consulting firm operating in forty cities in the United States
as well as in major cities around the world. In my thirty years in the employee ben-
efits field, I have worked with employers, joint union-management trusts, medical
societies and governments.
The questions you have posed in your "framework" for these hearings go to the
heart of the issues of "the distribution and economics of employer provided fringe
benefits".
Our firm has been concerned over the years about what should properly drive the
design of employee benefits. We have examined with our clients why an employer
should provide benefits, how they should be provided, and what are the final impli-
cations. With the specific issue of tax preferences in mind, we began a survey last
spring. We released that survey here yesterday, and it is included in this testimony.
Last week many of us had the privilege of hearing Senator Javits' comments to
the Subcommittee on Aging, of the U.S. Senate. He voiced his pride in the growth of
private sector pension plans and the vital needs these meet for those on or ap-
proaching retirement. He also spoke about the very favorable ratio of benefits these
plans provide vs. the tax revenue forfeited, and on the importance of social policy
when talking about cutting costs or raising taxes~
It has been our experience also that the broadening of income security benefits
that has evolved over the last thirty-five years has been significantly influenced by
the special status afforded to these benefits by their special tax treatment. Employ-
ee benefits have been different from fully taxable cash compensation and though
their tax-favored treatment has not been the reason for their existence, it has
played a significant role as a distinguishing characteristic and has encouraged their
growth by making these benefits more affordable to employees.
In your announcement of these hearings, you asked first about the effect of tax-
favored treatment on the selection of fringe benefits.
The C.E.O.'s that answered our survey told us that virtually all the issues that
have influenced the design and implementation of most plans are non-tax issues.
They added that tax status has little direct effect on benefit selection even though it
has significant impact on their readiness to implement benefits generally.
36 percent of our respondents said that employers sponsor benefit plans in order
to be competitive.
26 percent expressed concern for the economic security of their employees.
25 percent identified desire for good employee relations as their reason.
5.2 percent cited tax effectiveness compared to direct compensation.
We found somewhat the same answers from another Mercer-Meidinger survey re-
leased last week, which focused only on flexible benefits. We asked what plan spon-
sors had hoped to achieve in undertaking the considerable effort and expense in be-
plementing these flex plans.
31 percent of the respondents said they implemented their plans to "encourage
cost containment."
25 percent have "flex" plans "to give employees greater choice."
23 percent have "flex" plans to "foster employee relations."
PAGENO="0483"
477
Your next question asked about the effect of tax-favored treatment of benefits on
the horizontal and vertical equity of the income tax system. Our survey group felt
that hourly employees would be affected most by the elimination of the tax-favored
status of benefits, followed by Administrative/Clerical employees, and then by
Middle and Top Management.
You asked what shift might occur in the incidence of income tax if nontaxable
benefits were to become taxable. It is our opinion that little shift will occur betw.~en
higher and lower paid employees. Nontaxable group life insurance is currently
pegged at $50,000 which would generally apply to those earning $25,000 or less.
Health insurance costs apply roughly equally at various income levels; disability in-
surance usually has a maximum eligible salary which is a limit imposed by under-
writers. And pensions, and 401(k) plans have a combination of dollar limits and dis-
crimination tests which for the most part prevent nontaxable contributions from
producting benefits which are inconsistent with the relative income needs of all
levels of wage earners.
There would however be a wrenching shift in the form of taxation that would
become payable by all taxpayers. Since benefits were first introduced, they have
been understood by employees to be for the most part without taxation. A major
shift to tax benefits would be seen as a tax increase to every employee in the coun-
try. In fact, the costs of benefits such as health insurance tend to be level regardless
of income so that taxing contributors would be a regressive form of taxation.
Benefits are very personal to employees and any benefit changes brought about in
response to taxing them would likely be seen to have a greater dollar effect than
the taxes actually assessed.
Your next question concerned caps. In our survey we asked a question much like
yours. We asked: "Would you favor or oppose proposals to place a cap on employer-
paid health insurance premiums? (All amounts over the limit would be taxable
income to the employees.)"
Fifty-six percent of the respondents voiced opposition citing such reasons as: a cap
would cause internal inequities between employees (e.g. between older and younger
employees) as well as geographic inequities; a cap would not contain the rising cost
of health care; and government should not interfere with business.
Thirty-nine percent favored the use of a cap because in their view: a cap would
force the medical industry to provide cost-effective medical care and would decrease
the cost of health care; caps would increase employees' awareness of the costs of
benefits incurred by the employees (an argument also made in support of flexible
benefit plans).
In another open-ended question, 70 percent of the respondents expressed opposi-
tion to the idea of limiting the amount of tax-free employer contributions to benefits
such as pensions and profit sharing plans, saying that such a cap would be unfair to
lower-paid and long-term employees.
We asked which type of cap they believe would be most fair. Those who responded
ranked caps as follows: 43 percent cited a flat-dollar cap indexed to inflation; 29 per-
cent named a flat-dollar cap in the same amount for all employees; and 14 percent
each identified a cap based on employee geographic location and a cap based on age.
You asked about the relationship between private sector benefits and social pro-
grams and the effect on federally funded social programs if employers did not pro-
vide fringe benefits.
Again, that question was asked specifically in the Mercer-Meidinger C.E.O.
survey. We first asked whether they agreed or disagreed that "if many tax prefer-
ences for employee benfits are eliminated, the majority of U.S. employers will
reduce their employee benefit programs. 79 percent believe this will happen.
To find out more specifically which benefits would be most affected, we asked the
respondents how they expected each of 15 different benefits to be affected by tax
change. That is, would each of these benefits be increased or decreased between now
and 1990 if tax preferences remain unchanged or if they are reduced or eliminated.
The answers, which I think you will find interesting, are on page 19 of our survey.
We then asked that if they thought benefits would be reduced, did they believe
this "will put pressure on the government to increase Social Security and/or pro-
vide additional welfare benefits". 72 percent answered "yes" and 21 percent an-
swered "no".
Let me now share with you some views that I have based on my years as an inter-
ested observer.
Discussion of benefit costs has tended to center on employer paid benefit costs as
an alternative form of compensation, and there are some good arguments for this.
In reality though, the vast majority of benefits enhance the work environment just
as surely, for example, as safety equipment and workers compensation, by providing
PAGENO="0484"
478
a vehicle for employers and employees alike to prepare in advance for those contin-
gencies that could otherwise be destructive to them.
These benefits then might be considered not only in the simplistic sense of being a
form of compensation but also as a non-compensation cost of doing business that
contributes to a more secure, attractive work environment. Any shift away from the
providing of benefits by employers will also have an effect on employees' attitudes
to the workplace and employers' concern for their employees' security.
I have also noticed that the vast majority of employers and employees alike do
not appear to be using today's spendable cash which they need for rent and food or
want for cars and TV's, to buy unneeded benefits or to save for excessive pensions
because the costs are tax free.
Regarding caps, I would be concerned that caps that would treat with reasonable
fairness and equality the wide demographic range in the workforce, from a young
two-parent family in New York to a near-retirement worker in Spokane, in a
system that could monitor its application, would add another complex layer of regu-
lation in an already heavily legislated area.
You asked about the most efficient use of resources, either by encouraging em-
ployers to provide benefits through preferred tax treatment or providing them
through directly funded public programs.
To me this is at the very heart of the matter of tax-favored benefits.
We know that publicly funded programs are taking a growing proportion of the
GNP.
We know that controlling the costs of publicly funded programs on a broad scale
has been difficult even though there have been some notable efforts such as Medi-
care's DRG program.
And we know how difficult it is to cut benefits under universal programs even in
areas where we find there is no need.
Health care is a current example of the need to contain costs. We have are seeing
in the private sector is a scramble to bring health care costs under control and to
increasingly involve employees as individuals, in the decision making on how much
money is spent. Flexible medical plans, for example, let employees decide whether
they want to pay a much higher contribution for a low deductible. 401(k) plans let
each employee decide whether they want to save relatively a lot or a little for their
retirement.
And, the entire community-employers, unions, employees, hospitals, doctors and
others such as consultants like us-are all addressing the issue of rising health care
costs, each from their own perspective, each searching for the right answer in their
own area, unencumbered by any overall scheme that has had to be imposed on a
nation-wide, industry-wide basis. I believe that although this approach produces
some turmoil and pain during the search for right answers, the system will produce
the most cost effective solutions.
I believe also that the floor of protection provided by public programs such as
Social Security, Medicare and Medicaid are important to be preserved and to be
linked cooperatively with private sector plans which have done an outstanding job
of providing income security and health care benefits to about 150 million employ-
ees and their families with little government effort beyond creating a favorable,
supportive tax climate.
I do fear, however, that the role assumed by the private sector may be more frag-
ile than is commonly believed. In the equation we are now studying, we need to con-
sider with care that any reversal in this tax-favored treatment beyond fine-tuning to
remove abuses, runs the danger of reversing the trend of employer support and pos-
sibly even abdication of the role. This is particularly true in respect of smaller em-
ployers who already find the costs difficult to absorb.
I agree there is a limit to the amount of tax-favored treatment we can afford to
give to non-cash compensation, but we have all seen that when it is used judiciously
as an incentive to achieve social objectives, it has been extremely effective. I believe
then that the benefits to which we accord tax-favored treatment should be those
which support the country's social policy and limits should be applied only where
abuse is a significant concern.
it is a tribute to the system that committees such as this are examining this im-
portant subject with such care and we at Mercer-Meidinger are dedicated to assist-
ing in any way we can.
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479
Employer Attitudes Toward
Employee Benefits and Tax Change
A Mercer-Meidinger Survey, September1984
WILLIAM M.
~WR~RPJED ~iWi~i~
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480
William M. Mercer-Meidinger, Incorporated
Table of Contents
Page
Preface 1
Survey Highlights
Detailed Findings 7
Section 1: Employee Benefits, Tax Preferences and The Federal Deficit 7
Section 2: The Effect of Tax Change on Employees and
The Structure of Benefit Plans
Section 3: Views are Split on Capping Employer Contributions 15
Section 4: Effect on Capital Markets 17
SectionS: Reduction of Benefits Will Press Social Security System 17
Section 6: Tax preferences and The Future of Benefits
-A Message to Congress 18
Classification Data of Companies Surveyed 20
Questionnaire 21
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Preface
The substantial federal deficit has prompted several
members of Congress to look skeptically at the
tax-favored status of employee benefits as though they
represent a tax give away that bears no relation to the
social objectives of the nation.
Some view this special status for income security and
medical benefits as a "revenue loss" which should be
stopped by cutting back or eliminating the traditional
benefit program tax preferences which have been
granted to both employers and employees.
This issue is attracting increased attention from our
legislators. If legislators focus on "revenue loss" rather
than on the "income security needs" of virtually all U.S.
employees and their families, their actions could have a
material and possibly unintentional effect on the manner
in which financial security is provided to 150 million
Americans.
481
In hopes of contributing to this discussion, William M.
Mercer-Meidinger, Incorporated, the employee benefit
and compensation consulting firm, has conducted its
eighth annual survey of chief executive officers to elicit
their views on the tax status of employee benefits.
The 502 CEOs who responded to the survey represent
America's large and medium-sized corporations in a
variety of industries. Forty-six percent of the respondents
head companies employing over 5,000 employees, with
14 percent employing more than 20,000 employees.
Their overwhelming conclusion is that any material
change in tax preferences for employee benefits will
significantly alter the role of employers and employees
in providing for their own income security and will create
pressure on the government to fill any void left by
reduced company-sponsored benefit programs.
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482
Survey Highlights
Introduction
Questions frequently asked are whether tax preferences
have influenced the private sector's initiatives to provide
income security and medical benefits to employees
and whether this initiative and the level of security
employees currently enjoy would be reduced if tax
preferences were removed.
The survey results indicate that tax preferences have set
benefits apart from cash compensation and in so doing
have encouraged employers, unions and employees to
provide for themselves a higher level of income security
than might otherwise have been possible. This in turn
appears to have minimized pressure on the government
to provide such benefits.
According to the survey findings, changing the tax laws
without considering the effect on present employee
benefit programs may lead to a reduction in the benefits
that employees and employers currently provide for
themselves.
1. Employee Senefits, Tax Preferences and the
Federal Deficit
The chief executive officers surveyed were virtually
unanimous in believing that the federal deficit must be
reduced. Two-thirds said efforts to reduce the deficit
are "crucial" and one-third said they are"important."
They do not believe, however, that changing the
tax status of benefits is an appropriate method for
reducing the deficit, nor that any revenue loss
attributed to tax-sheltered plans that help employees
prepare for their retirement is too great.
Most believe that the current policy of providing
favorable tax treatment for employee benefits should
remain essentially unchanged and foresee several
problems that would result from changing tax policy.
Eighty to ninety percent believe there would be a
negative effect on the health and welfare of workers
and their families and on the economic security
of retired workers, because the majority of U.S.
employers would, according to survey results, cut
back on their benefit programs.
This, they believe, would put pressure on the
govemment to increase Social Security or to provide
additional welfare benefits. Significantly, CEOs are
of the view that such company-sponsored benefit
reductions would have a negative effect on U.S.
capital markets and capital formation.
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2. The Effect of Tax Change on Employees and the
Structure of Benefit Plans
The CEOs were more pessimistic about what would
happen to employee benefits at U.S. companies in
general than at their own companies. This may be true
because those companies represented in the survey
are among the largest U.S. corporations which might
be expected to maintain more generous employee
benefit programs.
When asked how companies would react if many
of the present tax preferences were eliminated, 41
percent thought companies in general would cut back
their benefits, while only 28 percent thought their
own company would do so.
Only 30 percent of the CEOs thought all U.S.
companies would maintain their benefit programs
at current levels if tax preferences were eliminated,
while 47 percent thought their own company would
maintain its benefits. The rest predicted that benefits
would be cut, and direct compensation increased, so
that the total would remain constant.
When asked to consider what would occur if benefits
were reduced but compensation increased, 88
percent believe that employees would not invest the
extra money to ensure their future financial security
and 74 percent believe employees would not buy
replacement insurance to make up for lost benefits.
Hourly workers would, in the view of the CEOs, be
affected most by any change in the tax status of
benefits. Almost half predict that union leaders would
ask employers to maintain current benefits, and less
than 1 percent thought union leaders would accept
the reduction in total compensation that would occur
if benefits became taxable to employees.
483
3. Views Are Split on Capping Employer Contributions
Placing additional caps on tax-free employer
contributions to employee benefit plans has been the
subject of frequent discussion and several proposals
to Congress. When CEOs were asked what they
thought about these caps, 56 percent said they
opposed them because they would cause internal and
geographic inequities among employees. Thirty-nine
percent favored caps as a means of increasing
employee awareness of the costs of benefits incurred
by the employer.
Those favoring caps felt they would force the medical
industry to provide cost effective medical care, while
those opposing caps believed that caps would not
contain the rising cost of health care.
When asked how their company would react if a
dollar cap was enacted which was lower than their
current medical plan premiums, 44 percent said they
would probably establish a second, more limited
medical plan with premiums below the cap and offer
employees a choice between two plans. A third of
the respondents would make no changes, while the
remainder would cut benefits to a level where costs
would fall beneath the cap.
When the concept of capping contributions is
extended beyond medical plans to pensions and
other benefits, opposition rises to 70 percent.
Respondents believe such caps "would be unfair
to lower-paid and long-term employees" and that
"employees need an incentive to save for retirement."
If a cap were to be placed on benefits, the CEOs
thought it would be fairest to have a uniform dollar
cap, indexed to inflation.
4. Effect on Capital Markets
The assets of private tax-qualified pension plans now
exceed $900 billion. A change to limit the tax status
of these funds would, in the opinion of 87 percent of
the CEOs, affect US, capital markets and capital
formation. Forty-one percent of the CEOs said they
believe capital markets would be affected "to a great
extent."
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5. Reduction of Benefits Will Press Social
Security System
CEOs, who said they thought employers would
reduce their benefits if tax preferences were
eliminated, were asked if they would expect
increased pressure on the government to increase
Social Security and/or to provide additional welfare
benefits. Seventy-two percent believed this would
occur.
Most of the respondents-86 percent-strongly
support tax-sheltered savings plans such as l.R.A.s,
401(kls and thrift plans because they believe
employees need to be encouraged to save for
retirement because "employers and Social Security
cannot do it all."
6. Tax Preferences And The Future Of Benefits-
A Message To Congress
484
The survey findings identify several issues that
warrant thoughtful consideration in any examination
of proposals to reduce or eliminate tax preferences for
employee benefit plans.
Income security and medical benefits provided by
employers are very much an integral part of the U.S.
socio-economic system. Of the companies in the
survey, 99 percent provide medical insurance, 98
percent provide group life insurance, 95 percent
have retirement plans and 87 percent have disability
insurance plans.
According to the CEOs, these programs are provided
for three main reasons. First, to remain competitive in
the labor marketplace and attract to good employees.
Next, to encourage good employee relations, and
third, because of their concern for the economic
security of their employees.
If favorable tax treatment of these programs were
reduced, company-sponsored benefit programs
would not disappear, but-according to the
CEOs-benefits would probably be cut back.
Employees would suffer, with the lower-paid
employees being affected most. Employees would
not likely replace reduced benefits on their own.
Pressure would be.placed upon the government to
make up some of the difference.
As for future benefits, a continuation of existing tax
preferences would not prompt employers to increase
most benefits beyond their present level, but would
lead to more flexible benefit plans, 4011k) plans and
child care benefits.
The CEOs said, that in determining tax policy for
employee benefit plans, Congress should be more
concerned about the economic security of U.S.
workers than any other consideration. They ranked
health care cost containment as a second concern and
employee access to quality health care servicesas
their third concern. Reducing the federal deficit ranked
fourth.
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485
Detailed Findings ~
Section 1: Employee Benefits, Tax Preferences and the Federal Deficit
Reasons for Sponsoring Employee Benefit Plans
The principal reason why their companies sponsor employee benefit plans, say the chief executives surveyed, is
the "need to remain competitive in the labor marketplace and attract good employees.~ The "desire for good
employee relations" and concern for employees' economic security also were considered very important. The
least important reason was the tax deductibility of a company's expenses incurred to provide these benefits.
Question 1 Please rank the reasons why, in your opinion, your company sponsors employee benefit plans
(#1 representing the most important, #2 the next most important, etc.).
Weighted
Rank Ranked Ranked Ranked Rank
Order #1 #2 #3 Points
1 Need to remain competitive in Labor
marketplace and attract good employees 258 114 66 1,068
2 Concern foreconomic security of employees 149 100 113 760
3 Desire forgood employee relations 70 186 144 726
4 Tax.effectiveness of benefits to employees
(compared to direct compensation( 9 35 55 152
5 Belief that benefits improve productivity 4 33 56 134
6 Taxdeductibility of benefit costs by company 3 19 35 82
* Findings based on rank points: 3 points forevery #1 ranking, 2 points forevery #2,1 point forevery #3.
Importance of Reducing Federal Deficit
There is near unanimity of executive opinion on the need to reduce the federal deficit. A majority (65 percent)
termed the need "crucial."
Question 2: Thinking broadly for a moment about the nation's deficit, how important, in your opinion, are
current efforts to reduce the deficit?
Crucial 6S%
Important 35%
Unimportant 1%
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486
Taxing Employee Benefits
Although the tax deductibility of company benefit costs was considered the least important reason for
sponsoring a benefit plan, a sizeable majority-81 percent-expressed the view that reducing or eliminating tax
preferences for employee benefits is not a sensible approach to increasing revenues. Sixty-nine percent reported
that the favorable tax treatment granted benefit plans has been influential in encouraging their companies to
sponsor these plans, and 87 percent indicated that existing tax preferences for benefit plans should remain
unaltered.
Question 3: Please cirde the number which best reflects your own opinion on each of the following statements:
Strongly lend to Tend to Strongly No
Agree Agree Disagree Disagree Opinion
Cimirtatinguome of the taxpreferences foremployee benefits Ito
bothemployers andemployees) is a sensible approach to increaseing
revenues and reducing the federaldeficit. 3% 15% 31% 50% 1%
The current policyof providing tan preferences foremployer.
sponsored employeebenefit programs should remain intact. - 52% 35% 11% 1% 1%
The currentpolicyof providing tax preferences foremployer-
sponsored employee benefit programs should be changed. 3% 14% 39% 41% 3%
Taxpreferencesfsremployee benefits have been influential is
encouraging mycornpany tosponsoremployee benefit plans. 30'!, 39", 13% 10'!, 8%
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487
Section 2: The Effect of Tax Change on Employees and the Structure of Benefit Plans
Reactions to Eliminating Benefit Tax Preferences
If Congress were to eliminate or reduce the tax preferences for benefit plans, 41 percent of the executives
surveyed believe that companies in general would tend to cut back on benelito but leave direct compensation
unchanged-producing a net decrease in employees' total (direct and indirect) compensation. Fifty-five percent
would either continue benefits without material change or would reduce benefits and add the value to direct
compensation.
Question 4: If Congress were to eliminate many of the tax preferences for employee benefits, how do you
believe U.S. companies would generally react?
Would continue to provide benefits without material change, much as they do now 30/'
Would cut benefits back but increase direct compensation so total would remain constant 25%
Would cut benefits back and leave direct compensation unchanged so total would be reduced 41%
No opinion 4%
QuestionS: How do you think your company would react if Congress were to eliminate many of the tax
preferences for employee benefits?
Would continue to provide benefits without matenal change. much as they do now 47%
Would cut benefits hack but increase direct compensation so totalwould remain constant 21%
Would cut benefits hack and leavedirect compensation unchanged so total would be reduced 28%
Noopinion
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Reactions to Increasing Cash Compensation
If their companies increased salaries in lieu of reduced benefits, 88 percent of the executives indicated that they
did not think employees would invest this additional compensation to ensure their future financial security.
Three-fourths of the executives believed that their employees would not use the additional income to purchase
personal replacement insurance.
Question 6: Please indicate whether you agree or disagree with the following statement: If my company were
to increase salaries to make up for reduced benefits, most employees would:
Strongly Tend to Tend to Strongly No
Agee Agee ~ 2~ Opmion
lnvestthemoneytoensuretheirfuturefinanciajsecuivy .1% 10% 50% 38% 1%
Purchasereplacementinsuranceonthetiown 2% 23% 51% 23% 1%
Eliminating Benefit Tax Preferences; Where Greatest Burden Would Fall
Hourly wage earners and administrative wo&ers are the two categories of employees which would be most
affected by the elimination of the tax-favored status of benefit programs, in the view of.the executives surveyed.
Top and middle management would be the least affected groups.
Question 7: If Congress were to eliminate many of the tax preferences for employee benefits, please rank how
the following employee groups could be affected (#1 representing the most affected, #2 the next most
affected, etc).
Weghted
Rank Ranked Ranked Ranked Rank
Order #i #2 #3 Pomts
1 Hourly 195 38 16 677
2 Administrative/clerical 71 191 39 625
3 MiddieManagement - 54 150 92 554
4 TopManagement 149 32 33 544
5 OtherProfessionals 13 65 285 454
Findings basedon rankpoints: 3pointsforevecy #1 ranking, 2pointsforevery #2,1 pointforevery #3.
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489
Awareness of Employee Benefit Program Tax Effectiveness
A substantial majority of the chief executives surveyed (85 percent) believe that most employees are unaware of
the present tax effectiveness of employee benefits.
Question 8: Do you agree or disagree with the following statement: Most employees are unaware of the current
tax effectiveness of employee benefits.
Strongly agree 36%
Tend to agree 49%
Tend to disagree 11%
Strongly disagree 4%
No opinion 0%
Types of Tax-Favored Benefits Sponsored
Of the companies surveyed, the benefits provided to employees on a tax-favored basis by the largest number
of employers include: retirement plans, group medical insurance, group life insUrance and disability insurance.
Fifty-three percent of the employers report that their organizations sponsor a 4011k) program allowing
employees to save part of their earnings on a before-tax basis.
Question 9: Which of the following benefits (providing employees with tax advantages) does your company
sponsor? (Check all that apply.)
Retirement plans (pension and/orprofit sharing) 95%
Group medical insurance 99,1~
Group life insurance 96%
Disability insurance
Thrift orsaving plans (employee contributions are post-tan, but employercontributions and earnings are sheltered) 395'
401(k) pm-tax saving plans (alicontributions and earnings she)tered) 53%
Flenible spending accounts providing pre-tan reirnbursernentol medical expenses 10%
Flexible spending accounts providing pre-tan reimbursernentof otherenpenses (dependent care, etc.) 6'!,
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490
Anticipated Union Reaction to Elimination of Benefit Tax Preferences
Almost half of the chief executives (48 percent) believe they will be asked by union leaders to maintain existing
benefit plans if Congress eliminates the favorable tax status of employee benefits. (Thirty percent of the
executives indicated that their work forces are non-unionized.)
Question 10: If part of your company's work force is unionized, what do you anticipate union leaders would do
if Congress eliminated many tax preferences for employee benefits?
Askemployers to maintain existing benefit plans . 48%
Askemployers to increase direct compensation to make up forreduced benefits 18%
Do nothnig as long as totalcompensation stayed the same 4%
Accept reduced totalcompensation resultingfrom employer-paid benefits becoming taxable income to employees 0%
No unionized workforce at mycompany . ` 30'!,
Loss of Tax Preferences-Effects on Employees and Retirees
Almost nine of every ten chief executives feel that the loss of tax preferences for employee benefits would have
a negative effect on the health and welfare of workers and their families.
As for the economic security of retired workers, 86 percent feel that a similar negative effectwill result.
Question 11: From an employer's point of view, what effect do you feel eliminating many tax preferences for
employee benefits would have on: -
Very Somesvhat No Somewhat Very
Negative Negative Effect Positive Positive
The health and welfareof active workers and theirfamilies 28% 61% 10% 5% .5% -
The economic securityof retired workers 43% 43% 14% 0'!, 0'!,
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491
Restructuring Benefits: What Congress Should Consider
Chief executives agree overwhelmingly that Congress should be concerned with the economic security of
employees when it considers restructuring employee benefit tax policy.
The containment of rising health care costs and employee accessibility to quality health care are two other areas
that employers believe should be considered as the employee benefit taxation issue is debated by Congress.
Question 12: Please rank what, in your opinion, ought to be of greatest concern to Congress when it
restructures employee benefit tax policy (#1 representing the greatest concern, #2 the next most important,
etc.l.
Weighted
Rank Ranked Ranked Ranked Rank
Order #1 #2 #3 Points
1 Economic security of employees 205 102 65 884
2 Containment of escalating health care costs 95 101 98 585
3 Employee access to quality health services 68 111 97 523
4 Federal deficit reduction 57 40 50 301
5 Continued growth of the private
pension system 35 55 51 266
6 Support forgrowing number of retired workers 16 43 75 20~
7 Employee fleoibility in selecting benefits 12 32 28 128
* Findings based on rank points: 3 points forevery #1 ranking, 2 points forevery #2,1 point forevery #3.
Order of Priorities in Changing Tax Climate
If tax deductions for employer contributions to benefits were reduced, or if those contributions were made
taxable to employees, the chief executives say Congress should change the favorable tax treatment of flexible
compensation plans before doing so for welfare or retirement plans.
Question 13: In the event that allowable deductions for employer payments for benefits are reduced, or if those
contributions become taxable income to employees, check the type of benefit plan that, in your opinion, should
be taxed first:
Fleoible compensation plans First
Savings plans lwhere withdrawals can be made before retirement) - Second
Welfare plans lhealth, life, disability, etc.) T~hird
Retirementplans Fourth
40-046 0 - 85 - 32
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492
IRAs, 4QlQc)'s and Employer-Sponsored Thrift and Savings Plans
The employers surveyed unanimously support tax-sheltered savings plans IIRAs, 401(k)s, etc.) and
employer-sponsored thrift and savings plans because employees must be encouraged to save for their
retirement.
Sixty-nine percent say they support such plans because of the tax-preferences provided to executives and
high-paid employees at little cost to the company.
Chief executive opinion was divided on the rules and regulations governing tax-sheltered plans. While half agree
that the rules for these plans should be tightened to allow only pay-outs for retirement or serious emergencies,
46 percent say the rules should be loosened so that funds can be made available for home purchases, college
education, etc.
Moreover, 88 percent agree that these tax-sheltered plans are worth the loss of revenues which would otherwise
be generated. However, 56 percent agree that these savings plans, while basically good, should be modified to
prevent tax abuses.
Question 14: Many workers have tax-sheltered savings in Individual Retirement Accounts and in 4011k) pre-tax
savings plans, tax-sheltered annuities and other employer-sponsored thrift and savings plans. Please circle the
number which best reflects your opinion on each of the following statements:
Strongly Tend to Tend to Strongly No
Agree Agree Oisagree Oisagree Opinion
I support such plans because employees must be encouraged to save
for their retirement; employers and SocialSecurity cannot do it all. 86% 14% 0'!, 0% 0'!,
lsupport such plans because they provide attractive tax preferences
forenecutives and higher.paid employees at little cost to the company. 22% 47'!, 18% 10% 3%
Rules for these plans should be tightened so that money is not used as
all-purpose savings, but only for retirement orserious emergencies. 11% 40% 32% 16% 1%
Rules for these plans should be loosened so money is available for
home purchases, college educations,etc. 11% 35% 38% 13% 3%
These plans are not worth the loss of tan revenues which would
otherwise be generated. 2% 6% 23% 65% 4%
Tax preferences forthese plans should be reduced because revenue
loss is too great. 1% 5'!, 32% 60% 2%
Tax preferences forthese plans should be reduced because they
disproportionately benefit higher-paid employees. 1% 7% 39% 51% 2%
Such savings programs are basicallygood. but should be modified to
preventabuses. 7% 49% 24% 14% 6%
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493
Section 3: Views are Split on Capping Employer Contributions
Capping Employer-Paid Health Insurance Premiums
In an openended question inviting comments, 56 percent of the respondents voiced opposition to placing a
dollar cap on the amount of tax-free employer-paid health insurance an employee can receive. Some
representative comments citing this opposition include:
* "A cap would cause internal inequities between employees as well as geographic inequities;"
* "A cap would not contain therising cost of health care which is the real problem;"
* "Government should not interfere with business."
Thirty-nine percent favored the use of a cap. Explaining why they favored limiting the dollar amount of
employer-provided health coverage an employee can receive on a tax-favored basis, respondents offered
comments such as:
* "A cap would force the medical industry to provide cost-effective medical care. It would decrease the cost of
health care;"
* "Caps would increase employees' awareness of the costs of benefits incurred by the employer."
If a dollar cap were enacted and their organizations' health insurance premium payments exceeded the cap,
44 percent of the employers say they would establish a second health benefit plan and offer employees the
-alternative coverage with lower premiums (at or below the cap limit).
Question 15*: Would you favor or oppose proposals to place a cap on employer-paid health insurance
premiums? (All amounts over the limit would be taxable income to the employees.)
Favor: 39% Oppose: 56% ` No opinion: 5%
Open-ended question that solicitedcomments
Question 16: If a cap was enacted and your company's curthnt payments for health insurance premiums
exceeded the dollar cap amount, how do you think yourcompany would react?
Reduce itscontributionstothe health benefit plan sothat theyfellwithin the dollarcap 22%
Establishaseco*d health benefit plan with the company's contnbutions fallingwithin the dollarcap amount and offer
employeesachofcebetween thecurrentplanand this second plan 44%
Leave theexistingplan unchanged 34%
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494
Capping Employer Contributions for "Other" Benefits
In another open-ended question, 70 percent of the respondents expressed opposition to the idea of limiting the
amount of employer contnbutions to benefits such as pensions and profit-sharing plans, which employees can
receive on a tax-free basis. Employer contributions above the limit would be taxable income to employees, and a
representative comment from respondents was:
* "This type of cap would be unfair to the lower-paid and long-term employees."
When asked to rank (according to faimess) several caps limiting the amount of tax-free funds employees could
receive, the employers selected a flat-dollarcap indexed to inflation as the most reasonable, followed by a
non-indexed flat-dollar cap.
Question 17": Would you favor or oppose proposals to place a cap on employer contributions to "other"
benefits such as pensions, profit-sharing, etc.?
Favor: 22% Oppose: 70% No opinion: 8%
Open-ended question that solicited comments.
Question 18: Please rank the following types of caps on the basis of how fairly you believe they would limit the
amount employees could receive on a tax-free basis. (#1 representing the most fair, etc.)
W&ghted
Rank Ranked Ranked Ranked Rank
Order #1 #2 #3 Points
1 FIat-doltarcap indexed to inflation 281 103 28 1,077
2 Flat-do5arcap (same forallemployees( 86 201 63 723
3 Cap determined on the basis of employee
geographic location 50 32 134 348
4 Cap determined on the basis olemployee age 34 45 148 340
Findings based on rank poInts: 3 points forevery #1 ranking, 2points forevery #2,1 point forevery #3.
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495
Section 4: Effect on Capital Markets
Pension Plan Assets and U.S. Capital Markets
With private tax-qualified pension plan assets now exceeding $900 billion, 87 percent of the chief executives
believe a change in the tax status of these funds would affect U.S. capital markets and capital formation.
Question 19: Currently, assets of U.S. private tax-qualified pension plans amount to over $900 billion. To what
extent to you believe a change in the tax-preferenced status of these funds would affect U.S. capital markets and
capital formation?
Toagreat extent 41%
To some extent 46%
Hardtyatall 11%
Notatatl 2%
Section 5: Reduction of Benefits will Press Social Security System
Prospective Cutbacks in Benefit Programs
Similar to the response to Question 4, 79 percent of the chief executives agree that if the tax preferences for
employee benefits are eliminated, U.S. companies for the most part will cut back on their employee benefit
programs.
Of the 79 percent that agree, 72 percent believe that a reduction in employee benefit programs by employers
will place additional pressure on the government to increase Social Security and welfare benefits.
Question 20a: Do you agree or disagree with the following statement: If many tax preferences for employee
benefits are eliminated, the majority of U.S. employers will reducetheir employee benefit programs.
Stronglyagree 22%
Tend toagree 57%
Tend todisagree 18%
Strongly disagree 3%
Question 20b: If you strongly agree or tend to agree that the majority of employers will reduce their benefit
programs, do you believe that this will put pressure on the government to increase Social Security and/or
provide additional welfare benefits?
Yes: 72% No: 21% Noopinion: 7%
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496
Section 6: Tax Preferences and the Future of Benefits-a Message to Congress
Future of Employee Benefits
lithe tax-favored status of employee benefits is reduced, 57 percent of the respondents anticipate that their
companies' total benefit programs will shrink by 1990. Over one-third, however, thought their programs would
remain unchanged.
Question 21: If many tax preferences for employee benefits are eliminated, do you anticipate that your
company's total benefit program will shrink, expand, or stay relatively unchanged by 1990?
Expand significantly 0%
Expand a little 8%
Shrinkan little 43%
Shrink significantly 14%
Stay the same 35%
Employee Benefits by 1990-Some Specifics
Employers were also asked to review 15 individual employee benefits and to consider whether they would
increase or decrease within their company's overall benefit packages by 1990-based on both the existing
favorable tax status of benefits and on a more restrictive tax restructuring.
Even with continutng favorable tax treatment, the majority of CEOs expect 13 of the 15 benefits to remain the
same. Only flexible benefits and 401(k) plans are expected to be increased by the majority of respondents.
A minority of the CEOs expect all benefits to increase while only a few expect benefits to decrease. The one
exception is health benefits, which 29 percent expect to decrease.
If tax preferences are reduced, a greater number of CEOs expect benefits to remain the same or to be decreased,
while a much smaller number expect benefits to be increased.
While a variety of conclusions might be drawn from these responses, there appears to be a general levelling off
in the pace at which benefits are being increased, a few areas of income security are still seen to need
improvement, and benefits are not likely to be reduced by management or by unions, except for health care
coverages. In the latter case, rapidly increasing medical costs are being addressed by employers who are
reducing benefits regardless of tax preferences.
However, if tax preferences are reduced or eliminated, a substantial shift can be expected with decreases being
made in all income security benefits. The percentage of respondents predicting a decrease in the 15 benefits
outweighs the respondents who see an increase by a ratio of 4 to 1.
Moreover, while 6 percent of the executives anticipate an increase in health benefits by 1990, 60 percent predict
a decrease if tax preferences are eliminated or reduced. With a changed tax status for employee benefits, 9
percent of the respondents predict increased company contributions to thrift plans, but one-third say they will
be decreased.
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Question 22: For each of the following employee benefits, please indicate whether you anticipate the benefit to
be increased or decreased by your company over the next six years (by 1990):
If Tax Preferences If Tax preferences
Type of Benefit Are Unchanged Are Reduced or Eliminated
Stay Stay
Increased Decreased The Same Increased Decreased The Same
Health Benefits 24% 29% 47% 6% 60% 34%
Vacation Time 20% 3% 77% 11% 10% 79%
Child care benefits 42% 1% 57% 12% 17% 71%
Educational benefits 23% 5% 72% 7% 26% 67%
Legal benefits 19% 0% 81% 2% 16% 82%
Lifeinsurancebenefits 35% 4% 61% 10% 29% 61%
Company contributions to
thrift/savings plans 40% 3% 57% 9% 33% 58%
Disability benefits 29% 2% 69% 8% 22% 70%
Dental benefits 35% 6% 59% 9% 30% 61%
Prescription drug benefits 19% 7% 74% 3% 27% 70%
Vision benefits 32% 3% 65% 6% 24% 70%
Flexiblebenefits 52% 1% 47% 17% 26% 57%
Pensions 33% 7% 60% 10% 24% 66%
Profit-sharing plans 25% 3% 72% - 6% 31% 63%
Salary reduction plans-4OllkI 54% 1%. 45% 17% 35% 48%
Changing Employer/Employee Relationships
Question 23: If employee benefit plans are reduced because of tax changes, how do you foresee the
employer/employee relationship changing?
In open-ended responses to this question, the chief executives most often cited poor morale, low productivity,
increased hostility, turnover and other adverse situations as the result of reduced employer-sponsored benefit --
programs.
497
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Classification Data of Companies Surveyed
Question 24: Type of company (please check appropriate category):
4% Agricultural 2% Food Products
2% Automotiveand AutoSupphes 14% Hospital/Health Care
9% Bankitig/Ftrtancial 4% Hotels & Lodging
2% Chemical 2% Metals
2% Communications 4% Petroleum
3% ConsumerProducts & Packaged Goods (Non-food) 9% OlherManufacturing
3% Construction 3% Retailing
6% Diversified/Conglomerate 2% Textiles
4% Electronics ~ 4% Transportation
4% Energy "-,,,,,,~ 28% Other (specify)
Question 25: Size of Company by sales:
23% Less than $lOOmil)ion 20% $400tourtder $1 billion
15% $lOOmil)ion to uxder$200 million 22% $1 billion to under $5 billion
11% $200million to under $400million 9% $5 billionand over
Question 26: Number of employees
8% Underl/)O0 12% 10001 to 20,000
46% 1,001 to 5,000 9% 20,001 to 50,000
20% 5,001 to 10,000 5% Over 50,000
Question 27: About what percentage of your company's work force is unionized? 15%.
Question 28: Please circle one of the geographc codes below that best descnbes where most of your
employees work. If your group is located in two or more of these regions, please circle either "6" or "7" for
NATIONAL or MULTINATIONAL, whichever is most appropriate.
Northeast 15% 1. - Maine, New Hampshire, Vermont,Massachuwtta Rhode Island Connecticut,
NewYork, Newjeesey,Penmyl,/ade Delaware, Matyland,Washington,DC,
south 15% 2 - V~rginia,West Virgioia,North Carolina, South Carolina, Georgia, Florida, Kentucky,
Tennessee,Atabarna Mississippi,Arkamas, Louisiana
Midwest 18% 3 - Ohio, tndana, tllinois,Michigan Wtsconsin, Minnesota, towa, Missouri, Nebraska,
North Dakota,South Dakota, Kansas
Southwest 5% 4 - Oklahoma, Texas, NewMexico, Arizona
West 11% 5 - Montarsa, Idaho, Wyoming, Colorado, Utah, Nevada, Washington, Oregon,
Cahfomia,Alaska, Hawaii
National 24% 6
Multinational 10% 7
Question 29: Is your company a public corporation or privately owned?
Public: 68% Private: 35%
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Original Survey Questionnaire
EMPLOYER ATTITUDES TOWARD EMPLOYEE BENEFITS AND TAX CHANGE
William M. Mercer-Meidinger, Incorporated's 1984 "employerattitude" survey is designed to elicit the views of chief executive
officers on possible taxchanges affecting employee benefits and how these changes could affect employer-sponsored benefit
programs and income security for employees.
1. Please rank the reasons why, in your opinion, your company sponsors employee benefit plans l#1 representing the most
important, #2 the next most important, etc.)
Concern for economic security of emplpyees.
Desire for good employee relations
Belief that benefits improve productivity ~. -
Need to remain competitive in labor marketplace and attract good employees
Tax deductibility of benefit costs by company
Tax-effectiveness of benefits to employees Icompared to direct compensation)
2. Thinking broadlyfor a moment about the nation's deficit, how important, in youropinion, are current efforts to reduce the
deficit?
Crucial
Important
Unimportant
3. Please circle the numberwhich best reflects yourown opinion on each of the following statements:
Strongly Tend to Tend to Strongly No
Agree Agree Disagree Disagree Opinion
a. Eliminating some of the tax preferences for
employee benefits Ito both employers and
employees) is a sensible approach to increasing
revenues and reducing the federal deficit. 1 2 3 4 5
b. The current policy of providing tax preferences for
employer-sponsored employee benefit programs
should remain intact. 1 2 / 3 4 5
c. The current policy of providing tax preferences for
employer-sponsored employee benefit programs
should be changed. 1 2 3 4 5
d. Tax preferences for employee benefits have been
influential in encouraging my company to sponsor
employee benefit plans. 1 2 3 4 5
4. If Congress were to eliminate many of the tax prefe?ences for employee benefits, how do you believe U.S. companies
would generally react?
Would continue to provide benefits without material change, much as they do now
Would cut benefits beck but increase direct compensation so total would remain constant
Would cut benefits backand leave direct compensation unchanged so total would be reduced
`No opinion
5. How do you think your company would react if Congress were to eliminate many of the tax preferences foremployee
benefits?
Would continue to provide benefits without material change, much as they do now
Would cut benefits back but increase direct compensation so total would remain constantS
Would cut benefits back and leave direct compensation unchanged so total would be reduced.
-No opinion
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6. Please indicate whether you agree or disagree with the following two-part statement: If my company were to increase
salaries to make up for reduced benefits,most employees would:
a) invest the money to ensure their future financial security. b) purchase replacement insurance on their own.
Strongly agree Strongly agree
Tend to agree Tend to agree
Tend to disagree Tend to disagree
Strongly disagree Strongly disagree
No opinion No opinion
7. If Congress were to eliminate many of the tax preferences for employee benefits, please rank the following employee
groups which would be most affected (#1 representing the most affected, #2 the nest most affected, etc.).
Top management
Middle management
Other professionals
Administrative/clerical
Hourly
8. Do you agree or disagree with the following statement: Most employees areunaware of the current tax effectiveness of
employee benefits.
Strongly agree
Tend to agree
Tend to disagree
Strongly disagree
Noopinion
9. Which of the following benefits providing employees with tax advantages does your company sponsor? ICIieck all that
apply)
Retireme~a plans pension and/or profit-sharing)
Group medical insurance
Group life insurance
Disability insurance
Thrift or savings plan employee contributions are past-tax but employer contributions and earnings are
sheltered)
401(k) pre-tax savings plan fall contributions and earnings are sheltered)
Flexible spending account providing pm-tax reimbursement of medical expenses
Flexib)e spending account providing pre-tax reimbursement of otherexpenses )dependent care, etc.)
10. If part of yourcomsany's workforce is unionized, what do you anticipate union leaders would do if Congress eliminated
many tax preferenes foremployee benefits?
Ask employers to maintain existing benefit plans
Askemployers to increase direct compensation to make up for reduced benefits
Do nothing as tong as totalcompensation stayed the same
Accept reduced total compensation resulting from employer-paid benefits becoming taxable income to
employees
No unionized work force at my company
11. From an employer's paint of view, whateffect do you feel eliminating many tax preferences for employee benefits would
have on:
a. the health and welfare of active workers and theirfamilies? b. the economic security of retired workers?
Very negative Very negative
Somewhat negative Somewhat negative
Noeffect No effect
Somewhat positive Somewhat positive
Very positive Very positive
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12. Please rank wliat, in youropinion, ought to be of greatest concern to Congress when it restructures employee benefit tax
policy (#1 representing the greatest concern, #2 the next rnost important,etc.)
Econornic security of employees
Employee access to quality health services
Support for a growing number of retired workers
Federal deficit reductions
13. In the event that allowable deductions for employer payments for benefits are reduced, or if those contributions become
taxable income to employees, check the type of benefit plan in each of the following pairs that, in your opinion, should be
taxed first:
Welfare plans (health, life, disability,etc.) OR Retirement plans (pension, profit-sharing, thnft)
Welfare plans OR Flexible compensation plans
Welfare plans Savings plans (where withdrawals can be made
OR before retirement)
Retirement plans OR Flexible compensation plans
Retirement plans OR Savings plans
Flexible compensation plans OR Savings plans
14. Many workers have tax-sheltered savings in Individual Retirement Accounts and in 4011k) pre-tax savings plans,
tax-sheltered annuities and otheremployer-sponsored thrift and savings plans. Please circle the number which best
reflects youropinion on each of thefollowing statements:
Strongly Tend to Tend to Strongly No
Agree Agree Disagree Disagree Opinion
a. I support such plans because employees must be
encouraged to save for their retirement;
employers and Social Security cannot do it alL 1 2 3
b. I support such plans because they provide
attractive tax preferences forexecutives and
higher-paid employees at littlecost to the
company.
c. Rules for these plans should be tightened so that
money is not used as all-purpose savings, butonly
for retirement or serious emergencies.
d. Rules for these plans should be loosened so
money is availablefor home purchases, college
educations, etc.
e. These plans are not worth the loss of tax revenues
which would otherwise be generated.
f. Tax preferences for these plans should be reduced
because revenue loss is too great.
g. Tax preferencesfor these plans should be reduced
because they disproportionately benefit
higher-paid employees.
h. Such savings programs are basically good. but
should be modified to prevent abuses.
501
Containment of escalating health care costs
Employee flexibility in selecting benefits
Continued growth of the private pension
system
4 5
4 5
4 5
4 5
2 3 4 5
2 3 4 5
2 3 4 5
2 3 4 5
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15. Would you favororoppose proposals to place a cap on employer-paid health insurance premiums? lAll amounts over
the limit would be taxable income to the employee.)
Favor Oppose No opinion
Why?
16 If a cap was enacted and yourcompany's current payments for health insurance premiums exceeded the dollar cap
amount, how do you think yourcompany would react?
Reduce its contribution to the health benefltplan sothatthey fell within the dollarcap.
Establish a second health benefit plan with the company's contributions falling within the dollarcap amountand
offeremployees a choice between the current plan and this second plan.
Leave the existing health plan unchanged.
17. Would you favororoppose proposals to place a similar cap on employer contributions to other benefits such as pensions,
profit-sharing plans,etc.?
Favor Oppose No opinion
Why?
18. Please rank the following types of caps on the basis of how fairly you believe they would limit the amount employees
could receiveona tax-free basis. l#1 representing the most fair,etc.I
Capdetermined on the basis of age
Capdeterminedon the basis of employee geographic location
Flat dollarcap (same forall employeesl
Flat dollarcap indexed toinflation
19. Currently assets of U.S. private tax-qualified pension plans amount to over $500 billion. To what extent do you believe a
change in the tax-preferenced status of these funds would affect U.S. capital markets and capital formation?
To a great extent
To someextent
Hardly stall
Not atall
20. a. Do you agree ordisagree with thefollowing statement: If many tax preferences foremployee benefits are eliminateci,
the majority of U.S. employers will reduce theiremployee benefit programs.
Strongly agree
Tend toagree
Tend to disagree
Strongly disagree
Noopinion
b. If you strongly agree or tend to agree that the majority of employers will reduce their benefit programs, do you believe
that this will put pressure on the government to increase Social Security and/or provide additional welfare benefits?
Yes No No opinion
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21. If many tax preferences for employee benefits are eliminated, do you anticipate that your company's total benefit
program will shrink, expand or stay relatively unchanged by 1990?
Expand significantly
Expand a little
Stay the same
Shrink a little
Shrink significantly
22. For each of the following employee benefits, please indicate whetheryou anticipate the benefit to be increased or
decreased by your company overthe next six years (by 19901:
a. If tax preferences for employee benefits remain unchanged
Stay
Increased Decreased the Same
Health benefits 1 2 3
Vacation time 1 2 3
Child care benefits 1 2 3
Educational benefits 1 2 3
Legal benefits 1 2 3
Life insurance benefits 1 2 3
Company contributions to thrift/savings plans 1 2 3
Disability benefits 1 2 3
Dental benefits 1 2 3
Prescription drug benefits 1 2 3
Vision benefits 1 2 3
Flexible benefits 1 2 3
Pensions 1 2 3
Profit-sharing plans 1 2 3
Salary reduction plans-401(kl 1 2 3
b. If tax preferences for employee benefits are reduced or eliminated
Stay
Increased Decreased the Same
Health benefits 1 2 3
Vacation time 1 2 3
Child care benefits 1 2 3
Educational benefits 1 2 3
Legal benefits 1 2 3
Life insurance benefits 1 2 3
Company contributions to thrift/savings plans 1 2 3
Disability benefits / 1 2 3
Dental benefits 1 2 3
Prescription drug benefits 1 2 3
Vision benefits 1 2 3
Flexible benefits 1 2 3
Pensions 1 2 3
Profit-sharing plans 1 2 3
Salary reduction plans-4Ollk( 1 2 3
23. If employee benefit plans are reduced because of tax changes, how do you foresee the employer/employee relationship
changing?
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CLASSIFICATION DATA
Please complete the following information about yourcompany. Answers will be used for analysis purpdses only.
24. Type of company (please check appropriate category(:
Agricultural
Automotive and Auto Supplies
Banking/Financial
Chemical
Communications
Consumer Products & Packaged Goods Inon-foodi -
Construction
Diversified/Conglomerate
Electronics
Energy
25. Size of company by sales:
Less than SlOGmillion
$100 million to under $200 million
$200 million to under $400 million
26. Numberof employees
Underl,000
1,001 to 5,000
5,001 to 10,000
27. About what percent of your company's work force is unionized? ___________ %
28. Pleasec,rcle one of the geographic codes below that best describes where most of youremployees work If your group is
located in two or more of these regions, please cirde either ~6" or ~7for NATIONAL or MULTINATIONAL,whichever is
most appropriate
NORTHEAST 1 - Maine, New Hampshire, Vermont, Massachusetts, Rhode Island,
Connecticut, New York, NewJersey, Pennsylvania, Delaware, Maryland,
Washington, D.C.
- Virginia, West Virginia, North Carolina, South Carolina, Georgia, Florida,
Kentucky, Tennessee, Alabama, Mississippi, Arkansas, Louisiana
- Ohio, Indiana, Illinois, Michigan, Wisconsin, Minnesota, Iowa, Missouri,
Nebraska, North Dakota, South Dakota, Kansas
- Oklahoma, Texas, New Mexico, Arizona
- Montana, Idaho, Wyoming, Colorado, Utah, Nevada, Washington,
Oregon, California, Alaska, Hawaii
Food Products
Hospital/Health Care
- Hotels & Lodging
Metals
Petroleum
OtherManufacturing
Retailing
Textiles
Transportation
Other lspecifyl
$400 to under $1 billion
$1 billion to under$5 billion
$5 billion and over
10,00110 20,000
-~ 20,00lIo 50,000
Over 50,000
SOUTH
MIDWEST
SOUTHWEST
WEST
NATIONAL
MULTINATIONAL
29. Is your company a pub(c corporation or privately owned?
Public Private
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Multiple-Option Flexible Benefit Plans
A Mercer-Meidinger Survey
WILLIAM M.
NCOR~ ~
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In late June 1984, a survey was conducted of 45
companies that currently have multiple-option flexible
benefit programs. Twenty-three of these companies
responded to the survey. These respondents had plans
covering over 250,000 employees, ranging in size from
under 200 employees to 85,000 employees. The median
size plan among the respondents covered 7,000
employees.
Part 1 of this report provides details on the responses
to the survey. Part 2 provides a list of participating
companies.
Key findings of the survey are summarized as follows:
* Over 60 percent of the respondents implemented a
flexible benefit program between 1982 and 1984.
* Approximately 56 percent of the respondents also
implemented Flexible Spending Accounts between
1982 and 1984.
506
* Two-thirds of the respondents identified cost
containment as a major motivating factor in
implementing flexible benefits. The two factors next
most important in motivating sponsorship of flexible
plans were to give employees greater choice and to
foster employee relations.
* The most common coverages included in the
programs were Medical, Dental, Life, Long Term
Disability, Dependent Care, and 401(kl, in that order.
* Over one-third of the respondents would have
communicated their programs more extensively if
they were starting up their program today. A slightly
lower number said they would do nothing
differently.
* Over one-half of the respondents added one to five
additional staff employees to help administer their
flexible benefit programs.
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PART 1 - SURVEY RESPONSES
DECISION TO IMPLEMENT FLEXIBLE BENEFIT PROGRAMS
The primary reason cited for implementing flexible benefit programs among the 23 corporate employers
responding to this survey is their desire to encourage the containment of rising benefit costs. Eight
respondents rank cost containment their number one reason for sponsoring a flexible benefit plan. The
second and third most important factors cited were to provide employees with greater choice and to foster
employee relations.
Question 1: Why did your company decide to implement a flexible benefits program?
No. No. No. No.
Motivating Factor For Ranking Ranking Ranking Ranksng Total
Rank Planlmplementation #1 #2 #3 #4 lTop4)
1 Encouragecost containment 8 7 1 0 16
2 Civeemployeesgreaterchoice 5 5 . 3 0 13
3 Fosteremployee relations 5 3 3 1 12
4 Maintain orenhance competitive 2 0 2 2 6
posture
5 Add new coverages at low cost to 1 0 / 1 2 4
company
6 Distinguish between union and 0 0 0 1 1
non-union benefit programs
(Notanswering this question- 2)
In most instances the idea to implement a flex program was initiated by the benefits/personnel departments.
Question 2: Who initiated the idea to implement a flex program?
Initialing Idea Numberof Companies
CEO 3
SeniorManagement 8
Benefits Department 13
Finance Department 0
Consultant 3
Other: 3 from human resource department.
2 from personneldepartment 5
Over 60 percent of the respondents decided to implement a flexible benefit program during the yearsl98l
and1982. Only three companies developed a flexible approach beforel979.
Question 3: When was the idea to conceive a flexible benefit program conceived?
Number of Companies
Year Conceiving plan in Year
1970-1978 3
1979 3
1980 3
1981 6
1982 8
1983 0
Total 23
40-0460-85-33
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FEASIBILITY STUDIES
Eighteen companies (78.3 percent) conducted studies to determine the feasibility of implementing a flexible
compensation program.
Question 4: Did you conduct a feasibility study?
Number of Companies
Yes 17
No - 6
Of the companies who conducted feasibility studies, over 40 percent completed their feasibility
investigation in less than three months and over 70 percent in less than six months.
Question 5: How long did the study take?
TtmePeriod Numberof Companies
Afewweeks 1
- 1-3 months 6
3-6 months 5
6-9months - 4
over9months - 1
-- Not applicable 6
Seventy-six percent of the studies conducted included employee attitude testing.
Question 6: Did the study include employee attitude testing?
Number of Companies
Yes - 13
No 3
Not answering 1
Not applicable 6
Over one-third of the feasibility studies utilized focus groups; slightly fewer utilized questionnaires.
Question 7: If employee attitudes were tested, what method was used?
Method Used Numberof Companies
Focus Groups lie. smaligroup meetings) 6
Questionnaire 4
Both 4
Notamss'ering 3
Not applicable 6
Fifty-two percent of the companies pm-tested employee election pattems based on preliminary
plan designs.
Question 8: Did you pre-test employee election patterns based on preliminary plan design?
Numberof Companies
Yes 12
No 11
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Of the companies that pre-tested employees, all found the actual election distribution to be similar to the
test results.
Question 9: Were employee election testing results similar to actual elections during implementation?
Number of Companies
Yes 12
No 0
Not applicable 11
Of the companies that made changes as a result of employee election testing, most changes were in the plan
design and communications areas.
Question 10: Did employee election testing result in any changes in the following:
Where Changes Occurred Numberof Companies
Plan Design 6
Pricing 3
Communications 5
No changes 6
Other 1
Not applicable 8
IMPLEMENTATiON, DESIGN AND EVALUATION OF FLEXIBLE PLANS
Nearly three quarters of the i~spondents implemented their flexible benefit plan between 1982 and 1984.
Only five plans became effective before 1982. One plan was implemented in 1973.
Question 11: When was the program actually implemented?
Number of
Year Plans implemented
1973 1
1980 1
1981 3
1982 5
1983 6
1984 6
Not applicable 1
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Before implementing the flexible benefits program, 65 percent of the companies viewed their benefit plara
as above average.
Question 12: Before implementing the flexible benefits program, did you view your benefit plan as:
Quality of
Benefit Plans Numberof Companies
Below Average 0
Average 8
Above Average 15
Most companies hired a consulting firm to assist in plan design, communications, conduct of the feasibility
study, and/or pricing.
Question 13: Did you use a consulting firm? For what purpose?
Purpose Numberof Companies
FeasibilityStudy 13
PlanDesign 17
Pricing 12
Communication 17
Administration 6
None of the Above 2
Not applicable 1
Over one quarter of a million employees are participating in the flexible benefit programs sponsored by 23
companies. With the largest plan covering 85,000 workers and the smallest 152 workers, the median
participation within this survey group is 7,000 employees.
Question 14: How many employees are currently in the program?
Number of Companies
Numberof Employees Employing this Number Total
152 to less than 5,000 9 23,652
53)OOtolessthanlO,000 B 61,100
10,000 to less than 15,000 2 24,000 -
15,000tolessthan20,000 0 0
20,000 to less than 25,000 2 43,000
25,000 to less than 30,000 0 0
30,000 to less than 35,000 0 0
35,000 to less than 40,000 0 35,000
40,000to less than 45,000 0 0
45,000or more 2 130,000
Total 23 316,702
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Over half the companies added staff to administer the program.
Question 15a: Did you add staff to administer the program?
Number of Companies
Yes `12
No 11
Since the amount of added staff could depend on the size of the existing benefits department, it is difficult
to measure the significance of these staff increases. The additional staff required by 12 companies is detailed
below with corresponding plan size noted:
Question 15b: If you added staff, how many?
Staff Members Added to Number of Plan
AdministerProgram Participants
1 1,800
1 8,600
1-1/2 4,500
1-1/2 2,000
2 9,600
2 45,000
2 14,000
2 85,000
2 5,000
3 , 4,200
5 8,900
5 10,000
Most flex programs are available to salaried and/or non-union hourly employees.
Question 16: What dasses of employees are included in your program?
Oass Number of Companies
Salaried 20
Non-Union Hourly 16
Union 4
Other 1
Not applicable 1
Thirty-nine percent of the plans have a waiting period for enrollment.
Question 17: Does your plan have a waiting period for enrollment?
Number of Companies
Yes 9
No 14
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Medical, Dental, Life, Long-Term Disability, Dependent Care and 401(k) are the predominant coverages
included as options.
Question 18: What coverages are included as options in your current program?
Number of Different
Numberof Plans Choices allowed by
Benefit Coverage Including this Benefit Numberof Plan Sponsors
# Choices
1 2 3 4 5 6 7 8 9 10 Infinite
Medical 22 4 1 6 5 2 2 0 1 0 1
Dental 20 13 3 2 0 1 0 0 1 0 0
Vision/Hearing 9 5 1 1 0 1 0 0 0 0 0
Life 17 7 1 2 2 0 4 0 1 0 0
Dependent Life 11 5 2 2 0 0 0 0 1 0 1
Accident 9 4 1 0 0 0 1 0 1 0 0 2
Long Term Disability 13 2 6 3 1 0 0 1 0 0 0
Vacation 12 6 2 3 0 1 0 0 0 0 0
Legal 8 7 0 0 0 1 0 0 0 0 0
Dependent Care 11 10 0 0 1 0 0 0 0 0 0
40116) - 12 10 1 0 0 0 0 1 0 0 0
Cash 10 9 1 0 0 0 0 0 0 0 0
Others 4
A small minority of employers adopted modular plans in which the employee chooses among different
complete plans of benefits, ratherthan among individual benefits.
Question 19: Is the flexible benefit plan a modular one in which the employee chooses among different
complete plans of benefits, rather than among individual benefits?
Numherof Companies
Yes 3
- No 20
Fifteen companies calculate the amount of benefit or flexible credits an employee will be credited under the
plan according to his or her age, length of service with the firm, family status, location, sex or salary. The
most popular determinant for benefit calculation was salary.
Question 20: How does the amount of benefits credited under the plan vary?
Numberof Companies
Using for
Benefit Determinant Benefit Calculation
Salary 8
Length of Service 5
Single vs. Family Status 6
Age 5
Sex 1
Geographic Location - 1
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Most companies reflected family status, followed by age, in the option prices under the flexible
benefit program.
Question 21: How do the charges for any of the benefits vary?
No. of Companies Using
Charge Oeterminant to Calculate Charges
Age 11
Length of Service 3
Single vs. Family Status 16
Sex 2
Other: Salary 4
Not applicable S
Most companies required new computer software to administer the flexible benefit program.
Question 22: Did you require new software to administer the program?
Number of Companies
Yes 17
No 6
If yes, how was this software developedl
Internally 6
Internally, w/outside advice 6
Purchase of System 4
Leasing of System 1
Not applicable 6
Most employers allowed employees to elect the same coverages as they had prior to implementation of
flexible benefits.
Question 23: At the original implementation date, could employees elect the same coverages as they had
previously?
Number of Companies
Yes 15
No 7
Not applivable 1
Over half the respondents permitted employees to buy and/or sell vacation time.
Question 24: With respect to vacation, can employees:
Number of Companies
Buy more 9
Sell some 11
Not included in plan 9
7 6 employers allow both)
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Nine of the respondents formally surveyed their employees after implementation to determine their
reaction. -
Question 25a: Have you surveyed your employees after implementation to determine their reaction?
Number of Companies
Yes 9
No 14
The general reaction of surveyed employees to the program was positive.
Question 25b: If you have surveyed employees, how would you describe general reaction to the program?
Very pleased 7
Pleased 5
Neutral 0
Displeased 0
Not Applicable 11
(3 employers conducted informal surveys)
Only five respondents provided average per-person costs for the program:
Question 26: What is the average per-person cost to the company for the program?
* $75/per person forone-time systems and communication
* approximately 35 percent of the compensation level 15,000 in plan)
* $70single, $l2ofamily 1152 in plan)
* 5150'month!person 12000 in plan)
* $827/person )8,600in plan)
Fifty-two percent of the respondents have done studies to measure the effect of the program on the
organization's benefits costs.
Question 27a: Have you done any studies to measure the effect of the program on the organization's
benefit costs?
Number of Companies
Yes 12
No 9
Not Applicable 2
Of these 12 companies, seven companies' costs were reduced, three increased and two did not know.
Question 27b: If yes, has the flexible program reduced or increased your company's benefit costs?
Number of Companies
Reduced 7
fncreased 3
Neither 0
Don't knosv 2
Notapplicable 11
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The outcome of the program mentioned most frequently by these flexible benefit plan sponsors is cost
reduction/cost management.
Question 28: What is the most important outcome of the program?
Outcome Number of Companies.
Cost reduction/cost management 11
Tax effectiveness 3
Employee awareness 3
Employee relations 4
Employee satisfaction 3
Employee attitude 2
Employee acceptance 1
Employee cost sharing 1
Some respondents cited multiple outcomes
More than half the respondents have made changes since initial implementation. Of those sponsors
changing their flexible benefit programs, all added complexity to their program.
Question 29: How has the program changed since you implemented it (if at all)?
Number of Companies
Morecomplex 8
Same 13
Less complex 0
Not applicable 2
If companies were starting up their programs today, knowing what they know now, 39 percent would
communicate the program more extensively and another 35 percent would do nothing differently.
Question 30: If you were starting up a flexible benefit program today, knowing what you know now, what
would you do differently?
Number of Companies
Run a pilot program 1
Includefewer choices 1
Allow more time fordesign 2
Communicate more extensively 9
Nothing 8
Other ISee belowl 4
Not applicable 1
Other:
Include more choice 1
Know IRS rulings 1
Price plan options furtherapart 1
Take out pension and life insurance options 1
Uselan. 1 plan yeardate 1
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FLEXIBLE SPENDING ACCOUNTS
Sixty-nine percent of the respondents have a Flexible Spending Account.
Question 31: Do you have a Flexible Spending Account?
Number of Companies
Yes 16
No 7
Most Flexible Spending Account plans became effective in 1984.
Question 32: When did your Flexible Spending Account become effective?
YearPlart Became Effective Numberof Companies
1961 2
1982 0
1983 3
1984 10
To be effective 1185 1
The source of the Flexible Spending Account contributions is primarily salary redudion only, or a
combination of salary redudion and company money.
Question 33: What is the source of the contributions?
Contribution Source Numberof Companies
Company only 2
Salary reduction, only 6
Both of the above ` 7
Other See below) 1
Other: Contributions arefromexcess credits and vacation this employeralso allows contributions from salary reductionand company).
Medical, Dental, Vision and Dependent Care expenses are predominantly covered under the Flexible
Spending Accounts. Legal care is covered by 25 percent of the respondents with Flexible Spending
Accounts.
Question 34: What expenses are covered under your Flexible Spending Account?
Expenses Covered Number of Companies
Medical 16
Dental 15
Vision 14
Dependent Care - 11
Legal 6
Auto 1
Other: Al) that is IRS deductible 1
Adoption expenses 1
Financial planning 1
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Question 35: What is the status of your program?
Status Number of Companies
Onhold 2
Running as usual 12
Terminated 0
Modified 2
At the time of the survey, most companies anticipated moderate or no changes to their programs as a result
of the proposed regulations.
Question 36: Will the effect of the proposed regulations require:
Degree of Change Number of Companies
Substantial revision ofyourprogram 4
Moderate change in the program 8
Nochange 4
PART 2- LIST OF PARTICIPATING COMPANIES
ARMCO, Inc.
American Mutual Life
Carpenter Technology Corp.
E-Systerns
Eastman Kodak
First Bank System, Inc.
Fluor Corporation
Girard Bank
LTV Corporation
Loews Corporation
Morgan Guaranty Trust Company
Morgan Stanley & Co., Inc.
Northern States Power
Northern Telecom
PepsiCo
Ponderosa, Inc.
Princeton University
Public Service Electric & Gas Co.
Sovran Bank
St Paul Coo.
St. Vincent's Hospital
TRW, Incorporated
Union Planters National Bank of Memphis
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Chairman PICKLE. We are to skip over Mr. Kaye, is that correct,
and go to Manuel Castells, a partner in Kwasha Lipton.
Proceed, please.
STATEMENT OF MANUEL CASTELLS, PARTNER, KWASHA LIPTON
Mr. CASTELIS. I am an actuary and a partner at Kwasha Lipton,
an independent employee benefits consulting firm that serves the
business needs of large corporations.
I am pleased to be here to testify on behalf of my firm.
In the 40 years that we have worked in this field, we have helped
our clients develop and improve programs that were designed with
one purpose in mind-improving the productivity, working condi-
tions, and general welfare of their work force.
Years ago employers realized that issues beyond pay affect their
employees and thus their own existence. In recent years, as quality
of life has become a major concern, the emphasis on the non-pay
aspects of work has increased, and with it employers' emphasis on
variety, flexibility, and choice in benefits has increased.
In the seventies, concern with equity and benefits brought about
significant legislation in the pension field, ERISA. ERISA, for our
clients, represented a minor change in terms of the way they were
providing benefits, but it represented a significant price in higher
administration and in paperwork, but the overall perception among
our clients is that this legislation was needed to control the abuse
that existed, and that while ERISA caused a shakeout with signifi-
cant plan terminations, that those plan terminations were plans
that probably should not have existed to begin with.
While in the seventies the focus was on correcting perceived
abuses of the system, the focus in the eighties seems to be on reve-
nue issues. There can be no question that employee benefits are
significant with regard to revenue. In the 1970's, the benefits issues
were looked at too narrowly with the result that the many paid for
the excess of the few. We feel the same could occur now if changes
are made without looking at the broader social issues.
Accordingly, we feel that Government can, by overregulation and
taxation, hurt our private pension system and that some years
down the road this will greatly increase the burden that the Gov-
ernment will face in caring for the welfare of its people.
Within that context, my written testimony addresses your specif-
ic concerns.
I would just like to move to the items which I feel ought to be
emphasized from this written testimony.
Changes in the working population, indeed, in American society
as a whole, have made flexibility one of the most important consid-
erations in the design of benefit programs.
In this regard we would encourage a further move in the direc-
tion of tax deductibility of employee contributions to benefit pro-
grams.
In the retirement area, we favor extending to defined benefit
plans the tax advantaged status currently available to employee
contributions in defined contribution plans under section 401(k).
In the flexible benefit area, we feel that the compromise reached
in the Deficit Reduction Act was the worst possible one. Flexible
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spending accounts were being used quite effectively by employers
in instituting high deductible and high coinsurance plans. This ap-
proach, which was effectively eliminated by the Deficit Reduction
Act, represented the best method available to the private sector in
controlling health care costs.
Those are the two items that we particularly wanted to address
at this point. This concludes my oral testimony.
Chairman STARK. Thank you. We can get back to exchanges here
when we finish the panel. I appreciate that.
[The prepared statement follows:]
STATEMENT OF MANUEL CASTELIS, PARTNER, KWASHA LIPTON
Honorable Chairman and Members of the Subcommittees: My name is Manuel
Castells and I am a Partner in Kwasha Lipton.
I am pleased to be able to appear before you to testify on behalf of our firm.
Kwasha Lipton is an independent employee benefit consulting firm located in Fort
Lee, New Jersey. We serve the business needs of some 400 American companies, pri-
marily large corporations. About one third of our clients are Fortune 500 Industrial
and Service companies.
During the 40 years that we have worked in this field, we have helped our clients
develop and improve programs that were designed with one purpose in mind: im-
proving the productivity, working conditions, and general welfare of their work
force. Years ago, employers realized that issues beyond pay affect their employees
and thus their own existence. In recent years, as quality of life has become a major
concern, the emphasis on the non-pay aspects of work has increased. And with it,
employers' emphasis on variety, flexibility, and choice in benefits has increased.
As a result, our clients have been and continue to be interested in creative means
of enhancing the quality of life for their workers-to keep the workers' loyalty and
to increase productivity and competitiveness. When the Government decided to
expand the regulation of benefits in the 1970s, our clients and other large compa-
nies were, by and large, already doing what the Government was soon to require.
Then as now, much of the legislation was aimed at the minority that abused, and in
some cases badly abused, the system.
Our clients paid a significant price in higher administrative and paperwork costs
in complying with ERISA. Nonetheless, the overall perception among our clients is
that this legislation was needed to control the abuses that existed and that, while
ERISA caused a shakeout with significant plan terminations occurring in 1976, they
were plans that probably should not have existed to begin with.
While the 1970s focussed on correcting perceived abuses of the system, the focus
in the 1980s seems to be on revenue issues. There can be no question that employee
benefits are significant in regard to revenue. In the 1970s the benefits issues were
looked at too narrowly, with the result that the many paid for the excesses of the
few; we feel the same could occur now if changes are made without looking at the
broader social issues and without some sort of national benefit policy being formu-
lated. We stand in the position of once again penalizing those who are doing the
most to aid social welfare in the most efficient way-the private sector.
Accordingly, we feel the government can by overregulation and taxation kill our
private pension system and that some years down the road-especially when the
baby-boom generation now in their 20s and 30s reaches retirement-this will great-
ly increase the burden the government will face in caring for the welfare of its
people.
Within the context, we are deighted to address your specific concerns.
1. PREVALENCE OF FRINGE BENEFITS
In discussing benefits it is important to distinguish exactly where benefit dollars
are going. In its most recent report on Employee Benefits, the Chamber of Com-
merce reported that the employer's portion of employee benefits averaged 36.7% of
payroll in 1982. The largest portion of this, 22.1%, went for legally required pay-
ments, paid time off and other taxable amounts.
Paid time off-lunch and rest periods, vacations, holidays, sick leave, etc.-
amounted to 11.9% of payroll. These payments are deductible by the employer and
taxable to the employee for income and Social Security tax purposes. Legally re-
quired payments-Social Security, Medicare, Workers' and Unemployment Compen-
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sation, and other payments imposed on employers by law-constituted 9.5% of pay-
roll. These payments are deductible by employers and are generally tax exempt for
the vast majority of employees.
The remaining 14.6% represent either tax-exempt or tax-deferred benefits that
the employer has a choice about and that are deductible by the employer. Of this,
6.5% went for pensions with taxes deferred until receipt by employees. And 6.6%
went for life and medical benefits that are generally tax-exempt. It is on this 14.6%
of payroll that I will focus my attention and the balance of my testimony will deal
with these discretionary, tax-exempt or tax-deferred benefits.
In looking at the 14.6% costs figure, it is revealing to look at which employees
those benfits cover. A recent study by the Employee Benefit Research Institute re-
veals that over 47 million of the more than 80 million nonagricultural workers in
the United States are covered by retirement plans. This represents 59% coverage,
including 37% of workers earning less than $10,000 a year, over 57% of workers
earning between $10,000 and $15,000 and almost 72% of those earning between
$15,000 and $20,000 a year.
Coverage for group health benefits is even greater. Almost 50% of the 15 million
workers earning $5,000 to $10,000 are covered by group health benefits where they
work. Over two thirds of the nearly 18 million workers earning $10,000 to $15,000
are covered, while coverage for those in the higher wage brackets ranges from 80%
to nearly full coverage.
In both cases, benefits are voluntarily provided by employers. If these benefits
were not provided, the Government's social welfare system would face a greater
burden for health benefits and the pressures on the social security system would
greatly increase. This would be especially true for those workers in the lower wage
categories who are less likely to have other resources to draw upon.
As to future increases in benefit levels, the period since the statistics were com-
piled has seen an expansion in the number of savings/thrift plans that include a
401(k) feature and this trend is likely to continue. The 401(k) feature permits work-
ers to save for retirement on a tax-deferred basis. Plans with this feature have
become increasingly popular with both employers and emplo~rees in recent years.
For employers, they provide "more bang for the benefit buck,' lower costs and less
administrative red tape. For employees, they provide a measure of portability and
greater control over investment.
Since employees (according to surveys) have greater faith in the private pension
system than they do in the Social Security system, employees also feel that these
plans give them greater control over their own retirement destiny. Employers find
that employees understand and appreciate their benefits more when the dollar
amounts involved are easily discernible and their sense of control greater. The ex-
pansion of the use of the 401(k) feature will increase the amount spent in the tax-
deferred benefit area. This will not, however, have a significant impact on Social
Security since the employee contributions to such plans are subject to Social Securi-
ty taxes.
2. BENEFITS BY SALARY RANGE
My previous comments have already addressed this area, but I want to discuss the
integration of plans with Social Security and the effect this has on benefits received
by various salary levels. Integration refers to the coordination of pension benefits
with Social Security. Since both these sources of retirement income are provided for,
at least in part, by the employer, it is reasonable to take them as a unit when defin-
ing retirement income objectives. Integration produces the following beneficial re-
sults:
(a) The level of retirement income (excluding personal savings) can be accurately
planned by the employer.
(b) The tilt in the Social Security benefit towards the low paid can be compensat-
ed for so that the employer provides equitable retirement supplementation at all
pay levels.
From a tax standpoint, the benefits received by a worker at the lower end of the
wage scale will be heavily weighted towards Social Security, which will generally be
completely tax exempt. For workers at the very upper end of the scale, the benefits
will be heavily weighted towards company pension, which is fully taxable. Further,
half of the Social Security benefit is subject to tax as well.
3. EMPLOYER STRUCTURE OF FRINGE BENEFITS AND THE IMPACT OF TAX STATUS
I want to address my discussion in this area to our experience with our clients,
who work in a broad variety of industries and services. I think the kinds of process-
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es we see them go through can help you understand what really motivates employ-
ers in determining the kinds of benefits and compensation they offer to their em-
ployees and how they structure those benefits.
Most of our clients are motivated by their employees' needs, by a strong desire to
be fair, and lastly almost as an afterthought, by tax effects. In their benefit pro-
grams, they work to assure equity in the various segments of their work force and
equity for their workers in comparison with those outside the company. Looking
outside, they are motivated to keep their workers' competitive with others in their
industry or service. They seek to keep benefits equitable within their community or
region.
Internally, there are various equity issues: Keeping salaried workers' benefits eq-
uitable with hourly workers, keeping workers' benefits equitable among various di-
visions or subsidiaries (including international operations in many cases), and keep-
ing benefits equitable and nondiscriminatory across various salary levels, occupa-
tions, and professions in the organization.
In recent years, we have seen greater employer concern for equity issues of a dif-
ferent sort. Employers have recognized that their work force has changed from pre-
dominantly one wage-earner families to a much broader group of single workers,
one-parent families, and dual wage-earner families. This has led them to look at
equity issues across these groups within their work forces as well.
They are also concerned about the needs of their work force. Once an employer
perceives a need-something that will improve workers' productivity, loyalty, and
promote their general welfare-they take steps to explore the feasibility of trying to
meet that need. Depending on their corporate culture, their place in the community
and other factors, some companies are very benevolent or even paternalistic in pro-
viding various benefits for their work force. This can be most pronounced when a
company is a leader in its field or dominant in its communities. And executives are
not unaware of the ripple effects their benefits decision making can have on others
outside the company in terms of general social welfare.
Lastly, our clients look at tax effects or considerations for the benefits they pro-
vide. They do this almost as an afterthought. To refer again to the Chamber of Com-
merce's 1982 Study, over 12% or one-third of the benefit dollars went for voluntary,
fully taxable, benefits that employers provided to employees. Moreover, since tax
qualification is an increasing necessity for all kinds of plans, they look at tax issues
to meet the necessary government regulatory requirements.
For employers, tax considerations are most important, however, when they affect
employee participation in and acceptance of various benefits. And for a variety of
reasons, not the least of which are the higher effective tax rates, employees are
much more tax conscious and tax wise than they have been in previous years. I
think this is easy to understand when you realize that from an employer's perspec-
tive, benefit costs are generally tax deductible. Lack of effective tax treatment can
mean, however, that an employer will not be able to offer a benefit, because equity
cannot be maintained. That is, the benefit may be discriminatory in its actual effect,
rather than its structure. And this can mean that employers may avoid giving those
benefits to any employees because a few, and not necessarily just lower paids, will
not participate.
4. ECONOMIC EFFECTS OF UTILIZATION OF BENEFITS
There can be no question that employer payrolled health care has had an effect
on the level of usage and costs in the U.S. This coverage is virtually tax-exempt for
the employee and, until relatively recently, employers paid virtually 100% of these
costs. Access to such coverage was a very high priority in collective bargaining and
an important issue for others as well. This can be illustrated by referring to the
statistics I cited earlier to note that medical coverage has the highest saturation for
all benefits.
Employers are already moving to cut costs in this area. And high health care
costs are increasingly a societal concern of a much broader nature. However, these
tax exempt benefits do not seem large enough-looked at on an individual basis-to
generate a significant amount of revenue. Moreover, I submit that taxing these ben-
efits might have a highly undesirable effect: Higher-paid employees will continue
their coverage regardless; however, lower-paid employees might choose to drop their
coverage and they are the ones most likely to fall back on Government. I think that
very careful analysis must be done before such a change is contemplated. Here espe-
cially, short-term revenue gain may lead to long-term revenue loss.
It would be ironic if government, which has increasingly looked to the employers
to increase their role in health care for the elderly by shifting more of Medicare's
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burden to them, would now contemplate a shift that might move more of the work-
ing population onto Medicaid as a health carrier of first resort.
In the concluding section of my presentation I will discuss this area further.
5. EFFECT ON FICA TAX BASE
First, let me say that we are extremely pleased that you are interested in ways to
lower the FICA tax rates. So far, the history of the FICA rates has been one of in-
creases rather than reductions.
As mentioned above, of the 36.7% of payroll costs going for benefits, 14.6% are
tax deferred or exempt and thus are not included in the Social Security wage base.
(Also excluded from the wage base are the various legally required payments-
mostly Social Security taxes themselves. But I don't think anyone is seriously sug-
gesting taxing the value of Social Security taxes-this would be a tax on a tax.) Con-
gress recently changed the law relating to 401(k) contributions to include them in
the FICA wage base. The benefits currently excluded from FICA taxation are not
that significant in terms of total payroll. Including these benefits in the FICA tax
base will generate corresponding increases in the benefit levels since overall covered
wages (including the imputed value of such benefits) will rise as result. And if such
a move has a deleterious effect on private provision of these benefits, especially
among the lower paid, then the burdens and pressures on Social Security and other
federally funded social programs will increase.
6. EFFECT OF A FIXED DOLLAR CAP
I think the negative effect from a fixed-dollar or percent-of-compensation cap
would be far greater than the simple revenue implications could lead you to suspect.
As I noted in No. 3, equity considerations play a primary role in motivating our
clients' benefit decision making. And it is in the area of equity that a fixed dollar
cap would create serious problems.
Such a cap would lead to equity problems for all aspects of employee populations.
It would mean that the actual benefits that employees in low cost of living areas
receive would be substantially higher than those in high cost of living areas. The
following table shows the approximate cost relationship for a typical health benefit
program for different age, sex, family status and region:
Category versus Category Cost ratio
Individual, 55-64/Male, 20's 4-to-i.
Family/Individual 2½-to-
1.
Southern California/North Carolina 2-to-i.
As you can see, a cap would much more heavily affect permissible benefit levels
at older companies in high cost areas. In short, it would create enormous difficulties
across the, very groups, regions, and individuals that employers have been taking
such pains to treat equitably.
7. RELATIONSHIP BETWEEN EMPLOYER PROVIDED AND GOVERNMENT PROVIDED PROGRAMS
While this is the last question addressed in this hearing, I think it is really first
and foremost in significance. Since the Great Depression, this country has been com-
mitted to providing some minimum levels for the social and economic welfare for all
its citizens. Since that time, government has played a significant role in providing
what has recently been characterized as the "safety net'. But so, likewise, has the
private sector played a role in providing this system of social welfare.
Where a government system is in place, employers have worked to support and
supplement it. Most employers have integrated their pension plans with Social Se-
curity as we noted earlier. Some employers have provided benefits to retirees which
coordinate with Medicare. And apparently, employers have not done a bad job. As I
noted earlier, workers have greater faith that they will receive an employer-spon-
sored pension than they do that they will receive Social Security.
If we are to look at benefits as a revenue source, perhaps it is instructive to in-
quire where the revenue will go. The answer is that it will go in large part for these
very programs: Social Security, Medicare, and Medicaid.
But let's look at a specific situation. Employer-sponsored health care for retirees
is largely a benevolent act, rewarding employees for their service. The costs for
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these benefits have risen and will continue to rise drastically. Congress has recently
increased employers' burdens in this area by making self-funding more difficult and
by making employers the carrier of first resort instead of Medicare for those active
beyond age 65. Since employers maintain these benefits on an entirely voluntary
basis, what will the effect be if they simply decide its too much trouble and too
costly to provide these benefits any more? Can there be any questions that Medicare
would face problems of a magnitude that would dwarf its already large problems?
Recently, the emphasis in our society has turned toward the individual providing
more for himself or herself and individuals have been seeking greater power and
choice over their benefits. Employers have responded to these needs. Savings/thrift
plans were already growing before 401(k) came along and accelerated the trend. As
noted before, these plans have proven very popular with employees because they
provide a measure of portability and greater individual control and choice.
Employers embraced the flexible benefits concept as a way to help control costs
by letting employees choose and use only those benefits they really needed. Flexible
spending accounts looked particularly attractive in this regard, because they let em-
ployees select the benefits they really needed and rewarded them for not using ben-
efits they didn't need by paying them taxable compensation at year's end. Flexible
spending accounts held great promise for helping control the vast spiral in health
care costs.
All that ended with IRS and Congress action in essentially eliminating flexible
spending accounts entirely. We remain shocked at this section, because it seems so
contrary to other Congressional actions encouraging individuals to look after their
own needs and interests.
Both 401(k) and flexible spending accounts went against the grain on nondeducti-
bility for employee contributions. In the U.S., employer contributions have generally
always been tax-deductible. But U.S. workers alone in the industrialized world are
unable to deduct their employee contributions to benefit programs. With flexible
spending accounts effectively eliminated, employees are now able to deduct only
401(k) and Individual Retirement Account (IRA) contributions.
If Congress wishes to look at placing greater tax burdens on employers by elimi-
nating deductibility for some benefit costs, we urge you to look at permitting great-
er deductibility for employee contributions. This would encourage employees to look
after their own retirement and benefit needs and be consistent with recent trends in
this direction. And if the success of 401(k) is any indication, such a move would be
not only equitable but well received by employees.
For in the final analysis, it is the private sector which has been and will continue
to be best able to provide benefits on an equitable, flexible, efficient, and more cost-
effective basis. Directly funded public programs are inefficient and contain no cost
containment incentives. It is to support public programs that we are seeking this
revenue to begin with. It makes little sense to take steps which can ultimately in-
crease the burdens for already strained public programs. Let us continue providing
these programs through preferred tax treatment for employers, employees, or both.
This concludes my testimony. On behalf of myself and my firm, I wish to thank
the Members of the Subcommittee for giving us this opportunity to present our
views on these important issues. I will be happy to try to answer any questions you
may have.
Chairman STARK. We have next Mr. Rex Adams, vice president,
Employee Relations, Mobil Oil Corporation.
We have finished this panel. Have I left anybody out here?
Just a couple of ideas that I would like you to comment on. I
don't think that anybody doubts that the numbers that concern
Chairman Pickle and that he has brought here. We have an in-
creasing percentage of compensation coming in the form of fringe
benefits. Mr. Cohen, my good and dear friend from the U.S. Cham-
ber of Commerce, he has been looking at the Laffer curve too long.
He couldn't see a curve if he wanted to because he has been brain-
washed by the supply side people.
But time will tell. At any rate, it is increasing and we are losing
some revenue, whether it is Social Security, or the Treasury, or
general revenues.
I think that Ms. Koralik's testimony is well received. There is
some incentive. The life insurance salesman will make that as his
40-046 0 - 85 - 34
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great argument. It may not be the best investment in the world, he
or she will say, but unless we force you to sign up for this policy,
you won't save, so that is an assumption that many of us accept.
I don't know as we have every proof of that one way or the other,
but the exemption for low income people might solve some of that.
I tend to think this, and this is the idea that I would like you to
comment on:
I think nobody denies the socially desirable end of providing
medical care and retirement benefits. I think, however, that that
should not rest entirely on the tax system.
If we, for instance, went to the VAT tax, which, if Secretary
Regan ever tells us what he has got in mind over there, they might
propose, this would all be moot because we could collect it right off
the top. I think, as they have in France and England and Germa-
ny, according to my studies, we could adjust.
There is this one big hullabaloo but then everybody pays their 18
percent on services and goods, it is forgotten, and it is never raised
again.
It is kind of like a devaluation. It is a glitch in the economy and
it goes on, so I guess what I am saying is that it is more likely that
we could solve your problems of getting employees-employers will
probably do it anyway out of the goodness of their heart, and there
is no tax differential to them, so if we were to tax-you are shak-
ing your head. We will come back to that.
What I am suggesting is that the employer gets to deduct it
either way as an expense, so there is no tax incentive necessarily
to him.
Mr. BEADLE. That is right.
Chairman STARK. We could increase our revenue, eliminate the
problem with the very lowest paid, and find other ways, legislative-
ly perhaps, to encourage either providing, as Kennedy attempted to
do some time ago in the Corman-Kennedy bill, an alternate federal
insurance, if the employer cannot provide insurance, so there are
other ways to deal with that. So my feeling is that your concerns
have more than one solution, that is, the Tax Code is not the only
thing that gets employees to sign up.
Certainly in medical insurance I would think. I would think they
would want that regardless of the tax consequences, and it is not as
big a lever on the employer to do what he has to do.
Therefore, I would tilt against this panel and say that we per-
haps ought to do something to extract a total charge, perhaps an
excise tax or some form of tax on these fringe benefits prospective-
ly, let's say, if they increase above some standard level.
Mr. BEADLE. I think there are two or three points here. First, on
the value added tax that is prevalent in some European countries
one has to remember that those countries have virtually totally na-
tionalized their health benefits, pension schemes and so on, and
they are a very costly drain on those countries.
Chairman STARK. I know that.
Mr. BEADLE. And influence the whole attitude towards the free
enterprise system. There is a cradle-to-the-grave system that has
influence the thinking of the people. I don't think you can ignore
the implications for the income security area in this country when
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considering a VAT tax in this country. I think that is one of the
issues that needs to be looked at very carefully.
You commented on rising costs. One of the things I find that has
been handled a bit simplistically in these examinations has been
what is causing the rising costs.
If we were talking 3 or 4 or 5 years ago, maybe 5 years ago, the
economy was rolling at that time, demands were high, there was a
kind of a runaway demand for benefits. That has stopped. It may
even be gone forever.
I wouldn't want to go that far, but it has stopped. It hasn't
stopped rising costs because health care costs are rising and they
would have risen under government or private plans. There is a lot
of activity now going on to bring those under control. I don't expect
the same rate of increase to prevail in the next 2 or 3 years that
we have seen in the last 2 or 3 years because forces were at work
to bring it under control.
You were talking about the UAW earlier this morning. One of
the things in which both the industry and the UAW agree is that
they must work together to bring health care costs under control.
Chairman STARK. I tend to call it medical care.
Mr. BEADLE. I beg your pardon?
Chairman STARK. I think somebody is overlooking the changing
age factor in our population in things like long term.
Mr. BEADLE. Absolutely.
Chairman STARK. Which I perceive going out of sight. That may
not be covered by employee medical benefit plans, but I really
don't see under our present system anything but tremendously in-
creasing medical costs.
Mr. BEADLE. What we are really saying is that the premiums
that need to be shouldered without tax benefits by employees
would become more than they could afford. If the cost is going to
be there, if it is a cost related to aging, and it is a cost related to
the genuine under control cost of delivering health services, the
costs will be there and will need to be absorbed by someone.
Finally on the subject of tax, tax incentives shouldn't do it alone.
I think that is absolutely right, but I don't think it is doing it
alone. Employers have undertaken quite a responsibility in this
country. There is an administrative responsibility, a communica-
tions responsibility, in some cases even a liability responsibility.
We have certainly seen that once benefits are installed, employ-
ers tend to have to pick up a lot of the costs of increases, and they
have taken that on their shoulder.
Without the tax incentive, I doubt that they would want to
engage in the sort of massive encouragement of employees to par-
ticipate, that would be necessary.
Chairman STARK. The only thing that occurs to me, and you may
know the. figures, is what would you guess is the percentage of em-
ployees in this country who are not covered by benefit plans such
as the type you would advise for your clients; that is, pension and
company-sponsored and supported medical benefit plans? Half?
Mr. KAYE. Less than half.
Mr. BEADLE. About 150 million employees and their families are
covered under such plans, so we are talking about the rest having
something less than full -coverage.
PAGENO="0532"
526
Chairman STARK. Can you quantify that?
Mr. KAYE. I would estimate that in the area of retirement plans,
if you took employees who were over age 25, that probably at least
two-thirds of the work force is covered under an employer-spon-
sored retirement plan.
Chairman STARK. What I am trying to get at is, how many.
Mr. ~ The figures are much higher for--
Chairman STARK. How many people are self-employed, employed
casually, employed in domestic service?
Mr. BEADLE. Roughly a third.
Chairman STARK. About a third?
Mr. CASTELLS. Health care coverage extends to about 80 percent
of the working population.
Chairman STARK. Commercial health care, medical care plans?
Mr. CASTELLS. Yes, so you are talking about 20 percent of the
population is not covered under employer-provided health care ben-
efits. Obviously a few of those do have some other benefits, but you
wouldn't think very many, so that is probably the core of the un-
covered working.
Mr. BEADLE. Have you included in your figure those who would
be covered by definition under Medicaid or Medicare?
Mr. CASTELLS. No, just the working population.
Mr. BEADLE. That is another group that is covered.
Mr. CASTELLS. The elderly and unemployed that would be cov-
ered under Medicaid.
Ms. KORALIK. I would like to comment on another question that
has been raised. You seem to be suggesting that benefits just keep
going up, and I think what Carson was suggesting is that the cost
of benefits keeps going up, but the benefits that are being provided
is not necessarily continuing to expand.
We did a survey recently of 1,200 of the large corporations that
you were referring to earlier that do provide good benefits. What
we have been seeing is a definite trend to decrease the level of ben-
efits that is being provided in the health care area.
Just to give you one example, in the area of what do you provide
to somebody who is hospitalized. In 1982, 67 percent of these com-
panies provided 100 percent of the cost of a semi-private room for
the full length of stay in the hospital.
By 1984 that 67 percent had dropped down to 42 percent. So we
are seeing a definite trend downward.
We are seeing similar trends in the level of benefits provided for
surgical expenses. The deductibles are increasing. They are provid-
ing incentives for people to have surgery done on an out-patient
basis, and to get second opinions before having surgery done at all.
So I think employers are trying to do quite a bit.
Another question that you had asked earlier was, have cafeteria
plans done anything to control health care costs. Someone on an
earlier panel said that there wasn't any quantitative information,
but there is quantitative information now. It is, I guess, what the
Treasury Department would call anecdotal information. It is a
fairly small group of companies, but I think some of the larger
companies like PepsiCo and American Can do have very clear in-
formation that their divisions that have flexible programs in place
PAGENO="0533"
527
are experiencing a much lower rate of cost increase for health care
than their divisions without the flexible programs.
So I think the cafeteria plans have been shown, in selected situa-
tions at least, to be successful.
Chairman STARK. Isn't that really saying that if you make a deci-
sion based on cost and preference, they will be a little selective?
Ms. KORALIK. Yes.
Mr. BEADLE. Precisely.
Chairman STARK. Whereas, if you just sign the employees' sheet
when you check in and get your time card and you are told this is
your life insurance, there is your disability insurance and this is
your health plan, you don't make any choice, so obviously some
people, given some preferential choosing in the ability to price, will
purchase those things which they perceive as being more beneficial
to them, and that may save them a good bit.
That is to be expected. The problem is that they may just all
overlook disability insurance, because they don't think that is very
likely. Our question is, how to quantify the benefits of this reduc-
tion of the tax base for the foregoing Federal revenue, what are we
getting for that, and is it growing, and ought that to be accounted
for in some other way? Ought we appropriate it and authorize it?
Those are the issues.
I don't think any of us would quarrel that it is great to have
medical plans and good retirement income and encourage thrift
and all those things. There are some who would say that we ought
not to do it with the Tax Code. I doubt if that will ever be an em-
pirical decision.
Mr. BEADLE. Congressman Stark, your committee may find it
useful to look, at the table on page 196 of our questionnaire.
We asked how the CEO's viewed the expansion of benefits, 15 dif-
ferent benefits between now and 1990, if tax preferences were un-
changed, and again if they were changed, and the statistics make
very interesting reading.
Briefly, if tax preferences aren't changed, by far the bulk of the
CEO's believe benefits will stay essentially the same, except for
health benefits which they expect-which more believe will be de-
creased than those who believe it will be increased.
That is sort of a sign of the times, but it does indicate a signifi-
cant slowdown in the pace of additional benefits, as Susan de-
scribed them without tax change.
Chairman STARK. If taxes are levied.
Mr. BEADLE. No, if things are continued as they are. There will
be a greater holding of the line of reduction, you might say, if
there are taxes, and then it starts to move into the social policy
area, whether it goes too far--
Mr. CASTELLS. Mr. Stark, I think when you start looking at these
statistics that show ever increasing dollars being spent in the bene-
fits area, that you have to be careful to separate the reasons for
each of the increases, and you start off with inflation generally.
Then you add on to that the fact that inflation on medical care is
significantly higher, and that in and of itself might explain the in-
crease in the dollars spent.
You also have, of course, the increase in the 80 percent or so that
is covered that has occurred over the last few years, and those of
PAGENO="0534"
528
us in this field wonder whether, if you eliminated all of those, and
you then only addressed the people that had reasonable programs
right now, whether or not those programs are in fact expanding as
a whole.
There is a lot of statistics that would seem to indicate that those
programs, at least in the medical care area, are not expanding be-
cause of the significant concerns with this extremely high level of
inflation in medical care.
Most employers of any size are very concerned about this and are
taking significant action both on their own directly, prodding the
medical establishment, and in the design of their benefit programs
to control medical care costs.
Chairman STARK. They suddenly realize that they have got a
fixed cost there and it is really not related very much to productivi-
ty, if you think about it.
Mr. CASTELLS. That is right.
Chairman STARK. It has more to do with the age of the work
force and a whole host of things.
Mr. CASTELL.S. On the other hand, they do want to provide the
b~efits that are needed to maintain the quality of life, and one of
the ways that they were doing this is through these flexible spend-
ing accounts where they were able to allow people to set aside
money in a tax sheltered environment, and then if an emergency
were to arise during the year, so that an expenditure was really
necessary-because now the moneys are actually moneys that the
employees had control of themselves-then the money would be
there to take care of that emergency.
It is a very effective cost control mechanism that is gone as the
result of recent legislation, which I think was unfounded, just un-
reasonable.
Chairman STARK. I want to thank the panel very much.
Mr. BEADLE. Thank you.
Chairman STARK. The next panel is a panel of employers. Rex
Adams, vice president, Employee Relations, Mobil Oil Corp.;
Howard Weizmann, manager, Benefits Planning and Design, Sun
Oil Corp., and Robert Winters, vice president, Prudential Insurance
Co. I am reading the letter that has been sent. I hope you under-
stand it better than I do.
I would ask if you would like your testimony in response to this
very succinct letter be made part of the record in full. I gather you
were requested in a microsense to bring us information about your
own companies. I guess you have heard enough of the testimony to
know our interests in terms of in this case what will happen.
I expect what we are seeking from you is how would you change
your strategies and how would your employees' benefits change?
You might want to speak to that, but otherwise proceed in any
manner you wish.
Mr. Adams, you are first on the list.
* STATEMENT OF ROBERT B. PETERS, CORPORATE
COMPENSATION AND BENEFIT MANAGER, MOBIL OIL CORP.
Mr. PETERS. Mr. Chairman, my name is Robert B. Peters, manag-
er, corporate compensation and benefits, Mobil Oil Corp. I apolo-
PAGENO="0535"
529
gize for Mr. Adams' inability to be here today. An unexpected busi-
ness commitment came up which prevented him from appearing.
I am very pleased though on behalf of Mr. Adams to take this
opportunity to discuss the development of benefit plans within
Mobil over the past several years, and also the outlook for those
plans, should Congress decide to amend the tax treatment of them, if
agreeable to you. -
We at Mobil have been in the employee benefit business for quite
a long time, the entire 20th century, as a matter of fact. Our first
formal pension plan was established in 1903.
Also, our wholly owned subsidiary, Montgomery Ward, estab-
lished the first group health life and accident insurance program in
this great country back in 1910.
As a result of this early start in the employee benefit area, our
current employees have all participated for their entire careers in
the favorable tax treatment of benefit plans which your subcom-
mittees are reviewing.
We have submitted answers to your questions and I will touch
specifically on them in a minute. Our employees today, however,
assume that their retirement, medical and other benefits, are truly
an integral part of their total compensation package.
As a matter of fact, many of them only came to work for our
company because of the security those programs offered.
I don't think many, if any, of them look on these benefits in any
way as tax loopholes. To date we feel there has been considerable
harmony both in the public and private sector. The current sys-
tems of benefits in this country represent a harmonious mix of
both public and private programs to cover the benefit needs of
American workers.
We believe it would be unfortunate if the favorable tax treat-
ment of four decades which has produced the private side of this
mix should be changed by Congress. We are concerned about the
security which our employees and their dependents enjoy under
our present benefits system. We believe that changing the tax
treatment could, I repeat, could do permanent and irreparable
damage to that system.
I would emphasize that if there are detrimental changes in the
tax treatment of benefit plans, there will be, without a doubt,
changes in our private benefit package. There is already a change
in management's attitude toward private benefit plans because the
members of top management themselves in a great number of com-
panies are restricted by the section 415 limits in the benefits that
they can receive from a qualified defined benefit or defined contri-
bution plan.
They are becoming part of a very large, growing group that are
no longer protected by the full security of funded benefits.
If the favorable tax treatment is further reduced, or the section
415 limit continues frozen, attitudes toward the private benefit
system will be more adverse or at least will show some signs of
lack of enthusiasm.
One number that is not in the paper we submitted that I would
like to bring forth for the record deals with the deductible cost of
our plans and the taxable benefits received from them.
PAGENO="0536"
530
The benefit programs of Mobil Oil, which I have been discussing,
cost our company in 1983 approximately $263 million and that
amount was tax deductible to the corporation.
On the other hand, those same benefit programs in 1983 generat-
ed in excess of $350 million in taxable benefits to employees and
our retired employees.
Finally, I believe your letter has asked a bit about our philoso-
phy and you did orally at the beginning, as we develop our total
compensation package. In response, I would say that we focus fun-
damentally on the need of our employees. We obviously have to be
concerned about our ability to finance those programs, and certain-
ly we keep a very watchful eye on the competitive trends in our
industry.
We provide first for wages or salaries. That is the prime desire of
all employees. We think of their medical disability and life insur-
ance needs after that, while they are active and indeed, while they
are also retired.
Of course, the primary concern to us and to your subcommittee
is the fact that we provide retirement income when employees are
no longer able to be gainfully employed.
Most of our employees do not have the knowledge or the techni-
cal resources to arrange for these programs themselves. We think
we must continue to play an important role in this area and we
would suggest strongly that we make progress in this review slowly
and weigh the possible consequences of each of the changes, if
there are in fact changes to be made.
Specifically, the eight questions, Mr. Chairman, that you raised
in your letter of August 30. The first question asks what is the cost
of benefits provided to employees?
Well, the total cost for tax-free or tax-deferred benefit plans at
Mobil Oil Corp. was $263 million in 1983.
Attachment A to the paper we have submitted sets forth on a
plan-by-plan basis details of our program, and also shows the 10
year earlier set of costs for comparison purposes.
Question 2 asks what percentage of total compensation does the
total cost of benefits represent. Our 1983 costs represented 17.6 per-
cent of total payroll. Again, this is spelled out in detail on attach-
ment A.
The cost of tax-free or tax-deferred benefits provided to our em-
ployees is that $263 million previously mentioned.
Question 4 asks what percentage of total compensation and total
cost of benefits does the cost of tax-free or tax-deferred benefits rep-
resent.
As I stated earlier, all of the benefits in attachment A to our
paper are either tax-deferred or tax-free. We estimate, on the other
hand, that the cost of benefits which are fully taxable, for example,
payment for time not worked, amounts to an additional 10 percent
of total compensation.
Question 5, what is the per employee cost of both the total bene-
fits provided and each type of benefit? The cost per employee for
Mobil Oil Corp. employees in 1983 was just slightly over $8,000 per
employee. Again this is broken down by each of the programs in
the attachment.
PAGENO="0537"
531
Question 6, what percentage of the employee's salary does the
cost of the benefits provided represent?
I presume now the distinction here between salary and total
compensation earlier means just on wage and salary base. The per-
centage on that lower base is 21.5 percent for 1983.
I will skip to question 8, which asks about cafeteria plans, be-
cause we simply do not have any cafeteria programs.
Question 7 deals with what benefits are provided to employees in
various salary ranges; what is the cost of these benefits, and what
percentage of salary does the cost represent.
Well, 100 percent of Mobil Oil employees have each and every
one of Mobil benefit plans available to them. There are no plans
that are restricted to one employee versus another. As a matter of
fact, our historic practice has been to provide the same benefit pro-
grams for the chairman who we still call chairman and the tank
wagon driver that we now call truckdriver.
We did look at the highest paid and the lowest paid employees,
and what the percentage of total compensation was in each of the
five programs spelled out in the attachment. It is interesting to
report that the retirement plan, the medical plan, and the disabil-
ity programs all show a higher percentage of total compensation
for the lower paid employees than the high paid employees.
The savings plan is a wash because we have a program that just
offers a flat percent of pay for everybody in the plan and the life
insurance program shows that the percentage of total compensa-
tion is higher for the highest paid employees than it is for the
lower paid employees.
Thank you.
[Mobil submitted the following:]
SPECIFIC RESPONSES OF THE MOBIL OIL CORP., PRESENTED BY ROBERT B. PETERS,
CORPORATE COMPENSATION AND BENEFIT MANAGER
Mobil would reply as follows to the specific questions of Chairmen Pickle and
Stark in their letter of August 30, 1984:
Question. What is the cost of benefits provided to employees?
Answer. The total cost for tax-free or tax deferred benefit plans of Mobil Oil Cor-
poration was $263,004,000 in 1983. (See Attachment A for plan-by-plan details and a
10-year earlier comparison).
Question. What percentage of total compensation does the total cost of benefits
represent?
Answer. 17.6% of total payroll (See Attachment A).
Question. What is the cost of tax-free or tax deferred benefits provided to your
employees?
Answer. $263,004,000.
Question. What percentage of total compensation and total cost of benefits does
the cost of tax-free or tax deferred benefits represent?
Answer. All of the benefits in Attachment A are either tax deferred or tax-free.
We estimate that the cost of benefits which are fully taxable (e.g., payment for time
not worked) amounts to an additional 10% of total compensation.
Question. What is the per employee cost of both the total benefits provided and
each type of benefit?
Answer. The cost per employee for Mobil Oil Corporation employees for 1983 was:
Cost per employee
Retirement plan $4,116
Savings plan 1,373
Life insurance 465
Disability 83
PAGENO="0538"
Tnt~1
532
1,969
8,006
Question. What percentage of the employee's salary does the cost of the benefit
provided represent?
Answer. 21.5 percent.
Question. What benefits are provided to employees in various salary ranges? What
is the cost of these benefits? What percentage of salary does the cost represent?
Answer. 100% of Mobil Oil employees have each and every one of Mobil's benefit
plans available to them. Our historic philosophy has been to provide the same bene-
fit programs for the chairman and the tank wagon driver.
Question. Are any benefits provided through a cafeteria plan?
Answer. No.
ATTACHMENT A-TOTAL COMPANY COSTS OF FRINGE BENEFITS PROVIDED TO DOMESTIC
EMPLOYEES-1983
[Dollars in thousands]
Annual cost Percent of total
compensation
Direct compensation
Benefits:
Retirement plan
Savings plan
$1,224,489
135,215
45,118
15,263
2,722
82.4
9.1
3.0
1.0
.2
Life insurance
Disability
Medical
64,686
4.3
Total benefits
263,004
17.6
Total compensation and benefits
1,487,493
100.0
TOTAL COMPANY COSTS OF FRINGE BENEFITS PROVIDED TO DOMESTIC EMPLOYEES-1973
[Dollars in thousands]
Annual cost Percent of total
compensation
Direct compensation
Benefits:
Retirement plan
Savings plan
Life insurance
$436,500
88.4
20,500
16,200
10,000
500
10,600
4.1
3.3
2.0
.1
2.1
Disability
Medical plan
Total benefits
Total compensation and benefits
57,800
11.6
494,300
100.0
Chairman PICKLE. I thank you gentlemen for your statements.
I regret I was not here to hear all of the statements.
I beg your pardon. The next witness is Mr. Howard Weizmann.
You are manager of the benefits planning and design of the Sun
Oil Corp. Mr. Weizmann, we will be pleased to hear your testimo-
ny.
PAGENO="0539"
533
STATEMENT OF HOWARD WEIZMANN, MANAGER, BENEFITS
PLANNING AND DESIGN, SUN CO., INC.
Mr. WEIZMANN. Thank you.
Mr. Chairman, we welcome the opportunity to testify today con-
cerning employee benefits at Sun. I call to your attention a fact
sheet that we had supplied to the committee concerning the direct
cost of benefits to Sun Co. There is a correction which I hope will
be read into the record in those figures.
My calculator lied and in fact under tax deferred benefits for
active employees only, tax deferred amounts represent 28.1, not
13.6 percent of benefits provided to active employees.
May the record be corrected on that?
One of the difficulties I have in coming to Washington is trying
to understand whether we are talking here today about changing
the pitcher or selling the ball team.
I find difficulty sometimes in understanding or comprehending
the two issues that seem to be driving both tax policy and national
policy with regard to employee benefits. Those two issues seem to
be equity versus revenue.
In Sun's own experience, we have found that equity in fact costs
money. If we are more equitable, it means we are providing bene-
fits to a greater number of people, and we also are providing them
at fair and usable replacement ratios in the case of retirement
income-fair and equitable programs in the case of programs such
as medical and life insurance. This costs money. You cannot do
both at once.
We have also found that we can't simply spread out the benefits
paid to higher paid employees to provide a larger proportion of
those benefits to lower paid employees. The two issues of equity
and revenue remind me of a professor that I once had in college
who was both a sociology professor and an anthropology professor.
When I question people down here exactly on issues of equity
versus revenue, and point out that equity costs money, the re-
sponse is similar to what my professor used to say when you asked
him a sociology question; he said, I am an anthropologist. And
when you asked him a question in anthropology, he used to say he
was a sociologist. I don't understand that.
It is either a revenue issue or an equity issue. Caps which intend
to promote equity and raise revenue don't work. For example, we
found with regard to our experience most recently with the cap on
the 415 limits of which Mr. Peters spoke a few minutes ago; that
cap on the 415 defined benefit plan means that for an employee
earning as little as $13,000 at Sun Co., that we can't fund his pen-
sion today for when he is going to retire in the year 2014 as we
would be required under our own plan assumptions, reasonable as
they are. Is this more equitable? Did it raise much revenue?
The other aspect that I have heard on the equity issue, or dis-
cussing the equity issue, seems to be that we have had all this
growth in benefits, which means more people being covered, but
that this growth costs money-particularly in the area of medical
plans.
I have heard the figure of 80 percent coverage for medical bene-
fits, and at the same time I have heard phenomenal figures in
PAGENO="0540"
534
terms of the cost, all of which, as you can read by our own experi-
ence, are true. I fully believe that they are true.
Specifically, you cannot have this growth without spending
money. You cannot have the equity evidenced by the coverage pro-
vided by these medical programs without incurring significant
costs. My fact sheet will detail what in fact those costs are per em-
ployee at Sun. We must choose whether we want equity or reve-
nue-you can't have both.
We have also been asked to isolate what kind of behavior or in
fact which corporate behavior will change with regard to benefits. I
have heard on the preceding panel a survey of CEO's and high
level employees of various corporations indicating in fact what
would happen to benefits at various corporations if the tax incen-
tives were changed.
With all due respect to my own chief executive officer, and the
officers of other corporations, they are probably not the right
person to ask about the influence of tax policy on the design of ben-
efit programs in a large corporation.
Why is there a belief that employers do not respond to tax
policy? In fact, we have responded in the past to what tax policy is
by providing benefits that aim at what those benefit levels are
sanctioned by tax policy.
Today we have a limit, for example, under our life insurance pro-
gram, of a maximum of $50,000 worth of life insurance. That
$50,000 was not simply pulled out of the air, but in fact coincides
very neatly with the section 79 limit for that very same insurance.
We responded like most major employers to the extension of
salary reduction to 401(k) plans by instituting a similar kind of pro-
gram in our own corporate context. We have found that fully 14
percent of those people who did not participate in our program
prior to the institution of a 401(k) plan, I am talking about lower
paid individuals, 14-percent more now save under Sun's retirement
plan in response to that tax incentive, if you will, the 401(k) mecha-
nism.
[The prepared statement and testimony subsequently received
follow:]
STATEMENT OF HOWARD WEIZMANN, SUN Co., INC.
DIRECT COST OF BENEFITS PROVIDED TO EMPLOYEES OF SUN CO., IN OIL RELATED
OCCUPATIONS AS OF 1983
Total benefit expense
In 1983, Sun Company spent $159,259,000 to provide retirement savings incen-
tives, medical and dental, long-term disability and death benefits to 15,067 employ-
ees in oil and gas related occupations and approximately 9,000 retirees. Other bene-
fits were provided, principally in the form of vacation, holiday and sickness and dis-
ability pay, which amounted to an additional expenditure of $77,140,000. For every
dollar of total wages provided by Sun to its employees, another 41~ was directed
toward employee benefits.
Tax deferred, tax free and taxable benefits
1. Tax deferred benefits.-These benefits included pensions and savings incentives
amounting to (excluding governmentally required payments) $69,818,000 for all
active and retired employees and $58,298,000 for employees only. For active and re-
tired employees, tax deferred amounts represented 29.5% of total benefits. For
active employees only, tax deferred amounts represent 28.1% of benefits provided to
active employees and 11.5% of total wages.
PAGENO="0541"
535
2. Tax free benefits.-Tax free benefits include medical, dental, death, sickness,
gifts, educational reimbursement (in 1983), service recognition awards and travel
and accident insurance. These benefits totalled $58,767,000 for all active and retired
employees, or 24.9% of total benefits. For active employees only, tax free amounts
represent $40,102,000 or 19.3% of benefits provided to active employees only and
7.9% of total wages.
3. Taxable benefits.-These benefits include vacation and holiday pay, long-term
disability, certain direct retirement payments and total $70,677,000. These taxable
benefits represent 29.9% of all benefits for active and retired employees. For active
employees only, these benefits totalled $68,586,000 and represented 33% of all bene-
fits provided to active employees and 13.5% of total wages.
Distribution of benefits
Sun Company provided benefits amounting approximately to $13,377 for each em-
ployee. For non compensation related benefits such as medical and dental insur-
ance, this amounted to approximately $1750 for active employees ($1486 for retirees)
and $156, respectively. Compensation related benefits, such as life insurance, aver-
aged $168 per employee ($187 for retirees).
Although it is not possible to satisfactorily portray proportionate savings and re-
tirement income as an average dollar contribution, Sun contributed an average
more than $4.5% (out of a maximum of 5%) of participants' compensation who
earned less than approximately $35,000 (67% of all participants), in the form of a
matching contribution to Sun's defined contribution capital accumulation plan.
Income replacement ratios provided under Sun's Retirement Plan as related to sala-
ries are provided on the attached chart. The success of Sun's Retirement Program is
further indicated by the fact that as of the end of 1982, fewer than .3% of Sun's
retirees received public welfare or other assistance.
Responsiveness of private sector
Current tax policy permits employers to be responsive to the needs of employees
and their dependents. In Sun's instance, this meant that since 1960 Sun could make
up nearly one-half of the impact of inflation, at a cost of over $100 million, on re-
tirement income and led to the development of Sun's retirement income protection
program we call "Orbit". This also meant that when tax incentives were made
available under Section 401(k) and Sun passed them on to its employees, an addi-
tional 14% of those who were not previously saving under Sun's savings program
began to do so. Finally, when Sun became aware of the spiraling cost of medical
payments, we shifted away from first dollar coverage and began programs which
raised employee consciousness concerning medical costs. In part as a result of these
efforts, the rate of increase in medical care costs have slowed from 26% in 1981 to a
projected increase of only 7.7 % (the actual to date increase is 5.2%) in 1984.
APPROXIMATE RETIREMENT BENEFITS
[As a percentage of earnings at retirement]
Earnings at retirement
Percentage of
emploYee
earnings level
Percentag
es of earnings at retirement
r~t?~r~~t `~Pn
~
~ci~~Secur~
~
Total retirment
income
$10,000 to $19,999
8.2
26
44
70
$20,000 to $29,999
51.7
12.2
32
36
32
24
64
60
$30,000 to $39,999
$40,000 to $49,999
$50,000 to $59,999
$60,000 to $69,999
12.5
7.5
3.0
3.0
.9
.5
.7
39
40
41
42
`~
43
44
19
15
13
11
10
9
8
58
55
54
53
53
52
52
$70,000 to $79,999
$80,000 to $89,999
$90,000 to $99,999
$100,000
+
Notes.-(l) Retirement in 1984 at age 65 with 35 years
of service. (2)
Historical salary
increases of 6
percent per
year.
PAGENO="0542"
536
STATEMENT OF SUN Co., INC.
Mr. Chairman, we welcome the opportunity to testify today concerning the future
of employee benefits and economic security.
Today, the economic security of over 150 million Americans is being protected in
some measure by the private benefit system. This economic security is comprised of
disability programs which allow disabled employees to maintain their standard of
living while encouraging rehabilitation to return to productivity; medical insurance
programs which assist employees and their families to meet their medical expenses
and to encourage health care; death benefit programs which protect dependents
against loss of income at the time of an employee's premature death; and retire-
ment programs which are designed to replace a reasonable portion of an employee's
income at retirement. Most importantly, these programs supplement the govern-
ment safety net of Social Security, Medicare and Medicaid.
These programs do not exist solely due to the good will of employers. As you will
see, they are expensive. To make them affordable, Congress in its wisdom has pro-
vided tax incentives which lessen the cost to employers to provide them and permit
the employee to devote the full benefit dollar for its intended purpose.
Do not pretend that if these tax incentives are withdrawn that employer behavior
will not change. If current tax incentives for retirement, medical, death and disabil-
ity are withdrawn or curtailed, employer sponsored programs will be likewise with-
drawn or curtailed. Eventually, of course, they will be replaced by expensive govern-
ment provided benefits, funded directly by tax dollars and, of course, by the large,
inefficient, bureaucracy needed to administer them.
it is ironic that employee sponsored programs are being called into question at a
time when their governmental counterparts are in financial crisis. Imagine the
magnitude of these crises today if there was no private system. Imagine the crises of
tomorrow if short-term revenue needs are allowed to drive these programs out of
existence.
In order to divert attention from this peril, those who would curtail or eliminate
the tax incentives have by sheer assertion convinced some members of Congress
that these benefits go only to the rich. To be sure abuses exist. To be sure the cover-
age of these programs needs to be extended. However, the vast preponderance of
these benefits are distributed equitably. At Sun, our CEO receives the same medical
benefits as his secretary, he receives less in the way of income replacement from tax
favored retirement programs. Moreover, despite the ups and downs of the national
economy over the last fifteen years, fewer than .3% of Sun's retirees-people who
retired at all levels of income-received public welfare as of 1982 (the last year fig-
ures were available).
We do understand the revenue needs of government must co-exist with national
policy goals. We will be happy today, and in the future, to provide whatever assist-
ance we can to assure that where limitations are placed they are rational and ad-
ministrable. However, we will also speak out against those approaches which will
jeopardize the economic security of our workers.
In the following pages, we first describe Sun's benefit program in some detail.
Next, we describe the costs of this program. Finally, we discuss the distribution of
these benefits.
I. sUN'S BENEFIT PROGRAM
The following discussion describes the specifics of Sun's benefit program and how
it provides for our employees' welfare.
A. Retirement plan
Sun maintains a carefully designed retirement program which is intended to meet
the replacement income needs of its employees. This program is made up of two
plans. One is a defmed benefit pension plan, the Sun Company, Inc. Retirement
Plan, which provides fixed retirement income and serves as a typical employee's pri-
mary source of retirement benefits. This plan covers all regular hourly and salaried
employees and retirees. It provides retirement benefits equal to (1%% times final
average earnings times plan service up to 30 years) plus (%% times final average
earnings times plan service over 30 years) less (1%% times primary social security
at age 65 times plan service up to 30 years). Examples of retirement income at vari-
ous pay levels are as follows:
PAGENO="0543"
537
EMPLOYEES RETIRING JAN. 1, 1985 AT AGE 65 WITH 30 YEARS OF SERVICE
Final average pay
Plan benefit
Social Security
Combined
retirement
income
Percent of
final average
pay
$15,000
20,000
$3,890
6,076
8,474
15,843
$1,222
7,849
8,055
8,321
$11,112
13,925
16,529
24,164
74
70
66
60
25,000
40,000
B. Sun capital accumulation plan (SunCAP)
The other part of Sun's retirement progam is a defined contribution plan, which
is called "SunCAP." This plan combines a cash or deferred arrangement (401(k))
with a thrift plan feature. The first 5% of employee pre-tax contributions are
matched dollar for dollar by employee contributions. Upon termination of retire-
ment, an employee's account balance is made available in the form of a lump sum.
More than 80% of all regular eligible employees participate in SunCAP.
C. Post-retirement increases
Sustained periods of inflation seriously threaten any retirement program. As in
many companies, Sun's retirement program is linked to pay and, in this way, keeps
pace with changes in the standard and cost-of-living which occur during an employ-
ee's career. However, this self-adjusting mechanism stops at retirement, leaving re-
tirement income vulnerable to even modest rates of inflation. For example, the
income of a Sun worker who retires on a pension of $1,000 per month, assuming an
inflation rate of 5% per year, will be worth $783 after five years in real dollars;
after 10 years, the individual's pension will be worth only $613.
In the past, Sun responded to the impact of post-retirement inflation by periodi-
cally granting non-qualified supplemental payments, payable from its general
assets, which increase the basic benefits provided under the retirement plan. Sun
granted ten such increases between 1960 and 1983 which made up for almost half of
the impact of inflation. The present value of these previous increases is approxi-
mately $100 million.
Sun subsequently developed the Optional Retirement Income Truat ("ORBIT")
Program which protects retirement income and is designed to augment basic bene-
fits without changing the underlying design of Sun's qualified plans. It is designed
to encourage employees to dedicate a portion of their account balances in SunCAP
to the purchase of retirement income.
Under Sun's ORBIT program, participants in the Sun Retirement Plan and
SunCAP who retire are given an option under SunCAP to purchase an annuity from
their accumulated account balances. The employee pays only a portion of the full
cost of the annuity and Sun pays the balance. The ORBIT annuity provides, in
effect, a total of 15 annual supplemental retirement income increases. Beginning in
the second year of retirement and for each of the nex 14 years, the annuity pays an
increase equal to 3% of the benefits paid in the prior year form both the basic Re-
tirement Plan and ORBIT. This compounds, so that by the 15th year of retirement,
the retiree's income has increased by 56% (3% compounded 15 times). At that time,
the augmented retirement income remains level for life. The annuity also contains
a 50% survivor benefit coupled with a refund feature which preserves the employ-
ee's contributions used to meet a portion of the cost of the annuity.
The following example illustrates how Sun's ORBIT program works:
Frank retired on January 1, 1984 at age 62. His basic retirement benefit is $585
per month. He learns from Sun that an ORBIT annuity would cost $10,498. He pays
15% of the cost-or $1,575-and Sun pays the other 85%, or $8,923. During his first
full year of retirement, Frank receives $585-per-month benefit from the Sun Compa-
ny, Inc. Retirement Plan (SCIRP) or $7,020 for the year. The following year, that
benefit is boosted by 3% or $17.55. Frank would receive this amount in a check from
an insurance company, bringing his monthly retirement income from Sun's plans to
$602.55. His total benefit in that year would increase from $7,020 to $7,231 for an
increase of $211. The following chart describes how Frank's benefits grow annually:
PAGENO="0544"
538
Total annual Annual ORBIT
Year of retirement benefit (SCIRP increase over
_________________________ - plus ORBIT) SCIRP
10
11
12
13
14
15
16 and (thereafter)
Accumulated ORBIT increase.~
By the time Frank has received all 15 increases, his retirement income from Sun
plans has grown to $10,937 annually or $911 per month, and it remains at that level
for the rest of his life. When he dies, his surviving spouse receives 50% of the $911
monthly benefit, or $456 a month.
As can be seen from this example, Sun's ORBIT program is intended to benefit
employees by: increasing their retirement benefits; guaranteeing the source of those
benefits during retirement years; providing flexibility in the approach toward fund-
ing the benefit at retirement; and encouraging employees to save for their retire-
ment years. Under current law, the full implementation of the Orbit Program
cannot be achieved since the current contribution limits to defined contribution
plans prevent a large company contribution at the end of an employee's career. Leg-
islation introduced in the House by Representatives Kennelly, Pickle and Archer as
H.R. 4530 and in the Senate by Senators Chafee, Baucus and Bentsen as S. 1066
would correct these limitations and allow Sun to assure retirement income protec-
tion to its retirees.
~L). Medical programs
Due to high cost of medical care toady, few individuals can afford to "go it alone"
when they become ifi or need expensive surgery. To help meet these financial re-
sponsibilities when these events occur, Sun provides a Medical Program for all of its
regular employees, as well as retirees and their dependents for life.
Additionally, if an employee dies, Sun will continue coverage for all eligible de-
pendents for six months free of cost. The employee's dependents may continue the
coverage beyond this time by making any necessary employee contributions. Cover-
age may continue for a period equal to the employee's years of completed company
service.
The type of medical coverage which Sun provides is what industry calls "compre-
hensive" medical coverage. It has no lifetime maximum benefit, provides coverage
for a wide range of health care treatment and places a limit on out-of-pocket medi-
cal expenses which the employee would have to pay in one year.
An example of how this program specifically works is as follows:
Example: Suppose John, an employee should be hospitalized after suffering a
heart attack. Upon discharge, he convalesces at home for six weeks. This example
shows what his bills would have been and what benefits he would have received
under Plan ifi. (Assume John has not incurred any covered medical expenses this
year.)
$7,020
7,231 $211
7,448 428
7,671 651
7,901 881
8,138 1,118
8,382 1,362
8,633 1,613
8,892 1,872
9,159 2,139
9,434 2,414
9,717 2,697
10,009 2,989
10,309 3,289
10,618 3,598
10,937 3,917
PAGENO="0545"
539
EXPENSES COVERED BY PLAN IU
.
Type of service
Comprehensive coverage
Bills (No $150
deductible) deductible
Ambulance to clinic
$40
$40
Emergency medical care (outpatient hospital)
300
150
4,500 $4,500
8,000 7,200
1,000
200
900
200
250
900
300
150
450
800
1,000
200
900
200
250
900
Emergency doctor's care
and board, 15 days at $300 per day
Hospital miscellaneous expenses
Surgery
Consultation
Special nurses
Doctor's visits at home
Outpatient drugs
Outpatient hospital tests
Total
16,440 11,250
5,190
Plan III would pay:
Benefits payable with no deductible $11,250
Of the $5,190 in expenses subject to the $150 deductible, John would
pay 75% of the balance 3,780
The remaining expenses of $1,410 exceed the out-of-pocket limit on
employee medical expenses ($1,000), so the Plan pays expenses
above the limit in full, so $1,410 - $1,000 = 410
For a total benefit of 15,440
So, of the total bills of 16,440
Plan III would have paid 15,440
John would have paid 1,000
Sun also provides dental coverage to all active employees.
Sun is also very concerned about the rapid escalation in the cost of medical goods
and services in this country and has taken numerous steps towards cost contain-
ment and the effective management of such plans. These have included movement
away from first dollar coverage as well as accomplishments as developing a Health
Maintenance Organization in the Philadelphia area, implementing a comprehensive
Medical plan as a lower cost option for active employees, and beginning a nurse con-
sultant program which conducts utilization review and monitors the cost and qual-
ity of medical care provided. Since 1981 when these programs began, the rate of in-
crease has been reduced from 26% to a current projected rate of 7.7%. (Actual expe-
rience in 1984 suggest that the rate of increase will only be about 5.2%)
E. Death benefits
Sun Company also provides all regular employees with life insurance which is
payable to a beneficiary in the event of an employee's death before or after retire-
ment. The Plan offers non-contributory life insurance equal to one times base com-
pensation up to a maximum of $50,000 and supplemental insurance up to three
times compensation so an employee may choose the type of coverage which best
suits his/her needs. The Company pays the cost of the non-contributory coverage
under the Plan. A portion of this life insurance protection is provided after retire-
ment as well.
In addition to Sun's Death Benefit Program is an automatic 25% spouse's pension
in case of an employee's death. This coverage is provided for all active employees
once they become eligible for early retirement. The cost is satisfied totally by Sun.
The employee may also elect an additional 25% spouse's pension which is financed
through a reduced benefit at retirement or for the spouse upon the employee's
death prior to retirement. After retirement there is an automatic 50% spouse's pen-
sion provided at company expense.
F. Additional benefits
Sun also makes contributions to its Payroll Employee Stock Ownership Plan for
every regular employee and like most employers, provides benefits for time not
worked such as up to six weeks vacation; educational assistance which provides all
40-046 0 - 85 - 35
PAGENO="0546"
540
regular employees with 90% of the cost of any approved course of a recognized edu-
cational institution to further his/her career; a scholarship pian whereby children,
of active, deceased or retired employees may compete for scholarship assistance; and
a matching gift pian whereby Sun matches the amount of a personal gift of money
or securities that an employee or retired employee contributes to a domestic educa-
tional institution. Sun also provides an amount equal to the employee's personal
contribution to a qualified community organization.
II. DIRECT COST OF EMPLOYEE BENEFITS TO SUN
-A. Total benefit expenditure
Sun Company, Inc. is an integrated oil company with approximately 35,000 em-
ployees world wide. In oil-related occupations, Sun employs approximately 15,000
employees and has about 9,000 retirees. In 1983, Sun Company spent $159,259,000 to
provide basic benefits to all rgular employees and approximately 9,000 retirees. This
included expenditures for the following benefits:
-~ Expense Percent of
Core benefits:
Pension obligations $51,967,000 32.6
Medical insurance 39,756,000 25.0
Legally mandated payments (FICA, FUT, SUT, Worker's compensation) 37,137,000 23.3
Sun capital accumulation Plan (SunCAP) 19,322,000 12.1
Long-term disability 4,507,000 2.8
Death benefits 4,213,000 2.6
Dental insurance 2,357,000 1.5
Total 159,259,000 99.9
Of these amounts, $127,637,000 was the expense accrued to active employees,
while $28,146,000 was accrued on behalf of retirees. This latter amount includes
$11,370,000 attributable to retirement, $13,377,000 attributable to post retirement
medical payments and $1,685,000,000 attributable to death benefits.
Sun also provided additional benefits totalling $77,140,000. The largest component
of this figure were amounts expended for time not worked which may be broken
down as follows:
Vacation $40,785,000
Holiday 18,300,000
Sickness and disability 10,301,000
Other absences 2,000,000
71,386,000
In 1983, Sun paid $485,018,000 in the form of base wages. If the time not worked
is subtracted from these base wages (i.e. $485,018,000 less $71,386,000), the remain-
ing base wage figure for time actually worked is $413,632,000. Total compensation
for 1983 less time not worked was approximately $507,614,000. The total cost of ben-
efits expensed on behalf of active and retired employees was $236,399,000. The total
cost of benefits expensed for active employees, only, was $207,591,000 ($127,637,000
plus $79,954,000). The percent of base wages represented by this figure was in 1983,
therefore, 50.2% (i.e., $207,591,000 divided by $413,632,000). Thus, for every dollar
Sun spent in 1983 on base wages, another 50~ was used to provide benefit coverage.
As a percent of total compensation (less time not worked), $207,591,000 divided by
$507,614,000, this figure is about 41~.
On a per employee basis, total company provided benefits average annually ap-
proximately $13,377,000 for each employee ($207,591,000 divided by 15,067 employ-
ees). The average cost of medical insurance to employees was in 1983, $1750. (For
retirees, this cost was approximately $1486). The average cost of dental benefits for
employees was $156. The average cost of death benefits (which are compensation re-
lated) to employees was $168. (For retirees, this cost was approximately $187). The
average company expense per employee for SunCAP was $1282. Given the group
nature of benefits provided under Sun's retirement plan, a defined benefit plan, an
average figure of these costs would have little or no meaning and none is presented.
PAGENO="0547"
541
However, on average, the Retirement Plan contribution averages 7% to 9% of base
wages.
The costs of administering these benefits in 1983 was $5,998,000 or 2.5% of total
benefits expense (i.e. $236,399,000).
B. Costs of taxable, tax deferred, tax free benefits
These benefits may be further categorized as taxable, tax deferred and tax free.
Tax deferred benefits include pensions and capital accumulation amounts. Sun's
cost of providing tax deferred benefits to active and retired employees (treating gov-
ernmentally required payments as tax neutral for this purpose and excluding cer-
tain direct, unfunded obligations) is $69,818,000. This represents 29.5% of total bene-
fits for active and retired employees. For active employees only, these tax deferred
amounts represent $58,298,000 or 28.1% of benefits provided to active employees,
14.1% of base wages and approximately 11.5% of total compensation.
Tax-free benefits on the other hand include medical, dental, death, sickness and
disability, gifts, educational reimbursement (in 1983), service recognition awards and
travel and accident insurance. These benefits total approximately $58,767,000 for all
active and retired employees. This represents approximately 24.9% of total benefits.
For active employees only, tax free amounts represent $40,102,000 or 19.3% of bene-
fits provided to active employees, 9.7% of base wages and 7.9% of total wages. -
Taxable benefits, including vacation and holiday pay, long-term disability, certain
direct retirement payments, total for active and retired employees, $70,677,000, and
$68,586,000 for active employees only. These taxable benefits represent 29.9% of
benefits expense for all active and retired employees. For active employees only,
taxable amounts represent 33% of all benefits provided to active employees, 16.6%
of base wages and approximately 13.5% of total wages.
Legally mandated payments make up the remainder of the total benefits expense.
These are comprised of F.I.C.A. ($30,021,000), F.U.T. ($1,216,000), S.U.T. ($2,424,000)
and Worker's Compensation ($3,476,000). These total $37,137,000 or 15.7% of total
benefits. This approximates 9% of base wages and 7.3% of total compensation.
III. DISTRIBUTION OF BENEFITS
While it is difficult, if not impossible, to break down these benefits directly by
salary ranges, what evidence exists suggests that these benefits are equitably dis-
tributed as a percent of salary. In the case of the pension income replacement, when
a portion of the social security benefit is taken into account income replacement is
generally higher for the lower paid than is available for the higher paid. The follow-
ing table illustrates the relative income replacement ratios provided by the Sun Re-
tirement Plan and Social Security:
APPROXIMATE RETIREMENT BENEFITS
[As a percentage of earnings at retirement]
Earnings at retirement
Percentage of
ernlsl~?Yee~
earnings level
Percentages of earnings at retirement
retiremeri plan Social Security
benefit payable p ya ea g
at age 65
Total retirement
income
$10,000 to $19,999
8.2
26 44
70
$20,000 to $29,999
51.7
12.2
32 32
36 24
64
60
$30,000 to $39,999
$40,000 to $49,999
12.5
7.5
39 19
40 15
58
55
$50,000 to $59,999
$60,000 to $69,999
3.0
41 13
54
$70,000 to $79,999
$80,000 to $89,999
3.0
.9
42 11
43 10
53
53
$90,000 to $99,999
$l00,000+
.5
.7
43 9
44 8
52
52
Notes.-(1) Retirement in 1984 at age 65 with 35 years of service.
(2) Historical salary
increases of 6 percent per year.
In the case of Sun's Capital Accumulation Plan, the average company matching
contribution for employees who fall into the lower two-thirds of eligible participants
is greater than 4.5% out of a maximum 5%. In the case of medical benefits, the
same coverage is afforded to all employees at the same dollar cost. This means that
as a percent of salary, lower paid employees benefit at a higher rate. While certain
PAGENO="0548"
542
additional retirement, life and other more minor benefits are provided to Sun's
senior executives, these are generally not tax deferred nor tax free and on the
whole constitute a very small expenditure in comparison to the rest of these bene-
fits. For example, amounts provided directly to active and retired executives which
were neither tax free nor tax deferred under Sun's executive retirement plan in
1983 totaled $3,100,000 or only 1.3% of total benefits provided to all employees and
retirees. This amounted to .8% of total compensation.
Naturally, we will be happy to work with the Committee to provide further docu-
mentation as to the equitable distribution of employee benefits.
IV. TAX POLICY AND BENEFITS
As you can see, Sun has a very strong benefits program. This program would be
severely eroded if tax incentives as they currently are designed did not exist or were
limited in the degree of deductibility.
Post-retirement benefits such as medical and life insurance would most likely be
the first to be curtailed if significant funding or deductibility restrictions were
placed on such benefits. Plans such as the educational assistance, scholarship sup-
port, and matching gift plans would likely be the next to be eliminated. Finally the
medical and life insurance coverages for active employees of all salary levels would
be reduced to coincide with any future limitations.
Company support for pension plans would also be reviewed in light of Congres-
sional amendments which affect pension plans. One can expect over the long run
that amendments which make retirement plans more expensive or to deny ad-
vanced funding of future pension obligations such as the current freeze on cost of
living adjustments to the maximum limitations on contributions to qualified plans 1
will force Sun to ultimately reduce retirement benefits by decreasing the amount
employees receive as a percent of final average earnings. Sun would also not be in-
clined to provide funds which augment pension benefits for retirees through our
current ORBIT Plan.
Sun's retirement and welfare programs are designed to provide financial security
and independence for employees, which are long-standing national policy goals.
Without the current tax incentives Sun would be less inclined to develop new pro-
grams and would likely reduce existing benefits to coincide with new limitations,
providing employees and retirees with lowered level of security. To the extent these
incentives are "rolled-backed" by Congress, financial independence must be replaced
by dependence on the public systems which are far more inefficient, inappropriate
and costly than Sun's current programs.
Chairman PICKLE. Thank you.
Mr. Winters, vice president of the Prudential Insurance Co.
STATEMENT OF ROBERT C. WINTERS, EXECUTIVE VICE
PRESIDENT, PRUDENTIAL INSURANCE CO. OF AMERICA
Mr. WINTERS. In point of fact, I am executive vice president, but
as long as the company maintains that distinction I am happy to
be here on the basis you describe. Although our business is insur-
ance, I am appearing here today on behalf of an employer whose
benefit plans cover some 220,000 U.S. employees and their depend-
ents.
I will, as Mr. Stark requested, simply summarize what is in our
written testimony. We try to make four points:
First, the deficit is a much more important problem than seems
to be recognized in the Nation at large currently. We need to
attack this complacency, and I urge the subcommittee to continue
the efforts which I know you have been putting forward, to raise
awareness of this issue. That awareness is necessary before any of
the problems can be--
1 Sun drafted testimony as of July 28, 1983 on behalf of the Association of Private Pension
and Welfare Plans which demonstrated the impact of a permanent freeze under such limits.
Under even reasonable assumptions such a freeze reduces current funding for a retiree who
earns as little as $13,000.
PAGENO="0549"
543
Chairman STARK. Will you speak into the microphone or pull it a
little bit closer to you.
Mr. WINTERS. Yes, sir. I am sorry.
I am simply urging that the nation as a whole has to have a
clearer awareness of the deficit problem and what it portends for
us, before we can effectively marshal support for the kinds of an-
swers which are required. We applaud the course you are on.
Second, the employee benefit system which we have in place now
is functioning well, to provide needed basic financial security for
most working Americans and their families. That point has been
covered in prior testimony.
Third, tax preferences for employee benefits are an important
contribution to the success of the plans. You have heard from a
panel of economists. I didn't have the benefit of all of it, but the
essence of their testimony was that employees behave as rational
economic people, and that their choices are driven entirely by the
economics of the selections made available to them. The economists
undertook to predict how employees would behave if certain
changes in the Tax Code were made.
The fact is that employees have not historically behaved nor
have I, nor I suspect has anyone else in this room, as purely eco-
nomic animals in dealing with the choices which we face in our
lives. The preference of employees, particularly recently, has been
cash compensation over benefits, and if benefits do not have some
additional appeal, over time the contract, whether formal or infor-
mal, negotiated between employers and employees, will shift in the
direction of cash.
I think there is a very important point of how will people
behave. I think it deserves more research than it has received, and
I would certainly urge you to ask employers and employees how
they will behave and why, not economists, and to look at how they
have in fact behaved in the past. We have a very vivid although
small example in the recent history of the Prudential.
For some 50 years we have provided free meals to our employees
in our Newark, NJ, location. This without tax to them, the kind of
tax arbitrage which is pointed to in these kinds of discussions that
both we and the employees are better off and there is a revenue
loss to the Treasury.
We recently discontinued that arrangement. We increased our
employees' taxable wages and started charging them for lunches.
The reason was that they did not value the tax preference lunch as
much as they did the compensation, even though economic ration-
ality says they should have, but that is the way people are.
Finally, and an extension of that point, what you do here can
have very great impact. If these committees and the Congress sig-
nificantly reduce tax preferences, there is a very serious risk of
damage to an effective system for delivering needed benefits,
damage which in fact could well increase the deficit rather than
decrease it.
That is the essence of our written testimony. I would like simply
to add one point in connection with the questions which have
arisen concerning future increases in tax preferences to benefits.
For a relatively stable employer with mature benefit plans, there
are two principal sources of increase in benefit costs, Social Securi-
PAGENO="0550"
544
ty tax increases and medical cost care inflation. I can think of no
one in this room or probably anywhere else in a better position
than you to estimate whether we will face increasing Social Securi-
ty taxes in the future. It is currently our largest tax preference
benefit for our employees.
The medical care cost inflation issue is a vital one which has al-
ready received considerable attention. We would simply add that it
ought to be addressed directly rather than indirectly through ele-
ments of the Tax Code that affect only working Americans. Thank
you.
[The prepared statement follows:]
STATEMENT OF ROBERT C. WINTERS, EXECUTIVE VICE PRESIDENT, PRUDENTIAL
INSURANCE Co. OF AMERICA
My name is Robert C. Winters. I am an Executive Vice President at the Pruden-
tial Insurance Company of America. Although or business is insurance, we are testi-
fying today as an employer, whose benefit plans cover more than 220,000 individ-
uals-employees and their dependents.
The employee benefits structure in the United States is an excellent example of
tax incentives inducing behavior which serves social and economic policy goals. This
structure provides basic financial security to millions of American workers and
their families. It is working well; any significant tampering with it entails consider-
able risks.
I do not mean to suggest that tax preferences for employee benefits should go un-
examined when the Federal deficit approaches 200 billion dollars. The Prudential
believes very strongly that there is too much complacency in the nation about our
fiscal situation. We applaud the actions of the Ways and Means Committee in ad-
dressing this problem. We hope that you will continue your efforts to draw attention
to the importance of the deficit issue.
On the revenue side, all tax preferences, certainly including employee benefits,
should receive scrutiny. Perhaps more importantly, although less directly the imme-
diate concern of the Subcommittees, all categories of expenditures must also be sub-
ject to scrutiny.
While acknowledging that the tax treatment of employee benefits warrants exam-
ination, I suggest that this area is an unlikely source for substantial reduction of
the deficit. The economically significant, tax-preferenced employee benefits are cov-
erage of health care and pensions. As a nation, we have made a commitment to
defray both the costs of our workers' health care and the cost of a decent retire-
ment. The only question is how these costs will be met. If we inhibit the private
sector in meeting these needs, we simply increase the burden on the public sector.
We might increase tax revenues, but there is substantial likelihood that we would
increase public expenditures even more; and, that is no way to reduce a deficit.
We believe there is general agreement that the legitimate costs of health care and
retirement must be met by our society. Yes, there are excessive costs in our health
care delivery system, but that problem should be addressed directly and comprehen-
sively-not indirectly through tax code changes that affect only workers and their
families.
I would urge the Subcommittees to consider carefully whether there is any more
cost-effective way than the one now in place for the nation to meet these health
care and retirement costs. The structure we have is working-not perfectly, but
well. Any significantly different structure involves major risk of increasing the defi-
cit. Minor changes cannot achieve much in dealing with the deficit, and may impede
th~ currently effective use of tax preferences to energize efficient private sector re-
sponses to important social needs.
I would like to use my remaining time to address some of the specific issues you
have put forward. Many of your questions call for statistical responses and we have
answered them in an appendix to this testimony.
Some of your questions imply a concern that employers and employees are con-
spiring to abritrage against the tax code-that we agree on total compensation and
then decide what compartments to put it in for tax advantage. I have already ac-
knowledged the effectiveness of tax incentives to motivate behavior in the private
sector, but that does not add up to a rip-off of other taxpayers. The driving force in
employee compensation over the past few years has been towards cash, not benefits.
PAGENO="0551"
545
In the Prudential's case, the voluntary increases in our compensation to our em-
ployees over the last four years-voluntary, as distinguished from the inflationary
increases which we had to pay in our health insurance premiums-the voluntary
increases were more than seven-to-one cash versus benefits. For our total employee
group, we increased cash compensation 235 million dollars during this period, while
making voluntary increases in our benefit costs of 31 million dollars.
This is sound evidence that the nation does not face a runaway tax loophole.
Secondly, you asked whether we have any benefits provided through a cafeteria
plan. We do not-regrettably. A year ago we decided to develop a cafeteria plan to
be effective January 1, 1985. We had two objectives: to give our employees choices,
and through those choices to involve them in decisions affecting health care costs.
We anticipated that a well-designed cafeteria plan would reduce costs for both our
employees and for the company. The IRS limitations on cafeteria plans announced
last spring stopped us. We are working on a limited alternative, but it can not incor-
porate the cost-containment features we had originally targeted. I hope that one
result of your examination will be a thorough reconsideration of the trade-offs avail-
able in well-designed cafeteria plans, which include appropriately limited flexible
spending accounts.
Finally, I would like to point out an adverse impact of Congressional activity over
the last decade. Employee benefits, particularly pension benefits, are very long-term
commitments by employers. We need to plan for these commitments over the work-
ing lifetime of our employees-periods which often exceed forty years. In the ten
years since the passage of ERISA, this kind of long-term planning has become in-
creasingly difficult because of the proliferation of new law. As illustrated in the ac-
companying chart, we have seen a myriad of legislation affecting employee benefits,
including twelve major tax acts, in the last decade. For the private sector to contin-
ue its successful record of developing cost effective employee benefits it needs more
stability. Frequent, revenue-driven changes are destabilizing the process.
To summarize, we share your concern about the deficit. We do not see the employ-
ee benefits area as offering significant opportunity for closing the deficit gap. The
employee benefits system in the United States is working well and should not be
changed significantly. Our recent experience at the Prudential suggests that con-
cern over significant erosion of the revenue base by employee benefits is misplaced.
I commend you for beginning a very important process-and I urge you to let us
participate actively with you to find a set of answers that will curb the deficit and
lead to a stable set of employee benefit rules.
THE DISTRIBUTION AND ECONOMICS OF EMPLOYER-PROVIDED FRINGE BENEFITS
(1) What is the total cost of benefits provided to employees?
The total cost of providing benefits to employees and Special Agents during 1983
was $471,411,097.
(2) What percentage of total compensation does the total cost of benefits repre-
sent?
The total cost of benefits during 1983 represented 25.5% of total compensation.
(3) What is the cost of tax-free or tax-deferred benefits provided to your employ-
ees?
The cost of tax-free benefits provided during 1983 was $242,568,349. The cost of
tax-deferred benefits provided during 1983 was $79,005,813.
(4) What percentage of total compensation and total cost of benefits does the cost
of tax-free and tax-deferred benefits represent?
Tax-free benefits provided to employees in 1983 represented 13.1% of total com-
pensation and 51.5% of the total cost of benefits.
Tax-deferred benefits provided to employees in 1983 represented 4.3% of total
compensation and 16.8% of the total cost of benefits.
(5) What is the per-employee cost of both the total benefits provided and each type
of benefit?
Average per-employee cost of benefits provided during 198,S'
Medical/dental benefits $1,532
Disability 440
Group life insurance benefits 134
Retirement plan benefits 827
Prudential investment plan 409
Government-mandated benefits 1,540
PAGENO="0552"
546
Other miscellaneous benefits . 2,493
Total benefits 7,375
(6) What percentage of the employee's salary does the cost of the benefits provided
represent?
The cost of benefits provided to employees in 1983 represented 34.13% of average
employee compensation of $21,605.
(7) What benefits are provided to employees in various salary ranges? What per-
centage of salary does the cost represent?
Percent of
Salary range and Benefit plans provided
All Employees: . tion
Medical/dental 7.09
Disability 2.04
Group life .62
Retirement 3.83
Prudential investment plan 1.89
Government mandated 7.13
Miscellaneous 11.54
Executive:
Retirement.-No early retirement reduction if at age 60 with 25
years of service (instead of 30). Provided under a nonqualified
program, i.e., financed on a cash disbursement pay-as-you-go basis.
There are some recipients. Benefits are taxable.
Disability.-10 year's of service eligibility requirement waived. Appli-
cable to those at FVP rank or above. Provided under a self-insured
program. There are no recipients. Benefits would be taxable when
received.
(8) Are any benefits provided through a cafeteria plan? If so, which ones?
No.
PAGENO="0553"
ERISA -
Tax Reform ~
Act1978
Age Diacrim.
InEmpi.
Rev.Act 1978 _________
LII Tech.Com IIJT -I
it
_ M
ID MPPAA ~ IA
ERTA ______ Sr
TEFRA Cu
Tech. Corr.
0 Act.of 1982 !fl
Soc. Sec. __________
Act Amend. ___________
1983
Tax Reform
Act 1984 - -
Retirement
Equity ______
Act 1984
PAGENO="0554"
548
Chairman PIcKu~. Mr. Winters, did I understand you to say that
in recent years you offered employees a chance to increase their
base, although it was taxed, that they preferred that route to tax-
free benefits?
Mr. WINTERS. Yes, sir. I referred to a particular example having
to do with the tax-free meals. I can give you a somewhat broader
one. Over the last 4 years our increases in compensation as be-
tween cash and voluntary increases in benefits-I distinguish the
involuntary increases from inflation-have been 7 to 1 cash over
benefits.
Chairman PICKLE. Does that mean that your company then has a
policy that it is going to reduce fringe benefits or employee benefits
and yet increase the base? Is that a policy of your company now?
Mr. WINTERS. Our policy is to try to provide a total compensation
package which seems to accord most closely with what our employ-
ees want-and our reading of our employees is certainly reinforced
in the case of our union represented employees by the collective
bargaining discussions-our reading is that our employees want
cash.
Chairman PICKLE. Aside from what the employees want or what
you want for them or don't want for them, what should we do with
respect to employee benefits? Should we the Congress let them
alone or should we attempt to set some kind of control or limita-
tion on them? Do you think they will continue to grow? Does the
panel think that they will?
Mr. WEIZMANN. Mr. Pickle, there was a study, I know, conducted
that demonstrated, at least it is my understanding or the reading
of it, that employee benefits have grown as inflation forced people
up in the tax brackets, obviously it became more attractive. That is
on a macro basis.
Speaking from my own experience, we are looking for ways, and
I think it is borne out in the medical plan area, ways in which we
can share costs with employees, not only for medical benefits, but
in the post-retirement increase area, which I know you are familiar
with. We are looking for ways in fact to share some of the costs of
the employer-provided program with employees. With that shifting,
my guess is that in fact a significant reduction in usage will occur.
That happened in our medical plans, for example, when we shift-
ed from first-dollar coverage to a deductible, we achieved a reduc-
tion in the growth in benefits from 1981 of 26 percent down to a
projected increase for this year of 7.7 percent, and the actual in-
crease to date is 5.2 percent in medical costs.
We are looking for ways in which we can fairly shift some of the
benefit costs to employees, and with that I fully believe that some
of the usage will also go down.
Chairman PICKLE. I have a little difficulty finding an answer to
my question. Do you think that employee benefits are going to
grow in your industry?
Mr. WEIZMANN. No.
Mr. PETERS. I would like to echo that, Mr. Chairman. I see by the
history we have provided that in the last 10 years there was a sig-
nificant growth in the tax-deductible expenditures in Mobil Oil
Corp. for employee benefits. Now, that was not driven solely by the
PAGENO="0555"
549
fact that it is a tax-deductible expense. The economics of the indus-
try had an awful lot to do with it.
I think you will see that the costs I have shown for 1983 for
Mobil Oil tax-free or tax-deferred expenses is significantly higher
than what we will show for 1984. Again, we are not looking for a
tax deduction. The economy of our industry has changed. We are
looking for ways of economizing. Employee benefits is a very big
one. The pension plan and the medical plan are two of the greatest.
Now, we like the tax deduction, but there is more of an economic
reason for spending money on benefits than just taxes.
Chairman PICKLE. None of us know whether these benefits will
grow or not. Perhaps we have peaked out in the last 2 or 3 years. It
could peak up again in the next two or three quarters too, or they
could even have declined. That is why we are trying to make up
our mind. What is going to happen to them? I recognize that in
many of the industries there is a leveling off, but we don't have
enough of a history to show that that is going to be the level, or
whether it is just a temporary lull before further escalation, so we
are trying to find that out.
Let me ask you, with respect to each one of you, do you think
some of, for example, educational benefits-that is a good exam-
ple-should Congress review that program, institute it again, al-
lowing the tax deductibility by the employee, and no income status
on the part of the employee? Is it the type of program that the in-
dustry would want?
Mr. PETERS. I would have to answer for Mobil Oil Corp., very
positively on that, yes, sir.
Chairman PICKLE. Would you all be for it?
Mr. WINTERS. I am sorry, were you saying are we all for it?
Chairman PICKLE. I am asking you, are you for that?
Mr. WINTERS. Congressman, I continue to believe that the first
problem which we need to be addressing, and which of course par-
ticularly the Ways and Means Committee needs to be addressing, is
the deficit. I think that any proposals which increase the deficit
and further tax deductibility of employee benefits would have risk
of increasing the deficit, have to be very suspect at this point in
our economic history.
I believe that we have to marshal the forces of all of the people
involved to try to figure out how we are going to deal with the defi-
cit, and I believe that specific individual questions of this sort are
really subordinate to that larger issue.
Chairman PICKLE. Inasmuch as the educational system program
expired last December, and inasmuch as we may or may not settle
this deficit question for some time to come, should we then set the
educational system on the shelf and look at it in another 2 or 3
years from now?
Mr. WEIZMANN. Mr. Pickle, may I respond? I believe that things
such as educational assistance, particularly educational assistance
where we, for example, in a mature industry are dealing with re-
training costs, re-education of our employees who are either going
to leave us or are leaving us in fact because of shifts in the open
market with regard to oil over which we have no control, that this
benefit is very useful to us, and I think we would echo what Bob
PAGENO="0556"
550
Peters said with regard to we would like to see a continuation of
that.
Mr. PETERS. It is an extremely popular program.
Chairman PICKLE. Mr. Winters, have you changed your educa-
tional system program, your tax program within the company in
any way?
Mr. WINTERS. No, sir, we have not.
Mr. PETERS. I wanted to add, sir, the reason we feel so strongly
on that program is our review shows quite clearly that it is the mi-
nority and the lower paid, lesser educated employee that by and
large takes the far greatest advantage of that program, and it dis-
turbs us greatly to see that taken away from them.
Chairman PICKLE. If it was restored, would you be for or against
including the FICA and the FUTA tax with respect to those bene-
fits?
Mr. PETERS. I think I would like to review the effect of this first
on employees, but I have to say I have less of a problem of includ-
ing elements in tax bases that produce benefits in the future, and I
think FICA clearly falls under that category, whereas income tax
would not. In a way, I am saying yes to your question but I would
hesitate to answer it without further study.
Chairman PICKLE. Tentatively yes.
Mr. WEIZMANN. I hate to sound like a "me too," but me too.
Chairman PICKLE. You want to settle the deficit first. You can
hide behind that one.
Mr. WIN'ri~a~s. I--
Chairman PICKLE. I want to say to you and the others, this com-
mittee, this Congress is not looking for ways to reduce employee
benefits. They have been added with our concurrence and under-
standing for years. In many respects they are delivered more eco-
nomically and efficiently than we the government could give them.
We also recognize that there has been a tremendous growth in
them, and we have to ask ourselves again how much will they con-
tinue to grow, and if they are leveled off, what assurance do we
have that they will keep at that level, and what effect does it
really have on the tax base with respect to our income.
These are questions we are looking at, and contrary to what
some of the organizations may say, we are not starting any kind of
a scare campaign, and we don't hope that the industry or the em-
ployees start the same thing. But I think this committee is going to
continue to look at this question, because it is fundamental, it is
serious, and it deserves further study.
If you have other statements or other comments to make to us,
we will be glad to have it, but in the meantime we appreciate your
testimony very much.
Mr. WEIZMANN. Thank you.
Chairman PICKLE. The next witness is Mr Robert Georgine,
chairman of the National Coordinating Committee for Multi-Em-
ployer Plans. Will you introduce the other gentlemen with you.
Mr. GEORGINE. I have with me Jack Curran and Peter Schmidt.
Chairman PICKLE. Glad to have both of you gentlemen. If you
will proceed.
PAGENO="0557"
551
STATEMENT OF ROBERT A. GEORGINE, CHAIRMAN, NATIONAL
COORDINATING COMMITTEE FOR MULTIEMPLOYER PLANS,
ACCOMPANIED BY JACK CURRAN, LEGISLATIVE DIRECTOR;
AND PETER SCHMIDT, ATTORNEY
Mr. GEORGINE. Mr. Chairman, my name is Bob Georgine, chair-
man of the National Coordinating Committee for Multiemployer
Plans, an organization that represents the interests of the more
than 8 million working men and women, and their families, who
are covered by multiemployer plans.
The NCCMP and its affiliates welcome this opportunity to testi-
fy, since we are deeply concerned about the continuing viability of
collectively bargained employee benefit plans. These plans provide
a wide range of essential benefits to workers who generally could
not otherwise afford them, and thus serve a number of important
public policies.
A more detailed discussion of these benefits, the workers who are
covered by them, and other points covered by the questions set
forth in the subcommittees' press release is contained in a written
statement we will submit later in the week.
Chairman PICKLE. It will be included in the record in its entirety.
Mr. GEORGINE. Despite the important social policies referred to
above, a disturbing trend appears to be developing-a trend to cur-
tail the Federal tax incentives that have played a key role in the
development of benefit funds.
Several factors appear responsible. First, the continuing Federal
deficits have created intense revenue pressures. Reducing the tax-
favored status of employee benefits appeals to some as a low-visibil-
ity way to generate additional revenues. In our view, however, this
nation cannot justify any attempt to balance the Federal budget on
the backs of the working men and women of this country.
Our workers and their families depend on the retirement, health
care, disability, life and unemployment insurance benefits provided
by these plans. More equitable and humane ways of raising reve-
nue exist than curtailing or eliminating these ~~nefits. Moreover,
cutbacks in privately funded benefits will certainly result in new
revenue pressures on federally funded or assisted programs.
A second reason for the restrictive legislative trend may be the
instances of reported abuse-for example, doctors and other profes-
sionals arranging for yachts to be contributed to a purported bene-
fit plan. To the extent such abuses actually exist, the coordinating
committee has no interest in protecting them. However, we believe
that actual abuses must first be identified, and that any remedy
must be carefully tailored in order to excise only the abuse situa-
tion. Abuse surgery that cuts deeply into healthy tissue-for exam-
ple the recent VEBA legislation-has already worked unnecessary
and unfair hardship on participants in legitimate benefit plans.
In this connection, we are aware of no abuse in collectively bar-
gained plans, and no such abuse has been reported. It has long
been established that the very nature of the collective bargaining
process-where the employer and the employee have a healthy ad-
versity of economic interest-precludes the kinds of abuses that
may exist elsewhere. Apparent abuses in one sector should not be
PAGENO="0558"
552
used as a smokescreen for revenue-motivated cuts in a nonabusive
area.
In this regard, we note that the House and Senate Labor commit-
tees have a familiarity and expertise on collective bargaining issues
that is not shared by all members of the tax-writing committees.
As a matter of fact, just a little earlier Congressman Stark men-
tioned that you are not considering the social policy problems, and
I submit that somebody should. We believe that their effective ex-
clusion from the legislative consideration of these issues has pro-
duced many unfortunate results, and should not continue.
A third rationale sometimes advanced for restrictions-for exam-
ple the proposed tax cap on health care benefits-is supposedly
grounded in principles of efficiency and cost containment. Extend
the incentive to a flat dollar amount, the theory goes, and actual
health care costs will magically shrink to stay within the limits.
This is, of course, pure pipe dream. The actual result would be
the taxation of medical benefits for any middle- and low-income
workers. In this respect, cost containment is nothing more than a
pleasant euphemism for the imposition of taxes on health care ben-
efits programs.
Moreover, the efficiency and cost-containment arguments have
generally ignored the substantial, historical contributions of collec-
tively bargained plans in these areas. These plans pioneered ex-
perimentation with health care delivery systems, such as HMO's,
designed to provide care efficiently and at low cost.
In addition to curtailment of current tax incentives, the imposi-
tion of new taxes-FICA taxes, for example-is apparently now
open for discussion. Any enlargement of the FICA tax base,
through inclusion of such essential employee benefits as pension
and health insurance, would, in our view, be a regressive and
highly inequitable step. Many now receiving these benefits are
among those least able to pay additional taxes.
Mr. Chairman, the 73 million workers covered under pension and
health insurance plans represent a substantial constituency that
must be taken into account. The taxation of benefit programs may
appear to constitute a low-visibility/no-constituency issue at the
present time. Plan participants tend to take these benefits for
granted. Our experience has been, however, that when the change
actually takes effect, participants become very vocal. I expect, Mr.
Chairman, that you have observed this phenomenon yourself.
In closing, our fundamental belief is that the private sector plays
an essential role, and is often more efficient and cost-effective than
government programs, in providing health care and other essential
benefits. The relatively modest tax incentives set forth in current
law are an essential element to the viability of the private benefits
system, as currently in effect.
As a matter of fact, if you took away the income from the tax
revenue you expect to receive, you may not, because the funds may
just not be there any longer. We look forward to the continuation,
through the collective-bargaining process, of the health, welfare
and retirement benefits on which our members so strongly depend.
Thank you very much for the opportunity to make our views
known.
[The following statement was subsequently received:]
PAGENO="0559"
553
STATEMENT OF ROBERT A. GEORGINE, CHAIRMAN, NATIONAL COORDINATING
COMMIrPEE FOR MULTIEMPLOYER PLANS
My name is Robert A. Georgine, and I appear here today in my capacity as Chair-
man of the National Coordinating Committee for Multiemployer Plans.
The Coordinating Committee was organized, shortly after the passage of ERISA in
1974, in order to represent the interests of the more than eight million working men
and women, and their families, who are covered by multiemployer plans. The Com-
mittee's affiliates include more than 140 pension funds, health and welfare funds,
and related international unions.
Messrs. Chairmen, the NCCMP and its affiliates are deeply concerned about the
continuing viability of collectively bargained employee benefit plans. These plans
provide a wide range of essential benefits to workers who generally could not other-
wise afford them, and thus serve a number of important public policies.
Nonetheless, a disturbing trend appears to be developing to curtail the federal tax
incentives that have played a key role in the development of such benefit funds.
Most recently, the Deficit Reduction Act of 1984 imposed new limits on contribution
deductibility and subjected the earnings of employee benefit funds to new taxes on
so-called unrelated business taxable income. That Act also repealed the estate tax
exclusion for benefits paid from pension plans. Before that, the TEFRA legislation
subjected pension benefits to withholding taxes and imposed other restrictions and
burdens on employee benefit plans. There have been several major efforts, so far
unsuccessful, to impose a "cap" on health care deductions or, alternatively, to in-
clude a portion of an employer's payments for health care in the income of the ben-
eficiary. Numerous other examples might be cited to illustrate this trend.
Several factors appear responsible. First, the continuing federal deficits have cre-
ated intense revenue pressures. Reducing the tax-favored status of employee bene-
fits appeals to some as a low-visibility way to generate additional revenues. In our
view, however, this nation cannot justify any attempt to balance the federal budget
on the backs of the working men and women of this country. Our workers and their
families depend on the retirement, health care, disability, life and unemployment
insurance benefits provided by these plans. More equitable and humane ways of
raising revenue exist than curtailing or eliminating these benefits.
Moreover, attempting to raise revenues in this manner is likely to be counterpro-
ductive. The curtailment of supplementary unemployment benefits, for example,
would likely impose substantial additional pressures on federally funded or assisted
welfare and unemployment programs. Cutbacks in the provision of pension benefits
would create even more obvious participant needs. The loss of such benefits would
also likely result in significant grassroots pressure for new programs involving
direct federal spending. Existing federal tax incentives provide an efficient cost-ef-
fective incentive for the provision of these essential benefits by the private sector.
Substantial curtailment of these incentives would represent short-sighted and inef-
fective economic planning.
A second reason for the restrictive legislative trend may be the instances of re-
ported abuse-for example, doctors and other professionals arranging for yachts to
be contributed to a purported benefit plan. To the extent such abuses actually exist,
the Coordinating Committee has no interest in protecting them. However, we be-
lieve that actual abuses must first be identified, and that any remedy must be care-
fully tailored in order to excise only the abuse situation. Abuse surgery that cuts
deeply into healthy tissue, for example the recent VEBA legislation, has already
worked unnecessary and unfair hardship on participants in legitimate benefit plans.
In this connection, we are aware of no abuse in collectively bargained plans, and
no such abuse has been reported. It has long been established that the very nature
of the collective bargaining process-where the employer and the employee have a
healthy adversity of economic interest-precludes the kinds of abuses that may
exist elsewhere. All other things being equal, an employer's economic interest does
not lie in making excessive contributions to employee benefit plans. While contribu-
tions are in the employee's interest, employees generally want contributions limited
to what is necessary to fund the benefit involved. A dollar in additional employer
contribution generally means a dollar less in wages. Moreover, multiemployer plans
are jointly trusteed, so that this healthy adversity is reflected in the administration
of such plans. Finally, collectively bargained plans do not selectively provide bene-
fits to owners or highly compensated individuals, thereby posing discrimination
problems, as is generally recognized by the anti-discrimination provisions of the
International Revenue Code.
Thus, in our view, the perception of abuse or abuse potential offers no justifica-
tion for new restrictions, tax or otherwise, on collectively bargained benefit plans.
PAGENO="0560"
554
Apparent abuses in one sector should not be used as a smokescreen for revenue.
motivated cuts in a nonabusive area. In this regard, we note that the House and
Senate Labor committees have a familiarity and expertise on collective bargaining
issues that are not shared by all members of the tax-writing committees. We believe
that their effective exclusion from the legislative consideration of these issues has
produced many unfortunate results, and should not continue.
A third rationale sometimes advanced for restrictions-for example the proposed
"tax cap" on health care benefits-is supposedly grounded in principles of efficiency
and cost containment. Extend the incentive to a flat dollar amount, the theory goes,
and actual health care costs will magically shrink to stay within the limits. Lower
health care costs would benefit everyone (except perhaps the health care providers),
and important social policy and federal revenue considerations would thereby be
served.
This is, of course, pure pipe dream. The actual result would be the taxation of
medical benefits for many middle- and low-income workers. Had the $175 per month
"cap" proposed last year actually been adopted, one study conservatively estimates
the following: 35 percent of the union-represented employees covered by multiem-
ployer plans would have been subject to an average of $145 per year in additional
tax. Some employees in the study would have owed nearly $500 in additional tax. In
this respect, "cost containment" is nothing more than a pleasant euphemism for the
imposition of taxes on health care benefits programs.
Moreover, the efficiency and cost-containment arguments have generally ignored
the substantial, historical contributions of collectively bargained plans in these
areas. Such plans pioneered experimentation with health care delivery systems de-
signed to provide care efficiently and at low cost. These plans were among the first
to utilize Health Maintenance Organizations, second opinions on the necessity for
surgery, and dental clinics. This experimentation has continued outside the health
care arena, as our plans' experience with legal services programs amply demon-
strates.
In summary, then, the Coodinating Committee believes that any reappraisal of
the tax incentives presently afforded to employee benefit plans should not lose sight
of the central facts. First, such plans-particularly collectively bargained plans-
have proven to be overwhelmingly successful arrangements for the private sector
provision of essential benefits. Many of those for whom such benefits are provided
have totally inadequate personal resources, and would otherwise fall back on the
public sector. Efforts to improve on a system that is working so efficiently may well
prove counterproductive.
Second, any so-called "reform" measures must be carefully directed, so as to cover
only instances of actual abuse. Such measures should not result in restrictions on
plans, like collectively bargained plans, where the perceived abuse cannot exist.
Finally, questions of revenue loss, efficiency and cost containment must be consid-
ered in the proper context. Historically, collectively bargained plans have been inno-
vative leaders and experimenters in providing benefits efficiently and at low cost.
Moreover, the "savings" from curtailment of tax incentives in this area may well be
illusory, as plan participants will necessarily look to alternate sources-primarily
federally funded benefit programs.
Messrs. Chairman, with the foregoing as prologue, I would like to address some of
the specific questions posed by the Subcomitttees.
In their August 29, 1984 press release, the Subcommittees asked for information
on the prevalance of fringe benefits (percentage of work force covered) and the per-
centage of total compensation that these benefits represent. As to prevalence-pen-
sion, health, and disability coverage is virtually universal for workers covered by
collective bargaining agreements in industries with multiemployer plans. These in-
dustries include construction, entertainment, the needle trades, retail workers, mar-
itime and trucking. Where other benefits, e.g., supplemental unemployment assist-
ance or severance pay, have been bargained for, they are also provided on a univer-
sal basis.
In general, multiemployer plan benefits are nondiscriminatory not only as to cov-
erage but also as to benefit levels. Even pension benefits generally bear no relation-
ship to position or rate of compensation, but rather are ususally based on length of
service alone and do not increase with higher compensation levels. The total ab-
sence of discrimination in the collectively-bargained context is specifically recog-
nized by the Internal Revenue Code. Id. at § 413(b).
As to the percentage of compensation accounted for by fringe benefits, we esti-
mate that the appropriate figure in industries with multiemployer plans is between
15 and 25 percent. In our industries, at least, true fringe benefits still account for
only a small fraction of total compensation. The big growth in benefit coverage in
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our industries occurred in the mid- to late-fifties. In the sixties, growth in the
number and kinds of plans was slow, but contributions to and the benefits of such
plans increased somewhat. In the seventies and eighties, the legislative atmosphere,
including ERISA and subsequent legislation, has made providing benefits more com-
plicated and less attractive. We expect that the future will also depend to a great
extent on the legislative atmosphere. Without change in applicable law, we would
expect the basic benefit structure and level to remain relatively unchanged. Curtail-
ment or expansion of tax-favored treatment, on the other hand, would likely
produce a parallel cutailment or expansion of benefits.
In you examination of percentages cited to you by others, we caution you to deter-
mine the basis on which the computations were made. Where, for example, FICA,
FUTA, vacation and holiday costs are counted as "fringe benefits," the percentage
will be higher than where they are not. Moreover, some apparent "growth" in
fringe benefit costs has nothing to do with voluntary behavior by employers or em-
ployees, or any desire to convert wage income into tax-favored compensation. For
example, the more rapid funding of pension benefits required by ERISA results in
higher current costs for the same ultimate pension benefit. Health care cost in-
creases may produce similar "growth" in the percentage of compensation accounted
for by health benefits without any real expansion in what participants actually re-
ceive. To the extent Social Security were counted as a "fringe benefit," FICA tax
increases would also have produced such an artificial growth. In summary, the Com-
mittees should be careful not to jump to unwarranted conclusions from numbers
cited to them concerning the percentage of total compensation accounted for by
fringe benefits.
The Subcommittees' press release also asks how the "tax-favored treatment" of
various benefits affects the selection decisions in structuring a compensation pack-
age. To answer this question, different types of "tax-favoring,"-i.e., tax-free receipt
of benefits on the one hand and current deductibility and deferral on the other-
must be distinguished. Current deductibility by employers (whether or not contem-
poraneously includible in employee income) is essential if the selection is to be tax
neutral from the employer's point of view. Compensation that appears in the em-
ployee's pay envelope is clearly deductible, and employers will likely resist compen-
sating in some other form that involves a current expenditure with out a current
deduction. (Until the recent VEBA legislation, there was no such concern regarding
multiemployer plan benefits. Unfortunately, this concern is now all too real.)
Similarly, employees would likely resist being compensated in a form that gener-
ated current taxability even though there were no benefit currently in hand. The
likely reaction will be: "If I'm going to be taxed on some benefit now, I want to
receive the benefit now also, in cash or otherwise." By their very nature, of course,
benefits like retirement income cannot be provided on a current basis to active em-
ployees. Health care coverage presents a similar situation. For this reason, some
asyymetry in taxation, i.e., deferral, may be necessary to preserve tax neutrality in
the selection between benefits and pure wage compensation.
The press release also asks about the effect of including nontaxable benefits in
the Social Security wage base. In the Coordinating Committee's view, any nonwage-
based expansion of the FICA tax base is intrinsically regressive and inequitable.
Subjecting health care coverage to FICA tax, for example, would clearly hit low and
middle-income workers much harder than others. First, health coverage costs are
not generally dependent on income, so equivalent additional amounts would poten-
tially be subject to tax, regardless of income level. Since FICA taxes are assessed as
a fixed percentage, the additional tax would represent a larger percentage of the
lower-paid worker's income.
Second, the income of the most highly compensated already exceeds the maxi-
mum subject to tax. Thus, subjecting health coverage costs to FICA tax would, for
these individuals, result in no additional taxes.
Third, benefits like health care coverage involve no cash income to the recipient.
Thus, workers would have additional taxes withheld from their take-home pay with-
out receipt of any additional moneys with which to pay the taxes. The NCCMP op-
poses any federally-mandated pay cut of this sort.
In brief response to the other questions posed by the press release, the Coordinat-
ing Committee opposes any new caps, excise taxes, or other limits on fundamental
fringe benefits like pension, disability and health care coverage. In the collectively-
bargained context, at least, the natural economies involved (e.g., the worker's natu-
ral desire to receive cash compensation and the employer's natural inclination not
to provide additional gratuitous compensation in any form) provide their own effec-
tive limits on benefits.
40-046 0 - 85 - 36
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As to the relationship between privately-provided fringe benefits and social pro-
grams provided by government agencies, the fundamental link is undeniable. Pen-
sion policy, for example, has been discussed for many years in the context of a
"three-legged stool" supported by Social Security, private pension programs, and in-
dividual savings. If the balance between these three elements is altered, e.g., by a
curtailment of a tax-favored treatment of private pension programs, a compensating
change elsewhere is clearly essential to prevent the stool from toppling. Social Secu-
rity is the obvious possibility. Similarly, cuts in private health care coverage will
clearly increase Medicare/Medicaid costs, and will lead to new and vociferous calls
for additional federal coverage.
Messrs. Chairmen, the seventy-three million workers covered under health insur-
ance plans represent a substantial constituency that must be taken into account.
The taxation of benefit programs may well constitute a low-visibility/no-constituen-
cy issue now. Plan participants tend to take these benefits for granted, and do not
generally scrutinize the Daily Tax Reporter or other public accounts of proposed
changes in this area. Our experience has been, however, that when the change actu-
ally takes effect, participants become veiy vocal. I expect that you have observed
this phenomenon yourselves.
In closing, our fundamental belief is that the private sector plays an essential
role, and is often more efficient and cost-effective than government programs, in
providing health care and other essential benefits. The relatively modest tax incen-
tives set forth in current law are an essential element to the viability of the private
benefits system, as currently in effect. We look forward to the continuation, through
the collective bargaining process, of the health, welfare and retirement benefits on
which our members so strongly depend.
Thank you very much for the opportunity to make our views known.
Chairman PICKLE. Thank you, Mr. Georgine.
I notice that you keep referring to the fact that there ought to be
an involvement of a collective bargaining nature more and more in
these negotiations rather than the tax aspect of it. On page 3 you
state that you are aware of "no abuse in collectively bargained
plans and no abuse has been reported." Well, we in this committee
are not contesting that there are or there aren't abuses. We
haven't said there have been abuses.
We are not going to proceed from a basis that we are claiming
that there have been abuses. Perhaps there have been with some of
the higher paid plans, such as you mentioned with the doctor, but
whether there have or haven't been abuses that is not the question.
What we are concerned about is not who has got the expertise so
much from this committee's standpoint, but what is the extent of
the growth of these programs.
Disabuse yourself that we are trying to balance the social needs
with the tax aspect. The only thing we can consider is the tax. We
don't have to take a position about whether the collective-bargain-
ing process ought to be or whether it should be involved with the
Education and Labor Committee. That may or may not be, but this
committee is concerned about the tax aspect and the growth, and
we are not going to get to chasing that rabbit, that we are going to
raise some money in order to give it to others.
There may not be any abuses in the collective bargaining system,
and we can recognize that, but theoretically, through collective bar-
gaining, you could continue to give collective bargaining that you
think is a good program and it could get higher than a cat's back.
Just collective bargaining itself is not the answer. It can be help-
ful, and you do have expertise there, but we are trying to concern
ourselves now with the growth of these benefits.
Have they grown enough or too much; will they continue to
grow; and should the Congress try to concern itself with some kind
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557
of a standard in the growth of them. That is what we are trying to
get at, and not whether we are trying to recommend that you are
or are not having some kind of abuse or you have more collective
bargaining. That may be.
Mr. GEORGINE. I made that comment with regard to the recent
VEBA legislation, but I would say that there should be some con-
cern if the taxes that are going to be imposed are really in effect
hurting those people who can least afford to pay additional taxes.
That is the point. The point is that what you are doing really is
you are imposing a pay cut on those people.
Chairman PICKLE. If we don't have concern about it, there is a
vast area of people out there, 15 to 20 percent of them, who get
none of these benefits. That is an inequity, and they are usually
the lower paid worker. They are not in unions, many of them, but
they are terribly hurt, and they think this is unfair, and our com-
mittee recognized that they do have a valid point there.
I want to ask you another question, because the question is
before us now with respect to educational benefits. Do you, does
your organization think that we should renew, for instance, the
educational benefit program?
Mr. GEORGINE. We support that, although it doesn't affect in
large measure the members that I represent, which are building
and construction trade workers. But we do support that, yes, sir.
Chairman PICKLE. If you support it, and it has been on the books
previously by statutory exemption, and the Congress is now faced
with the question do we renew it; if we renew it, should we with-
hold FICA and/or FUTA?
Mr. GEORGINE. I think not.
Chairman PICKLE. On the one hand you want the benefits to go
to the employees, but you don't want him to pay any tax on them,
not even withholding or FICA and FUTA; is that correct?
Mr. GEORGINE. That is right.
Chairman PICKLE. Then you want it both ways, don't you?
Mr. GEORGINE. Not really. What I am saying is that these pro-
grams would not be in effect if Congress hadn't passed legislation
that would encourage them. We didn't begin developing pension
funds and health and welfare programs and prepaid legal insur-
ance and all of those kinds of benefits for workers until laws had
been passed that made it permissible to do so.
Chairman PICKLE. The fact that a law is passed and it didn't
withhold doesn't mean that it has to stay in forever. As these pro-
grams continue and as they grow, and as they multiply, we have to
ask ourselves, do we or do we not also have a withholding of FICA
and FUTA, not that it has been on the books previously.
Admittedly, when these laws were on the books previously, the
benefits weren't taxed. I think this committee is willing to now
review them, but we are asking, if so, since they are an item of
value, it should be a small matter about withholding. It is a rela-
tively small matter but it is terribly important with respect to
being a symbolic position.
Mr. GEORGINE. We disagree on that, that it is relatively small. I
don't believe it is relatively small to those workers who are making
such little money that this would be an additional tax and a real
deduction from their income.
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558
Chairman PICKLE. They all don't make a little money. It is not
just a little thing. They could get two or three thousand dollars
benefits a year and you say no withholding on it.
Mr. GEORGINE. Many don't get the benefit.
Chairman PICKLE. But many of them do. Many of them are cer-
tainly able to pay it.
Mr. GEORGINE. That is the purpose of the system, to augment
what they do not get right now.
Chairman PICKLE. If you gave somebody a $2,000 benefit, and
there is a withholding of let's say 7 percent, that would mean each
employee even then would have to pay approximately $10 or $12 a
month. Do you think that is onerous to that employee? They get
$2,000 worth of free benefits and are not willing to pay $10 or $12 a
month for that?
Mr. GEORGINE. In that one year that they get those benefits, I
guess you could say not, but the fact of the matter is that they may
or may not get benefits in any given year. That is the way the
system is designed. The system is designed so that people who
cannot afford hospitalization will have some way of getting it when
the occasion occurs.
Chairman PICKLE. We understand that, and we want them to
have it. I think the Congress takes the position that this is a good
thing and that perhaps it is worthwhile because that improves the
employee's skill. But as that employee gets a very definite value,
then we say that we ought to perhaps include that in FICA.
You realize in the process of doing that, that employee gets a
lower wage base for a period of 1, 2, 3, 4 years, however long it
lasts, however many times it is going to occur. Because these bene-
fits are not included for tax purposes, by the time the employee
gets Social Security benefits, they are a considerably less sum. Do
you admit that?
Well, it is a fact, and you can ask counsel later, but it is a fact,
and we have to look at that also. It seems to me I would think that
it would be equally of an advantageous nature to the unions or to
the employee to include that in the wage base, so that in the histo-
ry, in the long term, they get more of a return.
Mr. GEORGINE. Whether they will get more in the long term is
really speculative and a long way down the road.
Chairman PICKLE. Nobody takes those wages and credits away
from him. All he has to do is just stay alive and he will get them.
I thank you. I am not arguing the question. It just seemed to me
sometimes that in many respects the employees and the unions
want these benefits and they are good, helpful and they fit into our
overall program and training, unemployment trying to improve the
status of that individual and his ability to earn, but they don't
want to pay anything for it.
I won't make the success or failure of Social Security an impor-
tant factor, but it is something we must look at and be honest
about it on both sides. That is what we are trying to do. We will
continue to work with you on this and be glad to deal with you fur-
ther.
Thank you very much.
Mr. GEORGINE. Thank you, Mr. Chairman.
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Chairman PICKLE. Now the Chair will recognize as our last panel
Mr. Ray Denison; Mr. Mike Tiner; and Mr. Alan Reuther.
Thank you, gentlemen. We have Mr. Ray Denison, director, de-
partment of legislation, American Federation of Labor and Con-
gress of Industrial Organization, AFL-CIO. Mr. Mike Tiner is as-
sistant director of government affairs, United Food and Commer-
cial Workers International Union. Mr. Alan Reuther, assistant gen-
eral counsel, International Union, United Automobile, Aerospace
and Agricultural Implement Workers of America. You have got
them all.
First we will be glad to hear from Mr. Denison.
STATEMENT OF RAY DENISON, DIRECTOR, DEPARTMENT OF
LEGISLATION, AMERICAN FEDERATION OF LABOR & CON-
GRESS OF INDUSTRIAL ORGANIZATIONS, ACCOMPANIED BY
ARNOLD CANTOR, ASSOCIATE DIRECTOR, DEPARTMENT OF
ECONOMIC RESEARCH
Mr. DENISON. Thank you, Mr. Chairman. I am accompanied this
afternoon by Arnold Cantor, associate director of our economic re-
search department, AFL-CIO.
The AFL-CIO is pleased to present its views on the tax treat-
ment of employer-paid fringe benefits. We are especially pleased
that the purpose of these hearings is not to draft a particular legis-
lative proposal but to conduct a comprehensive examination and
achieve an understanding of the entire issue of tax-exempt fringe
benefits.
Chairman PICKLE. Mr. Denison, that is why we haven't submit-
ted any legislation, no specific legislation. We are looking at the
broad picture of it. You are correct, and I am glad you mentioned
that.
Mr. DENISON. Thank you.
We appreciate the critical need for measures to reduce the deficit
and make the Nation's tax structure more efficient and productive.
But there are far better means to attain these goals than increas-
ing the taxes of working people and jeopardizing benefits and pro-
tections that are essential to their welfare and that of their fami-
lies. The revenue-raising measures endorsed by the AFL-CIO are
detailed in attachment II on pages 10 through 14.
In December 1979, the AFL-CIO convention set forth general
standards with respect to the taxation of fringe benefits and specif-
ically urged the continuation of present statutes, which expressly
grant tax exemptions under limited circumstances for benefits,
such as qualified pension plans, group life insurance, health bene-
fits, group legal services, employee death benefits, educational as-
sistance programs, and moving expenses.
The Congress, in the just enacted 1984 tax legislation, did much
to end the confusion and uncertainty over the tax status of fringe
benefits. As a result of the 1981 legislation, many fringe benefits
achieved through collective bargaining have now been stabilized. If
they remain so, they will have eliminated the possibility of becom-
ing serious issues in future contract discussions. Unfortunately, in
the legislative process a number of hard fought gains of workers
were unfairly and unnecessarily jeopardized.
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560
Many Americans will suffer as a result of the provisions regard-
ing voluntary employees' beneficiary associations [VEBA's], supple-
mental unemployment compensation benefit trusts [SUB's], group
legal services organizations, certain pension plans and the termina-
tion of the exclusion from income of benefits provided employees
under an educational assistance program.
In the fringe benefit group under consideration at this hearing,
however, the stakes are much higher. At risk are widely used pro-
grams that fulfill major, demonstrable needs and social purposes
that affect the great majority of working Americans.
Health insurance, pensions, day care, education programs, pre-
paid legal plans have evolved over many years and have been sub-
jected to the checks and balances of the legislative process as well
as the collective bargaining process. They have been created to
achieve specific goals. They were won through tough decisions
based on economics and equity.
In examining these benefits Congress is not dealing with frivo-
lous "perks" or gimmicks to shelter income, generate phony losses
or otherwise reduce the taxes of a privileged few. These measures
are for the most part longstanding economic buttresses of the tax
code, that affect millions of workers and are widely distributed.
Most significant is the fact that, in order to qualify for tax exclu-
sion, the plans must comply with stringent rules that prohibit dis-
crimination in favor of owners, officers, shareholders and highly
compensated employees and generally contain limitations and con-
straints to assure that the intended beneficiaries and purposes are
served.
That test in our view distinguishes these provisions from so
many other so-called tax "preferences" which by design or effect
primarily benefit a privileged few and provide no assurance that
their stated purpose will be served.
Private employer paid pension plans, for example cover the vast
majority of the workforce. The latest-1983-Bureau of Labor Sta-
tistics study of employee benefits found that 82 percent were cov-
ered by a pension plan-attachment I, page 9.
The 1983 BLS study also found that 96 percent of all workers are
covered by health insurance plans and that 93 percent had cover-
age for their dependents. Over the past several years employers
have transferred increasing health care costs to their employees-a
trend that runs directly counter to the assertion that the tax struc-
ture unduly influences the growth of such plans.
This is not to suggest that present practices leave nothing to be
desired nor that tax exclusion is a preferred route to attainment of
social goals. It does, however, clearly suggest that:
Any revenue that Congress attainS from taxing fringes will be di-
rectly and exclusively taken out of the pockets of working people,
and
Any changes in relative tax burdens that may come about will be
strictly the result of shifting and rearranging the tax liabilities of
working people.
It seems to us that, at best, Mr. Chairman, taxing these "statuto-
ry" fringes adds up to taxing the same group of people even more.
We are also quite concerned that efforts will be made, in the
search for revenue, to deal with problems that should not and
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561
cannot be solved by the tax code. The administration's proposal to
place annual limits per family and per individual on the amount of
tax-free contributions employers make to worker health insurance
plans is a prime example of misuse of the tax structure.
The claim is that this will make workers more cost-conscious and
the rise in health care costs will be blunted, and, at the same time,
revenue will be raised. Eliminating the tax-free status of employer
health care contributions would force a major reexamination of
these plans with the potential effect of forcing millions of low and
middle income families to lose protection against the high cost of
getting sick.
Those who advocate eliminating tax exclusion for employer
health insurance contributions or placing a cap on tax-free employ-
er contributions grossly overstate the potential for such proposals
to reduce health care inflation. The underlying premise of their ar-
gument is that an employee health tax would give consumers an
incentive to reduce coverage which, in turn, would force a reduc-
tion in demand for health care; and doctors, hospitals and the
health care "providers" would reduce prices.
This is a so-called "market solution" to our health care crisis.
Unfortunately, the health care market does not function like other
"markets." For example, a recent article in the "Journal of Human
Resources" used data from the Department of Health and Human
Services to conclude that health care expenditures which are initi-
ated by physicians represented 89 percent of total health care ex-
penditures.
In other words, unlike other markets where consumers make
their own purchasing decisions, in health care physicians function
as purchasing agents for patients. Physicians decide when patients
need to go into the hospital, how long they stay, and what tests and
medications they receive while they are there. We believe it makes
no sense to use a tax penalty to encourage patients to act in an
area over which they have little control.
Moreover, the most likely effect of scaled back benefits will be
loss of coverage for preventive care, outpatient diagnostic services,
dental, eyeglasses and other benefits which save money. What
would be left intact is coverage for hospital and surgical benefits
which have been the major source of our health inflation problems
and over which patients have very little control.
Attempts to tax employees on the deferred income value of em-
ployer contributions to qualified pension plans raises a huge array
of issues. First, of course, is the fact that pension income is taxed
when received by the employees and their beneficiaries. And, to
qualify, plans must comply with elaborate minimum participation
standards and other rules that forbid contibutions or benefits dis-
criminating in favor of the employer's officers, shareholders, and
other highly compensated employees.
Moreover, the entire legislative history in the area of qualified
pension plans has been one of concern with the level and security
of employee benefits. On this point this committee in 1974 stated
(H. Rep. No. 93-779):
* * * clearly the greatest single protection for rank and file employees during this
time has been the Internal Revenue Service's administration of the provisions deny-
ing any special tax treatment in favor of employees who are officers, shareholders,
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562
supervisdrs, or highly compensated employees. The thrust of this provision is to re-
quire broader substantial participation in the plans than would be provided but for
the Service's administration of the statute.
Other concerns that come to mind surround the fact that since
workers do not have control over the use of pension contributions
it's hard to envision a fair method of considering the contributions
as taxable income. For example:
Many workers never get vesting rights to the money which was
placed in the pension fund in their name. Thus people would be
taxed on money that they will never use.
Although about 50 percent of all private sector pension funds are
for union workers, no union fully controls the fund and only 10-15
percent jointly control their funds. Thus workers, both union and
nonunion in the public and private sector, would be taxed for pen-
sion contributions as if they were recovering benefits that were
equivalent to their paychecks. By taxing pension contributions,
workers would pay taxes on money over which they have almost no
influence.
Many pension funds are not fully funded. Would workers be
taxed on the benefits they have accrued or on the amount which
the employer has actrually contributed?
Frequently, there are larger year-to-year fluctuations in employ-
er contributions based on changing actuarial assumptions. How
would this affect the taxes of individual workers?
Recent hearings before the Subcommittee on Labor of the Senate
Committee on Labor and Human Resources has shed light on the
problem of corporations terminating healthy pensions to "recap-
ture excess assets." Would workers be given tax credits when this
happened?
The interest in taxing employer contributions to workers' pen-
sion plans is particularly difficult to understand in the light of the
many recent attempts and actions to widen the exclusions for Indi-
vidual Retirement Accounts and to expand plans for the self-em-
ployed. These measures contain few of the constraints and assur-
ances against abuse that apply to qualified employee plans and
have a proven track record of reducing the tax burdens of wealthi-
er individuals while doing little or nothing to add to the Nation's
"savings" rate.
With regard to group legal services plans, we continue to urge
that the Congress adopt S. 2080, a bill to make permanent section
120 of the Internal Revenue Code and thus continue to encourage
qualified group legal service plans. We believe that current tax
treatment of qualified group legal service plans has helped in
making such services available to many who would otherwise be
denied such protection at minimal cost. There is no evidence that
such plans have been abused, exploited as tax shelters, or led to in-
equities or discriminatory practices
Stringent limits also preclude abuse in the dependent care assist-
ance exclusion, the revenue loss is minimal and we believe it is in
the national interest to encourage the growth and development of
such programs.
We also believe Congress was wrong allowing expiration of the
statutory exclusion from income of benefits provided employees
and laid-off workers under an educational assistance program.
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563
Again, there is no evidence of abuse and the limitations and condi-
tions needed to qualify, assure again unintended benefits or actions
contrary to congressional intent. And programs under these plans
have helped employees and laid-off workers receive essential train-
ing. Also the expiration of these measures will result in back-tax
payment requirements for ambitious low-level people trying to get
ahead through employer aid for continuing education.
We do not wish to be negative nor do we feel that Congress can
afford to overlook any opportunity to make the tax structure fairer
and better equipped to meet the Nation's needs.
Nevertheless, the fact that the root cause of the problem is the
1981 tax cut cannot be put aside. That act decimated the Treasury
and shifted much of the remaining burden onto the backs of work-
ing Americans.
The 1982 and 1984 tax measures raised some revenue through
curbing abuses and trimming some loopholes. However, substantial
reliance was on excise taxes, taxing employee benefits and other
measures which hurt working people. At the same time measures
such as the withholding of taxes on interest, dividends, and foreign
portfolio income were defeated, corporations were given a $12 bil-
lion windfall by the forgiveness of taxes which were "deferred"
under the Domestic International Sales Corporation (DISC) pro-
gram and the capital gains holding period was cut in half, widen-
ing the loophole responsible for most of the inequities in the indi-
vidual income tax.
We believe this pattern of heaping more and more of the tax
burden on working people must be reversed. We urge you to recog-
nize that any revenue to be gained through taxing workers on their
fringe benefits-particularly those in the areas of health, educa-
tion, pensions, and similar social needs-would result in more in-
justice, not less. The list of alternative means to achieve both reve-
nue and equity goals is a long one. We have appended beginning on
page 10 for your consideration the AFL-CIO's list of recommenda-
tions.
Thank you.
[The prepared statement follows:]
STATEMENT OF RAY DENI50N, DIRECTOR, DEPARTMENT OF LEGISLATION, AMERICAN
FEDERATION OF LABOR & CONGRESS OF INDUSTRIAL ORGANIZATIONS
The AFL-CIO is pleased to present its views on the tax treatment of employer
paid fringe benefits. We are especially pleased that the purpose of these hearings is
not to draft a particular legislative proposal but to conduct a comprehensive exami-
nation and achieve an understanding of the entire issue of tax exempt fringe bene-
fits. We appreciate the critical need for measures to reduce the deficit and make the
nation's tax structure more efficient and productive. But, there are far better means
to attain these goals than increasing the taxes of working people and jeopardizing
benefits and protections that are essential to their welfare and that of their fami-
lies. The revenue-raising measures endorsed by the AFL-CIO are detailed in Attach-
ment II on pages 10 through 14.
In December 1979, the AFL-CIO Convention set forth general standards with re-
spect to the taxation of fringe benefits and specifically urged the continuation of
present statutes, which expressly grant tax exemptions under limited circumstances
for benefits, such as qualified pension plans, group life insurance, health benefits,
group legal services, employee death benefits, educational assistance programs, and
moving expenses.
The Congress, in the just enacted 1984 tax legislation did much to end the confu-
sion and uncertainty over the tax status of fringe benefits. As a result of the 1981
PAGENO="0570"
564
legislation, many fringe benefits achieved through collective bargaining have now
been stabilized. If they remain so, they will have eliminated the possibility of be-
coming serious issues in future contract discussions. Unfortunately, in the legisla-
tive process a number of hard fought gains of workers were unfairly and unneces-
sarily jeopardized. Many Americans will suffer as a result of the provisions regard-
ing voluntary employees' beneficiary associations (VEBAs), supplemental unemploy-
ment compensation benefit trusts (SUBs), group legal services organizations, certain
pension plans and the termination of the exclusion from income of benefits provided
employees under an educational assistance program.
In the fringe benefit group under consideration at this hearing however, the
stakes are much higher. At risk are widely used programs that fulfil major, demon-
strable needs and social purposes that affect the great majority of working Ameri-
cans.
Health insurance, pensions, day care, education programs, prepaid legal plans
have evolved over many years and have been subjected to the checks and balances
of the legislative process as well as the collective bargaining process. They've been
created to achieve specific social goals. They were won through tough decisions
based on economics and equity.
In examining these benefits Congress is not dealing with frivolous "perks" or gim-
micks to shelter income, generate phony losses or otherwise reduced the taxes of a
privileged few. These measures are for the most part long standing economic but-
tresses of the tax code, that affect millions of workers and are widely distributed.
Most significant, is the fact that, in order to qualify for tax exclusion, the plans
must comply with stringent rules that prohibit discrimination in favor of owners,
officers, shareholders and highly compensated employees and generally contain lim-
itations and constraints to assure that the intended beneficiaries and purposes are
served.
That test in our view distinguishes these provisions from so many other so-called
tax "preferences" which by design or effect primarily benefit a privileged few and
provide no assurance that their stated purpose will be served.
Private employer paid pension plans for example, cover the vast majority of the
work force. The latest (1983) Bureau of Labor Statistics study of employee benefits
found that 82 percent were covered by a pension plan (Attachment I, page 9).
The 1983 BLS study also found that 96 percent of all workers are covered by
health insurance plans and that 93 percent had coverage for their dependents. Over
the past several years employers have transferred increasing health care costs to
their employees--a trend that runs directly counter to the assertion that the tax
structure unduly influences the growth of such plans.
This is not to suggest that present practices leave nothing to be desrired nor that
tax exclusion is a preferred route to attainment of social goals. It does however,
clearly suggest that:
Any revenue that Congress attains from taxing fringes will be directly and exclu-
sively taken out of the pockets of working people, and
Any changes in relative tax burdens that may come about will be strictly the
result of shifting and rearranging the tax liabilities of working people.
It seems to us that, at best, Mr. Chairman, taxing these "statutory" fringes adds
up to taxing the same group of people even more.
HEALTH CARE
We are also quite concerned that efforts will be made, in the search for revenue,
to deal with problems that should not and cannot be solved by the tax code. The
Administration's proposal to place annual limits per family and per individual on
the amount of tax-free contributions employers make to worker health insurance
plans is a prime example of misuse of the tax structure. The claim is that this will
make workers more cost conscious and the rise in health care costs will be blunted,
and, at the same time, revenue will be raised. Eliminating the tax-free status of em-
ployer health care contributions would force a major reexamination of these plans
with the potential effect of forcing millions of low and middle income families to
lose protection against the high cost of getting sick.
Those who advocate eliminating tax exclusion for employer health insurance con-
tributions or placing a cap on tax-free employer contributions grossly overstate the
potential for such proposals to reduce health care inflation. The underlying premise
of their argument is that an employee health tax would give consumers an incen-
tive to reduce coverage which, in turn, would force a reduction in demand for health
care; and doctors, hospitals and the health care "providers" would reduce prices.
PAGENO="0571"
565
This is a so-called "market solution" to our health care crisis. Unfortunately, the
health care market does not function like other "markets." For example, a recent
article in the Journal of Human Resources used date from the Department of
Health and Human Services to conclude that health care expenditures which were
initiated by physicians represented 89 percent of total health care expenditures.
In other words, unlike other markets where consumers make their own purchas-
ing decisions, in health care physicians function as purchasing agents for patients.
Physicians decide when patients need to go into the hospital, how long they stay,
and what tests and medications they receive while they are there. We believe it
makes no sense to use a tax penalty to encourage patients to act in an area over
which they have little control.
Moreover, the most likely effect of scaled back benefits will be loss of coverage for
preventive care, outpatient diagnostic services, dental, eyeglasses and other benefits
which save money. What would be left intact is coverage for hospital and surgical
benefits which have been the major source of our health inflation problems and
over which patients have very little control.
PENSIONS
Attempts to tax employees on the deferred income value of employer contribu-
tions to qualified pension plans raises a huge array of issues. First of course, is the
fact that pension income is taxed when received by the employees and their benefi-
ciaries. And, to qualify, plans must comply with elaborate minimum participation
standards and other rules that forbid contributions or benefits discriminating in
favor of the employer's officers, shareholders, and other highly compensated em-
ployees. Moreover, the entire legislative history in the area of qualified pension
plans has been one of concern with the level and security of employee benefits. On
this point this Committee in 1974 stated (H. Rep. No. 93-779):
clearly the greatest single protection for rank and file employees during
this time has been the Internal Revenue Service's administration of the provisions
denying any special tax treatment in favor of employees who are officers, sharehold-
ers, supervisors, or highly compensated employees. The thrust of this provision is to
require broader substantial participation in the plans than would be provided but
for the Service's administration of the statute."
Other concerns that come to mind surround the fact that since workers do not
have control over the use of pension contributions it's hard to envision a fair
method of considering the contributions as taxable income. For example:
Many workers never get vesting rights to the money which was placed in the pen-
sion fund in their name. Thus people would be taxed on money that they will never
see.
Although about 50 percent of all private sector pension funds are for union work-
ers, no union fully controls the fund and only 10-15 percent jointly control their
funds. Thus, workers, both union and nonunion in the public and private sector,
would be taxed for pension contributions as if they were receiving benefits that
were equivalent to their paychecks. By taxing pension contributions workers would
pay taxes on money over which they have almost no influence.
Many pension funds are not fully funded. Would workers be taxed on the benefits
they've accrued or on the amount which the employer has actually contributed?
Frequently, there are larger year-to-year fluctuations in employer contributions
based on changing actuarial assumptions. How would this affect the taxes of indi-
vidual workers?
Recent hearings before the Subcommittee on Labor of the Senate Committee on
Labor and Human Resources has shed light on the problem of corporations termi-
nating health pensions to "recapture excess assets.' Would workers be given tax
credits when this happened?
The interest in taxing employer contributions to workers' pension plans is par-
ticularly difficult to understand in the light of the many recent attempts and ac-
tions to widen the exclusions for Individual Retirement Accounts and to expand
plans for the self-employed. These measures contain few of the constraints and as-
surances against abuse that apply to qualified employee plans and have a proven
track record of reducing the tax burdens of wealthier individuals while doing little
or nothing to add to the nation's "savings" rate.
OTHER PROGRAM OF CONCERN TO WORKERS
With regard to group legal services plans, we continue to urge that the Congress
adopt 5. 2080, a bill to make permanent Section 120 of the Internal Revenue Code
and thus continue to encourage qualified group legal service plans. We believe that
PAGENO="0572"
566
current tax treatment of qualified group legal service plans has helped in making
such services available to many who would otherwise be denied such protection at
minimal cost. There is no evidence that such plans have been abused, exploited as
tax shelters, or led to inequities or discriminatory practices.
Stringent limits also preclude abuse in the dependent care assistance exclusion,
the revenue loss is minimal and we believe it is in the national interest to encour-
age the growth and development of such programs.
We also believe Congress was wrong allowing expiration of the statutory exclusion
from income of benefits provided employees and laid-off workers under an educa-
tional assistance program. Again, there is no evidence of abuse and the limitations
and conditions needed to qualify assure against unintended benefits or actions con-
trary to congressional intent. And programs under these plans have helped employ-
ees and laid-off workers receive essential training. Also the expiration of these
measures will result in back tax payment requirements for ambitious low-level
people trying to get ahead through employer aid for continuing education.
We do not wish to be negative nor do we feel that Congress can afford to overlook
any opportunity to make the tax structure fairer and better equipped to meet the
nation's needs.
Nevertheless the fact that the root cause of the problem is the 1981 tax cut
cannot be put aside. That act decimated the Treasury and shifted much of the re-
maining burden onto the backs of working Americans.
The 1982 and 1984 tax measures raised some revenue through curbing abuses and
trimming some loopholes. However, substantial reliance was on excise taxes, taxing
employee benefits and other measures which hurt working people. At the same time
measures such as the withholding of taxes on interest, dividends, and foreign portfo-
lio income were defeated, corporations were given a $12 billion windfall by the for-
giveness of taxes which were "deferred" under the Domestic International Sales
Corporation (DISC) program and the capital gains holding period was cut in half
widening the loophole responsible for most of the inequities in the individual
income tax.
We believe this pattern of heaping more and more of the tax burden on working
people must be reversed. We urge you to recognize that any revenue to be gained
through taxing workers on their fringe benefits-particularly those in the areas of
health, education, pensions and similar social needs-would result in more injustice,
not less. The list of alternative means to achieve both revenue and equity goals is a
long one. We have appended beginning on page 10 for your consideration, the AFL-
CIO's list of recommendations.
ArTACHMENT I
FULL-TIME EMPLOYEES BY PARTICIPATION 1 IN EMPLOYEE BENEFIT PROGRAMS, MEDIUM AND LARGE
FIRMS, 1983
[Amounts in percent]
Employee benefit program
.
At employees
Professional
and
administrative
Technical and
clerical
employees
.
Prod~ictron
e P nyees
Sickness and accident insurance
49
29
34
67
Long-term disability insurance
45
96
66
98
58
95
28
96
Health insurance for employees
Health insurance for dependents
Life insurance
93
96
95
97
91
95
92
95
Retirement pension
82
86
84
79
Participation is defined as coverage by a time off, insurance, or pension plan. Employees subject to a minimum service requirement before they
are eligible for a benefit are counted as participants even if they have nut met the requirement at the time of the survey. If employees are required
to pay part of the cast of a benefit, only those who elect the coverage and pay their share are counted as participants. Benefits for which the
employee must pay the full premium are outside the scope of the survey. Only current employees are counted as participants; retirees are eucleded
even if participating in a benefit program.
Note-This survey covers medium and large private sector ronagricultural establishments in the United States, excluding Alaska and Hawaii.
Minimum firm size ranges from 50 to 250 employees depending on the industry covered. The number of employees included in this survey is about
55.6 million which is 54 percent of all employed, 80 percent of full-time employees, and 73 percent of private sector nonagricultural employees.
Source: "Employee Benefits in Medium and Large Firms, 1903". U.S. Department of Labor, Bureau of Labor Statistics, August 1904.
PAGENO="0573"
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ArrACHMENT II
THE AFL-CIO TAX REFORM PROPOSALS
The AFL-CIO supports a major tax reform initiative based upon fairness and the
need to raise enough revenues for the federal government to carry out its many
very important responsibilities. For any tax reform proposal to be fair, income must
be retained as the tax base, and the rate structure-as well as actual effective tax
rates-must be progressive.
The AFL-CIO's tax reform proposal calls for the termination of loopholes that
favor business and the rich, and the reversal of some of the more unfair and unwise
features of the 1981 Tax Act.
Basically, we recommend the approach adopted in February, 1983, by the AFL-
CIO Executive Council. That program, through a combination of measures ad-
dressed to the 1981 Act, and some fundamental reforms, would raise the needed rev-
enues, and lead to a fairer tax code, capable of sustaining economic recovery.
A principal cause of the deficit crisis is the 1981 Tax Cut, and raising revenues
requires a major revision of some of the worst features of the 1981 law.
We support a cap on the personal tax cut that would limit the third year of the
tax cut to $700.
A key element of the AFL-CIO's tax justice program is repeal of the indexation
provisions of the Economic Recovery Tax Act of 1981. Repeal of indexation will in-
crease revenues by $6.2 billion in fiscal year 1985 and $16.7 billion in fiscal year
1986.
Without indexing, the system of progressive tax rates automatically serves as a
contracyclical force, moderating excessive demand during inflationary periods and
helping to sustain purchasing power during recessions. If indexing goes into effect,
however, the tax structure will automatically adjust in a procyclical fashion, adding
momentum to inflations and recessions. Moreover, the ability of government to use
discretion in the conduct of tax policy would be severely curtailed by the linking of
tax rates to the rate of inflation. Monetary policy would become an even more domi-
nant factor in the economy.
Another tax loophole mistakely characterized as a savings incentive is the exemp-
tion from taxation of individual retirement accounts. The higher a taxpayer's
income, the greater is the tax windfall this gimmick provides. To make the IRA
somewhat more equitable, the tax benefit should be changed from an exclusion from
gross income to a credit which would provide the same dollar benefit amount re-
gardless of the taxpayer's bracket.
Another feature of the tax code high on our list is the 60 percent exclusion from
income of capital gains. Combined with the lowering of the maximum tax rate to 50
percent by the 1981 Tax Law this exclusion reduces the maximum tax rate on cap-
ital gains to only 20 percent. This exclusion costs the Treasury $18 billion a year in
revenues and primarily benefits the wealthy-with the top 5 percent of taxpayers
getting 60 percent of the benefits. The 1984 law has now reduced the holding period
for long term capital gains from one year to six months and will result in additional
revenue losses. This new gimmick should be reversed.
The AFL-CIO supports restoring the capital gains exclusion to the 50 percent
level that prevailed before 1979, and beginning in 1985, the exclusion should be
phased out over a 5-year period, with adequate protection for homeowners. This
would raise nearly $3 billion in FY 1975 and over $5.0 billion in FY 1986.
The federal tax system was tilted further in favor of the wealthy by the virtual
elimination of the Estate and Gift Tax in 1981. The 1984 tax law delayed the reduc-
tion from 55 to 50 percent, in the top estate and gift tax rate that was scheduled for
1985. The 55 percent rate will remain in effect through 1987. When the rate cuts
and increases in exemption enacted in 1981 are fully phased in, only 0.3 percent of
all estates will be subject to estate taxes, and the liabilities of these few estates that
are taxed will be substantially reduced.
The reduction of estate and gift taxes eliminates an important and equitable con-
straint on the accumulation and intergenerational transfer of vast fortunes. Equity
considerations require effective taxation of accumulated wealth and the recent
array of exemptions of capital from taxation makes this even more urgent.
Restoration of the estate and gift tax to its former structure, which allowed
$250,000, or over half of the estate (whichever is greater) to be passed on to the sur-
viving spouse tax free and provided generous credits for heirs would raise $3.7 bil-
lion in FY 1985, and $5.0 billion in FY 1986.
As a result of the business provisions of the 1981 Tax Act, the corporate income
tax has been virtually eliminated. We call for reinstatement of the corporate income
PAGENO="0574"
568
tax as a source of revenue, equity, and economic balance. Primarily because of the
accelerated cost recovery (ACRS) provisions of the 1981 act, corporate tax revenues
for the 1983 and 1984 budgets are estimated at only $35.3 and $64 billion, respective-
ly. At these levels, corporate receipts will be only 5.9 percent of total 1983 budget
receipts and 9.6 percent of anticipated 1984 revenue. In 1980, the ratio was 12.5 per-
cent, and in 1970, it was 17 percent. In 1960-before the enactment of depreciation
speed-ups, the investment tax credits, and rate reductions-the corporate income
tax financed nearly 25 percent of the entire federal budget. If the corporate income
tax were to bear the same share of the federal tax burden in 1984 as it did in 1980,
receipts would be $20 billion higher. (See the attached chart illustrating the sources
of federal revenues.)
We also support the restoration of a portion of lost corporate tax receipts by
ending the tax subsidies that encourage the overseas operations of U.S.-based multi-
national corporations. These preferences have eroded the tax structure, destroyed
American jobs, and spurred the outflow of U.S. capital, technology, and know-how.
Specifically:
Foreign tax credits-The present practice of allowing dollar-for-dollar credits
against a multinational company's U.S. income tax liability is a loophole which en-
courages U.S. corporations to produce abroad. Foreign taxes should be deducted just
like state taxes and other costs of doing business.
Deferrals-The deferral privilege allows multinational corporations to defer U.S.
income tax payments on the earnings of their foreign subsidiaries until such profits
are brought home-which may never occur.
Foreign Sales Corp. (FSC).-Although the 1984 tax law terminated the Domestic
International Sales Corporation (DISC) program, it replaced it with the new Foreign
Sales Corporation (FSC) provisions, and it forgave the taxes on income that DISCs
have been deferring for years. The Foreign Sales Corporation program, which allows
deferal of taxes on profits of export subsidiaries, should be repealed, and the taxes
defered through DISC should be collected.
Ending these three foreign tax subsidies would ralse $6.5 billion in revenues in
FY 1984 and over $33 billion in the 1984-1986 period.
The Investment Tax Credit.-In 1982 Congress went halfway toward eliminating
the practice of deducting, as depreciation allowances, costs that were already de-
ducted as investment credits. If the job was completed and business was required to
reduce the depreciation base by the full ITC rather than only one-half, over $4 bil-
lion would be recaptured in the 3-year 1984-1986 period. Cutting the credit back
from 10 percent to its previous 7 percent level would raise over $14 billion in 1984-
1986 period.
Oil and Gas.-High on the list of unfinished business is the elimination of the
special tax loopholes for the oil and gas industry. Eliminating percentage depletion
and the immediate expensing of drilling costs and terminating the 1981 law's Wind-
fall Profit Tax changes would increase revenue in 1984 by $3.7 billion and generate
a cumulative revenue increase of over $15 billion during the 1984-1986 period.
We also believe that a temporary surtax should be enacted to meet the current
defense budget needs. Such a tax should be levied on both corporations and individ-
uals; the rate should be graduated, and it should include as part of its base the
income that currently escapes tax through phantom write-offs, special exclusions
and shelters-it could raise annual revenues by as much as $30 billion.
PAGENO="0575"
569
Source of Federal Tax Revenues
Cbrpora fions Have Shifted Their Share of The Costs
of Government
100
F-
z
Ui
0
0::
LII
80
60
40
20
1980
FISCAL YEARS
1/ OTHER INCLUDES PAYERS OF EXCISE AND SOCIAL SECURI1Y TAXES
SOURCE: HOUSE BUDGET COMMITTEE
1 984(proj)
PAGENO="0576"
570
Chairman PICKLE. Thank you, Mr. Denison.
Now we will let Mr. Tiner proceed. Mr. Tiner.
STATEMENT OF MICHAEL L. TINER, ASSISTANT DIRECTOR OF
GOVERNMENT AFFAIRS, UNITED FOOD & COMMERCIAL WORK-
ERS INTERNATIONAL UNION, AFL-CIO
Mr. TINER. Thank you, Mr. Chairman.
My name is Michael Tiner. I am the Assistant Director of Gov-
ernment Affairs of the United Food & Commercial Workers Inter-
national Union (AFL-CIO).
For several years, Congress declined to address the question of
taxing fringe benefits. Congress statutorily prohibited the Internal
Revenue Service from addressing the problem by regulation. At the
same time, Congress was providing a statutory income exclusion
for certain fringe benefits.
Congress provided an exclusion for these statutory fringe benefits
because it believed that the service provided was sufficiently impor-
tant to warrant encouragement. Encouragement was provided in
the form of a statutory income exclusion. The UFCW believes that
nothing has changed to merit the withdrawal of the congressional
encouragement needed to continue to provide these statutory
exempt fringe benefits.
Questions regarding the tax status of non-statutory fringe bene-
fits were resolved recently when Congress passed the Tax Reform
Act of 1984. As the committee knows, five categories of fringe bene-
fits were excluded from the employee's gross income for Federal
income tax purposes and from the wage and benefit base for pur-
poses of social security.
We also believe that the two sets of fringe benefits, both statuto-
ry and non-statutory, minimally should be treated for tax purposes
the same way.
As we said earlier, the tax bill of 1984 only partially addressed
the question of taxing fringe benefits and did not resolve all of the
problems in this area. For example, the statutory exclusion for edu-
cation assistance was not renewed. As the committee is well aware,
this worthwhile program was allowed to lapse because an agree-
ment could not be reached on whether FICA and FUTA taxes
would be paid on this benefit. The UFCW opposed efforts to impose
FICA and FUTA taxes as the price for excluding educational assist-
ance from withholding tax. Additionally, the tax reform bill did not
address the need to extend the income exclusion on group legal
services.
Accordingly, the UFCW was pleased to endorse Representative
Pete Stark's H.R. 5361 extending for five years Section 120 of the
Internal Revenue Code and thus continuing to encourage qualified
group legal service plans.
Although legal service plans exhibit considerable diversity in
structure, costs and benefits, all plans help remedy the unmet legal
service needs. It is important to point out that for the most part
these covered employees are receiving preventive legal services
that often make it possible to avoid litigation or protracted remedi-
al services.
PAGENO="0577"
571
We sincerely hope that the efforts of Representative Stark will
not meet with the same fate as the statutory exclusion on educa-
tional assistance.
It is the UFCW's position, Mr. Chairman, that there cannot be
any real cost containment until the providers and suppliers of serv-
ices have strong financial incentives to change. We urge the com-
mittee to ask itself whether health care is the right place to look
for ways to reduce deficits.
In closing, let me say that we look forward to working with the
Chairman in an attempt to come up with a fair and equitable solu-
tion to the problem of fringe benefit taxing.
[The prepared statement follows:]
STATEMENT OF MICHAEL L. TINER, ASSISTANT DIRECTOR OF GOVERNMENT AFFAIRS,
UNITED FOOD & COMMERCIAL WORKERS INTERNATIONAL UNION (AFL-CIO)
My name is Michael L. Tiner. I am Assistant Director of Government Affairs of
the United Food and Commercial Workers International Union (AFL-CIO).
The UFCW is a labor union with 1.3 million members organized in some 600 local
unions throughout the United States and Canada. The UFCW and its local unions
have collective bargaining agreements with tens of thousands of employers through-
out the food processing, retail sales, fur, leather, health, commercial, shoe and other
industries.
For several years, Congress declined to address the question of taxing fringe bene-
fits. Congress statutorily prohibited the Internal Revenue Service from addressing
the problem by regulation. At the same time, Congress was providing a statutory
income exclusion for certain fringe benefits-for example, health and accident
plans, life insurance, group legal services and educational assistance to mention a
few.
Congress provided an exclusion for these statutory fringe benefits because it be-
lieved that the service provided was sufficiently important to warrant encourage-
ment. Encouragement was provided in the form of a statutory income exclusion.
The UFCW believes that nothing has changed to merit the withdrawal of the Con-
gressional encouragement needed to continue to provide these statutory exempt
fringe benefits.
Questions regarding the tax status of non-statutory fringe benefits were resolved
recently when Congress passed the Tax Reform Act of 1984. As the committee
knows, five categories of fringe benefits were excluded from the employee's gross
income for federal income tax purposes and from the wage and benefit base for pur-
poses of social security and other employment taxes. These five categories are: (1)
No-additional-cost services; (2) qualified employee discounts; (3) working condition
fringes; (4) "de minimis" fringes; and (5) qualified tuition reductions.
We believe that the usefulness to workers and the nation of statutorily exempt
fringe benefits to be far greater than that of the five categories of benefits that Con-
gress just exempted from federal income tax and from wage and benefit base for
purposes of social security. We also believe the two sets of fringe benefits, both stat-
utory and non-statutory, minimally should be treated for tax purposes the same
way.
We realize that there will be strong pressures to raise revenue to offset the huge
deficits created by the tax giveaways of 1981. We suggest Congress look to those who
benefited most in 1981 to now begin to share in the burden of cutting the deficit.
In 1979, the AFL-CIO Convention set forth some general principles with respect to
taxation of fringe benefits on which Congress should base its actions in the area of
fringe benefits.
(1) Sensible "de minimis" rules should be written so that employers and employ-
ees need not take into account small benefit values which would cause unreasonable
record keeping and administrative burdens.
(2) Benefits that facilitate the employee's work performance, are provided for the
convenience of the employer, or other support services, such as the furnishing of
uniforms, should not be taxed.
(3) Limited benefits historically and broadly available such as discounts for em-
ployees of retail stores should be exempted from taxation.
40-046 0 - 85 - 37
PAGENO="0578"
572
(4) Provisions of present law, which under specified conditions expressly grant tax
exemptions for fringe benefits including, among others, qualified pension plans,
group life insurance, health benefits and group legal services should be continued.
As we said earlier, the Tax Reform Bill of 1984 only partially addressed the ques-
tion of taxing fringe benefits and did not resolve all of the problems in this area.
For example, the statutory exclusion for education assistance was not renewed. As
the committee is well aware, this worthwhile program was allowed to lapse because
an agreement could not be reached on whether FICA and FUTA taxes would be
paid on this benefit. The UFCW opposed efforts to impose FICA and FUTA taxes as
the price for excluding educational assistance from withholding tax. Additionally,
the Tax Reform Bill did not address the need to extend the income exclusion on
group legal services.
Since Congress amended the Taft-Hartley Act in 1973 to permit the use of employ-
ee benefit trusts to provide legal services, it has acted twice to extend the income
exclusion. In 1976, Congress extended Section 120 for five years, and in 1981, it was
extended for three years. The UFCW believes that the current tax treatment of
qualified group legal services has helped in encouraging the use and protections of
these plans at minimal costs.
Accordingly, the IJFCW was pleased to endorse Representative Pete Stark's (D-
CA) H.R. 5361 extending for five years Section 120 of the Internal Revenue Code
andthus continuing to encourage qualified group legal service plans.
Although legal service plans exhibit considerable diversity in structure, costs and
benefits, all plans help remedy the unmet legal service needs. Recent studies show
that some 35 percent of the population encounters some problems that could be
solved by a lawyer, but only 10 percent actually seek legal assistance. By contrast,
an average of 20 percent of covered employees in a group plan obtain legal assist-
ance. It is important to point out that for the most part these covered employees are
receiving preventive legal services that often make it possible to avoid litigation or
protracted remedial services.
Although we were unable to determine the total number of UFCW locals current-
ly providing group legal service benefits to members, we have identified three
UFCW locals that provide this benefit. These examples will illustrate the benefit
that this program provides:
(1) In the Paterson, New Jersey area, UFCW Local 464A provides free group legal
services for approximately 6,500 UFCW members. As the result of recent negotia-
tions, an additional 3,000 members began receiving group legal service benefits
August 1, 1984. Local 464A was the first New Jersey local to negotiate group legal
services having negotiated this benefit for its members in 1976.
(2) In the Detroit metropolitan area, UFCW Local 876's group legal service plan
provides free legal services to approximately 14,000 of its members.
(3) In the metropolitan Washington, D.C. area, UFCW Local 400 has a legal serv-
ice plan that provides free legal services to approximately 18,000 employees of two
area retail chains and their families. An additional 10,000 members and their fami-
lies, who are not employed by these two chains, qualify for reduced cost legal serv-
ices by virtue of their membership in Local 400.
By making advance arrangements on a group basis, the time, cost and uncertain-
ty involved in selecting and consulting a lawyer when a legal question arises is dra-
matically reduced. Thus, though the people covered by a plan tend to contact a
lawyer more often, they also do so at an earlier point in the course of a problem. As
a result, more people receive legal advice, matters are handled at lower costs and, in
a way, that minimizes disputed litigation.
The legal services provided by plans are those most often needed by average citi-
zens, starting with initial legal consultations, advice and routine follow-up, and con-
tinuing through routine matters such as wills, divorces, real estate transactions,
consumer matters and so on,depending on the level of plan funding. Most plans at-
tempt to provide reasonably generous benefits in case the individual is sued in civil
court. Some plans provide some coverage in criminal cases. Traffic and misdemean-
or matters are more often covered thatn felonies. Sometimes only the emergency
stages (arraignment and bail) of criminal matter are covered. Plans generally tend
not to cover matters subject to contingency arrangment, such as personal injury and
probate cases. Some plans cover court costs and other litigation expenses. Almost all
plans cover both the employee and his family. Coverage for retirees is also frequent-
ly provided. Although legal service plans fill a real and important need, their cost is
modest.
According to the Joint Committee on Taxation, the annual revenue loss associated
with qualified group legal service pIano i~ $25 million. Itis likely that if Section 120
were made permanent, the figure would grow as more people are covered. Neverthe-
PAGENO="0579"
573
less few sections of the tax code have so clearly achieved their objective at such a
low cost. We believe that workers should not have to pay taxes on employers' contri-
butions to qualified legal service plans.
We sincerely hope that the efforts of Representative Stark to enact H.R. 5361 will
not meet with the same fate as the statutory exclusion on educational assistance.
The UFCW is opposed to the imposition of FICA and FUTA taxes on group legal
service benefits. It is our opinion that the attempts to add FICA and FUTA to edu-
cational assistance is a harbinger of things to come not only on group legal services
but on health and wefare plans as well.
Attempts to cap or limit the amount of tax-free health insurance workers enjoy
are not new or innovative. However, prior to current deficit problems, these attemps
were billed as a means of controlling rapidly rising hospital costs. Now to help pay
for the excesses of the 1981 tax cuts for the wealthy, workers are expected to help
balance the budget by allowing Congress to tax their educational assistance pro-
gram, their group legal service program and their health and welfare program.
Those who advocate taxing health and welfare contributions understand neither
collective bargaining or the health care market. If reductions in benefits are re-
quired due to the imposition of a health tax, what would be dropped from plans are
coverage for preventive care, dental, optical and other benefits which save workers
money. What would be left untouched is coverage for hospital and surgical benefits
which have been the major source of our health inflation problems and represent a
problem over which users have very little control.
We have several other problems with attempts-whether under the guise of cost
containment or deficit reduction-to limit tax exempt contributions. They are:
(1) Worker benefits negotiated through collective bargaining should not be subject
to the vagaries of the tax code, which force distortion in coverage and encourage
circumvention of the process.
(2) Workers in high cost areas will be severely penalized by a national cap.
(3) Employees with chronic conditions and older workers will be forced to pur-
chase expensive supplemental insurance.
(4) The proposal will discourage hiring of older workers and those with higher
health care costs.
(5) The proposal discriminates against workers in unhealthy industries, such as
coal and steel, where health care costs are higher.
(6) The plan would be almost impossible to administer for the self-insured. Since
they do not pay premiums, it would be difficult for tax purposes to determine
monthly employer contributions.
(7) The proposal would require opening up large numbers of existing labor con-
tracts, while the issue of whether the proposal will reduce overall health costs is, at
best, open to question.
It is the UFCW's position, Mr. Chairman, that there cannot be any real cost con-
tainment until the providers and suppliers of services have strong financial incen-
tives to change. We urge the committee to ask itself whether health care is the
right place to look for ways to reduce deficits.
In closing, let me say that we look forward to working with the Chairman in an
attempt to come up with a fair and equitable solution to the problem of fringe bene-
fit taxing.
STATEMENT OF ALAN REUTHER, ASSISTANT GENERAL COUNSEL,
INTERNATIONAL UNION, UNITED AUTOMOBILE, AEROSPACE &
AGRICULTURAL IMPLEMENT WORKERS OF AMERICA (UAW)
Mr. REUTHER. Mr. Chairman, my name is Alan Reuther. I am an
assistant general counsel for the UAW. The UAW appreciates the
opportunity to testify before these subcommittees concerning the
tax treatment of employer-provided fringe benefits.
We commend the subcommittees for holding general oversight
hearings on this issue. It is especially important for Congress to ex-
amine all of the ramifications of the tax treatment accorded vari-
ous employee benefits-including the availability of these benefits,
as well as the tax and fiscal implications-so that it can develop a
sound, comprehensive policy before taking any further actions in
this area.
PAGENO="0580"
574
The UAW urges Congress to simply extend the favorable tax
treatment accorded existing fringe-benefit programs-including
educational assistance and group legal services-and to defer con-
sideration of any further changes in the tax treatment of fringe
benefits until next year, when it will have had time to consider
carefully the information gathered through these hearings and to
formulate a comprehensive policy in this area. In particular, Con-
gress should not single out certain benefits-such as educational
assistance and group legal services-and try to use the continu-
ation of their favored tax status as a vehicle for instituting major
policy changes, such as the imposition of FICA and FUTA taxes on
fringe benefits.
There is no need for such drastic action at this time. Taxing
these benefits will only bring in a minimal amount of revenue
during the next several years.
In addition, careful consideration has not yet been given to the
serious (and we believe insurmountable) problems that would be in-
volved in any attempt to impute taxable value to these benefits in
a fair and consistent fashion.
The UAW strenuously opposes the various proposals which have
been advanced to eliminate or restrict the favorable tax treatment
of certain employee benefits. There are two basic reasons for our
position.
First, the imposition of Federal income or FICA-FUTA taxes on
fringe benefits would constitute a tax increase that would fall most
heavily on middle and lower income workers. Taxing fringe bene-
fits cannot be camouflaged by euphemistic desriptions such as reve-
nue enhancement or broadnening the revenue base. This amounts
to a tax increase, pure and simple.
The increased taxes would be substantial for middle and lower
income workers. For example, if health care and educational assist-
ance benefits were subjected to FICA taxes, the extra yearly tax
burden for a typical auto worker would be about $343. The tax
burden would be much larger if these benefits were subjected to
Federal income tax.
Taxing fringe benefits cannot be defended on grounds of tax
equity. The fact is that taxing fringe benefits would make our tax
system even more regressive than it already is, because the distri-
bution of fringe benefits-such as health insurance-varies only
moderately by income. Furthermore, because there is a cap on the
wage base which is used for computing FICA, the imposition of this
tax on fringe benefits would be particularly regressive.
Second, the imposition of Federal income or FICA-FUTA taxes
on fringe benefits would have a detrimental impact on the distribu-
tion and availability of these benefits among the work force. Espe-
cially in the case of non-cash fringe benefits-such as health insur-
ance, educational assistance, and group legal services-where the
fringes are provided in the form of in-kind services and cannot be
converted to cash under any circumstances, the imposition of Fed-
eral income or payroll taxes would inevitably have a chilling effect
on the commitment of employers and employees to the growth and
development of these benefits.
In our judgment, employees are likely to find the taxation of
these benefits to be unacceptable, because there would be an in-
PAGENO="0581"
575
crease in their tax burden while nothing is added to their earn-
ings-thus resulted in a net reduction in their take-home pay.
I would like to emphasize that the UAW's position does not rep-
resent a blanket endorsement of tax-favored treatment for all
fringe benefits-regardless of their nature or the amount of the
benefits. We believe that the tax treatment of employee benefits
should be based on an evaluation of the merits of the particular
benefit involved. The UAW draws a sharp distinction between
those employee benefits which protect wage-earners from the vicis-
situdes of illness, old age, or layoffs through mechanisms they
could not set up by themselves, and those benefits which are pri-
marily used as a device to shelter earnings for small groups of
upper income individuals.
Using this yardstick we have strongly urged Congress to retain
the tax-free status of health insurance benefits, group legal service
benefits, and educational assistance benefits. There is no evidence
that any of these benefits has been used in a discriminatory
manner or as a device by upper income individuals to avoid tax li-
ability.
On the other hand, the UAW did not oppose the employee bene-
fit changes in TEFRA, or the taxation of group life insurance bene-
fits above $50,000. We have also advocated repeal or reduction of
the tax expenditures associated with 401(k) plans, IRAs and other
tax avoidance devices. And where it is demonstrated that a particu-
lar fringe benefit is being abused by professional corporations or
upper income individuals as a tax avoidance device, the UAW sup-
ports narrowly drawn measures-including limits on the funding
or amounts of tax benefits-which are targeted at eliminating
those abuses.
However, the UAW is strongly opposed to the enactment of any
overall cap on the amount of tax-favored fringe benefits which are
available to a worker-regardless of whether this is structured in
terms of a flat dollar amount or as a percentage of compensation.
An overall cap on fringe benefits would not take into account the
different merits of various fringes. It would also introduce inequi-
ties among different groups of workers, as well as workers residing
in different parts of the country.
The taxation of employee benefits has been proposed by some
persons because of concerns about the huge deficits which are cur-
rently projected for the Federal Government, and because of con-
cerns about the future solvency of the social security and medicare
programs. The UAW share these concerns. However, the Federal
budget deficits have been caused by the enormous and unnecessary
increases in defense expenditures under the Reagan Administra-
tion, coupled with the huge and wasteful tax cuts that were en-
acted in the Economic Recovery Tax Act of 1981 [ERTA]. Those
deficits should therefore be attacked by scaling down the projected
course of military spending and by repealing or reducing some of
the costly tax provisions that were enacted in 1981 and more re-
cently in 1984.
Thanks to the legislation enacted by Congress in 1983, the social
security system is now projected to be financially sound for 75
years. There is no need to impose Federal income or FICA taxs or
fringe benefits, in order to "save" social security. It is true that
PAGENO="0582"
576
substantial deficits are projected to develop in the medicare pro-
gram, beginning some time after 1990. However, those deficts are
largely attributable to the excessive inflation which has character-
ized the health care industry in recent years.
Instead of imposing Federal income or FICA taxes on health in-
surance and other fringe benefits, the UAW submits that the medi-
care financing problems should be attacked through the institution
of comprehensive cost controls on the delivery of health care, such
as those contained in the Medicare Solvency and Health Care Fi-
nancing Reform Act of 1984, H.R. 4870, proposed by Representative
Gephardt.
In conclusion, the UAW recognizes that Congress faces difficult
choices in dealing with the huge Federal deficits and the financing
problems of the Medicare program. Some sacrifices are going to
have to be made by everyone if these problems are going to be re-
solved. However, we do not believe that taxing fringe benefits is
the proper solution. Saddling the middle class with taxes on em-
ployee benefits to raise additional revenues will simply compound
the inequities created by ERTA and make the tax code even less
progressive than it already is.
We believe this would be perceived as fundamentally unfair by
the public and thus only serve to fuel the "tax revolt" mentality by
undermining support for the tax system and useful social pro-
grams. Moreover, we believe it would be particularly unfair to
single out particular fringe benefits-such as educational assist-
ance and group legal services-for taxation at this time. If the Fed-
eral budget deficits and medicare's financing problems are going to
be solved in a fair and effective manner, this will only be accom-
plished through comprehensive tax reform and medicare legisla-
tion-not through piecemeal changes in the tax status of certain
fringe benefits.
Thank you.
[The prepared statement follows:]
STATEMENT OF ALAN REUTHER, ASsIS~rANT GENERAL COUNSEL, INTERNATIONAL
UNION, UNITED Au'rOMomix AEROSPACE & AGRICULTURAL IMPLEMENT WORKERS OF
AMERICA (UAW)
Chairmen, my name is Alan Reuther. I am an Assistant General Counsel for the
UAW. The UAW appreciates the opportunity to testify before these Subcommittees
concerning the tax treatment of employer provided fringe benefits.
The UAW represents more than 1.5 million active and retired workers and their
families. The collective bargaining agreements negotiated by the UAW provide our
members with a variety of employee benefits, including pensions, income protection
during layoffs, health care, life insurance, legal assistance, and education and train-
ing.
The UAW commends the Subcommittees for holding general oversight hearings
on fringe benefits. It is especially important for Congress to examine all of the rami-
fications of the tax treatment accorded various employee benefits-including the
availability of these benefits, as well as the tax and fiscal implications-so that it
can develop a sound, comprehensive policy before taking any further actions in this
area.
Due to the absence of any comprehensive policy, Congress has recently been send-
ing mixed signals with respect to fringe benefits. The Deficit Reduction Act of 1984
helped to stabilize and rationalize the tax treatment of employee benefits, by codify-
ing the rules governing the treatment of so-called "non-statutory" fringes. At the
same time, however, Congress took certain actions in connection with this legisla-
tion which could have a deleterious impact on the development of voluntary employ-
PAGENO="0583"
577
ee beneficiary associations (VEBAs), supplemental unemployment benefit (SUB)
plans, and educational assistance programs.
The UAW submits that Congress should defer consideration of any further
changes in the tax treatment of fringe benefits until next year, when it will have
had time to consider carefully the information gathered through these hearings and
to formulate a comprehensive policy in this area. In particular, Congress should not
single out certain benefits-such as educational assistance and group legal serv-
ices-and try to use the contribution of their favored tax status as a vehicle for in-
stitution major policy changes, such as the imposition of FICA and FUTA taxes on
fringe benefits.
There is no need for such drastic action at this time. Taxing these benefits will
only bring in a minimal of revenue during the next several years.
In addition, careful consideration has not yet been given to the serious (and we
believe insurmountable) problems that would be involved in any attempt to impute
taxable value to these benefits in a fair and consistent fashion. For example, it is
unclear whether taxes would be imposed on the value of services actually received
by an employee, or on the value of the contributions, premiums, or payments made
by the employer to or on behalf of the employee. There would be obvious problems
in valuing any services provided to employees. There would also be problems in de-
termining to whom employer contributions, premiums, or payments should be at-
tributed-especially in cases where an employer makes contributions based on a cer-
tain number of cents per hour worked by active employees, but the benefits are ac-
tually received by retirees and unemployed persons, as well as active workers.
Accordingly, the UAW urges Congress not to embark on any major policy changes
at the present time. Instead, it should extend the favorable tax treatment of exist-
ing fringe benefit programs, including educational assistance and group legal serv-
ices, so that Congress will have time to develop a comprehensive, equitable policy
dealing with the tax treatment of all fringe benefits.
The UAW strenuously opposes the various proposals which have been advanced to
eliminate or restrict the favorable tax treatment of certain employee benefits. There
are two basic reasons for our position.
First, the imposition of federal income or FICA-FUTA taxes on fringe benefits
would constitute a tax increase that would fall most heavily on middle and lower
income workers. Taxing fringe benefits cannot be camouflaged by euphemistic de-
scriptions such as "revenue enhancement" or "broadening the revenue base". This
amounts to a tax increase, pure and simple.
The increased taxes would be substantial for middle and lower income workers.
For example, the complete taxation of health care and educational assistance bene-
fits would increase the total yearly tax burden of an average auto worker with a
family by about $1300 and $330 respectively. Even if these fringes were only subject-
ed to FICA-FUTA taxes, and not federal income tax, the extra yearly tax burden
would still be substantial, costing a typical auto worker approximately $273 and $70
respectively.
Taxing fringe benefits cannot be defended on grounds of tax equity. The fact is
that taxing fringe benefits would make our tax system even more regressive than it
already is, because the distribution of fringe benefits (such as health insurance)
varies only moderately by income. Furthermore, because there is a cap on the wage
base which is used for computing FICA, the imposition of this tax on fringe benefits
would be particularly regressive. In practical terms, middle and lower income work-
ers who are below the FICA wage base would wind up having tp pay increased
taxes, while upper income persons who are already above the wage base would not
have any additional tax liability. We believe this would be fundamentally unfair.
Some persons have argued that workers would still benefit by having FICA taxes
levied on fringe benefits, because this would enlarge the wage base used to compute
their future social security benefit entitlements. We simply do not believe however,
that any marginal increase in future benefit entitlements can justify the imposition
of the substantial additional taxes that workers would have to pay if FICA taxes
were levied on fringe benefits-especially in view of the regressive nature of this
payroll tax.
Second, the impositon of federal income or FICA-FUTA taxes on fringe benefits
would have a detrimental impact on the distribution and availability of these bene-
fits among the workforce. Especially in the case of non-cash fringe benefits-such as
health insurance, educational assistance, and group legal services-where the
fringes are provided in the form of in-kind services and cannot be converted to cash
under any circumstances, the imposition of federal income or payroll taxes would
inevitably have a chilling effect on the commitment of employers and employees to
the growth and development of these benefits. The additional costs and administra-
PAGENO="0584"
578
tive burdens will dampen the enthusiasm of employers. And employees are likely to
find the taxation of these benefits to be unacceptable, because there would be an
increase in their tax burden while nothing is added to their earnings-thus result-
ing in a net reduction in their take-home pay. The problems inherent in trying to
impute taxable value in a fair and consistent manner would also exacerbate employ-
ee dissatisfaction.
The favorable tax treatment accorded employer provided fringe benefits has cer-
tainly been a factor in the development and extension of these benefits-especially
pensions and health insurance-to a very broad segment of the workforce. This has
resulted in improved economic well-being and security for millions of workers, and
thereby contributed to the general welfare of society as a whole. Taxing these bene-
fits will only serve to curtail their availability, to the detriment of workers and the
entire country.
I would like to emphasize that the UAW's position does not represent a blanket
endorsement of tax-favored treatment for all fringe benefits-regardless of their
nature or the amount of the benefit. Rather, we believe that the tax treatment of
employee benefits should be based on an evaluation of the merits of the particular
benefit involved, including its actual or expected utility to various income and de-
mographic groups. The UAW draws a sharp distinction between those employee
benefits which protect wage-earners from the vicissitudes of illness, old age, or lay-
offs through mechanisms they could not set up by themselves, and those benefits
which are primarily used as a device to shelter earnings for small groups of upper
income individuals.
Using this yardstick, we have strongly urged Congress to retain the taxfree status
of health insurance benefits, group legal services benefits, and educational assist-
ance benefits, which have recently come under challenge. These fringe benefits have
helped to make health care, legal services, and education and training available to a
broad segment of the workforce. There is no evidence that any of these benefits has
been used in a discriminatory manner or as a device by upper income individuals to
avoid tax liability.
On the other hand, the UAW did not oppose the employee benefit changes in the
Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), or the taxation of group
life insurance benefits above $50,000. We have also advocated repeal or reduction of
the tax expenditures associated with 401(k) plans, IRAs and other tax avoidance de-
vices. We continue to strongly support measures which make favorable tax treat-
ment contingent on non-discrimination and other requirements. And where it is
demonstrated that a particular fringe benefit is being abused by professional corpo-
rations or upper income individuals as a tax avoidance device, the UAW will contin-
ue to support narrowly drawn measures-including limits on the funding or amount
of benefits-which are targeted at eliminating those abuses.
However, the UAW is strongly opposed to the enactment of any overall cap on the
amount of tax-favored fringe benefits which are available to a worker-regardless of
whether this is structured in terms of a flat dollar amount or as a percentage of
compensation. An overall cap on fringe benefits would not take into account the dif-
ferent merits of various fringes, and would not distinguish between those benefits
which are serving important social purposes and those benefits which are being
abused as tax avoidance devices. An overall cap would also introduce inequities
among different groups of workers, as well as workers residing in different parts of
the country. For example, health insurance protection is generally more expensive
for workers in high-risk occupations such as assembly-line workers, mineworkers,
and steel and foundry workers. And persons residing in Los Angeles have to pay
twice as much for a given health insurance policy as persons in Raleigh, North
Carolina. Finally, an overall cap tied to a percentage of compensation would be par-
ticularly unfair, since it would wind up allowing a greater tax expenditure for upper
income persons.
The taxation of employee benefits has been proposed by some persons because of
concern about the huge deficits which are currently projected for the federal govern-
ment, and because of concerns about the future solvency of the Social Security and
Medicare programs. The UAW shares the concerns about the need to reduce the fed-
eral deficits, and to insure the solvency of Social Security and Medicare. But taxing
employee benefits is not the way to accomplish these goals.
The tax-favored status accorded various employee benefits has not been responsi-
ble for the creation of the federal deficits or the financing problems of Social Securi-
ty and Medicare. Although it is true that employee benefits have represented an
increasing percentage of wages and salaries in recent years (reaching 32.5 percent
in 1982), it is important for Congress to recognize that most of these benefits are not
tax-exempt fringes. Indeed, of the 32.5 percent of wages and salaries going to em-
PAGENO="0585"
579
ployee benefits, 13.9% was devoted to taxable fringes (such as vacations, holidays,
and sick pay), 9.5% was devoted to legally required employer contributions to social
security, unemployment and workers compensation, and only 9.0% went to tax-fa-
vored fringe benefits.' Moreover, of the 9.0% devoted to tax-favored fringes, 4.0%
went to pensions and other benefits which simply involve a tax-deferral rather than
a tax-exemption. And 4.4% was attributable to health, life and short-term disability
incurance benefits. Thus, it is apparent that other tax-favored fringe benefits-such
as educational assistance and group legal services-do not represent a substantial
portion of employees' compensation, and thus cannot be blamed for the financial
problems facing the federal government. The tax expenditures associated with these
fringe benefits are minimal, and certainly do not represent a cause for concern.
The federal budget deficits have been caused by the enormous and unnecessary
increases in defense expenditures under the Reagan Administration, coupled with
the huge and wasteful tax cuts that were enacted in the Economic Recovery Tax
Act of 1981 (ERTA). Those deficits should therefore be attacked by scaling down the
projected course of military spending and by repealing or reducing some of the
costly tax provisions that were enacted in 1981 and more recently in 1984-especial-
ly those which eroded the corporate tax base and are further lining the pockets of
rich individuals.
Thanks to the legislation enacted by Congress in 1983, the Social Security system
is now projected to be financially sound for seventy-five years. There is no need to
impose federal income or FICA taxes on fringe benefits, in order to "save" Social
Security. It is true that substantial deficits are projected to develop in the Medicare
program, beginning some time after 1990. However, those deficits are largely attrib-
utable to the excessive inflation which has characterized the health care industry in
recent years. Although some persons have suggested that health care benefits ought
to be taxed because they have become "excessive" and helped to foster inflationary
pressures in the health care industry, this reasoning is simplistic and erroneous. As
we will show later in our testimony, the inflation in the health care industry has
multiple causes; workers having "too much" health insurance is not one of them.
Instead of imposing federal income or FICA taxes on health insurance and other
fringe benefits, the UAW submits that the Medicare financing problems should be
attacked through the institution of comprehensive cost controls on the delivery of
health care, such as those contained in the "Medicare Solvency and Health Care
Financing Reform Act of 1984" (H.R. 4870) proposed by Representative Gephardt.
The UAW recognizes that Congress faces difficult choices in dealing with the huge
federal budget deficits and the financing problems of the Medicare program. Some
sacrifices are going to have to be made by everyone if these problems are going to
be resolved. However, we do not believe that taxing fringe benefits is the proper
solution. Saddling the middle class with taxes on employee benefits to raise addi-
tional revenues will simply compound the inequities created by ERTA and make the
tax code even less progressive than it already is. We believe this would be perceived
as fundamentally unfair by the public, and thus only serve to fuel the "tax revolt"
mentality by undermining support: for the tax system and useful social programs.
Moreover, we believe it would be particularly unfair to single out particular fringe
benefits-such as educational assistance and group legal services-for taxation at
this time. If the federal budget deficits and Medicare's financing problems are going
to be solved in a fair and effective manner, this will only be accomplished through
comprehensive tax reform and Medicare legislation-not through piecemeal changes
in the tax status of certain fringe benefits.
Finally, the UAW's support for granting favorable tax treatment to certain em-
ployee benefits does not mean that we have abandoned our longstanding support for
meeting social needs with federal programs, in favor of a private sector approach.
On the contrary, we still believe comprehensive federal programs are the best
means of making retirement income, health care, training and other benefits avail-
able on an equitable basis to the largest number of persons. Specifically, we contin-
ue to support enactment of a national health insurance plan and an effective feder-
al job training program. Government programs are the best way to insure that dis-
placed workers, minorities, women and the poor share fairly in the progress made
by the rest of society.
But in the absence of federal action, the UAW and other unions have understood
that employer-provided fringe benefits are the only way to insure that large groups
of workers have access to necessary protection. Government backing through tax ex-
1 Cited in Employee Benefit Research Institute, "Testimony on Employee Benefits and Eco-
nomic Security,' June 26-30, 1984, p. 15.
PAGENO="0586"
580
emptions and deferrals is therefore justifiable for workers to preserve the protec-
tions that they now enjoy.
I would now like to discuss in more detail some specific employee benefits.
HEALTH CARE BENEFITS
The expansion of employer health insurance plans since the end of World War II
has been dramatic. The growth of group health insurance coverage among workers
and their dependents has promoted wide access to health care, particularly through-
out the non-elderly population. In 1979, more than 60% of the civilian population
was covered by an employer group health plan; nearly 90% of full-time, year-round
workers participated in an employer group health plan that year.2 Coverage has
reached beyond the higher-wage sectors of the workforce; the economies of scale as-
sociated with greater inclusion of workers in a group plan have encouraged the ex-
tension of health insurance coverage to lower-income workers.
This expansion of health insurance coverage, both in numbers and scope, has pro-
vided greater financial security and peace of mind to covered families. While the
full array of benefits are not available to everyone and millions of people still lack
effective access to the health care system, the expansion of health insurance cover-
age has benefited society as a whole, by contributing to the remarkable improve-
ment in the health of Americans, to their increased longevity, and to the countless
breakthroughs achieved in the care and treatment of illness during the last three
decades.
One important factor in this development, although by no means the only one,
has been the tax-exempt status of employer-provided group health care benefits.
The proposals to have workers pay taxes on the health insurance premiums paid by
their employers threaten the integrity of existing health insurance plans and would
adversely affect beneficiaries. Specifically, the proposal by the Reagan Administra-
tion that tax-free employer contributions be limited to $70 per month for individuals
and $175 per month for families would be wrong because:
It would create pressure to reduce negotiated health care benefits, to add copays
and deductibles, and to drop various coverages (such as dental and vision care) from
employee health benefit plans.
It would penalize groups with more older workers who need to use more health
care services. This in turn would discourage employment of older workers.
It would act as an incentive for the younger, healthier workers in a plan to leave
the plan, opting instead for reduced, inadequate coverage, and raising the cost of the
plan to the remaining workers. The fragmentation of plans would add to the admin-
istrative costs of employers.
It would penalize workers in higher risk occupations, such as assembly line work-
ers, steel and foundry workers, and mineworkers.
It would unfairly affect certain geographic regions because of variations in medi-
cal care costs in different areas.
It would put pressure on employers and unions to reduce coverage for preventive
health services. Such barriers to prevention and early treatment of illness could
lead to increased use of high cost hospital inpatient facilities.
Taxation of health care benefits would impose substantial, unfair new taxes on
working people. If the Reagan Administration's proposal had been enacted, many
workers required to pay income taxes on employer premium payments in excess of
the "cap" would have wound up paying federal income taxes in 1984 on more than
40% of the health insurance premiums paid by their employer. The tax cap proposal
could have cost a worker with a family as much as $300 to $375 per year in in-
creased taxes, equivalent to a cut of up to $7 in his or her weekly paycheck.
From the point of view of tax equity, the taxation of health care benefits would
result in a more unfair after-tax distribution of income since employer costs for
health insurance are relatively constant with respect to income levels.
The tax cap and other efforts to tax health care benefits would be ineffective in
stemming the rapid rise in health care costs. Inflation in the sector is not due to too
little cost sharing among workers. Most workers covered by health insurance are
still exposed to substantial out-of-pocket payments for personal health services.
UAW members employed by the major auto companies, for example, whose health
insurance protection compares favorably with the broadest and most comprehensive
coverage among American industrial workers, can expect to foot about 30% of their
medical care bills on their own. Their program excludes almost all services (except
2 in Employee Benefit Research Institute, "Testimony on the Tax Treatment of Employ-
ee Benefits," June 22, 1983.
PAGENO="0587"
581
surgery and emergency care) performed by doctors in their offices and requires sig-
nificant patient copays for such items as prescription drugs, dental care and vision
care services.
Inflation in the health care industry also cannot be attributed to the expansion of
health insurance coverage. In fact, health insurance coverage practically ceased
growing in the 1970's while that period and the early 1980s have seen the greatest
increases in health care prices along with increases in consumer out-of-pocket pay-
ments. It is hard to believe that if we had less coverage or more cost sharing the
problems of the health care system would go away.
A careful look at the problem suggests that health care inflation has multiple
causes including cost based reimbursement of hospitals, reasonable charge reim-
bursement of fee-for-service physicians, provider generated overuse of services, pro-
liferation of for-profit health care providers, the introduction and spread of high-
tech equipment, aging of the population, excess hospital capacity and the absence of
any rational comprehensive cost control program. Taxing health care benefits does
not attack these causes of inflation. Indeed, proponents of reducing insurance and
increasing patient cost sharing fail to realize that:
(1) There is no study which indicates that cost sharing has any long term effec-
tiveness in reducing total health care costs. One only has to look to the federal Med-
icare program to see the ineffectiveness of cost sharing in controlling costs. Medi-
care has had extensive deductibles and coinsurance since its beginning in 1966, and
both have increased over the years. Yet the cost of the program to the federal gov-
ernment has risen from $4.5 billion in 1967 to nearly $60 billion in 1984.
(2) The effect of cost sharing on health status is uncertain. In fact, there is some
evidence that patient cost sharing can serve as a barrier to early treatment and ac-
tually increase costs because more expensive treatment is required for conditions
which have deteriorated due to postponement of care.
(3) After the patient makes the decision to go to the doctor in the first place, vir-
tually all decisions about what services are to be provided are made by doctors and
other providers. Deductibles and copayments have been shown to have little effect
on treatment decisions made by doctors.
Consumers do not admit themselves to the hospital or arrange for their dis-
charges, nor do they make the decision to stay in the hospital for an inordinate
amount of time.
Consumers do not write prescriptions for themselves, not do they order an array
of unnecessary tests and services for themselves.
Consumers do not decide to build unnecessary hospital beds; neither do they
decide to keep beds on line that should be closed down. It is not consumers who
permit the continued existence of hospitals that should be closed.
Consumers do not decide to acquire additional expensive equipment already avail-
able within the community.
(4) Cost sharing has been shown to have almost no effect on the prices doctors and
hospitals choose to place in their services. Providers decide the price of their serv-
ices, not some free market.
(5) The greatest increases in health care costs in recent years have been in the
hospital sector. Yet patient cost sharing has been shown to have even less impact on
use of hospital services than on other kinds of health care.
(6) Patient cost sharing discourages access to care by lower-income persons. Study
after study has shown that the burden of cost sharing falls inequitably on the poor,
on blue collar workers, on minorities, and on those with large families.
In fact, the principal effect of patient cost sharing is to penalize consumers and to
distract focus from the more politically difficult issue of holding our health care
system accountable to public and consumer goals.
The cutbacks imposed by the Reagan Administration in federal spending for Med-
icare and Medicaid have not resulted in real health care cost containment. Rather,
they have simply shifted costs to the private sector by raising Medicare deductibles,
by requiring employers to provide primary coverage for older employees also cov-
ered by Medicare, and by allowing providers of care to pass along the burden of cer-
tain governmental "cost containment" efforts to private sector payers. The UAW
and other unions have negotiated health insurance benefits for their active and re-
tired members and their dependents which supplement Medicare coverage. When
Medicare benefits are reduced there are no "savings"; there is simply a massive
transfer of liabilities to individuals, insurers and private sector employers. In the
case of private sector employers, the transfer of liabilities results in higher health
insurance premiums over which neither the employer nor active and retired em-
ployees have any effective control. It is unconscionable that the Reagan Administra-
tion, which has been responsible for this massive cost shifting to the private sector,
PAGENO="0588"
582
also proposes to tax the increased health insurance premiums that result from that
shifted responsibility.
A more constructive and effective approach to the problem of rising health care
costs is to begin the reform of the overall health care system. Ultimately such
reform will be accomplished only under a comprehensive national health program.
In the short-run, we favor an approach by which states would establish, within
broad federal guidelines, "all payer" systems of prospective hospital reimbursement,
negotiated fee schedules for doctors, and fixed diagnostic and laboratory fees. In ad-
dition, alternative forms of delivery, such as health maintenance organizations,
should be encouraged. A serious example of such an approach is the proposed "Med-
icare Solvency and Health Care Financing Reform Act of 1984," which has been in-
troduced by Senator Kennedy (5. 2424) and Representative Gephardt (H.R. 4870).
We urge these Subcommittees to consider such legislation as a positive alternative
to proposals to tax the health benefits of workers. It would begin to get at the root
of the problem by containing escalating costs in the overall health care system
through reduction of the inefficiencies and the excessive profits which characterize
much of the health care industry. This would be of great benefit to all payers for
health care services, including the federal Medicare and Medicaid programs, as well
as to private employer-provided health insurance plans.
RETIREMENT PLANS
Like employer-provided group health insurance, employer-sponsored pension
plans have greatly expanded since World War II. By 1983, approximately 43% of all
employees participated in an employer-sponsored pension plan.3 The growth of such
pension plans has been due in large part to the efforts of the labor movement,
which recognized that Social Security needed to be supplemented in order to insure
that workers' retirement years would be free of financial worry. However, the tax
deferred status accorded to pension contributions has also helped to encourage the
establishment of funded pension plans-thus assuring workers a greater measure of
security against the risk of poverty in old age, and creating a "safety net" whose
benefits reverberate throughout the entire society.
In recent years the tax code has been modified in order to encourage the expan-
sion of salary reduction or 401(k)-type plans, and so-called Individual Retirement Ac-
counts (IRAs), rather than the traditional employer-sponsored pension plans. These
are very disturbing developments.
IRAs and salary reduction plans blatantly favor upper income individuals. In the
case of IRAs, this is borne out by the results of a May 1983 survey conducted by the
Census Bureau for the Employee Benefits Research Institute and the Health and
Human Services Department.4 Of the 16.7 million IRAs established in 1982, 50%
were used by the 15% of all survey respondents earning above $25,000. Proportion-
ately more than twice as many workers earning $50,000 or more contributed to
IRAs as did workers earning between $20,000 and $50,000, and more than five times
as many workers earning over $50,000 contributed to TEAs as did those earning be-
tween $15,000 and $20,000. By contrast, coverage under employer-sponsored pension
plans is approximately the same for each of these groups: over $50,000, 74.4%;
$20,000 to $50,000, 74.4%; $15,000 to $20,000, 63.7%. Salary reduction or 401(k)-type
plans are also inequitable because they favor higher-paid employees: only employees
who have discretionary income will participate, and those will typically be more
highly-paid employees. In addition, contributions are allowed as tax deductions
rather than tax credits, again benefiting those in higher tax brackets.
The dramatic expansion of IRAs and 401(k)-type plans has caused a considerable
drain on the Treasury. After TEAs were expanded in 1981, the Office of Manage-
ment and Budget estimated that tax expenditures for them and similar plans would
increase by $2.1 billion from fiscal 1981 to 1983. In fact, the total jumped by $11.3
billion; and 0MB now projects that TEAs alone will reduce revenues by $14.2 billion
in the next fiscal year.
The UAW is also concerned about the growing trend of government policies which
favor an "individual account" approach to employee benefits, such as TEAs or 401(k)
plans, at the expense of traditional benefit plans. The UAW firmly believes that de-
fined benefit plans meet workers' retirement needs better than other private-sector
vehicles because they provide a predictable retirement income and do not subject
participants to investment risks. Since benefits can be increased based upon service
already accrued, adjustments can be made to take account of inflation both for
~ Benefit Research Institute Issue Brief No. 32, July 1984.
4lbid.
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583
active employees and for retirees. Flexible funding arrangements allow these costs
to be paid over reasonable periods of time. While they are superior to other pension
arrangements, defined benefit plans cannot be set up individually; thus the tax in-
centive provided for establishing these plans on a group basis clearly enhances
social welfare.
The promotions of IRAs, which often "promise" to make younger workers million-
aires by retirement age, have downplayed the interest-sensitivity of these projec-
tions and the impact that the inflation accompanying these interest rates would
have on purchasing power. Unrealistic expectations engendered by such promotions
could represent a widespread problem in the future.
EDUCATIONAL ASSISTANCE BENEFITS
The UAW is profoundly disappointed by the failure of Congress to establish the
tax-exempt status of educational assistance benefits provided by employers as part
of the tax legislation which was recently enacted. We believe the continuation of
hundreds of programs to improve the education and skills of American workers is
now in jeopardy. These programs not only help those directly involved; the public at
large also benefits from higher productivity, a more dynamic economy, and a more
equitable society.
The importance of these programs is underscored when we look at the massive
dislocation of American workers that has occurred in recent years. Recession,
import penetration, and technological change have taken an increasingly severe
toll, causing an unprecedented number of workers to permanently lose their jobs. In
addition, the skills of scores of thousands of active workers are quicidy falling
behind the demands posed by the new, redesigned jobs.
Within the UAW, our concern about re-employment opportunities for unemployed
members and the uncertain occupational future that many currently employed
members face has led us to give training and retraining a high priority in our col-
lective bargaining agenda. Early in 1982 we established important new joint train-
ing programs with the Ford Motor ~ompany and the General Motors Corporation.
Under both programs, the goal is to provide training, retraining, and developmen-
tal opportunities for active and laid-off UAW-represented workers. For laid-off work-
ers, these programs provide invaluable assistance in seeking re-employment. For
active workers, the programs have provided an opportunity to upgrade skills and
enhance job security.
The response of our members has been enthiisiastic. Close to thirty thousand
workers have participated in the various educational, training and related pro-
grams.
Taxing these benefits will discourage employees from participating in the pro-
grams, to the detriment of workers' chances for employment and career advance-
ment. Efforts already in place, including costly buildings and equipment, will be uti-
lized far below capacity or not at all. As a result, the entire cconomy will be short-
changed.
Failure to reestablish the tax-exempt status of these benefits means a return to
the situation prior to 1978, when the IRS required that employer-reimbursed tuition
assistance relate solely to present job responsibilities in order to merit tax-exempt
status: This will result in benefits being confined mostly to upper-income individuals
in executive and management positions, and will clearly restrict the availability of
benefits to rank and file workers.
In addition, taxation of educational assistance provides many American workers
with a disincentive to invest in their own human potential, in stark contrast to the
incentives that the tax code lavishes on business for investment in plant and equip-
ment.
Taxation of educational assistance cannot be defended on grounds of revenue loss:
its current impact on the deficit is very small. Indeed, as a matter of revenue policy,
taxation of educational benefits seems woefully shortsighted. It makes much more
sense to subsidize education and training now, and tax the resulting higher incomes
in the future; in effect, we are not talking about exemption as much as about tax
deferral, on higher future earnings.
The UAW commends Representatives Shannon and Frenzel for introducing legis-
lation (H.R. 2568) which would permanently exclude employer-provided education
assistance from taxable income. We urge the Members of the Ways and Means Com-
mittee to act promptly to approve this important legislation.
PAGENO="0590"
584
GROUP LEGAL SERVICE PLANS
The UAW has long been a supporter of group legal service plans. In our view,
they represent the best means of making quality, low cost legal services available to
average working men and women. Traditionally, legal services have been available
in this country only to the top and bottom segments of society. The wealthy and
powerful can afford to hire the best law firms. And the very poor are provided free
representation through legal aid offices. Average middle class Americans have been
left out in the cold.
This situation began to change because of a number of developments in the late
1960s and 1970s. An important one was the addition of Section 120 to the Internal
Revenue Code in 1976, making it clear that employer contributions to and services
provided under qualified group legal service plans do not constitute taxable income
to employees.
That tax change removed an obstacle, and the UAW and other labor unions in-
creasingly began to take an interest in negotiating group legal service plans as a
means of assuring that their members have access to quality, low cost legal repre-
sentation.
The UAW now has approximately 630,000 active employees and retirees, along
with their families, covered under negotiated group legal service plans. The reponse
of our membership to the programs has been enthusiastic. They have expressed sat-
isfaction with the quality of the legal services provided by the programs. And our
members have indicated that they consider group legal services to be an important
and valuable fringe benefit which they are interested in preserving and expanding.
The types of legal problems handled by our group legal service plans are diverse.
The consumer-debtor services have proven to be especially important for our mem-
bership, which has faced financial pressures as a result of layoffs and the recession.
The real estate and probate services have also proven to be valuable. By making
these legal services readily accessible to our members, they have often been able to
obtain legal advice before serious problems have risen.
The UAW remains committed to the growth and development of group legal serv-
ice plans which can provide quality, low cost legal services to our members. Howev-
er, the continued growth and viability of group legal service plans would be ob-
structed by termination of their tax-exempt status embodied in section 120 of the
Internal Revenue Code.
Section 120 is currently scheduled to expire on December 31, 1984. If it is not ex-
tended, the acceptability among employers and unions of new group legal service
plans will be seriously undermined: Worse, the continued operation of existing plans
will be jeopardized.
Keeping the tax-exempt provisions for group legal plans will not cause any seri-
ous revenue loss for the federal government. The Joint Committee on Taxation has
estimated that the tax expenditure associated with Section 120 amounted to only
$20 million in 1982. Even assuming that the number and size of group legal service
plans were to grow considerably in the future, because such plans are relatively in-
expensive, the tax expenditure still would not be of sufficient magnitude to warrant
concern.
In order to encourage the continued development and growth of group legal serv-
ice plans, Congress should now act to extend Section 120. We commend Chairman
Stark for introducing H.R. 5361, which would extend Section 120 for five years. We
urge the Members of the Ways and Means Committee to act promptly to approve
this important legislation. This will give employers and labor unions the assurance
they need in the long term viability of group legal service plans in order to make a
major commitment to such programs in collective bargaining. In turn, it will help
make legal services available to millions of middle class Americans.
FUNDED WELFARE BENEFIT PLANS
For about two decades, most UAW members have been covered by contract
clauses providing for supplemental unemployment benefits when they get laid off.
These cash benefits have cushioned the impact of cyclical or seasonal unemploy-
ment on our members, as well as the communities where they live. While SUB ben-
efits are taxable income to employees, the total contributions made by the compa-
nies to the SUB funds have always been tax deductible.
The Tax Reform Act of 1984 limits the deductibility of employer contributions to
voluntary employee beneficiary association (VEBAs), supplemental unemployment
benefit (SUB) plans, and prepaid legal service plans. We understand that Congress
acted because of concern about various abuses associated with "pre-funding" of top-
heavy plans by professional corporations. The UAW strongly supports curbing those
PAGENO="0591"
585
abuses. However, since no abuses have been documented in connection with collec-
tively bargained plans, there was no justification for extending the funding limits to
these plans. As currently structured, the funding limits could have an adverse
impact on our SUB plans, because they are not sensitive enough to accommodate
the wide cyclical swings in SUB payouts. Specifically, these limits could prevent em-
ployers from being able to make sufficient contributions to the SUB plans so that
sufficient reserves are built up to pay benefits during future recessions.
The recent history of the UAW-GM SUB plan demonstrates the need for substan-
tial reserves and the adverse impact of the new restrictions. In July 1979, the
UAW-GM SUB plan had assets of $443 million. By September 1980, the auto crisis
had caused the balance to shrink to $30 million. Under the new law, the funding
limits would now restrict the UAW-GM SUB plan to just $367 million,~ despite the
fact that during the preceding seven years which can be taken into account in calcu-
lating the funding limits, there were two years (1980 and 1982) when the plan paid
out almost $1 billion. Worse yet, by 1990-when neither 1980 nor 1982 can be count-
ed in calculating the funding limits-the UAW-GM SUB plan could be restricted to
a potentially inadequate reserve of $150 million.
During the recent depression in the auto and farm implement industries, the ex-
istence of large reserves in our SUB plans not only spared many UAW families
from destitution, but also cushioned the shock on numerous communities through-
out the country which were hit hard by massive layoffs and plant closings. Thus,
the new limitations on the funding of SUB plans could have an adverse impact on
the general public, as well as UAW members.
Under the new law, the Treasury Department is required to promulgate regula-
tions by July 1, 1985, establishing special reserve limits for collectively bargained
plans. We urge Congress to closely monitor the actions of the Secretary, to insure
that collectively bargained plans are in fact accorded sufficient flexibility in their
funding arrangements.
CONCLUSION
Chairmen, this statement has focused upon a number of important employee ben-
efits, pointing out that they warrant favorable tax treatment because of their
merits, the role they play in the lives of broad groups of people, and the non-cash
form in which they are paid. There are other employee benefits which I have not
discussed due to space limitation, but which are also supported by the UAW. For
example, well designed employer sponsored child care programs can provide desira-
ble mechanisms and economies not otherwise available to most working people.
They deserve to be encouraged through the tax laws because they accomplish a
function not fulfilled by the current tax credit allowed to individuals for child care
expenses.
On the other hand, the UAW supports stringent rules against top heavy fringe
benefit plans and limits on the amount of pension or severance payments which are
tax exempt. Fringes which merely reduce taxable income for those who are already
well off and paying less than their fair share of taxes should not receive favorable
tax treatment.
The UAW is concerned about the size of federal deficits and supports efforts to
raise taxes to reduce them. The attached UAW tax program sets out in detail
sources of revenue that would bring in substantial funds, while increasing the pro-
gressivity of the tax code and the share of taxes paid by corporations. In the search
for higher revenues, the employee benefits I have discussed should be the last
source taped, on the basis of the protection they afford to those covered, their posi-
tive impact on society and the fact that no federal action seems to be forthcoming in
the near future to take their place.
We have appreciated the opportunity to present our views concerning the tax
treatment of employer provided fringe benefits. We urge the Subcommittees to give
them careful consideration in any future actions relating to the tax status of vari-
ous employee benefits.
UA W tax program
[Additional revenues for fiscal year 1985 in billions]
Taxation of individuals:
Cap the third year of the 1981 tax cut at $700 $6.9
Repeal indexation of tax brackets scheduled to begin in 1985 6.2
Restore the estate and gift tax, which was largely repealed by ERTA 2.1
Change IRAs from a deduction to a credit, to provide the same dollar
amount of savings to all "savers" regardless of tax bracket 3.7
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586
Phaseout of capital gains preferences. The exclusion should be cut back
to the pre-1979 level of 50 percent, and a phasedown begun to totally
eliminate this preference over a 5-year period. Special provisions to
protect homeowners should be enacted. Capital gains preferences for
investing in gold, collectibles, and other nonproductive assets should
be eliminated outright. The provision in the Tax Reform Act of 1984
that reduced the long-term capital gain and holding period from one
year to 6 months should be repealed 3.9
Taxation of corporations:
If the corporate income tax were to bear the same share of the federal
tax burden in 1984 as it did as recently as 1980, receipts would almost
double. One way to move in that direction is by adoption of a mini-
mum tax for corporations. Other measures toward the same goal in-
clude:
Phase out tax preferences related to foreign operations. Foreign
taxes should be treated just like other costs of doing business.
Right now, foreign tax credits allowed on a dollar-for-dollar basis
against a multinational company's U.S. income encourage U.S.
corporations to export jobs and to produce abroad. Multinational
corporations should not be allowed to defer U.S. income tax pay-
ments on the earnings of their foreign subsidiaries until such
profits are brought home. The recently enacted Foreign Sales Cor-
poration provision that allows deferral of taxes on export profits
is no improvement over the DISC it replaced and like DISC
amounts to a wasteful and costly tax expenditure 9.5
Eliminate tax breaks for the oil industry. Oil depletion allowances
and writeoffs for intangible dwelling costs have no economic justi-
fication. They favor both major oil companies and so-called inde-
pendent producers, and provide a generous tax shelter to the
income of highly-paid individuals 6.0
Allow the Research and Development Credit for Incremental Re-
search and Experimentation Expenditures to expire at the end of
1985. The preferable approach is for the federal government to
target assistance through a NASA-type agency, so that there is as-
surance that the new technologies which are fostered will lead to
job-creating investment in the U.S (1)
Attach meaningful strings to investment incentives. The UAW has long
advocated the repeal of across-the-board investment incentives; Most
often, they become a windfall for companies that would make the in-
vestment anyway. Instead, we support targetted federal relief. Either
directly or through the tax system, federal help would be made avail-
able to those companies, industries, and regions which need it most
and which agree to commit themselves to desirable actions with re-
spect to employment levels, location of facilities, labor standards, etc.
While this shift takes place, there should be curbs on the revenue
drain related to the investment tax credit and accelerated deprecia-
tion schedules. In particular:
End double-dipping on the investment tax credit. Since 1981, accel-
erated depreciation write-offs have been allowed on the entire
purchase price of new equipment, although as much as 10 percent
of the price is offset by the investment tax credit. In 1982, Con-
gress disallowed accelerated depreciation deductions for half the
value of the investment tax credit. That job should be finished by
allowing depreciation deductions only after the full amount of the
investment tax credit has been subtracted 1.3
Stop tax inducements for mergers and acquisitions. Companies
should not be allowed to take advantage of the unused tax breaks
of firms they acquire. Deductions of interest paid to finance un-
justified corporate mergers and acquisitions should also be disal-
lowed (2)
`None in fiscal 1985, but substantial savings in future years.
2 available.
Chairman PICKLE. Thank you, Mr. Reuther.
I thank all you gentlemen for your testimony. Obviously you
have spent a good bit of time on this and feel very strongly about
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587
it. Do any of you gentlemen feel that some Members of the Con-
gress, of this committee in particular, are advocating taking away
fringe benefits or employee benefits from the employees?
Mr. DENISON. I don't think they are thinking in those terms, but
that would be the practical effect of such an act.
Chairman PICKLE. What act?
Mr. DENISON. The effect would be that if there is an imposition
of taxes on these benefits, the logical end result, would be a reduc-
tion in the benefits.
Chairman PICKLE. Your contention is that you don't know if any-
body is trying to take away employee benefits, but a tax would be
the same thing as taking away their benefits?
Mr. DENISON. That would be the result because eventually the
benefits would be eroded.
Chairman PICKLE. You must have in mind if there is imposition
of a FICA or FUTA in any category that would be a tax increase?
Mr. DENISON. It would be and it is our feeling that if the commit-
tee is looking for revenues--
Chairman PICKLE. There is no bearing if there has to be a tax,
FICA, that it would go into social security or unemployment?
Would that not help the workers?
Mr. DENISON. Not to impose further taxes.
Chairman PICKLE. If the funds went into the social security trust
fund.
Mr. DENI50N. These programs came about as a result of a need
and they answer a strong social need and they are working well,
with no abuse. If we are looking for revenues, we suggest other
places to look.
Chairman PICKLE. There are a lot of ways to look. We know that
this committee over the years, each session seems to look at a dif-
ferent way to try to raise revenues. There are a lot of ways, but
whether that happens that may take some time, meanwhile we
have a question, do we renew the educational exemption? You say
yes, we should. I don't know that anybody is going to disagree with
you, but you say you must not have any kind of a withholding for
social security benefits on it. I guess that is the whole issue. The
purpose of these hearings is not just to raise revenue for social se-
curity or for the unemployment program, but rather to get on the
record here as comprehensive a set of facts to use as a data base as
we can to determine the thing to do. That is the purpose of it.
By listening to your testimony, I have a feeling that you have
mounted a campaign against FICA and FUTA. We tried to say at
the beginning we hope there is not a campaign put on to scare
people by the employers or the employees. We have a serious prob-
lem in the Congress to determine how to handle these things. If we
get involved in a lot of rhetoric or accusations, we might have diffi-
culty establishing a proper level of it. That is my contention. The
fact that we have never had anything like that doesn't mean that
we should not look at it.
If we have collective bargaining and continue these programs,
the question is will they continue to grow and should they grow?
Mr. REUTHER. If the concern of the committee is that certain
fringe benefits are growing such that they are being abused, we be-
lieve that the proper response is to place a limit on those benefits.
40-046 0 - 85 - 38
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588
Chairman PIcKi~. I won't argue with you about abuse.
Mr. REUTHER. This was done with pension benefits which we sup-
ported.
Chairman PIcKLE. We have made corrections on abuses in pen-
sions, we think considerable corrections.
Mr. REUTHER. Take the example of educational assistance. If the
committee believes that there are some people getting three or four
thousand dollars worth of benefits and that is excessive, we believe
the solution would be to place a cap on it, but under our collective
bargaining agreements, people are not getting two, three, or four
thousand dollars worth of benefits. The maximum amount is $1,000
and we don't believe that that is abusive.
Under the prepaid legal plans, the yearly cost involved for a
member is about $48. We hardly think that is an abusive amount.
Chairman PIcKLE. Mr. Reuther, you had said earlier with respect
to FICA or FUTA that there is no need for such drastic action. Do
you call putting a FICA on an educational program a drastic
action?
Mr. REUTHER. Yes, I would, because, first of all, the taxes that
would be imposed on our members would be significant.
Chairman Piciu~. We will have to look at the facts and have
some comparisons to see what is being asked of the employee. That
will remain for answer at a later time.
It is difficult for me to see how drastic it is. You point out that
the amount of revenue is not important and we ought not to do it.
Was that not your statement?
Mr. REUTHER. There is no need for the action to be done this
year.
Chairman PIcKLE. Because it wouldn't raise that much revenue.
If it is not, it wouldn't hurt the employees that much. Getting the
benefits but not including it in the wage base works both ways. It
seems to me like you are asking for it both ways.
Mr. DENISON. We are finding that every time there is a tax ex-
amination up here, it always seems to end up that the workers end
up paying the most and we are concerned--
Chairman PICKLE. I hope we haven't done that.
Mr. DENISON. We feel we are being nickeled and dimed to death.
Every time there is a tax bill there is more in terms of social secu-
rity taxes, individual taxes or whatever. When you look at the pay-
ments of the Federal revenues now in terms of corporations, that is
the only area where it shrunk; but in terms of excise taxes, they
have gone way up and those usually fall heaviest on working
people.
Chairman PICKLE. I don't think we are going to settle that today.
Mr. DENISON. No, but I am saying perhaps FICA by itself doesn't
appear to be a great amount of money, but for a person making
$12,000 to $18,000 a year who is being hit continuously with in-
creased taxes at state and local levels, it is cumulative.
Chairman PICKLE. How much of a hardship is that going to apply
in actual dollars of an employee's benefit?
Mr. DENISON. I think we would look with some favor if the same
tax were imposed on withholding of interest and dividends and cap-
ital gains and we start showing concern for that.
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589
Chairman PICKLE. You are trying to balance one against the
other. We can't do that today. That is not the purpose. We are
trying to ask ourselves, if these benefits grow, how much will they
grow?
Mr. DENIs0N. Our concern is to retain employee benefits. We are
in periods now where union after union are giving up health care
benefits.
Chairman PICKLE. I don't know of anybody that is trying to take
them away.
Mr. DENISON. The economic realities are every union represented
here at the bargaining table is being asked to give up eye glass pro-
tection, dental protection--
Chairman PICKLE. I don't want to get into that at this hearing.
Mr. DENISON. That is the reality.
Chairman PICKLE. You are saying that this would be a drastic
tax on the individual if we held it for legal services or any of these
categories. Suppose the Congress is willing to renew educational as-
sistance. That is an important thing in my judgment. It ought to be
renewed. But the question is should we renew it with the FICA and
FUTA? Would you give up educational assistance if we put FICA
and FUTA on it?
Mr. DENISON. No. We would continue to fight for it without FICA
and FUTA.
Chairman PICKLE. We think that is a symbolic point in this
whole discussion. Do we do this or do we just continue on the same
level, and I don't know what position the committee will take, but I
think it is important that we ask ourselves these questions because
we find in the Congress that many times these benefits are deliv-
ered more efficiently through private enterprise working with the
employees on choice of benefits. We like that.
The question is how far do we go with it?
Mr. CANTOR. Mr. Chairman, you seem to make much of the
notion of symbolism and what will be meant by this and it raises to
me the point that I think we agree that the intent of these is not to
do away with these benefits, but nevertheless over the past several
years the tax structure has been used in the sense of forgiveness,
so we tried to encourage retirement, for instance, by reducing taxes
on individual retirement income, tried to encourage capital forma-
tion by reducing taxes on corporations. Now you are saying that we
should increase taxes on workers but that would not discourage
something.
I think there is a kind parallel reasoning here--
Chairman PICKLE. I don't want to put a tax on workers, not
single out workers. We don't intend that.
Mr. CANTOR. I am just looking for a little of that same kind of
symmetry.
Chairman PICKLE. As one of the co-authors of the IRA program,
which we think works well, we have almost reached a point where
they may become too good, the Congress will have to look at that,
how much do we allow into those kinds of programs. We get into
the question of what is good tax policy on IRA's, savings, social se-
curity and employee benefits and it comes to where we have to ask
ourselves on the part of government what is the proper level of it. I
don't like the idea of a cap, but I don't know how we control it
PAGENO="0596"
590
without some standard and I guess we are looking for that, but
none of us that I know of are trying to take away fringe benefits.
That is the hue and cry, we are trying to tax them and take them
away. I don't accept that.
Mr. DENISON. I think that is the perception out there already.
Around the country at the meetings this is the hottest issue.
Chairman PIcKu~. That perception is being fed a little bit.
Mr. DENISON. The Wall Street Journal reports that chief execu-
tives of corporations say that taxing of benefits probably would
mean that benefits will be cut.
Chairman PICKLE. I know it is being observed in the newspapers
over the country. I can see the campaign that is afoot. But we need
to determine what is the best approach on these programs. We
have to decide that and that is the purpose of the hearings.
I want to say that I anticipate that we will be having other hear-
ings on this quesiton. I hope to have another hearing or two be-
tween now and the time that we adjourn and we will take them up
again next year. We are not trying to rush into some kind of a de-
cision now. This is a very broad question, probably the most vexing
problem facing the American people now and we are doing it not
for purposes of correcting the deficit, although that is one aspect of
it, the question is what is good tax policy and how far does it go
and I am sure that you all agree with me on that.
I hope we can work together on this and we will continue to visit
with you and talk with you about it and perhaps have other testi-
mony from you and your organizations. So I thank you and appre-
ciate your bringing your testimony.
The subcommittee will stand adjourned until further notice.
[Whereupon, at 2:30 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
STATEMENT OF ROBERT AG. MONKS, ADMINISTRATOR, OFFICE OF PENSION AND
WELFARE BENEFIT PROGRAMS, U.S. DEPARTMENT OF LABOR
My office and the Department of Labor is pleased to submit for the Subcommit-
tees' consideration an overview of the recent growth and development of perhaps
the most important single employee benefit-private pensions.
The period since the enactment of the Employee Retirement Income Security Act
of 1974 (ERISA) has been marked by a high degree of growth in the private pension
system. This growth is particularly evident in the two-fold increase in pension plan
assets, the more than doubling of the number of pension plans and the 50 percent
increase in total plan participants. Details on the growth of the individual compo-
nents of the pension system are presented below. A table summarizing many of
these trends is appended by my written statement.
PRIVATE PENSION PLAN COVERAGE
The participation rate for full-time private wage and salary workers has remained
at about 50 percent since 1972. However, there have been significant shifts in cover-
age rates among age groups. Between 1972 and 1979 the percentage of covered work-
ers under age 25 decreased from 31 to 27 percent. In part, this happened because a
number of plans adopted participation requirements during this period. Workers
aged 50-59, however, experienced an increase in coverage, from 54 percent in 1972
to 64 percent in 1979. This increase in the coverage rate of older workers, combined
PAGENO="0597"
591
with ERISA minimum standards on vesting and retirement requirements, has sig-
nificantly increased the number of employees becoming eligible to receive a pension
at retirement.
In 1972 the vesting rate for plan participants in their 50's was 42 percent; in 1979
it was 68 percent. Given the low mobility rate of workers in this age group it can be
expected that the vast majority of older covered workers will receive a pension.
Thus, while the overall coverage rate for full-time workers is 50 percent, as many as
two-thirds of all full-time workers can ultimately expect to participate in and vest
in a pension based upon the long term jobs which they will find later in their ca-
reers.
Women workers, in particular, have benefited from higher coverage rates and
minimum vesting requirements. From 1972 to 1979 the overall participation rate for
women increased from 37 to 40 percent and for women aged 50-59 coverage in-
creased from 42 to 53 percent. During the same period the overall percent of cov-
ered women employees who were vested increased from 26 to 41 percent and for
women in their 50's from 31 to 59 percent.
PENSION RECIPIENTS AND BENEFIT AMOUNTS
The number of private pension recipients increased by two-thirds over the last 10
years, from 4.8 million in 1974 to approximately 8 million in 1983. The amount of
pension benefits being received has also increased substantially in recent years,
both for new annuitants and for retirees already receiving benefits. In 1973 the av-
erage annual benefit received by a newly retired annuitant was $2,429. By 1978 new
pension recipients were receiving an average annual benefit of $3,947 and in 1983
new recipients were estimated to be receiving an average annual pension of $6,400.
From 1973 to 1983 new annuitants have received an initial average benefit 10 per-
cent higher than annuitants retiring the previous year.
In addition to providing increased benefits to new annuitants, many plans periodi-
cally increase the benefit rate for annuitants retired in prior years. Generally the
increases are provided on an ad hoc basis, with only a relatively small number of
plans providing increases based on cost of living provisions. Plan participants re-
tired prior to 1973 received annual benefit increases averaging 3.6 percent from
1973 to 1979, raising their average benefit amounts from $2,128 in 1972 to $2,638 in
1979. The overall benefit increase of 24 percent from 1973 to 1979, however, did not
keep pace with consumer prices, which rose 63 percent during the same 6 year
period.
NUMBER OF PRIVATE PENSION PLANS AND PARTICIPANTS
From 1975 to 1983 the number of private pension plans climbed from 340,000 to
an estimated 775,000. This rapid growth occurred both among defined contribution
plans, which increased by 132 percent, and among defined benefit plans, which in-
creased by 120 percent.
Part of the increase in the number of private plans is attributable to employers
establishing initial pension plans for their employees. Most of this type of growth
occured among smaller firms with fewer than 100 employees and, particularly,
among firms with fewer than 10 employees. Because the growth in initial new
plans, although substantial, is concentrated among small firms, it has not resulted
in any measurable increase in the overall coverage rate.
In addition to the increase in total plans resulting from firms adopting plans for
the first time, a significant portion of total plan growth resulted from firms with
existing defined benefit or money purchase plans establishing defined contribution
plans to provide supplemental benefits. These supplemental plans are frequently
profit sharing, savings or stock bonus plans.
In contrast to the concentration in growth of initial plans among small firms,
much of the increase in supplemental plans has occurred among very large firms.
This has substantially increased the total number of plan participants by providing
dual coverage of many workers without affecting the net coverage rate. While the
net number of employees covered by at least one pension plan increased from 27.5
million in 1975 to 35.5 million in 1981, a 29 percent increase, the total number of
active participants in all pension plans increased from 37 to 50.5 million, a 36 per-
cent increase. The difference in growth rates is attributable to the increase in dual
coverage. In 1981 an estimated one-third of all workers in a basic plan also partici-
pated in one or more supplemental plans. This compares with a 29 percent dual cov-
erage rate in 1975.
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592
TYPE OF PLAN
For approximately 82 percent of all covered workers basic coverage is provided by
a defined benefit plan. Most of the remaining 18 percent are covered by a money
purchase plan. About 60 percent of the supplemental coverage is provided by profit
sharing plans, with stock bonus plans covering an additional quarter of the dual
plan participants. Generally, basic plans are noncontributory, while supplemental
plans often require employees to contribute as a condition for participation. Supple-
mental plans, however, usually provide more liberal vesting. The vesting rate for
participants in defined benefit plans is about 46 percent, compared to 82 percent for
defined contribution plans, most of which provide supplemental coverage.
PENSION PLAN ASSETS
From 1975 to 1983 private pension plan assets increased from $294 billion to an
estimated $900 billion. This represents an average annual growth rate of 15 percent.
The average growth rate in 1983 dollars was 6.5 percent. Plan assets are projected
to grow to $2.2 trillion in 1983 dollars by the year 2000.
Of the $900 billion in assets held by private pension plans at the end of 1983
almost three-fourths were held by defined benefit plans. The growth rate in assets
among defmed benefit and defined contribution plans since 1975 has been similar.
There is evidence that defined contribution plan assets may grow at a faster rate in
the future. The average age of defined benefit plans is 9 years, with plans covering
100 or more participants in existance for an average of 17 years. Over 90 percent of
all defined benefit plans are now fully funded and the proportion of retirees to
active participants is increasing, causing benefit payouts to increase at a faster rate
than contributions. Contributions, however, still substantially exceed benefit pay-
ments and in 1980 were 90 percent more than benefits.
In contrast to the more mature status of many defined benefit plans, the average
age of defined contribution plans is 6 years, with plans covering 100 or more partici-
pants adopted an average of 13 years ago. In recent year a number of very large
firms have established employee stock ownership plans and 401K plans, with the
potential for rapid growth of assets through accumulation of contributions and earn-
ings. With 62 percent of all defined contribution plans, covering 78 percent of all
defined contribution plan participants, consisting of profit sharing and/or stock
bonus plans, future asset growth will be dependent to a large extent upon the profit-
ability of the firms sponsoring the plans and the value of the firms' stocks.
CONTRIBUTIONS
From 1975 to 1980 total contributions increased from $38.6 to $64.7 billion, an av-
erage of 11 percent per year. However, contributions have been increasing at a
lower rate each year and in 1980 increased by only 5.6 percent. The trend toward
lower rates of increase in contributions occurs only among defined benefit plans.
Among these plans the rate of increase was only 3.2 percent in 1980. The apparent
peaking of contributions among defined benefit plans appears to be caused, at least
in part, by the fully funded status of over 90 percent of these plans.
Contributions to defined contribution plans are generally made on the basis of a
fixed rate, in the case of money purchase plans; on profits, in the case of profit shar-
ing plans; and as a percentage of employee contributions, among savings plans. Re-
flecting the rapid growth of defined contribution plans in recent years, total contri-
butions have increased substantially, from $13.0 billion in 1975 to $22.8 billion in
1980. In contrast to defined benefit plan contributions, the growth rate of contribu-
tions to defined contribution plans has been fairly constant. About 29 percent of
total contributions to defined contribution plans consist of employee contributions,
compared to only 2 percent for defined benefit plans.
BENEFITS
Benefit payments from private pension plans increased an average of 12.5 percent
per year from 1975 to 1980. Benefit payments totaled $19.0 billion in 1975 and $34.3
billion in 1980. Sixty-two percent of pension benefits are paid from defined benefit
plans. For these plans benefit payments increased by 76 percent from 1975 to 1980,
compared to a 91 percent increase for defined contribution plan payments.
CONCLUSION
America's private pension system is one of the most remarkable institutions of
the post-war period. This totally voluntary system has amassed nearly a trillion dol-
PAGENO="0599"
593
lars in private capital to provide retirement benefits to tens of millions of workers
over the next several decades. Private pension benefits are already important to
large numbers of retirees, and within two decades these benefits may be nearly as
important a contributor to retirement income as Social Security for at least a sub-
stantial minority of older Americans.
TABLE 1.-NUMBER OF PRIVATE PENSION PLANS, PENSION PLAN PARTICIPANTS AND PENSION PLAN
ASSETS BY TYPE OF PLAN, 1975-83 1
Year
Total
Total plans
D f d
benefit
Detined
contribu~
Particip
Total
ants (thou
D d
b~~t
sands)
Detined
contdbu~
As
Total
sets (billions
~
~
Defined
~
1975
340,171
107,399
232,772
44,511
33,004
11,507
$293.5
339.8
$211.4
244.8
$82.1
95.0
1976
398,407
120,773
277,634
47,679
34,207
13,472
372.3
268.2
104.1
1977
451,458
131,768
319,690
49,928
34,731
15,197
432.6
314.0
118.6
1978
495,845
139,340
356,505
52,371
36,103
16,268
510.3
368.4
141.9
1979
538,751
157,639
381,112
55,192
36,925
18,268
612.3
444.7
167.6
1980
589,893
179,424
410,469
57,903
37,979
19,924
691.9
499.6
192.3
1981
653,370
198,624
454,746
61,700
39,241
22,459
795.7
574.5
221.2
1982
718,847
218,529
500,318
65,200
40,424
24,776
900.0
649.8
250.2
1983
775,477
235,745
539,732
66,800
40,280
26,520
Excludes Keogh plans tsr the selt-employed.
Note-Data tsr years 1975-80 based on Form 5500 annual financial reports and on Pension Facts" published by the American Council ot Life
Insurance. Data tsr years 1981-82 based on projected estimates.
STATEMENT OF BURTON E. BURTON, SENIOR VICE PRESIDENT, AETNA LIFE INSURANCE
Co.
We welcome the opportunity provided by the Subcommittees on Social Security
and Select Revenue Measures to comment on current tax policies affecting employ-
ee benefits and whether these policies should be continued.
Aetna Life Insurance Company is the largest group insurer in the country. We
have over 50,000 employer customers who are pension and welfare benefit plan
sponsors. These employers range in size from the small business persons to the large
multinational corporation. We insure or administer benefits for more than 12 mil-
lion employees and dependents under plans providing life and health insurance. We
have as pension clients 80 percent of the Fortune 500 companies. In addition, we are
a major plan sponsor for about 80,000 of our own employees and their dependents
nationwide. From this vantage point, we have gained a great appreciation of the
critically important social value of employee benefits and have in intense interest in
the ongoing discussions of tax policy toward benefit plans.
RATIONALE FOR PRESENT TAX POLICY
Employee benefits, including pensions, life and health insurance, have made enor-
mous contributions to the economic security of American workers and their families
across the income spectrum. For most employees, anxiety over large medical ex-
penses, an adequate level of retirement income and loss of income from an unex-
pected, untimely death has been substantially alleviated. In the case of health insur-
ance, it has been virtually eliminated. This degree of economic security is a fairly
recent phenomenon, attributable to the growth in scope and availability of private
benefit plans which has complemented expansions in the Social Security retirement
income and Medicare programs. The value of this combination of private and public
plans in terms of social stability and the public welfare is immeasurable, and, we
think, beyond argument.
The Congress, in its wisdom, has long recognized the value of promoting orga-
nized, efficient ways for people to provide for their future economic security. The
Congress has done so directly, with the Social Security system, and indirectly
through the private sector by means of tax policy that encourages retirement plan-
ning and life and health insurance in the employment setting. We disagree with
those who adovate a reversal of this tax policy now for the purpose of raising addi-
tional tax revenue. We believe tax preferences for employee benefit plans are in the
public interest, have contributed greatly to the development of existing plans and
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594
need to be preserved. Indeed, there is at least one area where they may need to be
expanded.
Tax-favored treatment of contributions to employee benefit plans has encouraged
development of the most efficient way yet devised to provide pension and insurance
benefits to the greatest number of people at the lowest possible cost. The group dis-
tribution system for benefits is far less costly than individual marketing, which
would be the only alternative. Intense competition in the group insurance and plan
administration business, economies of scale and the relatively sophisticated buying
power of employers and organized employee groups result in employee group cover-
age that is as much as fifty percent less costly than coverage available in the indi-
vidual market. Even more important, underwriting of health and life insurance on a
group basis makes benefits available to employees and dependents who, because of
their age or health status, might find it difficult or impossible to obtain individually
underwritten coverage, particularly at a reasonable cost.
Recognition of these advantages of employee benefit plans over alternative sys-
tems of distribution has contributed to dramatic growth in the numbers of people
covered by these plans.
Those who favor taxation of employee benefits argue that the employee welfare
benefit system is mature; that tax policy has hastened the achievement of this ma-
turity; and that the Congress should now withdraw the tax preferences for employee
benefits. On the contrary, the goal of adequate coverage for all workers and their
families is still being met. Although health insurance (except for dental care) is
almost universally available across income levels, its comprehensiveness still varies
widely among employers. The financing of long-term care for the elderly may soon
become a social problem of alarming proportions. Very few private benefit plan ar-
rangements address this problem. Furthermore, coverage under private pensions is
still less than adequate for lower and lower-middle income employees and for those
working for smaller employers.
It's clear considerable progress has been made under the current tax policy favor-
ing employee benefits; more progress can be made if these policies are continued.
CONSEQUENCES OF CHANGING TAX POLICY
The consequences, both political and economic, of eliminating or greatly reducing
the encouragement given by tax policy to private social protection systems would be
severe. While no one knows precisely how employers would respond, reducing the
tax incentives enjoyed by employee benefit plans would definitely shift the prefer-
ences of both employers and employees away from benefits and towards cash wages.
The tremendous progress made in addressing the basic economic needs of American
workers would be summarily halted, and more than likely over time, we would be
taking steps backwards. The effect on small employers could be particularly pro-
nounced as another layer of disincentives is added to the formation of employee ben-
efit plans.
Perhaps the most disadvantaged from any change in current tax policy are the
low income workers. They are the ones who presently are least likely to be covered.
Without tax incentives to encourage the provision of new benefit plans, they will be
effectively foreclosed from obtaining affordable health and retirement protection.
Those low income people who are currently covered will find themselves paying a
substantially higher percentage of their cash compensation for taxes. And if employ-
ers drop plans in favor of cash compensation, low income people are much less
likely than higher income people to replace those benefits from their own resources.
For higher income people, many would continue to have the capacity to save (by
means of IRAs, annuities, life insurance, etc.), but they may have to pay more for
the same benefits if coverages are not available through employers. Furthermore,
the effect of the Social Security payroll tax, combined with other taxes, would mean
that all employees would face significantly higher taxes.
Some have suggested that the Social Security system is being jeopardized by the
growth of employee benefit plans. In reality, the national wage-base subject to the
Social Security tax has grown substantially in real terms over the last two decades,
during the period of greatest expansion in the employee benefit system. Prospects
are for this situation to continue, especially as the growth in now maturing employ-
ee benefit plans levels off.
In addition, the specter of additional Social Security taxes poses a serious policy
question for the Congress with respect to the current generation of working Amen-
cans. Because of the high levels of Social Security (including Medicare) benefits, rel-
ative to past payroll taxes paid, that are enjoyed by those currently retired or ap-
proaching retirement, it is likely that the majority of those now working will get
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595
back less in Social Security benefits than the time-adjusted value of their and their
employers' payroll taxes. This situation is acceptable only if the current generation
of workers can supplement Social Security benefits with reasonable private sector
benefits (particularly pensions). If, however, working Americans find that their pri-
vate sector benefits have become less adequate at the same time as they are being
asked to accept a lower return on their Social Security contributions, the social con-
tract needed to sustain the Social Security system is likely to unravel.
Those who argue that the tax preferences for employee benefit plans should be
reduced or eliminated contend that high income people are uniquely advantaged by
these plans and would be the only ones to be seriously disadvantaged by taxation of
these plans. Yet there is ample evidence that rank and file workers regard employ-
ee benefits at least as highly as owners, executives and professionals. In a recent
survey by Cambridge Reports, Inc. on employee satisfaction with wages and bene-
fits, lower income households reported being considerably more satisfied with their
employee benefits than with their wages. Among higher income households there
was virtually no difference.
Percent very or somewhat
satistied
Wages Benetits
Total household income:
0 to $8,000
$8,000 to $12,000
$12,000 to $15,000
$15,000 to $20,000
$20,000 to $25,000
$25,000 to $35,000
$35,000 and over
27
57
66
67
71
79
65
59
71
80
63
76
79
Unions, even in companies close to bankruptcy, have been reluctant to give up
their benefits. Under the present tax structure, they have been more willing to give
up wages instead. If benefits became presently taxable, the opposite result would be
more likely. Lower income people especially would find it difficult to pay taxes im-
posed on benefits. After all, these taxes would have to be paid out of their remain-
ing cash income which would presumably not have increased accordingly.
COST EFFECTIVENESS OF PRESENT TAX POLICY
We cannot, however, have our cake and eat it too. We know what public policy
should be. The issue is, can we afford to support it? The answer to this question
involves two other issues: How cost-effective is the tax preference in buying social
protection through the private sector? And where do we rank tax-favored employee
benefits in the hierarchy of all the tax preferences in the Internal Revenue Code?
First, it is clear that tax incentives are a particularly cost effective way for the
federal government to accomplish the goal of widespread employee protection. Tax
incentives act as a lever, encouraging employers and employees voluntarily to skew
the compensation package so that it incorporates socially valuable savings and in-
surance benefits which would otherwise have to be provided by the government. In
other words, the government gets a dollar's worth of benefit by spending only 30 to
40 cents.
Second, there is a problem with the way in which the cost or "tax expenditure"
for private pensions is estimated by Treasury. While the tax preference accorded
health insurance plans is an exemption, taxes on pension contributions are merely
deferred. Eventually taxes will be paid when the participants collect their retire-
ment benefits. Obviously, the true estimate of foregone tax revenue is composed of
the cost to the Treasury of postponing the receipt of the revenue in time plus
(minus) the impact of the retirees being in lower (higher) tax brackets than they
were as workers.
Instead, however, of performing this longitudinal estimate, Treasury uses a cross-
sectional estimate of tax expenditure, subtracting taxes on this generation of retir-
ees from the foregone taxes on the pension contributions for this generation of
workers. Because of the rapid growth in both participation and benefit levels in U.S.
pension plans, this is an extremely biased estimate of the true long-run cost to the
Treasury of encouraging private pensions. In the long run, the true "cost" to the
Treasury may be less than half of what it is projected to be.
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596
Third, the context of these hearings is the need to broaden the tax base in order
to raise revenue. The decision on whether or not to tax employee benefit arrange-
ments can be made only after the cost-effectiveness and equity issues that prompted
this hearing are asked of other tax preferences too. For example, the tax benefits
accorded to home ownership are received by fewer than one-third of all tax-payers
(since only one-third itemize deductions) and among these the distribution is heavily
skewed toward high income individuals. It would be extremely difficult to make a
convincing case that the tax preferences which promote widespread health and pen-
sion coverage and are enjoyed by the vast majority of workers, provide a less valua-
ble and less universal social benefit than those supporting home ownership.
In the end, if the objective is to broaden the tax base, the question is which of the
panoply of tax preferences should be modified. Only after the whole range of tax
preferences has been examined should employee benefits be considered for this pur-
pose.
CONCLUSION
The value to society of present tax policy toward health benefits, pension plans
and life insurance is clearly established and has long been recognized by the Con-
gress and the public. Tax preferences for these benefit plans are cost-effective and
have promoted a highly efficient means of assuring financial security for workers
and their families through the private sector.
Changing this tax policy now would be premature. The full value of employee
benefit plans, particularly private pensions, has not yet been realized by lower and
lower-middle income employees. More must be done. Those most in need of an orga-
nized, employer-sponsored delivery system would be most adversely affected if tax
policy ceased to encourage growth in these plans.
In fact, we believe tax preferences should be expanded in at least one direction.
There is a growing awareness that the need for financing long-term care for the el-
derly will soon become a social problem of alarming proportions. Currently, there
are very few private benefit plan arrangements that address this issue. We would
urge the Congress to consider ways in which federal tax policy could encourage em-
ployers and employees to conduct more adequate financial planning for long-term
care for the next generation's elderly population.
The Congress should be applauded for its enlightened policy toward employee ben-
efit plans. We sincerely urge the Congress not to jeopardize the future success of
these plans.
STATEMENT OF THE AIR LINE PILOTS ASSOCIATION, INTERNATIONAL
The Air Line Pilots Association, International represents more than 34,000 pilots
under separate collective bargaining agreements with 45 airline carriers. The Asso-
ciation appreciates this opportunity to present our views on the taxation of employ-
ee benefits before these Subcommittees.
The Association considers the Federal tax treatment of employee benefits to be a
key factor in collective bargaining with employers. As a result, the Association has
been successful in securing for effectively all of its members reasonable levels of re-
tirement, life, disability and health benefits through qualified pensions plans, insur-
ance and voluntary employee beneficiary associations (VEBAs). Thus, the tax-
exempt status of the qualified pension trust, the exclusion from current income of
employer contributions to the trust and the favorable tax treatment accorded distri-
butions from such trust all work together in determining the value of the retire-
ment benefits negotiated on behalf of our members. Similarly, the exclusion from
current income of health premiums or benefits and premiums for the first $50,000 of
life insurance add to the value of those benefits. The tax-exempt status of negotiated
VEBAs has helped to assure our members that adequate funding levels will be
maintained with respect to negotiated benefits provided thereunder. Any alterations
which lessen the favorable status of the tax treatment of these benefits and trusts
will seriously impact the value of the benefits which have already been negotiated,
reduce the funding levels of the trusts and undermine the value of our members'
existing collective bargaining agreements.
A clear example of the reduction in the value of our existing contracts occurred
with the passage of TEFRA. Because pilots' working careers are often shorter than
most other employees', due to both the strict medical standards which pilots must
satisfy and the Federally-mandated retirement age of 60, retirements benefits are of
special significance. TEFRA drastically cut back the maximum levels of retirement
benefits and contributions which can be accrued under qualified plans, directly af-
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597
fecting the negotiated retirement benefits and retirement planning of many of our
members. Contrary to the collective bargaining process itself, these cutbacks consti-
tuted Congressionally-mandated bargaining concessions to the employers with
whom the Assocation negotiates, in terms of the lower level of funding required by
the lower benefit and contribution limitations. In addition, TEFRA altered the
status of prior law raising from 55 to 62 the age at which an actuarial reduction is
required from the maximum limits for defined benefit plans. This change further
reduced the value of the retirement benefits negotiated on behalf of our members,
who by Federal law must retire at age 60.
Another clear example of a cutback directly affecting existing benefits is the
modification made to the tax treatment of VEBAs and other funded welfare benefit
plans by the Tax Reform Act of 1984. This modification will severely limit the abili-
ty of employers to fund adequately for benefits over an extended period. As stated
previously, pilots are required to satisfy strict Federal medical standards in order to
continue flying. As a result, disability benefits are very important to our member-
ship. In many cases, these disability benefits are provided through VEBAs. Howev-
er, the stringent medical requirements make claims experience in this area even
more unpredictable than it is with respect to other occupations not so regulated. In
this regard, a VEBA funded under the new statutory guidelines could very quickly
become inadequate to pay disability benefits from one year to another.
Similarly, the provision of retiree medical benefits through a VEBA is jeopardized
if the VEBA cannot be funded on a level basis over the working life of the employ-
ee, with due consideration given to the escalating costs of medical care. The limita-
tions on VEBA funding may result in employers opting simply to fund these and
other benefits on a pay-as-you-go basis, with potentially devastating results in the
long run.
Thus, the Association's intention in providing disability and medical benefits
through a VEBA, to meet our members' unusual needs on a more level funding
basis, has now been legislatively thwarted.
The Association feels the recent legislative cutbacks in employee benefits such as
those discussed above are too harsh and does not wish to see further erosion in the
value of our negotiated benefits in the name of deficit reduction. Specifically, we
would like to address the taxation of health insurance premiums and pension plan
contributions.
HEALTH INSURANCE PREMIUM CAP
The proposal has been made to place annual limits on the amount excludable
from employees' current compensation by reason of employer contributions for em-
ployee health care coverage. The two goals expected to be reached by the proposal
are to raise revenues and contain health care costs. However, there is no evidence
that either of these goals will be reached.
If a cap is placed on tax-free contributions for health care, the most likely result
will be a wholesale reduction in the provision of health care coverage in the United
States to the levels that may be purchased with the amount of tax-free contribu-
tions. Second, contributions previously made to purchase tax-free health benefits
will be shifted, in some cases with union encouragement, to purchase other benefits
retaining tax-free status. Third, lowering health care coverage will result in the
more frequent utilization of the medical expense deduction by individual taxpayers
forced to pay expensive medical bills themselves. Obviously, none of these three re-
sults of placing a cap on tax-free health care coverage will yield an increase in tax
revenues.
Assuming health care coverages are limited to the levels which can be purchased
tax-free, the first benefits to be deleted will be those added most recently, namely,
preventive care benefits. Such benefits include dental and vision care plans, outpa-
tient services and other benefits, all designed to contain health care costs. However,
the deletion of preventive care benefits would only give rise to additional claims for
such basic benefits as hospital and surgical benefits, the most expensive health care
benefits provided. Of course, additional claims for such expensive benefits will yield
higher, not lower, health care costs.
Besides failing to* achieve the goals of raising revenues and reducing health care
costs, the proposal to limit tax-free health care coverage takes aim at the wrong tax-
payer group-the American worker. Because health care costs are equal whether an
individual is in a lower or a higher income bracket, the placement of a cap will dis-
proportionately affect the lower income worker. Assuming health care coverage con-
tinues to be provided at a cost above the cap, creating a previously untaxed portion
of compensation, lower and middle income workers will suffer a disproportionately
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higher income tax burden. Assuming health care coverage is dropped to a level
which may be purchased at or below the cap, lower and middle income workers will
suffer a disproportionately higher health care burden. Because the costs of health
care are concededly high, this effect will be devastating to the lower and middle
income worker.
It is the very nature of health care coverage, as universally needed by all workers,
regardless of income level, which prompted Congress to provide for the tax-free
status of employer contributions for such coverage in the first place. Previous at-
tempts to shift the burden of paying for such coverage to those least able to afford it
have been recognized as regressive and have been defeated by Congress. Health care
simply is not an appropriate vehicle for deficit reduction.
PENSION PLANS
Effectively all of the Association's members are covered by some form of qualified
retirement plan. These plans are especially important to our members, because they
are federally mandated to retire at the relatively low age of 60. Taxing employer
contributions to these plans would not significantly increase tax revenues, since dis-
tributions from the plans, in the form of retirement income, are already subject to
taxation. Furthermore, taxing the pension trusts themselves would subject such
trusts to the risk of underfunding, which risks was largely eliminated by ERISA.
This, in turn, would place an increased burden on the already overburdened federal
retirement plan insurance program, operated by the Pension Benefit Guaranty Cor-
poration.
Taxing either the contributions to, or the earning of, qualified pension trusts
would certainly lead to a reduction in the establishment of pension plans and would
act as a disincentive for the negotiation of retirement benefit increases. As a result,
the historically important national policy to foster the retirement security of Ameri-
can workers would be effectively defeated.
CONCLUSION
In summary, the Association believes that excessive erosion in the value of negoti-
ated benefits has already taken place. Attacking hard-fought gains in the areas of
health care and retirement security is not the appropriate solution to the present
tax deficit problem.
STATEMENT OF STEPHEN G. KELLISON, EXECUTIVE DIRECTOR, AMERICAN ACADEMY OF
ACTUARIES
BACKGROUND
On September 17 and 18, the Subcommittees on Social Security and Select Reve-
nue Measures of the House Committee on Ways and Means held hearings on the
taxation of fringe benefits. The Comments belows are submitted for the record of
these hearings on behalf of the American Academy of Actuaries ("Academy").
INTEREST OF THE ACADEMY
The Academy is a professional association of over 7,600 actuaries involved in all
areas of specialization within the actuarial profession. Included within our member-
ship are approximately 85% of the enrolled actuaries certified under the Employee
Retirement Income Security Act of 1974 (ERISA), as well as comparable percentages
of actuaries proving actuarial services for other employee benefit plans such as life,
health, and disability programs.
The Academy finds it difficult to comment on tax legislation in general, since we
are not advocates on major public policy decisions which are not actuarial in
nature. The Academy views its role in the government relations arena as proving
information and actuarial analysis to public policy decision-makers, so that policy
decisions can be made with informed judgment.
Nevertheless and in spite of the fact that actuarial considerations are unlikely to
ever be the driving force behind major decisions on tax policy, actuarial input can
be quite useful in shaping and molding tax policy to deal appropriately with the
extremely complex, yet vitally important, employee benefits area. For example, the
determination of required contribution levels to plans to provide the benefits, set-
ting appropriate reserve levels to meet future obligations, and financial calculations
involving the time value of money are all actuarial in nature.
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GENERAL COMMENTS ON EMPLOYEE BENEFITS PLANS
Employee benefit plans provide an array of insurance and retirement benefits
which greatly increase the present and future economic security of millions of
Americans. Salary dollars cannot replicate an annuity at retirement that cannot be
outlived, life insurance for the family of a deceased worker, the cost of hospitaliza-
tion in the event of major illness, or income to a disabled worker. Employee benefit
plans deliver dollars at the time they are needed most. Moreover, in general, these
benefits can be more economically provided on a group basis to an employee work-
force than on an individual basis, due to the significant savings in administrative
costs and to the stability that comes with a pooling of risks across a broad cross
section of employees.
There is no question that the growth of employee benefit plans in the past few
decades has been greatly stimulated by tax policy toward those plans. This tax
policy has been the result of deliberate Congressional intent which has been demon-
strably successful in fostering the development of employee benefit plans. It would
be naive and erroneous to assume that employers would continue to provide the
same level of benefits in the event that the favorable tax treatment of certain types
of employee benefit plans were significantly curtailed or even eliminated. The pres-
sure from employees with the basic attitude "If I have to pay taxes on it anyway,
give it to me in cash" would simply be too great. The end result would be a decline
in the level of protection provided by the private sector, inevitably leading to great-
er demand and strain on governmental programs. Given the financial difficulties
facing programs such as Medicare and Social Security, a decline in private sector
programs would hardly seem to be in the public interest.
NEED FOR NATIONAL POLICY
We hope these hearings will be useful in focusing attention on the need for a co-
herent, stable, and strongly articulated public policy toward employee benefit plans
by the federal government. The fact that no such policy exists leads to a seemingly
endless series of ad hoc changes and confused signals toward employee benefit
plans. In the tax area alone in just two short years we have seen the Tax Equity
and Fiscal Responsibility Act of 1982 and the Deficit Reduction Act of 1984. And
now before this last bill has even been printed into final form, Congress is talking
about changing it all around again in 1985.
There is a crying need here for more stability in the tax treatment of employee
benefit plans. Pension and insurance plans in particular involve long-term arrange-
ments and commitments. Plan sponsors are finding it increasingly difficult to make
rational decisions in such a chaotic environment. Much as this continual turmoil
may provide additional work for actuaries, it hardly seems to be in the public intest
to make the rules so complex and to change them so often that the typical plan
sponsor has no chance of coping. The administrative costs of complying with all the
changes being imposed on plans has risen significantly and is increasingly becoming
a burden, particularly on small plans.
TAX EXEMPTION VS. TAX DEFERRAL
In some of the debates on tax policy the distinction between tax exemption and
tax deferral seems to get lost. Although some employee benefit plans do provide tax
exempt benefits, others do not. In particular, the major retirement income programs
provide for tax deferral, not tax exemption. Within debates on tax deferral we in-
creasingly hear arguments involving the concept of the "time value of money." This
is a concept at the heart of actuarial science.
It is quite true that a dollar to be paid in the future is worth less than a dollar
today because of the interest that can be earned in the interim. Translating this
into tax policy for the federal government, the argument is heard that $1,000 of
taxes today is worth $1,000, but if these $1,000 of taxes can be deferred for ten years
their present value is worth only $386 if discounted at a 10% rate of interest. Thus,
the argument is made that it is better for the Treasury to get the money now rather
than later.
What this analysis overlooks, however, is that in many cases the Treasury will get
more than $1,000 at the end of ten years. For example, consider a defined contribu-
tion pension plan in which the account balances are growing at a 10% rate of inter-
est. $1,000 in tax deferral will continue to grow in the account and will amount to
$2,594, not $1,000, in ten years. The present value of $2,594 discounted for ten years
at a 10% rate of interest is exactly $1,000!
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In the real world, of course, things are seldom this simple. Differences in value
will arise if the rate of accummulation is different than the rate used in computing
the present value. Also, there is a question about how the tax rates in ten years
which will then apply compare with the tax rates which would apply today. Howev-
er, the example does clearly illustrate that introducing the concept of the time
value of money does not, on its own merits, make a convincing case against tax de-
ferral. It is a valid analytical tool, but must be carefully applied in any analysis to
present meaningful comparisons.
PUBLIC SECTOR PROGRAMS
If Congress intends to take a comprehensive look at the taxation of employee ben-
efit plans in order to create a more coherent tax policy toward such plans, then it
would seem appropriate to consider the tax treatment of public sector programs as
part of such a comprehensive review. For example, at the present time the tax
treatment of retirement benefits attributable to employer contributions under Social
Security is different than for private sector retirement plans. This may or may not
be good public policy-that is not an actuarial judgment. However, we do urge the
Congress to review tax policy toward insurance and pension benefits under govern-
ment programs as well as private sector programs in any comprehensive review of
the taxation of employee benefit plans.
It is also important to consider how private sector and public sector programs fit
together. For example, the integration of private pension plans with Social Security
has been a controversial tax issue for a number of years. Actuarial considerations
are vital in structuring sound integration rules for pensions or other employee bene-
fit plans.
ACTUARIAL ISSUES
There are six actuarial issues related to the general subject of the taxation of em-
ployee benefit plans which we address below.
1. Financial condition
The maintenance of a well-run insurance or pension employee benefit plan in-
volves the determination of both an appropriate contribution level to provide the
expected benefits and appropriate reserve levels to cover the accrual of benefit obli-
gations. Both of these are actuarial processes.
Tax policy should recognize the need for these determinations to be made accord-
ing to sound actuarial principles and practices. Such recognition does exist in the
pension area under ERISA. However, that recognition is not as clear in connection
with certain insurance programs.
The Academy stand ready to work with Congress and regulatory agencies tO
define such sound actuarial principles and practices where required. A major priori-
ty for the Academy at the present time is the establishment of a structure within
our profession to articulate actuarial standards of practice. This structure would be
appropriate to deal with issues such as actuarial principles and practices in connec-
tion with insurance and pension employee benefit plans. Included in actuarial prin-
ciples and practices are such matters as disclosure requirements and the content of
an actuarial report.
2. Qualifications
Along with a recognition of the need for plans to be operated according to sound
actuarial principles and practices there is the need to define the qualifications of
the actuaries certifying the plans.
Of course, this need was clearly recognized in ERISA and in that instance Con-
gress chose to create a Joint Board for the Enrollment of Actuaries to examine and
license individuals as "enrolled actuaries."
Another example has arisen in the Deficit Reduction Act of 1984. This act pro-
vides that in connection with funded welfare benefit plans (including voluntary em-
ployees' beneficiary associations (VEBAs) under section 501(c)(9) of IRC) reserves in
excess of "safe harbor" limits will be permitted if certified by a "qualified actuary"
(to be determined under Treasury regulations).
Academy membership includes actuaries in all areas of practice and serves as the
hallmark of a qualified actuary in the United States. However, we recognize that
not all actuaries are necessarily qualified for all assignments. Accordingly, our
Guides to Professional Conduct contain extensive guidance to ensure that: "The
member will bear in mind that the actuary acts as an expert when giving actuarial
advice and will give such advice only when qualified to do so."
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The Academy has a Committee on Qualifications to address issues such as these.
We strongly urge direct participation of the actuarial profession in defining the
qualifications of an actuary to engage in any particular assignment. The Academy
has a strong commitment to self-regulation and is prepared to work closely with the
Treasury if such regulations are to be developed.
3. Actuarial assumptions
The setting of actuarial assumptions is a key ingredient in any actuarial assign-
ment. The provisions relating to funded welfare benefit plans in the Deficit Reduç-
tion Act of 1984 (cited above) require that assumptions be reasonable in the aggre-
gate. This is quite appropriate and follows the precedent set by ERISA in the pen-
sion area.
However, the conference report goes further and indicates that "in addition to re-
quiring that actuarial assumptions are to be reasonable in the aggregate, Treasury
regulations may prescribe specific interest rate and mortality assumptions to be
used in all actuarial calculations." Such a simplistic approach would ignore the fact
that experience is different from plan to plan for a variety of reasons (age/sex com-
position of group, nature of work, geographical area, etc.). Attempting to mandate
any set of uniform assumptions will inevitably result in inappropriate assumptions
being used for large numbers of plans. Setting appropriate actuarial assumptions re-
quires the application of actuarial judgment to fit the facts and circumstances at
hand.
We are concerned at the prospect that the Treasury might attempt to prescribe
specific actuarial assumptions for funded welfare benefit plans. We believe the ap-
proach used in ERISA for setting actuarial assumptions for pension valuations is
much more appropriate.
4. Current tables
Certain portions of the Internal Revenue Code require the use of actuarial tables
promulgated by the Internal Revenue Service. Examples are the tables for the tax-
ation of group term life insurance under Section 79, the tables for the taxation of
annuities under Section 72, and the tables used for the taxation of life estates and
remainders.
Some of these tables have been allowed to get out-of-date. For example, the uni-
form premium table for group life insurance under Section 79 was changed in 1983,
but the prior table had been in effect since 1966, during which time group term life
rates dramatically changed. As another example, the current tables under Section
72 have not been changed since their release in 1954.
The use of actuarial tables to compute certain values required in the IRC is quite
appropriate, but may appear arcane or even obscure to many taxpayers. Maximum
credibility will be achieved if taxpayers perceive that the tables are based on cur-
rent interest and mortality factors rather than ones that may appear obsolete. Such
credibility should be an objective of tax policy.
5. Design aspects
On occasion, actuarial insights on design aspects of certain tax proposals may be
useful. For example, in the Academy testimony to the Senate Committee on Finance
on June 22, 1983 on proposals for a health insurance tax cap, our Committee on
Health Insurance pointed out some technical flaws with the proposal to base the tax
cap on premiums. The Committee went on to suggest basing it on the richness of
coverage provided as an alternative which would avoid these flaws.
[N0TE.-The Academy neither supports nor opposes such a tax cap. This is a
public policy decision up to Congress and is not an actuarial issue. However, we are
concerned with the technical details of any such proposals and their full ramifica-
tions.]
6. Adverse selection
A rather subtle, but potentially quite important, actuarial concept is the notion of
"adverse selection." There is a natural tendency for any person covered, or poten-
tially covered, by an insurance or pension plan to exercise any options available to
his or her apparent advantage, i.e. to select against the plan. Within limits, the cost
of such adverse selection can be absorbed by a plan. For example, in pension plans
with lump-sum options, retirees in poor health will.tend to elect lump sums, while
those in good health will tend to elect life annuities. In such a case, the plan spon-
sor has been willing to assume any extra costs involved in allowing such options.
In some cases, however, adverse selection could present more serious problems.
For example, consider a voluntary health insurance program with substantial em-
ployee contributions required (either directly through payroll deduction or indirect-
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ly through a health insurance tax cap). Younger, healthier employees will tend to
opt out of the program if they do not perceive they are receiving adequate value for
their contributions. If this happens, the group left behind will increasingly consist of
older or less healthy employees, and costs would increase significantly. In extreme
cases, this could result in a vicious cycle of further defections of healthy employees
as costs rise and spiralling cost increases for remaining participants, until the entire
financial structure of the plan is undermined.
Although the collapse of a plan due to adverse selection alone may appear a bit
farfetched, it is not impossible. On a lesser scale, adverse selection can and does in-
crease the costs of certain plans.
Congress should be careful in structuring tax policy toward employee benefit
plans to be aware of such subtle possibilites and not inadvertently undercut the fi-
nancial strength of plans to play benefits which have been promised.
SUMMARY
In summary, we encourage Congress to proceed carefully in structuring a rational
tax policy for employee benefit plans. To the extent that revenue enhancement is
the objective, Congress must weigh this "gain" against the costs if private sector
plans are discouraged, and less economic security is thereby provided by the private
sector. To the extent that elimination of real or perceived tax abuse is the objective,
we strongly encourage Congress to use the scalpel and not the meat ax, since the
large majority of benefits under employee benefit plans are not being provided with
tax avoidance as the primary motivation.
We appreciate the opportunity to present these comments for the record. The
Academy is available to offer an actuarial perspective on the taxation of employee
benefit plans in future considerations of such policy. We would be happy to answer
any questions or provide further information for the Subcommittee upon request.
STATEMENT OF THE AMERICAN DENTAL ASSOCIATION
The American Dental Association is extremely concerned with proposals to tax
employees for employer fringe benefit contributions. The Association is specifically
concerned with efforts to tax employer provided health benefits. The Association be-
lieves that such tax proposals will not raise significant revenues and could prove to
be very injurious to the continued existence of successful, prevention-oriented bene-
fits such as dental prepayment plans. Following is the Association's response to
those questions asked by the Subcommittees which are pertinent to dental coverage:
(1) Approximately 90 million Americans (employees and their families) are cov-
ered by employer sponsored dental benefits. This represents an expansion from cov-
erage of approximately 6 million Americans in 1968. The Association anticipates
that expansion of coverage, although not as rapid as in recent years, will continue
as long as the existing tax structure with regard to fringe benefits is maintained.
(2) Almost universally, employers who offer dental benefits provide them equally
for all their employees.
(6) With regard to dental benefits, different effects are likely to occur based upon
implementation of a fixed dollar tax exempt limit, a flat excise tax or a limit on the
percent of compensation which could be accorded on a tax exempt or tax deferred
basis. Also different results would occur depending upon whether or not the limits
relate to all fringe benefits or just to health benefits.
A fixed dollar limit on tax exempt benefits will result in employee efforts to avoid
taxation by assuring that their level of benefits are below the dollar limit. One
result of this effort will be to provide little or no revenues to the federal govern-
ment. As a general rule, it can be anticipated that employees will be willing to
forego benefits in approximately the reverse order of gaining them. If only health
benefits are subject to the limit, it seems quite clear, and studies have shown, that
dental benefits will be one of the first to be dropped if they are subject to taxation.
The result would be that a cost effective, prevention-oriented benefit would be lost
to employees while no revenue gain would be achieved by the federal government.
If all fringe benefits are subject to the limit, we expect that individuals would
prefer to receive taxable cash payments rather than taxable fringe benefits. Accord-
ingly, reductions in fringe benefits will occur. The order of that reduction would
depend on the benefit package. Certainly coverage for medical and hospital care, the
leading contributors to health cost inflation, will be continued in as comprehensive
a manner as possible by employees. We believe that the effect of a flat excise tax or
a percentage limit on fringe benefits would result in a reduction of the extent of
fringe benefits provided to employees.
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(7) To the American Dental Association the relationship between employer spon-
sored fringe benefits and federal social programs is one of the key issues to be ad-
dressed in this entire debate. We believe that employer sponsored fringe benefits
have played a significant role in reducing or preventing the need for massive feder-
al programs. Certainly employer sponsored health benefits have been a key reason
that this nation does not need a comprehensive, federally run national health insur-
ance program.
Within this framework dental benefits have provided the opportunity for in-
creased millions of Americans to receive dental services. This has resulted in im-
proved oral health for these individuals. As the same time dental fees have in-
creased at a rate which is below the overall Consumer Price Index. Improved oral
health at controlled costs provides a very significant social benefit to Americans. We
believe it to be clear that the establishment of impediments to the availability of
dental benefits will directly result in a lowering of the oral health of this nation.
It is more efficient to encourage employers to provide dental and other fringe ben-
efits with tax incentives as opposed to providing benefits through publicly funded
programs. The private employer sponsored system already is in place, economic in-
centives exist to encourage efficiency and the results have been successful. It would
seem to us to be unwise to establish barriers which will perhaps necessitate the
need for new, untried and inevitably very costly government run programs.
We thank you for your consideration of our views. Once again we must urge that
these Subcommittees not recommend tax policies which will impede the growth of
valuable fringe benefits such as dental prepayment plans.
STATEMENT OF THE AMERICAN DENTAL HYGIENISTS' ASSOCIATION
INTRODUCTION
Mr. Pickle and members of the Subcommittee on Select Revenue Measures, the
Association is pleased to be able to submit record testimony on the issue of fringe
benefit taxation. We hope that this statement will be included with the record of
the September 17-18 hearing.
COMMENTS ON FRINGE BENEFITS TAXATION
The American Dental Hygienists' Association is pleased to have this opportunity
to submit a record statement to the Subcommittee on Select Revenue Measures of
the Ways and Means Committee on the issue of fringe benefits.
The Association represents approximately 30,000 dental hygienists who are spe-
cialists in the delivery of preventive dental care. The majority of the members of
the Association practice dental hygiene in offices of private practice dentists but an
increasing number practice in institutional settings which include nursing homes,
long-term care facilities for the aging, special care facilities for the disabled and
handicapped, correctional institutions, hospital dental clinics, dental hygiene and
dental schools, community health centers, etc. As preventive oral health specialists,
the role of dental hygienists is expanding substantially in reducing the incidence of
dental caries and preventing the onset of periodontal disease.
The Association submitted a record statement to the Senate Committee on Fi-
nance in May 1983, addressing the proposed "tax cap" on employer-paid health in-
surance. The Association was concerned at that time that estimated income to be
derived from a tax on health insurance would be used to finance a health insurance
program for the unemployed which the Committee was also considering. The Asso-
ciation expressed deep concern that the linkage between the "tax cap" proposal and
health insurance program for the unemployed be carefully studied before any action
was taken by the Committee. We are pleased that the Committee did not act on
either proposal and that now a record is being developed in the House of Represent-
atives on the issue of fringe benefits generally with a view towards developing tax
policy that will be fair for employers and employees.
The Association understands that the Subcommittee wished to develop a full and
fair hearing record on current fringe benefit topics but, as providers of preventive
dental care, our statement for the September 1984 hearing will focus on dental in-
surance and the importance of maintaining the oral health of more than one third
of the nation's population who have employer-paid dental insurance for employees
and their families.
The Health Care Financing Administration has just reported that spending for
dental care in 1984 should reach $23.7 billion. Only $1 billion of this amount repre-
sents federal, state and local government funds. Patients out-of-pocket expenses to-
40-046 0 - 85 - 39
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taled $15.8 billion and private dental insurance accounted for $6.9 billion. Expenses
for dental care are expected to increase to approximately $31 billion in 1987 and $39
billion in 1990. The proportion of this total generated through employer-paid private
dental insurance can be expected to increase, with such increases continuing
through this decade. It appears possible that employer-paid dental insurance could
account for up to $10 billion of the estimated $39 billion dental expenditures in
1990.
Among the vast array of fringe benefits that will be considered during the Sep-
tember 1984 hearings, the Association will confine its comments to private dental
insurance plans and urge that this fringe benefit remain completely tax free for em-
ployers and employees. The Association's rationale for urging that the status quo be
maintained on dental health insurance plans was presented to the full Senate Com-
mittee on Finance last year and it is unchanged in 1984.
As an organization which represents preventive oral health specialists, it is logi-
cal that the Association encourage the Committee to develop tax laws which encour-
age employers to provide fringe benefits, especially oral health benefits, for their
empioyees. For the past 40 years health care benefits have been the central part of
what is now known as "fringe benefits" which are negotiated between labor unions
and industry and among these, beginning in 1954, was included dental pre-payment
insurance (the International Longshoremen's and Warehousemen's Union-Pacific
Maritime Association and the west coast shipping industry).
The pre-payment of dental services, both preventive and restorative, has been a
fact of life for three decades and has led to a life style that regards dental health as
ranking in importance with general health and well-being. The 98th Congress re-
cently passed the comprehensive debt reduction bill, leaving the proposal to tax
health care benefits for the next Congress to consider and current law, which does
not require that health care benefits be taxed, is still in force.
DO EMPLOYEES BENEFIT FAIRLY FROM THE TAX INCENTIVES?
Dental benefit plans, according to the American Dental Association, help to con-
trol dental costs. Dental insurance rewards patients who take care of their teeth in
order to avoid oral disease which would require expensive restorative care.
Major dental benefit plans, in most instances cover 100 percent of the cost of diag-
nostic and preventive treatment, which includes routine oral examination, prophy-
laxis, fluoride treatment, pit and fissure sealant applications, x-rays, tooth charting
and periodontic charting. All of these procedures, performed generally by dental hy-
gienists in most dental offices, are preventive oral health measures intended to help
patients avoid dental disease, such as dental caries and periodontia.
Most dental benefit plans are negotiated under the collective bargaining system
between labor and management. While the plans may vary in dental coverage from
industry to industry, they provide benefits fairly among the employees. Co-payment
requirements in most dental benefit plans help to control the cost of dental services
and encourage employees to care for their teeth. Failure to do so, with the co-pay-
ment features of these plans, requires more out-of-pocket expenses by employees.
ARE EXISTING BENEFITS EFFECTIVE IN ENCOURAGING EMPLOYER TO PROVIDE THEM TO
EMPLOYEES AT A LOWER COST THAN GOVERNMENT?
Earlier in this statement, we cited a current report of the Health Care Financing
Administration on the nation's spending for dental care in 1984. It is significant
that spending for dental care by federal, state and local governments was only $1
billion of a total annual expenditures of $23.7 billion. On the other hand, patients
themselves spent $15.8 billion and dental benefit plans accounted for nearly $. bil-
lion of the 1984 dental bill.
It appears that existing benefits for dental care do encourage employers to pro-
vide dental care at acceptable low cost levels, as opposed to providing benefits by
governmental agencies. The provision of dental care under Medicare and Medicaid
has been historically and traditionally minimal and inadequate.
CONCLUSION
The American Dental Hygienists' Association is a health provider organization
and is unquestionably dedicated to providing preventive oral health services to the
people of this nation. If the Association's goals and objectives to eliminate dental
disease appear to represent a special interest group to the Subcommittee, we can
offer no disclaimers or apologies. Our special interest is the promotion of oral health
to all who seek it and need it.
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The Association believes that taxing health care benefits, namely dental benefit
plans, is an unhealthy idea which will defeat the great progress made by the dental
hygiene and dental professions over the past three decades. The incidence of dental
caries has declined and periodontal disease has become a focal point of treatment by
the dental hygiene and dental professions. If oral health is a national goal and ob-
jective-and the Public Health Service Surgeon General thinks it is-we believe
that dental benefit plans should remain tax free and that current statutory law
should not be changed.
Despite our bias in addressing the issues of fringe benefits, the Association recog-
nizes that the House Ways and Means Committee, and the Congress generally, are
confronted with a dilemma. The plethora of fringe benefits is impacting on the na-
tion's revenue base. Congress and the Executive Branch as well, are compelled to
act. If revenues must be increased to offset deficits, it is apparent that the tax-free
health insurance fringe benefit will be carefully scrutinized.
The Association recognizes the problem of fringe benefits which the Subcommittee
is addressing in this hearing and we are sensitive to the need in Congress to develop
solutions to increase revenues in order to reduce massive federal deficits. It is our
hope, however, that fringe benefits for health care, especially oral health care, will
not need to be taxed.
We know that the Committee and Congress will need to make some difficult deci-
sions about whether fringe benefits should be taxed.
If the concept of taxation of employee benefits is accepted, the next step is to
decide which ones to tax and which to allow to remain tax free. It is our hope that
Congress will opt for healthy Americans and Americans with healthy teeth and
gums and save the tax free status of dental benefit plans.
STATEMENT OF THE AMERICAN HOSPITAL ASSOCIATION
SUMMARY
While the tax system should be designed to encourage employers to provide an
adequate level of health benefits to their employees, it should not be open-ended.
Individuals whose employer contribution exceeds a set limit could instead maintain
their current insurance levels with after-tax dollars, thus discouraging the purchase
of unneeded insurance.
Excessive health benefits are inflationary and insulate all elements of the health
care system from health care decisions, contributing to inefficient use of health care
resources.
Reducing the rate of inflation in the health care sector requires addressing not
only Medicare and Medicaid outlays but also private health spending. The limit on
tax-free benefits would help address these issues without limiting an individual's op-
portunity for protection against the serious financial consequences of illness.
INTRODUCTION
On behalf of our 6,100 institutional members and 38,000 personal members, the
American Hospital Association (AHA) is pleased to have this opportunity to present
our views on employer-provided health insurance benefits as part of your general
examination of the distribution and economics of employer-provided fringe benefits.
Under current law, an employer's contribution to an employee's health plan is a
tax-free fringe benefit-the second largest statutory fringe benefit in the tax code,
with the revenue loss estimated to be $18.6 billion in Fiscal Year 1983 and over $20
billion in Fiscal Year 1984.
The AHA strongly supports legislation introduced by Representative Conable
(H.R. 2575) which would limit tax-free employer-paid health benefits to $175 per
month for a family plan, and $70 per month for an individual employee plan. The
limit would be indexed to increase yearly in proportion to the consumer price index.
Employer contributions above these amounts would be added to employee income
and taxed accordingly.
This proposal would reduce the revenue loss to the U.S. Treasury by $2.1 billion
in FY 1984, $4.2 billion in FY 1985, $6.0 billion in FY 1986, $8.0 billion in FY 1987,
and $10.7 billion in FY 1988.
More important, according to the Congressional Budget Office (CBO), medical care
prices would be about 2 percent lower in 1987 than under current policies if a tax
cap were enacted and increased accordingly in future years. For the 85 percent of
the population with employer-based health insurance, spending on insured medical
services would be an estimated 9 percent lower in 1987. Studies conducted by the
PAGENO="0612"
606
National Center for Health Services Research (NCHSR) and many health econo-
mists also agree that such a proposal would help control health care cost inflation.
COST CONSCIOUSNESS
The current tax treatment of health insurance premiums has substantially in-
creased the demand for comprehensive insurance that, in turn, has distored the
demand for hospital care, often encouraging more expensive procedures.
Excessive health benefits are inflationary; they insulate consumers, providers, and
insurers from the cost consequences of health care decisions, contributi~tg both to
the use of inefficient forms of health care financing and delivery, and to the overuse
of health services. A cap would remove the insulation that separates consumers
from actual health costs, making them more cost conscious and encouraging them to
demand more cost-effective care as well as less costly services.
We share the view held by many that patients, guided by their physicians,
demand more services and more expensive services when a large part of their costs
are offset by insurance. The combination of private health insurance and public pro-
grams such as Medicare and Medicaid now pays for the vast majority of health care
services, with patients paying a small fraction of the cost.
While the cap would provide substantial federal revenues, it also would encourage
employees to play a more active role in choosing health insurance coverage and to
be more sensitive to cost implications in the exercise of that choice. A study con-
ducted by NCHSR found that only 18 percent of Americans receiving health care
coverage through employment-related plans now have a choice among plans. If a
ceiling were placed on the tax exclusion, many employers probably would make a
fixed-dollar contribution toward health insurance while offering employees a choice
of plans.
A tax cap would create new incentives for employers to restructure benefit pro-
grams and include cost-effective preventive services in their health plans, including
services that help reduce unnecessary hospital admissions. For instance, it might
provide employers, insurers, unions, and individual workers the opportunity and im-
petus to: experiment with alternative models of health care delivery, develop benefit
packages with built-in incentives toward lower-cost care, develop benefit packages
that target the most essential health services, and increase individual accountability
for spending on health care. Options ranging from the use of preferred providers
and prepaid capitation plans to comprehensive restructuring of the benefit mix may
be considered.
FEDERAL SUPPORT FOR HEALTH CARE
Federal resources and commitment, whether through direct grants, appropria-
tions, reimburement for services, or through certain tax policies, all are important
factors in the financing of health care. The tax cap proposal, in effect, would reduce
the level of federal subsidy to middle- and upper-income individuals by $30 billion
over the next four years. Without appropriate adjustments such as the tax cap, an
even larger share of federal resources will go' toward subsidizing the care of higher-
income individuals compared to the poor in the future. For instance, preliminary
CBO projections indicate that by 1995, under current law, the federal government
will be subsidizing those with employer-based coverage at a rate of $126.8 billion,
while the Medicaid program, designed to benefit strictly low-income individuals, is
projected to cost $58.4 billion that year by comparison.
NEED TO CONTROL PRIVATE HEALTH CARE SPENDING
The Social Security Amendments of 1983, P.L. 98-21, which enacted prospective
payment for inpatient hospital services under Medicare will yield significant pro-
gram savings. In addition, over the past few years there have been several changes
designed to reduce Medicaid growth. As consumers, providers, the Congress, and the
federal government continue to grapple with health care cost inflation, the impor-
tance of a tax cap becomes even greater. The' tax cap is one approach that can have
a direct impact on controlling private health care spending, which represents 57
percent of all national health expenditures. Reducing the rate of inflation in health
care means addressing not only Medicare and Medicaid, but private health care
spending as well.
TAX POLICY CONSIDERATIONS
The current income tax system makes the "price" of health insurance less than
the price of other goods and services because employer contributions for health in-
PAGENO="0613"
607
surance premiums are excluded from employees' taxable income. Employer-provided
health insurance, in effect, is purchased at a discount relative to goods and services
bought from taxable wages and salaries. The appropriateness of this policy needs to
be carefully examined.
In addition, the tax cap would have a progressive impact. The average tax benefit
derived under current law is directly related to income-the higher one's income,
the larger the tax subsidy for health benefits.
EXISTING COVERAGE
Companies and individuals should have the right to purchase health benefits as
they see fit. The proposed limit on tax-exempt employer-provided health benefits,
which would affect an estimated 30 percent of the population with employer-based
coverage, would be set at a level that would permit complete subsidization of protec-
tion against the financial consequences of serious unpredictable illness. Individuals
then could purchase additional coverage as desired.
Extensive private group health insurance coverage is readily available for about
$2,100 per year or $175 monthly-the levels most commonly discussed in conjunc-
tion with a cap. Certain comprehensive health plans provided through the Federal
Employees Health Benefits system are but one example of those within these limits
that would not be affected by the cap. This coverage includes: full coverage with
some copayment and deductible for inpatient hospital care, full coverage at reasona-
ble and customary charge with some copayment and deductible for physician serv-
ices, and some coverage for prescription drugs.
CONCLUSION
The AHA believes that reducing the rate of inflation in the health care sector
requires addressing private health care spending in addition to public programs
such as Medicare and Medicaid. Limits on the amount of health benefits provided
by employers to employees would help address the private side of the health care
cost equation while still providing the opportunity for employees to continue to be
protected against the serious financial consequences of illness. The Association ap-
preciates the opportunity to present its views on this matter and looks forward to
working with you on legislation in this area.
AMERICAN PSYCHIATRIC ASSOCIATION,
Washington, DC, September 21, 1984.
Hon. DANIEL R05TENK0w5KI,
Chairman, Committee on Ways and Means, House of Representatives, Longworth
House Office Building, Washington, DC.
DEAR MR. CHAIRMAN: The American Psychiatric Association, a medical specialty
society representing over 29,000 psychiatrists nationwide, is pleased to provide its
views of proposed tax law changes relating to fringe benefits. As you may be aware
from previous testimony we have submitted to the House Ways and Means Commit-
tee, we are most seriously concerned about past and present efforts to alter the cur-
rent tax-exempt status of employer-paid employee health insurance premiums.
We know from a recent painful experience with the Federal Employee Health
Benefit Plan that when benefits are cut-as they would be in this case to reduce
premium costs-the first cutbacks are those for the treatment of mental illness. His-
tory has instructed us well that the voiced or unvoiced concerns of the mentally ill,
whose benefits under most employer plans already are restricted at best, are not
heeded at such times.
Similarly, such a cap could have other serious, but more indirect adverse effects
on mentally ill, other chronically ill and older workers. If employers responded to
the tax cap by offering employees a choice of plans-a low option which is nontax-
able and a high option which is taxable-those who perceive themselves as health-
ier likely would choose the lower-cost, minimal coverage plan. Less healthy workers
would want the protection of a more comprehensive, higher cost (and therefore tax-
able) plan. Over time, the cost of providing services to the high users would drive up
the premium to that group, and those remaining healthier workers would drop out.
This adverse selection would put the cost of the more comprehensive protection out
of reach for those who need it. Thus, those at greatest risk for high health care
costs, for whom the concept of health insurance is intended to serve and who are
among the least able to bear the increased tax burden imposed by the tax cap,
PAGENO="0614"
608
among them the mentally ifi, mentally retarded or handicapped, will be least able
to afford the insurance coverage itself.
During Senate Finance Committee hearings on the fringe benefit issue, Chairman
Dole noted that "the exclusion from an employee's gross income for employer-pro-
vided health care coverage was intended to encourage employers to provide compre-
hensive medical coverage for all workers. Certainly this desirable social goal has
been achieved through the use of tax incentives." He then supported the Adminis-
tration's proposal to alter such benefit's tax status through the imposition of a cap
on such insurance benefits.
We are deeply concerned that changing the current tax status of such health ben-
efits most likely would lead to damaging alterations in that "comprehensive medical
coverage" which would work to the detriment of this nation's workers and their
families. Further, we understand it will not raise the revenues which the Adminis-
tration suggests could then be utilized to shore up either the Federal deficit or the
Medicare program.
The National Center for Health Services Research, the Employee Benefits Re-
search Institute and Price Waterhouse have all determined that the revenues pro-
jected to be raised by the imposition of such a cap are based on poorly founded as-
sumptions. For example, it is assumed that employees will maintain their insurance
coverage above a capped level. The facts are to the contrary; employees will opt for
lower-cost coverage, avoiding the tax and raising no revenues. As stated at the
outset, based on FEHBP experience, benefit packages likely will be reduced to hold
down premium costs.
We urge the Committee to retain the current tax status of employer-paid employ-
ee health insurance premiums not only because of its hollow promise of increased
revenues, but because of the hardship it will work upon a significant number of
mentally ill, mentally retarded, handicapped and chronically ill in this country-
populations already too often burdened by high insurance premiums for inadequate
coverage.
Sincerely,
JAY B. CUTLER,
Special Counsel and Director,
Division of Government Relations.
AMERICAN SOCIETY OF ASSOCIATION ExEcuTIvEs,
Washington, DC, September 19, 1984.
Mr. JOHN J. SALMON,
Chief Counsel, Committee on Ways and Means, House of Representatives, Longworth
House Office Building, Washington, DC.
Dn~ MR. SALMON: Enclosed for the record of the Hearing To Gather General In-
formation On The Distribution And Economics Of Employer Provided Fringe Bene-
fits are six (6) copies of an excerpt relating to fringe benefits of the Compensation
Study that was conducted by the American Society of Association Executives in
1983. Please be aware, however, that because the survey was performed in 1983, it
does not reflect the changes to employee benefit plans which have been made to
comply with the Tax Equity and Fiscal Responsibility Act of 1982, the Deficit Reduc-
tion Act of 1984 and the Retirement Equity Act of 1984.
If I can be of any further assistance, please do not hesitate to give me a call.
Sincerely,
JA1~css J. ALBERTINE,
Director of Government Affairs.
Enclosures.
PAGENO="0615"
609
Comji.
Compiled by
Priestland Associates
Alexandria, Virginia
1983
Association
Executive
Published by the
American Society
of Association Executives
1575 Eye Street, N.W.
Washington, D.C. 20005
PAGENO="0616"
610
Sedion ifi
Personnel Practices
and Fringe Benefits
Observations
The changes in distribution of answers to questions asked in both 1981 and
1983 surveys are attributable at least in part to whatever changes there were in
the make-up of the sample. The relationships among associations of various scopes
and among the listed alternative responses are similar for both surveys.
Questions new to this survey give additional information to association exec-
utives. There is a cash bonus system in less than one-fifth of the reporting as-
sociations. Bonuses are based on many criteria, including the following: merit,
association budget surplus, performance indepartment activities, increasing mem-
bership, excess of association revenue over annual goal, and others. Bonuses are
paid according to various formulae: "in kind," e.g., spouse travel or car allowance;
~alary levels; and as a means of recognizing good performance after the top of the
salary range has been reached.
There were a few changes in the retirement questions in the current survey.
Employer cost of the retirement program was broken out to show the cost as a
percent of total association payroll and a percent of the payroll of employees
covered. There are no clear patterns in these responses among associations by
scope of membership. Cost-of-living adjustments for retirees were defined in this
survey as "automatic," "ad hoc," or "none." Over two-thirds of the responding
associations make no cost-of-living increases for retirees.
In an effort to present the information on medical insurance in a more com-
prehensive format, we have presented all positive responses without regard to
whether coverage was for single plan, family plan, or both. Often, whether or not
a person reported the type of plan available depended on marital status. Hospital
indemnity insurance was added to the list of medical insurance coverage this
year.
A new question on base salary for an entry level clerk was added to this survey.
There were only slight variations in the averages and medians, regardless of
association characteristics.
PAGENO="0617"
611
Entry Level Clerk-Base Salary
By Type # of Responaea Average Median
Trade Associations 525 $10,500 $10,000
Professional Societies 433 10,200 10,000
By Budget
$200000 or under 141 10,400 10,000
$200001-300,000 115 9,800 10,000
$300,001-500,000 154 10,300 10,000
$500,001-750,000 121 10,400 10,000
$750,001-1,000,000 86 10,500 10,000
$1,000,001-2,500,000 193 10,600 10,400
$2,500,001-5,000,000 83 10,300 10,000
$5,000,001-10,000,000 41 10,100 10,000
Over $10,000,000 24 10,100 10,000
By Scope
National 421 10,800 10,500
State/Regional 405 10,100 10,000
Local 132 9,700 9,600
By Area
New England 38 10,300 10,000
Middle AtlantIc 118 10,000 10,000
East North Central 225 10,200 10,000
West North Central 66 9,700 10,000
South Atlantic 248 10,800 11,000
East South Central 41 9,000 9,000
West South Central 67 10,400 10,000
Mountain 53 9,800 9,600
Pacific 102 11,000 10,800
PAGENO="0618"
Established Salary Structure for
ManageO~flt Personnel:
Total Respondents
Salary Grades
Yes
No
No Answer
Salary Ranges
Yes
No
No Answer
Types of Salary Increases
Merit Increases
General (across-the-
board) Increases
Coat-of-Living Increases
Length-of-Service Increases
Usual Intervals and Timing of
Salary Reviews
Usual Interval
6 months
12 months
Other
No set interval
No Answer
Usual Tinting
Anniversary date
January 1
Fiscal Year
Annual Convention
Other
No Answer
Cash Bonus System
Far Chief Paid Executive
Yes
No
For Second Highest Paid Executive
Yes
No
612
TABLE 36 Personnel Practices
Analysis of Salary Administration Policies by Association Scope
Position: All Management Personnel
Total No.
of Auna.
% of
Total
Ao.sna.
National
Assns.
% of
National
Aims.
Stale'
Regional
Aims.
% of
State'
Regional
Mans.
Local
Mans.
% of
Local
Asana.
1.129
100%
476
100%
494
100%
159
100%
171
15%
96
20%
59
12%
16
10%
877
78%
346
73%
399
81%
132
83%
81
7%
34
7%
36
7%
11
7%
327
29%
177
37%
114
23%
36
23%
731
65%
273
57%
345
70%
113
71%
71
6%
26
6%
35
7%
10
6%
887
79%
398
84%
365
74%
124
78%
369
33%
139
29%
378
36%
52
33%
448
40%
179
38%
205
42%
64
40%
132
12%
51
11%
50
10%
31
20%
47
4%
15
3%
21
4%
11
7%
966
85%
438
88%
422
86%
126
79%
6
1%
1
4
1%
1
1%
33
3%
11
2%
15
3%
7
4%
77
7%
31
7%
32
6%
14
9%
261
23%
143
35%
87
18%
31
19%
293
26%
106
22%
127
26%
60
38%
343
31%
123
26%
182
37%
38
24%
36
3%
23
5%
13
2%
0
0
49
4%
25
5%
19
4%
5
3%
147
13%
56
12%
66
13%
25
16%
182
16%
69
15%
74
15%
39
25%
924
82%
396
83%
409
83%
119
75%
324
11%
51
11%
51
10%
22
54%
808
72%
389
78%
335
68%
104
65%
130
10%
51
11%
49
10%
16
10%
For Department Head
Yes
778
69%
360
76%
319
65%
97
61%
No
flnad toastsatdo aSh b.~iea1eao1saantiat1os, toast y.ssarsxeual auevesSoe.
tass thsa i~.
PAGENO="0619"
Chief Paid Executive
Total Respondents
Type of Contract
Formal Contract
Letter of Agreement
Retained by Resolution
of the Board
Verbal Arrangement Only
Other
Term of Contract
1 Year
2 Years
3-4 Years
5 Years
Over 5 Years
Continuous Contract
Deputy Chief Paid Executive
Total Respondents
Type of Contract
Formal Contract
Letter of Agreement
Retained by Resolution
of the Board
Verbal Arrangement Only
Other
Term of Contract
1 Year
2 Years
3 Years
4-5 Years
Over 5 Years
Continuous Contract
"Louttasl%
613
TABLE 37 Personnel Practices
Analysis of Employment Contracts by Association Scope
Position: Chief Paid Executive, Deputy Chief Paid Executive
total No.
of Assns.
% of
Total
Msns.
National
Asons.
% of
National
Assna.
State!
Regional
Assns.
% of
State!
Regional
Assns.
Local
Assne.
% of
Local
Assns.
1.129
100%
476
100%
494
100%
159
100%
330
29%
171
36%
122
25%
37
23%
143
13%
71
15%
54
11%
18
11%
350
31%
128
27%
173
35%
49
31%
297
26%
lOG
21%
142
29%
55
35%
6
1%
5
1%
1
0
0
90
8%
44
9%
28
6%
18
11%
51
5%
26
5%
18
4%
7
4%
121
11%
69
15%
39
8%
13
8%
47
4%
27
6%
16
3%
4
3%
7
1%
4
1%
3
1%
0
0
37
3%
15
3%
20
4%
2
1%
812
100%
371
100%
343
100%
98
100%
46
6%
22
6%
18
5%
6
6%
92
11%
52
14%
33
50%
7
7%
106
13%
47
13%
49
14%
10
10%
551
68%
240
64%
238
69%
73
75%
17
2%
10
3%
5
2%
2
2%
* 36
4%
23
6%
9
3%
4
4%
5
1%
4
1%
1
*
0
* *
17
2%
6
2%
8
2%
3
3%
1
I
0
0
0
0
0
0
10
1%
6
2%
4
1%
0
* *
PAGENO="0620"
contract clause allowing association
to terminate before the specified
number of Yasm
Chief paid Executive
Yes
No
Deputy Chief Executive
Yes
No
Length of notice to be given
Chief Paid Executive
1 month
2 months
3 months
4 months
6 months
9-11 months
12 monthi
Deputy Chief Executive
I month
2 months
3 months
4 months
6 months
614
TABLE 37 Personnel Practices
Continued Analysis of Employment Contracts by Association Scope
Position: Chief Paid Executive, Deputy Chief Paid Executive
Total No.
of Auns.
% of
Total
Anano.
National
Anans.
% of
National
Aoono.
State!
Regional
Assas.
% of
State!
Regional
Asons.
Local
Assets.
% of
Local
Assess.
251
22%
127
27%
95
19%
29
18%
129
11%
71
15%
40
0%
18
11%
41
5%
20
5%
14
4%
7
7%
51
6%
24
6%
22
6%
5
5%
42
4%
17
4%
16
3%
9
6%
36
3%
11
2%
19
4%
~6
4%
83
7%
40
8%
34
7%
9
6%
9
1%
6
1%
3
1%
0
*~
80
7%
52
11%
20
4%
9
5%
1
*~
I
0
*`
0
*`
24
2%
15
3%
9
2%
0
`~
21
3%
8
2%
8
2%
5
5%
5
1%
2
1%
2
1%
1
1%
12
1%
8
2%
3
1%
1
1%
3
2
1%
1
*~
0
Lossthsc 1%
PAGENO="0621"
Chief Paid Executive
Total Respondents
Number of years in present
position
1'-2
3.5
6-9
10-14
15-19
20-29
30 or more
No Answer
Previous Position
Current Association
(different capacity)
Another Association
Government
Military
Private Industry
Self-employed Professional
Educational Institution
Other
No Answer
Deputy Chief Executive
Total Respondents
Number of years in present
position
1'-2
3.5
6-9
10-14
15.19
20.29
30 or more
No Answer
Previous Position
Current Association
(different capacity)
Another Association
Government
Military
Private Industry
Self-employed Professional
Educational Institution
Other
No Answer
tsoladn less thas on. ysar.
"Loss has 1%
615
TABLE 38 Personnel Practices
Analysis of Employment Experience by Association Scope
Position: Chief Paid Executive, Deputy Chief Paid Executive
Total No.
of Auns.
% of
Total
Aasna.
National
Assns.
% of
Natlenal
Asans.
State/
Regional
Asans.
% ef
State/
Regional
Aaans.
Local
Mans.
% of
Local
Mans.
1129
100%
476
100%
494
100%
159
100%
183
t6%
92
19%
71
14%
20
13%
277
25%
114
24%
115
23%
48
30%
210
19%
80
17%
101
20%
29
18%
233
21%
98
20%
112
23%
25
16%
94
8%
37
8%
43
9%
14
9%
104
9%
43
9%
43
9%
18
11%
13
1%
5
1%
6
1%
2
1%
15
1%
9
2%
3
1%
3
2%
222
20%
108
23%
95
19%
19
12%
388
34%
155
33%
172
35%
61
38%
104
9%
34
7%
58
12%
12
8%
25
2%
13
3%
7
1%
5
3%
253
22%
103
22%
108
22%
42
26%
41
4%
16
3%
16
3%
9
6%
80
7%
39
8%
34
7%
7
4%
12
1%
6
1%
3
1%
3
2%
4
**
2
~`
1
~`
1
1%
812
100%
371
100%
343
100%
98
100%
238
29%
100
27%
109
32%
29
30%
222
27%
90
24%
101
30%
31
32%
153
19%
71
19%
65
19%
17
17%
108
13%
61
16%
36
10%
11
11%
43
5%
21
6%
18
5%
6
6%
37
5%
21
6%
14
4%
2
2%
3
~`
2
1%
1
`
0
0
8
1%
5
1%
1
2
2%
145
18%
76
20%
54
16%
15
16%
141
17%
77
21%
50
15%
14
1441,
92
11%
25
7%
58
17%
9
9%
14
2%
4
1%
7
2%
3
3%
201
34%
127
34%
111
32%
43
44%
30
4%
12
3%
14
4%
4
4%
79
10%
39
11%
35
10%
5
5%
25
3%
11
3%
9
3%
5
5%
5
1%
0
"
5
1%
0
PAGENO="0622"
Total Respondents
Types of Retirement Plans
IRS Qualified Retirement Plan(s)
IRS Qual. & Deferred Comp. Plan
Deferred Compensation Plan(s)
individual Retirement Acot. (IRA)
Tax Sheltered Annuity (TSA)
Other
Noab (no plan)
No Answer
Plan lx
Defined Benefit Plan
Defined Contribution Plan
No Answer
Eligibility
At age:
21 and below
22.24
25
28-30
And/or after:
1 year's employment
2 years' employment
3 years' employment
4.5 years' employment
Vesting
300% Immediate
Graded 100% In:
Lass than 10 years
10 years
11-15 years
Cliff vestIng: 100% after 10 yrs
616
TABLE 39 Fringe Benefits
Analysis of Retfrement Benefits by Association Scope
Position: All Management Personnel
Total No.
of Aaana.
%of
Total
Mans.
National
Aims.
%of
National
Auns.
Statel
Regional
Mans.
%of
Statel
Regional
Auna.
Local
Mans.
%of
Local
Mans.
1,129
100%
478
100%
494
100%
159
100%
sia
48%
248
52%
210
43%
60
36%
80
7%
37
8%
32
6%
11
7%
82
7%
33
7%
38
8%
11
7%
-~- -~- ~ 2~ ~ ~
94 8% 52 11% 28 6%
14
9%
60
5%
20
4%
29
6%
11
7%
195
17%
83
13%
99
20%
33
21%
18
2%
6
2%
a
2%
2
1%
347
37%
178
43%
133
34%
36
28%
429
46%
179
43%
181
48%
69
55%
158
17%
58
14%
81
20%
21
17%
35
4%
11
3%
18
4%
8
6%
47
5%
22
5%
22
6% .
3
2%
176
19%
98
24%
60
15%
18
14%
8
1%
6
1%
2
1%
0
~`
249
27%
128
31%
95
24%
26
21%
21
2%
9
2%
10
3%
2
2%
58
6%
25
6%
22
6%
11
9%
23
2%
14
3%
6
2%
3
2%
196
21%
87
21%
73
18%
36
29%
129
14%
57
14%
56
14%
18
13%
177
19%
91
22%
72
18%
14
11%
97
10%
48
12%
38
9%
13
10%
160
17%
68
16%
74
19%
20
18%
13
1%
9
2%
4
1%
0
358
38%
119
29%
178
45%
61
48%
Other
No Answer
Add~to oosi thin 1.129 bsaaszs.elmlttple p1sa~
"Larn than 1%
PAGENO="0623"
Retirement age
Normal retirement at:
Under 62
65
70
Other ages
Early retirement at:
Under 55
55
60
62
Other ages
Length of Service Requirement
Maximam Benefit:
Years of Service
Under 10
10
11-15
20
25
Over 25
Early Retirement
Years of Service
Under 10
10
11.15
Over 15
Minimum Benefit
Years of Service
5 or less
6-10
Over 10
Benefit reduction for early retirement
Na
No Answer
Funding and Payment
Percent of retirement program cost
paid by the association
50% or less
51-99%
500%
617
TABLE 39 Fringe Benefits
Continued Analysis of Retirement Benefits by Association Scope
Position: All Management Personnel
.
%of
% of
% of
% of
State!
State!
Local
Local
Total No.
of Auna.
Total
Mans.
National
Asans.
National
Asanu.
Regional
Asans.
Regional
Mona.
Mans.
Asona.
24
3%
9
2%
12
3%
3
2%
16
2%
6
1%
6
2%
4
3%
654
70%
318
77%
258
65%
78
62%
11
1%
4
1%
5
1%
2
2%
2
I
`
I
*~
0
14
2%
6
1%
6
2%
2
2%
240
26%
132
32%
82
21%
26
21%
58
6%
26
6%
28
7%
4
3%
83
9%
38
9%
34
9%
11
9%
22
2%
8
2%
7
2%
7
6%
48
5%
21
5%
22
6%
5
4%
157
17%
75
18%
67
17%
15
12%
75
8%
41
10%
28
7%
6
5%
53
6%
29
7%
20
5%
4
3%
14
2%
8
2%
5
1%
1
1%
42
5%
22
5%
17
4%
3
2%
.
/
45
5%
23
6%
18
4%
6
5%
149
56%
80
19%
56
14%
53
10%
32
3%
19
5%
10
3%
3
2%
30
3%
12
3%
lB
4%
2
2%
148
16%
78
19%
54
14%
14
11%
60
6%
29
7%
26
7%
5
4%
6
1%
5
1%
1
**
0
438
47%
221
54%
173
44%
44
36%
231
25%
93
22%
97
24%
41
32%
265
28%
99
24%
125
32%
41
32%
18
2%
II
3%
5
1%
2
2%
52
6%
31
8%
19
5%
2
2%
677
72%
303
73%
287
73%
87
69%
Yes
PAGENO="0624"
Retirement benefit integrated with
social security benefit
Yes
No
No Answer
Pm-retirement spouse'. benefit
Yes
No
No Answer
If yes. Is It:
Contributory
Funded by the association
No Answer
Employees can make additionat
voluntary contributions to the
plan
Ye.
618
TABLE 39 Fringe Benefits
~ntinued Analysis of Retirement Benefits by Association Scope
Position: All Management Personnel
Employer cost of program as % of
total association payroll
3% or less
4-5%
6-7%
8-9%
10%
11-15%
Over 15%
Employer cost of program as % of
payroll of employees covered
6% or less
7-9%
10%
11-14%
Over 14%
Retirement benefit adjusted
automatically for coot-of-living
Retirement benefit adjusted on an
ad hoc basis for cost-of-living
increases for retirees
No cost-of-living increases are
currently made for retirees
Total Na.
of Anna.
%of
Total
Ann.
National
Anna
%of
National
Auna,
Slate!
Regional
Anna.
% of
State!
Regional
Anna
Local
Anna.
%of
Local
Anna.
67
7%
35
8%
19
5%
13
10%
86
9%
40
10%
36
9%
50
8%
92
10%
48
12%
39
10%
5
4%
81
9%
43
30%
32
8%
6
5%
80
9%
30
7%
43
11%
7
6%
84
9%
38
9%
33
8%
13
10%
29
3%
14
3%
13
3%
2
2%
104
11%
47
11%
40
10%
17
13%
127
14%
72
17%
44
11%
Il
9%
101
11%
47
51%
46
12%
32
10%
73
6%
30
7%
31
8%
12
10%
80
9%
41
10%
34
9%
5
4%
40
4%
39
5%
18
5%
3
2%
39
4%
17
4%
18
5%
4
3%
644
69%
305
74%
259
66%
90
63%
326
35%
555
38%
133
33%
38
30%
468
50%
213
51%
196
50%
61
48%
140
15%
47
11%
66
17%
27
22%
190
20%
97
23%
77
19%
16
13%
578
62%
255
62%
240
61%
83
66%
166
18%
61
15%
78
20%
27
21%
15
8%
10
10%
3
4%
2
13%
159
84%
78
81%
69
90%
12
76%
16
8%
9
9%
5
6%
2
13%
455
49%
221
54%
178
45%
56
44%
352
38%
150
36%
153
39%
49
39%
127
13%
42
10%
64
56%
21
17%
No
No Answer
"ta. Ursa 1%
PAGENO="0625"
619
"Lass thas 5%
TABLE 40 Fringe Benefits
Analysis of Life & Accident Insurance by Association Scope
Position: All Management Personnel
Total Respondents
Basic Life Insurance Coverage
Yes
No
No Answer
Maximum amount
Under $50000
$50,000 or above
No Answer
Scheduleis determined by
Salary
Job classification
Both
Other
No Answer
If by salary, amount is
Under 2 times salary
2 times salary or more
No Answer
% of premium paid by association
100%
Under 100%
No Answer
Accidental Death and
Dismemberment Coverage
Yes
No
No Answer
If yes, is it included in
life insurance policy
Yes
No
No Answer
Maximum coverage is
Under $100,000
Sl00,000.$150,000
Over $150,000
No Answer
% of premium paid by association
100%
Under 100%
No Answer
Association provides travel
accident coverage
Yes
No
No Answer
Total No.
of A.sns.
% of
Total
Auna.
National
Mans.
% of
National
Auna.
Stat&
Regional
Assna.
Stat&
Regional
Assna.
% of
Local Local
Mans Assna.
1,029
100%
476
100%
494
100%
159
100%
967
86%
423
89%
415
84%
129
81%
052
13%
46
10%
76
15%
30
19%
10
1%
7
1%
3
1%
0
0
371
38%
141
33%
166
40%
64
50%
572
58%
271
64%
239
58%
62
48%
24
2%
11
3%
10
2%
3
2%
495
51%
235
56%
206
50%
54
42%
220
23%
85
20%
104
25%
31
24%
001
11%.
52
12%
39
9%
10
020
12%
43
10%
50
12%
27
21%
31
3%
8
2%
16
4%
7
~5%
310
52%
141
49%
133
54%
36
56%
271
45%
135
47%
110
45%
26
41%
15
3%
11
4%
2
1%
2
3%
910
94%
395
93%
394
95%
121
94%
27
3%
15
4%
9
2%
3
2%
30
3%
13
3%
12
3%
5
4%
822
73%
389
77%
351
71%
102
64%
34%
282
25%
93
20%
135
27%
54
25
2%
14
3%
8
2%
3
2%
548
67%
251
68%
226
64%
71
70%
226
27%
95
26%
107
31%
24
23%
48
6%
23
6%
18
5%
7
7%
395
48%
158
43%
182
52%
55
54%
239
29%
112
30%
100
28%
27
26%
143
17%
83
23%
44
13%
16
45
6%
16
4%
25
7%
4
4%
748
91%
331
90%
325
93%
92
5
90%
5%
30
4%
13
3%
12
3%
44
5%
25
7%
14
4%
5
5%
666
442
21
59%
39%
I_,~.
327
139
,,~,,,,,
69%
29%
2%
268 54% 71
218 44% 85
8 2% I ~
45%
53%
~
40-046 0 85 - 40
PAGENO="0626"
Total Respondents
Association provides a long-term
disability plan
Yes
No
No Answer
If yes. after total disability.
benefits commence is
30 days or less
60 days
90 days
Over 90 days
Other
No Answer
Duration of the payments
for accidents is
Less than five years
5-10 years
Over 10 years
To age 65'
For life
No Answer
Duration of the payments
for illness is
Less than five years
5-10 years
Over 10 years
To age 65'
For life
No Answer
Payments are integrated with
Social Security
Yes
No
No Answer
Benefits as % of salary
Over 60%
50%-80%
Less than 50%
No Answer -
620
TABLE 41 Fringe Benefits
Analysis of Long.Term Disability Insurance by Association Scope
Position: All Management Personnel
Total No~
of Aims.
% of
Total
Aaaon.
National
Mao..
% of
National
Mans.
State/
Regional
Aaana.
% of
State/
Regional
Msns.
Local
Aims.
% af
`Local
Aaaas.'
1.129
300%
478
100%
494
100%
755
67%
334
70%
324
66%
100%
352
31%
134
28%
358
32%
60
61%
38%
22
2%
8
2%
12
2%
198
26%
69
21%
-
96
30%
33
1%
34%
120
16%
52
15%
53
16%
15
15%
249
33%
107
32%
115
35%
27
28%
157
21%
92
28%
47
15%
18
19%
34
2%
8.
2%
4
1%
17
2%
6
2%
9
3%
2
2
2%
2%
83
11%
33
10%
31
10%
68
9%
25
7%
31
10%
12
20%
12%
15
2%
2
1%
12
3%
1
1%
-
47%
177
53%
143
44%.
37
189
25%
79.
24%
90
43
6%
18
5%
17
28%
5%
20
8
21%
9%
93
12%
34
10%
39
12%
20
21%
72
10%
25
7%
32
10%
15
12
2%
2
~%
9
3%
1
1%
342
45%
177
53%
131
40%
34
35%
137'
18%
56
17%
64
20%
17
18%
99
13%
40
`12%
49
15%
10
40
10%
335
44%
-
152
46%
143
44%
41%
388
52%
188
50%
169
52%
51
53%
32
4%
14
4%
12
4%
6
6%
213
28%
75
22%
109
34%
29
30%
352
47%
176
53%
133
41%-
43
44%
131
17%
60
18%
58
18%
13
14%
59
8%
23
7%
24
7%
12
12%
701
93%
308
91%
302
93%
93
96%
38.
5%
19
6%
15
5%
2
2%
18
-2%
9
3%
7
2%
2
2%
% of premium paid by association
100%
Less than 100%
No Answer
Ow,stssaOy sspommad ma a 70.
"lsi miss t%
PAGENO="0627"
Total Respondents
Association provides medical
insurance
Yes
No
No Answer
If yes, types of coverage
Basic HospitalizatiOn/Surgical
Major Medical
Health Maintenance
Organization
Direct medical expense
payments
Dental tnsurance
Hospital Indemnity
% of total medical insurance cost
paid by the association
Single plate
100%
51%-99%
50%
Below 50%
Family plan
100%
51%-99%
50%
Below 50%
Lsos thaa t%
621
TABLE 42 Fringe Benefits
Analysis of Medical Insurance by Association Scope
Position: All Management Personnel
.
Total No.
of Asses.
%of
Total
Asses.
National
Asses.
%of
National
Asses.
State!
Regional
Asses.
494
State!
Regional
Asses.
100%
Local
Asses.
159
%of
Local
Asses.
100%
1,129
100%
478
1,078
95%
455
98%
474
96%
147
92%
8%
48
4%
19
4%
~
17
3
3%
1%
0
5
1%
2
856
80%
378
83%
388
442
78%
93%
110
133
75%
90%
999
93%
424
93%
134
12%
63
14%
51
11%
20
14%
118
11%
50
11%
50
11%
18
64
12%
44%
459
43%
215
47%
180
38%
53
5%
20
4%
28
6%
5
3%
808
57%
272
80% .
258
iS
54%
3%
80
2
54%
1%
51
5%
34
7%
2
2
1%
11
1%
7
2%
1%
3
..
2
0
601
56%
227
50%
293
82%
81
8
55%
5%
-~ ~- L~ ~ 28 6%
3% 17 4% 8 2% 3 2%
9% 41 9% 35 7% 14 10%
PAGENO="0628"
622
STATEMENT OF AMERICAN TELEPHONE & TELEGRAPH Co.
AT&T is pleased to submit this testimony in connection with the House Ways and
Means Committee's hearings on the tax treatment of pensions and other employee
benefits and for the opportunity for a full and open hearing on this important sub-
ject.
With regard to Representative Pickle's questions, AT&T has reviewed the answers
formulated by the Employee Benefit Research Institute (EBRI) and believes that its
answers present a fair discussion of employee benefits, the implications of various
types of tax treatment relative to these benefits, and the complementary nature of
government benefit programs and those provided by the private sector. Much of the
data and statistics presented by EBRI speaks for itself-millions of Americans at all
income levels are covered by employee benefit programs and the existing rules con-
cerning employee benefits ensure that all of these employees benefit fairly from the
tax incentives provided under current law.
Relative to pension policy, AT&T is concerned with the disincentives for defined
benefit plans, which seem to be the trend in public policy. Public policy is being
driven more by short-term considerations and problems than concern for the long-
term implications. it is true that the federal deficits must be reduced. But the policy
in regard to pensions should take a long-term view and not a short-term one. Final-
ly, we have some other specific concerns regarding defined benefit pension plans-
specifically integration and the plan termination insurance program.
In 1913, at a time when fewer than 100 private pension plans had been estab-
lished in the United States, AT&T designed and adopted defined benefit pension
plans covering its 150,000 Bell System employees. The primary motives were based
on considerations of sound business practice. The establishment of the plans was
judged to be an effective solution to deal with the problem of an aging population, a
way of managing the systematic retirement of employees, while providing the retir-
ees a continuing income to assist in meeting their financial needs. As a social pur-
pose, it was believed that in order to minimize the economic adjustments necessitat-
ed by the retirement of an individual from active service, the retirement income
should bear some reasonable relationship to income earned during active employ-
ment and thus the pension benefit defined by the plans was based on a percentage
of final 10-year pay.
Originally, all costs of the plans were met on a pay-as-you-go basis. During the
first 14 years of operation of the plans, pension expense was set equal to pension
payments as such payments were made. During this period, there was no advance
funding of pensions as that concept is commonly known today. By the early 1920s,
however, it was obvious that because of the increasing pension roll, the pension pay-
ments as a percentage of payroll were increasing dramatically, and, if a sound fi-
nancial program were not instituted, the result would be a significant cost deferral
and a drain on future business operations, which could result in a termination of
the plan or a drastic reduction of benefits. Clearly, this approach provided far less
benefit security to employees than advance funding.
AT&T began intensive actuarial studies of the plans, together with related ac-
counting, financial and legal questions. As a result of these studies, the conclusion
was reached that benefits, other than retirement income benefits, could continue to
be financed satisfactorily on a pay-as-you-go basis, but that service pensions should
be placed on an actuarial basis with advance funding and segregated assets, an "off
balance sheet" concept. An actuarial accrual plan was adopted in 1927 and evolved
over the years to a plan where pensions and death benefits are now funded on a full
accrual basis.
The evolution of AT&T's pension plan and funding program, as well as that of
other companies, occurred during a time when there was minimal regulation re-
garding pensions. However, in an environment of sharply increased regulation, com-
panies would be less willing to establish and maintain pension plans since they
would have little flexibility in the funding of these plans.
Over the years, in order for our pension benefits to keep pace with others in in-
dustry, the benefit was improved many times, including the change from a 10-year
to 5-year fmal pay formula in 1959, and the elimination of a direct Social Security
offset. Our pension benefit remained among the country's best, and pension accrual
costs increased significantly with each improvement. With the high inflation of the
seventies, the benefit formula was further improved; and, from 1959 to 1979, pen-
sion accrual costs had risen from a level of about 6% of payroll to nearly 18% of a
payroll which was also increasing each year. In addition to improvements through
plan amendments, under the final pay formula pension benefit levels were improv-
ing automatically as pay escalated to a point where, in some instances, the combina-
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623
tion of the pension benefit and Social Security exceeded pre-retirement disposable
income.
At that point in 1979, a re-evaluation of the pension benefit structure was under-
taken and changes made which would give the Company more control in benefit
levels. These changes were designed such that benefits would not automatically in-
crease with inflation. Since costs are a function of benefits, by first controlling bene-
fits, the Company would be able to have some control over the costs of the plan. The
result of the redesign of the benefit structure was a lowering of the Company's pen-
sion cost as a percent of pay. AT&T's action was not unique. Even though pension
contributions are tax deductible, companies have and will take action to lower pen-
sion costs if those costs become too high relative to industry in general.
In October 1980 the plans of the individual Bell System companies were consoli-
dated into two national pension plans covering all Bell System employees. The bar-
gained-for plan for non-management employees adopted a pension formula not di-
rectly related to final pay, a so-called "flat-dollar" plan. Under this flat-dollar plan,
the monthly pension is determined by multiplying years of service by a dollar
amount based on job classification. This structure has the advantage of giving the
company the flexibility of agreeing to plan improvements at an appropriate time
rather than benefit increases occurring automatically through salary increases. The
plan adopted covering management employees was an adjusted career average pay
plan. This structure also permits management control on future benefit levels and
costs while initially providing improved benefits relative to the former formula.
Today the management and non-management plans of the post-divestiture AT&T
cover approximately 370,000 active and 60,000 retired participants, ranging in ages
from 25 to over 100. The benefit formulas in both plans have been improved since
1980 and today a manager retiring under the management plan at 65 with 35 years
of service receives a pension benefit from the plan of just over 40% of final pay.
Together with Social Security, the retirement income averages almost 65% of the
employee's last year's wages. Under the non-management plan, a craftsman retiring
at the same age and service also receives a pension of about 40% of final pay,
which, together with Social Security, produces a total retirement income of about
70% of final pay. Supplementing the defined benefit plans are defined contribution
savings plans. Our policy is that retirement income is best provided by a defined
benefit vehicle, although a defined contribution savings plan can provide a supple-
ment.
DEFINED BENEFIT AND DEFINED CONTRIBUTION PLANS
Many things have changed since 1913, but the purposes served by a pension plan
are still both business and social in nature. A plan should be designed so as to at-
tract and retain employees by providing an assurance of a retirement benefit which,
together with Social Security, will provide a retirement benefit which bears a rea-
sonable relationship to pre-retirement income. Of course, this concept of reasonable-
ness is a matter of company policy and affordability.
The delivery of the pension benefit can be provided either through a defined bene-
fit or a defined contribution plan. However, the advantages of a defined benefit plan
in providing retirement income within the framework of a sound financial program
far outweigh any strengths a defined contribution plan might appear to have. The
employer community has recognized these advantages as evidenced by the populari-
ty of the defined benefit plans as a retirement income vehicle. Clear preference over
the last several decades for defined benefit plans argues strongly for their superiori-
ty in providing retirement income over defined contribution plans.
Under a defined benefit plan, retirement income is definitely determinable as a
percentage replacement of pay and, through the plan formula, income levels near
retirement can be reflected in the pension benefit. Defined benefit plans can provide
credit for past service and thus permit the replacement of increases in employee
salary levels resulting from promotions or from an inflationary environment prior
to retirement (such as we have experienced during the last 15 years). In addition,
since the employer assumes the risk of poor investment performance, employees are
insulated from such risk. Finally, for a retired employee covered by a defined bene-
fit plan, the erosion of the pension benefit due to inflation is avoidable since the
employer may help insulate retirees from their decreased buying power via ad-hoc
pension benefit increases.
Under defined contribution plans, on the other hand, retirement income is not
definitely determinable, and the amount can vary depending on investment earn-
ings during the accumulation period and the condition of the securities markets at
the time of retirement. For example, if an employee had retired during the period
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624
1974 to 1975 under a defined contribution plan when the securities market was de-
pressed, the amount of accumulation in that individual's account would have been
significantly eroded, impacting on his retirement security. Since it is extremely dif-
ficult to provide credit for past service with this type of plan, any promotional or
inflation make-up salary increases cannot be fully reflected in retirement income
levels. An employee covered by a defined contribution plan faces a retirement
income which is uncertain at best without the possibility of benefit adjustments to
insulate the individual from the effects of inflation. The result of a fixed employer
contribution as a percentage of payroll is that contributions which would be ade-
quate for older employees would be excessive for younger employees, and contribu-
tions which would be adequate for younger employees would be less than adequate
for older employees-hardly an equitable system.
It is important to note that the role played by defined benefit plans is a vital one,
and the formation, growth, and stability of these plans must be encouraged if em-
ployees are to have any guarantee of retirement income security. With a defined
contribution plan as the primary vehicle for providing pensions, inflation can de-
stroy the security of retirement income. Provisions of recent legislation-TEFRA
and the Deficit Reduction Act-have generally discouraged the maintenance of de-
fined benefit plans. The objective of current policy has been to eliminate perceived
abuses in defined benefit plans and also to decrease tax expenditures. AT&T agrees
that the elimination of abuses is appropriate. However, any policy which focuses on
reducing tax expenditures without considering the long-term ramifications on retire-
ment income security of American workers may prove to be inappropriate long-term
policy. Legislation and tax proposals in the pension area should encourage employ-
ers to provide benefits to meet the retirement security needs of employees through
defined benefit plans.
TAX DEFERRAL VS. TAX SHELTER
The growth of employee benefits has caused much concern to policymakers in the
last few years because of their tax-favored treatment, and the resultant losses of
federal tax revenues to the government. Another concern is the abuse of tax defer-
ral rules leading to the rise of pension plans as mere tax shelters. Concern about
the federal deficit has caused many to interpret the growth of tax-favored benefits
as an erosion of the tax base, and a threat to the public sectors's ability to finance
government programs. Tax policy seems to be excessively concerned with current
tax expenditures at the expense of sounder long-term policy. There is no question
that it is important to distinguish between bona fide corporate pension arrange-
ments and arrangements where the pension plan is used as a vehicle to avoid cur-
rent taxation on a significant portion of income. Use of the pension plan as a vehi-
cle for tax shelter should, of course, not be permitted. On the other hand, the tax
deferral of employer pension contributions provides incentives for employers to pro-
vide for retirement income.
In most instances, determining whether or not a pension plan is being used as a
vehicle for tax shelter should not be a difficult process. As a general rule, in major
corporations, key employees are a very small percentage of the total employee popu-
latioh and the percentage of total contributions made on behalf of key employees is
small. And, since benefit plan contributions are ultimately paid out as taxable bene-
fits, these contributions will ultimately be part of the tax base at a later date. On
the other hand, if the percentage of total contributions made on behalf of key em-
ployees is significant (e.g. 50%), then perhaps the plan is being used as a tax shelter.
If pension plans are to provide benefits over a long future period, there must be a
sound financial program for meeting these obligations. Advance funding provides
the means of insuring the benefit security of employees and current retirees, result-
ing in less reliance on public programs. In addition, pension plan contributions rep-
resent a form of savings in the economy. Corporate plans have created a large
source of funds for investments. Pension assets backing private plans (including
those funded with life insurance companies) in the U.S. reached $680 billion at the
end of 1983, an increase of almost fivefold in the amount of assets from the end of
1970. This substantial increase in assets was, of course, tied to large increases in
liabilities. A good part of those increases was attributable to the inflation of the
1970s. Without these pension assets, under a pay-as-you-go funding program, the
cost of capital would be higher due to an increased demand for funds.
The problems created by pay-as-you-go financing are exemplified by our Social Se-
curity system. The Social Security program was designed to operate on a pay-as-you-
go basis with a trust fund to serve as a cushion so that benefits could be paid in
economic conditions where expenditures exceeded income. By the mid-1970s, it
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625
became apparent that the program was being seriously underfinanced. Changes in
Social Security law in 1977 were designed to correct the system's short-term financ-
ing problems and some of the long-range problems by increasing payroll tax reve-
nues and adjusting initial Social Security benefit levels. The problems which the
Social Security System has experienced should not be compounded by forcing the
underfunding of the private pension system.
FINANCING ARRANGEMENTS
Tax policy toward pension plans should encourage funding to meet the ultimate
obligations for benefits. With the increasing cost of Social Security and the emerg-
ing decline in the ratio of workers to retirees, the stability of private pension plans
is even more important. Thus, tax policy regarding pension plans should be estab-
lished with a long-term perspective; it should not change frequently and dramatical-
ly. Pension plans are long-term arrangements that call for financing over long peri-
ods of time, and frequent changes in tax policy make it very difficult for employers
to design and maintain their plans.
To insure adequate funding in specific instances, tax policy should also encourage
faster funding than currently required in the cases of "poorly funded" plans. For
example, a recent survey by a large consulting firm revealed that about 70% of flat-
dollar plans are less than 100% funded for accrued benefits. Of those, more than
one-fifth are less than 50% funded. We would consider a mature plan with an ac-
crued benefit security ratio of less than 50% to be poorly funded.
One final technical point-actuarial gains and losses of an extraordinary nature
should be permitted to be immediately reflected in the funding.
MAXIMUM BENEFIT LIMITATIONS
The concept of maximum benefit limitations (currently $90,000 on employees' ben-
efits) is frequently misunderstood. Limits on benefits were originally established to
deal with professional organizations and plans which were being used as tax shel-
ters. The concern which we have now is that these limits could impact middle
income employees if such limits are not indexed properly. Also, employees affected
by these benefit limitations make company pension policy, and these employees
could possibly decide to curtail funding or terminate a plan to the detriment of
others if the plan provides limited benefit payments to such affected employees.
Limits lead to more limited funding of plans, and the impact is significant over
time. The question that should be asked is why there should be limits if a plan is
not discriminatory.
With regard to the effect of the limits on the tax deduction for contributions, in
the plans of most corporations where key employees are a small percentage of the
work force, the impact on corporations' total tax liability is small. The possibility of
abuse is greatest in "tax shelter" plans and it is in these plans that the limits
should be applied. Another alternative is to not allow a deduction for employer con-
tributions when made if the contributions are for benefits above the limit for de-
ductible amounts, but to allow the tax deduction of the benefit amounts when they
are actually paid from the plan.
As indicated earlier, we have two other specific issues in regard to pension policy
which we would like to address-single employer plan termination insurance and
Social Security integration.
SINGLE EMPLOYER PLAN TERMINATION INSURANCE
In order for plan termination insurance to better serve the purpose for which it
was initially established under Title W of ERISA-the protection of plan partici-
pants in the event of plan termination-certain changes should be made. AT&T sup-
ports the linkage of any premium increase with reform in Title IV. Specifically, the
term "insurable event" should be redefined so as to prevent the dumping of private
pension plan liabilities of ongoing businesses onto the PBGC. In addition, premiums
should be risk-related as in other forms of insurance. Companies with poorly funded
plans who are more likely to use the benefits such insurance provides should pay
proportionately more than better funded, more stable plans. Furthermore, AT&T
believes that some form of contingent liability should be incorporated into the single
employer plan termination insurance program with respect to spinoffs, mergers,
sale of assets, etc. Finally, an advisory committee should be established to monitor
PBGC administration of Title P1-including premium requirements.
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626
SOCIAL SECURITY INTEGRATION
Regulations regarding Social Security integration should be brought up to date
and be based on a benefit delivery basis, not a presumptive cost basis. Currently,
these regulations impair proper benefit design. The current rules are also out of
date with respect to the benefits provided by Social Security. The redesigned Social
Security benefits should be taken into account in developing future regulations on
integration. In its paper on integration, the Society of Actuaries' Committee on Pen-
sions sets forth a view based on benefit delivery, and regulations should support this
view. Discrimination in integrated plans could be defined as providing retirement
income which is a greater percentage of pay to higher paid than to lower paid em-
ployees.
AMERITECH,
Chicago, IL, September 18, 1984.
Hon. J. J. PICKLE,
Hon. FORTNEY H. STARK,
Committee on Ways and Means, House of Representatives,
Washington, DC.
DEAR MR. PICKLE AND MR. STARK: I submit this to the Subcommittees on Social
Security and Select Revenue Measures of the Committee on Ways and Means con-
cerning employer provided fringe benefits at Ameritech.
The figures provided are estimates derived from previous AT&T split outs.
The latest data were from 1981-1982, but continue to be representative of current
conditions. Benefit costs have remained relatively stable since 1976 in the AT&T
system.
(1) What is the total cost of benefits provided to employees?
(2) What percentage of total compensation does the total cost of benefits repre-
sent?
Estimated Total Compensaton (1981) was $2,900,000,000
Benefit costs were about 27.81% of total compensation or almost $807,000,000
This does not include vacation pay, holiday pay and other paid time off.
The following represent tax free benefits:
Percent
Group Life .66
Medical 541
Dental .81
Other .41
Total 1729
1 Or about $210,000,000.
And the following represent tax deferred benefits:
Percent
Pension 13.16
Savings 1.69
1 14.85
1 Or about $430,000,000.
(4) What percentage of total compensation and total cost of benefits does the cost
of tax free and tax deferred benefits represent?
Percentage of total compensation
Percent
Tax free benefits 7.29
Tax deferred benefits 14.85
22.14
Percentage of total cost of benefits: (1) Tax free plus tax deferred benefits are
22.14% of pay; (2) Total benefits (including Social Security) are 27.81% of pay; and
(3) Percentage of benefits which are tax free and tax deferred is 79.61% (1+2).
(5) What is per employee cost of both the total benefits provided and each type of
benefit?
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627
There were approximately 104,000 employees in 1981. The per employee cost was
about $7,800 ($807,000,000 divided by 104,000 employees)
Each type of benefit cost was:
Total gross payroll
Fringe payments-outside payroll:
100.0
$28,000
Pension and death benefits
Group life
Medical
Dental
Savings
Other
Social Security
.66
5.41
.81
1.69
.41
5.67
27.81
200
1,500
200
500
100
1,600
7,800
Total fringe-outside payroll
Ameritech's retirement program consists of: Defined Benefit Plan; Savings Plan;
and Social Security
The defined benefit and savings plans are not integrated with Social Security and
provide the same percentage of income replacement for all employees.
On the other hand, Social Security replaces more income for the lower dollars of
pay then it does for the higher dollars up to the maximum taxable wage base. Thus,
Social Security provides greater inqome replacement for the lower paid. Graphical-
ly, this looks as follows:
$30,000 $-50,000
pay level
(6) What percentage of the employee's salaary does the cost of the benefits provid-
ed represent?
As stated above, approximately 28% for all benefits. Only 7.29% is for tax free
benefits.
(7) What benefits are provided to employees in various salary ranges?
We do not keep records in this format.
Medical benefits and dental benefits are not pay related. They are available to all
employees. Consequently, medical benefits will be a higher percentage of pay for the
lower paid employee.
The other fringe benefits are pay related. All employees receive coverage in the
same relation to their pay.
It is estimated that the range of benefits provided as a percentage of pay is as
follows:
Percentage of Estimated per
pay costs employee costs
income
repi acement
(% of pay)
retirement program
$10,000
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628
Percentage
Pay of Pay
$10,000 32
30,000 22
50,000 20
100,000 18
(8) Are any benefits provided through a cafeteria plan?
No. But this concept is attractive to Ameritech in providing benefits better suited
to employees' needs.
Yours very truly,
DONALD W. PHIUJP5,
Director, Investment Management.
JoINT STATEMENT OF THE AMERIcAN COUNCIL OF Liir~ INSURANCE AND THE HEALTH
INSURANCE ASSOCIATION OF AMERICA (HIAA).
This statement on employee benefits is submitted on behalf of the American
Council of Life Insurance (Council) and the Health Insurance Association of Amer-
ica (HIAA). The Council has a membership of 611 life insurance companies which,
in the aggregate, have 95 percent of the life insurance in force in the United States
and hold 99 percent of the assets of insured pension plans. The HIAA has 320 mem-
bers which write over 85 percent of the commercial accident and health insurance
in the United States. Most of the members of the Council are also in the business of
accident and health insurance.
Our statement will serve to document the vitally important role employee bene-
fits play in providing economic security to hundreds of millions of American work-
ers, their beneficiaries and retirees. In recent years, Congress seems to have lost
sight of this fact. It has enacted major legislation affecting employee benefits on an
ad hoc basis and as a tool to increase revenue in the short run, without fully consid-
ering the long-term implications of such legislation. Too often, such legislation has
been formulated and finalized in "eleventh hour" sessions without adequate discus-
sion or representation from plan sponsors, service providers and regulatory agen-
cies. We must adopt a national policy statement on how we want private employee
benefits to impact our lives and those of our children.
We believe it :s imprtant that Congress, as it seeks to reduce the deficit, examine
all tax incentivEs and federal spending program, not just those associated with em-
ployee benefits. Only after Congress has reviewed the cost, value, and the distribu-
tion of benefits among the population of all tax incentives and federal programs, is
it possible to discuss any changes in the tax status of employee benefit arrange-
ments.
GENERAL COMMENTS
A short time back as history counts time-no more than three-quarters of a cen-
tury ago-the average working person could:
Become ill, forfeit his pay for the period of his illness, spend his meager savings in
the process of recovering, and none but his family would care.
Become disabled, lose his earning power, sink with his family into poverty-and
no one but his kin would be concerned.
Grow old without savings to support him, lose his place to younger, stronger
workers and retire in penury.
Die early in life with nought for his surviving family.
Historians persist in calling this era of domestic concord and international amity
"La Belle Epoque"-the beautiful time. Yet in the everyone-for-himself pursuit of
industrial progress, the arrangements for dealing with the vicissitudes that might
befall the average working person were individual, largely voluntary and very much
uncertain. Henry Steele Commager summed up the social attitude of the day, as em-
bodied in the stories schoolchildren read in their McGuffey Readers: "Have faith.
Should ill befall you, some kind person will provide."
Today, thanks to both the persistence of Congress in building a system of social
support and the forbearance of Congress in encouraging the private sector to join in
this effort, working people no longer need to depend upon the magical appearance
of "some kind soul" when ill befalls them. In the 73 years since the first employer
bought for his employees the first group insurance policy, this country has devel-
oped a system of social support that is certain, manifold, unique and-as subsequent
discussion will show-robust, adaptable and growing more extensive with each pass-
ing year.
PAGENO="0635"
629
Today the typical working person can look at the evils that might befall him and
know that employer sponsored benefits will:
Pay health bills when he is ill;
Provide income during periods of both short and long-term disability;
Provide a solid foundation of life insurance benefits; and
Produce in retirement years an income proportional to his work life earnings.
As we will demonstrate, private enterprise has built an effective and efficient ar-
rangement covering the needs of employees through employer-sponsored pension
and welfare plans. It benefits the majority of rank and file workers and their de-
pendents and is far superior to any government program which could replace it. It
should not be modified in the name of greater tax revenues. Employee needs are
there and must be met and if private enterprise is not encouraged to meet those
needs, government will inevitably be pressured into doing the job. We believe the
ultimate price to our nation would be greater.
To be sure, there are blemishes in the tapestry of employer-sponsored pension and
welfare plans which will need attention in the years ahead. But, in recent years,
Congress has placed too much emphasis on tax revenue in drafting legislation that
affects pension and welfare plans. Congress needs first to study the security these
programs deliver to America's workers-in every income bracket and in every
state-and then try to develop a national policy before legislating further.
So, in this statement we want to focus attention on the part of the glass that is
full, rather than on the part that is empty. These employer-sponsored programs are
of major importance to the rank and file workers of America. The programs have a
simple goal. Coupled with government programs, the objective of employer-spon-
sored programs is to replace wages lost through retirement, death or disability, and
to protect against a significant portion of catastrophic medical costs.
How broadly has this goal been met? The response of the private sector has great-
ly reduced the need for government funded social programs. The health insurance
programs of U.S. businesses today cover about 162 million persons under age 65
through some form of private group health protection. This private effort has very
much reduced the demands on government for a national health insurance program
and its accompanying need for increased taxes. The pension programs of the U.S.
businesses are maturing: by the time individuals age 35-44 in 1979 retire, 71% can
expect to receive a pension benefit. The growth in private pensions substantially re-
duces pressure on the Social Security system to increase benefits and, therefore, to
increase Social Security taxes.
The Congress has been wise for decades in legislating, through the tax laws, en-
couragement to American business to create and maintain these programs for work-
ers' security. As a result, the United States now has a partnership between govern-
ment programs and employer-sponsored programs that delivers income security to
most workers against the major hazards of life. In the years ahead, your task will be
to legislate to maintain and improve this public/private partnership. The "tax ex-
penditure" for employer-sponsored programs is large because these programs are
and will be providing income security to most workers. Programs providing benefits
across the spectrum of the work force do not come cheap.
Congress should continue to provide maximum encouragement, through the tax
laws, for the vigorous growth and expansion of employer-sponsored pension and wel-
fare programs. Also, any proposals to increase the Social Security wage base
through the addition of non-taxable employee benefits should be rejected. Since the
financial status of the Social Security system has just recently been strengthened,
any effor to increase the wage base must be considered unnecessary and counter
production is the goal of preserving and strengthening the structure of employer-
sponsored programs.
As part of the effort to reach a national policy on employer-sponsored pension and
welfare programs, we ask the Congress to think long and hard on one fundamental.
The goal is to provide lifetime financial security for workers. To plan and carry out
programs that run for decades, employers need stability in government policy and
rules. Lately the Congress has been changing the rules for these programs in virtu-
ally every session. This creates an unstable environment full of uncertainty which
forces employers to think almost entirely in the short range. To preserve and
strengthen the structure of employer-sponsored programs, Congress should retreat
from this counterproductive annual revision of rules for pension and welfare pro-
grams, and focus instead on the long view. We understand the forces that have
pushed for an annual tinkering, but these must be resisted for the long-term welfare
of American workers and their families.
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EMPLOYEE PENSIONS
Social Security, employer-sponsored retirement plans and individual savings, to-
gether, have traditionally been used to provide retirement income security for
American workers and their families. It is important that there be a proper balance
among the three mechanisms. In this regard, the function of the Social Security
system is to provide only a basis floor of income protection for retired and disabled
workers and for the survivors of deceased workers.
There are two basic reasons why the private system for providing retirement ben-
efits should be voluntary. First, it is consistent with the market orientation of our
society. Even if the terms of a pension agreement are not bargaining in union nego-
tiations, an employer has good reason to cast his pension plan in a form most
valued by his own employees: plans are too expensive for an employer to provide
unwanted benefits. Moreover, government has minimum flexibility when adminis-
tering programs for everyone, but private decisions provide flexibility and minimize
political problems. Through the private employer-sponsored pension system, workers
and employers can easily adjust to changing views about retirement age and other
retirement issues. The other basic reason is that retirement provided through Social
Security does not generate a supply of capital as do private savings arrangements.
These two reasons-more individualized choice and more private capital-provide
strong arguments for placing heavy reliance on the private pension system for re-
tirement income protection. There is an additional consideration: the tax benefit
given to pension plans only postpones the tax on savings. In the current academic
debate about tax policy, there is a considerable school of experts who say the right
way to tax all savings is to postpone tax until the income is consumed and that cur-
rent taxation of savings results in double taxation.'
Future retirement benefits under employer retirement plans
Private pension plans currently make a substantial contribution to meeting re-
tirement needs of American workers. In 1979, more than 74% of full-time, full-year
workers participated in an employer pension plan.' Moreover, a significant percent-
age of all workers are employed by firms with pension plans so that non-participat-
ing workers have the potential to participate in plan and receive pension benefits.
Despite these impressive statistics, trends in pension coverage and participation
have recently been the subject of criticism and the perception in Congress that pen-
sion coverage is not wide-spread. In our view, however, these discussions of pension
coverage often miss several important points about the structure of employer retire-
ment programs and their relation to retirement income. Two important questions
which must be recognized are: (1) what percentage of families will receive private
pension benefits upon retirement? and (2) what will be the size of the average pen-
sion benefit?
Since 1980 the Council commissioned ICF Inc., a Washington, D.C. consulting
firm, to undertake two studies of these important questions. In October 1982, ACLI
published a report on ICF's findings entitled, "Pension Coverage and Expected Re-
tirement Benefits."
The study completed in 1982 concluded that the role of pensions could be expected
to expand substantially in the future as the pension system matured. The study
showed a dramatic increase over the 25-year period from 1979 to 2004 in the propor-
tion of families age 65 to 69 drawing an employer sponsored pension.
This study was based on detailed information about the U.S. work force, collected
by the Census Bureau, and a careful projection of how workers would gain or lose
pension coverage as they aged. The evidence of the study was that in each year over
the next 25, more retiring workers will have spent much of their working lives
under the broad coverage and fast vesting pension rules in place after the enact-
ment of ERISA. The increased proportion of retirees getting pension benefits does
not involve any assumption of pension growth; only a projection of conditions actu-
ally revealed by the Census study in 1979. The study found that private pension and
Social Security benefits alone could be expected to replace over 75 percent of after-
tax pre-retirement income in the initial year of retirement for over one-half of all
families.
In part because the results of the Council study challenged many preconceived no-
tions about the role of employer pensions, the study's methodology and results were
1 On this academic discussion, see "What Should be Taxed-Income Expenditure"? Jos. Pech-
man ed. Brookings, 1980.
2Schieber & Geor~e, "Retirement Income Opportunities in an Aging America: Coverage and
Benefit Entitlement' (Washington, D.C., Employee Benefit Research Institute, 1981)
PAGENO="0637"
631
scrutinized carefully. For example, in late 1982, the House Select Committee on
Aging asked the Congressional Research Service (CRS) to examine the study's re-
sults and its methodology. Their review culminated in a report prepared in July
1983 by the CRS for the House Committee on Aging. Other formal and informal cri-
tiques of the study were also prepared.
The CRS review was, on the whole, complimentary to the ICF study but, as did
other reviewers, suggested that the results might change if various key assumptions
were changed. To respond to the major questions which had been raised, ACLI con-
tracted with ICF in 1983 to conduct additional research on expected retirement
income receipt.
The major findings of the 1984 study have just been published and confirm the
findings from the 1982 study that benefit receipt under private pension plans will
increase sharply and that the average pension will increase faster than wages:
The percentage of families receiving pension benefits will increase rapidly in the
future.-The percentage of families expected to receive employer pension benefits is
increasing rapidly. The study shows that by the time those individuals age 35-44 in
1979 reach age 67, approximately 82 percent of all married couples and 58 percent
of unmarried individuals can expect to be receiving employer pension benefits from
at least one spouse's covered employment. Table 1 below shows that benefit receipt
at age 67 for the group age 35-44 in 1979 will be 25 percent higher than benefit
receipt for the group age 45-54 in 1979. Even these estimates understate the poten-
tial levels of benefit receipt because about 10-15 percent of individuals who will still
be working at age 67 and are nonetheless eligible for pension benefits are not count-
ed as receiving benefits.
Due primarily to the increase in the labor force participation rates of women and
the maturing of the pension system, Table 1 also shows that married couples have a
substantial likelihood that at least one family member will receive a pension bene-
fit. In addition, unmarried individuals have a substantial likelihood that they will
receive either pension benefits from their own prior employment, or survivor bene-
fits from a former spouse's employment.
TABLE 1.-EXPECTED AVERAGE FAMILY PENSION BENEFITS AT AGE 67
[In 1983 dollars]
Cohort age 45-54 in 1979 Cohort age 35-44 in 1979
Percent receiving Average pension Percent receiving Average pension
benefits benefits benefits benefits
Married couples
Unmarried individuals
All families
70
44
$8,200
5,500
82
58
$10,000
7,400
57
7,200
71
9,300
Source: ICE estimates. This table does not include benefits from IRA's. It understates the percentage of families eligible for pension receipt
because individuals working at age 67 who have a vested right to a pension benefit are not counted as receiving benefits.
Pension benefit levels will also increase. Table 1 shows that the average family
pension benefit at age 67 will increase to approximately $9,300 per year (in 1983
dollars) for those individuals age 35-44 in 1979. This is an increase of almost 30 per-
cent as compared to the average family pension benefit at age 67 for those individ-
uals age 45-54 in 1979. The built-in assumption of wage growth over time means
that the age 35-44 group would have real wages 16 percent higher at retirement
than the age 45-54 group. The remaining 14 points of the 30 percent increase reflect
the continuing maturation of the pension system. Specifically, workers aged 35-44
in 1979 will have worked under expanded employer pension programs and under
supplemental retirement plans and ERISA's vesting rules for 10 more years than
workers aged 45-54 in 1979.
Pension benefit levels will be significant at all income levels. The study shows that
among individuals age 35-44 in 1979, average pension benefits at age 67 will be
slightly larger than average Social Security Benefits. Thus, the average annual pen-
sion for this group will be about $9,300 (in 1983 dollars) while Social Security will be
only $8,700 (in 1983 dollars).
Pension and Social Security benefits combined will replace 70 percent of pre-retire-
ment income. The study calculated the expected replacement rates for families
which were not working in retirement. As expected, replacement rates from Social
Security and employer pensions will be higher for low income workers. Social Secu-
rity and pension benefits will replace an average of over 100 percent of pre-retire-
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632
ment income in the initial year of retirement for families who earned an average of
less than $10,000 per year (in 1983 dollars) in their highest five years of income
after age 65. Replacement rates fall below 60 percent for income groups above
$20,000. The study also estimates that over 70 percent of those families with an av-
erage of less than $10,000 in pre-retirement earnings will receive retirement bene-
fits that replace over 80 percent of their income. On the other hand, less than one-
quarter of those with over $15,000 in pre-retirement income will have replacement
rates larger than 80 percent.
Pension benefits will be widely distributed.-While a significant number of fami-
lies can expect to receive income from private pension plans, the distribution of av-
erage pension benefits differs among family categories. For families with individuals
age 35-44 in 1979, more than 60 percent of married couples and almost 40 percent of
unmarried individuals can expect to receive annual pension benefits above $2,500
(in 1983 dollars). Over 35 percent of married couples and 18 percent of unmarried
individuals can expect to receive annual pension benefits above $7,500 (in 1983 dol-
lars).
Pension funds in US. capital markets
Retirement savings are an important source of long-term investment in the cap-
ital goods so essential for a growing and dynamic economy. The general importance
of pension funds in capital markets is suggested by the data in Appendix 1. At the
end of 1983, total assets of private pension plans and state and local retirement
plans amounted to nearly $1 trillion. From 1980 to 1983, the total grew at about a
15 percent annual rate (which includes the effect of stock market and other capital
gains).
Private pension plans and state and local retirement plans are providing a grow-
ing part of the funds supplied to U~S. credit and capital markets. In Appendix 2,
flows of pension funds to U.S. credit and capital markets are shown by major type
for recent years. In 1983, these pension funds supplied about $101 billion, or 19 per-
cent of the total funds raised in U.S. credit and capital market. Five years earlier,
1978 these pension plans provided 12.5 percent of the total funds raised in these
markets.
The assets of non-insured private plans generally are more concentrated in corpo-
rate equities and U.S. government securities than are the funds of "insured pension
plans (Appendix 3). About one fourth of the pension funds administered by life in-
surance companies are now held in separate accounts. The assets in these accounts
are largely in corporate bonds and corporate equities, but with a growing amount in
mortgages and real estate (see Appendix 4). The remaining three fourths of these
funds, handled through general accounts of life companies, are invested primarily in
corporate bonds and commercial mortgages.
EMPLOYEE GROUP LIFE INSURANCE
The purpose served by group life insurance is to replace the income lost through
the occurence of an employee's untimely death. By promising such replacement,
group life insurance also serves to improve the morale and productivity of employ-
ees by relieving them of significant anxieties and risks resulting from death. Em-
ployer-sponsored benefit plans are the best way of accomplishing this purpose. Cor-
porate-sponsored employee benefit plans are now an integral part of the attitudes
and philosophy of our economic way of life.
The initiative for group life insurance has primarily come from corporate manage-
ment, spurred on by insurance companies who recognized the need for employee
protection and who formulated the instruments for serving that need. In slightly
less than three-quarters of a century, the concept of protecting a wage earner
against the physical hazards that threaten his or her paycheck has become an ac-
cepted part of private industry's thinking. The tremendous growth of group life in-
surance programs, not only in the number of workers insured, but also in the varie-
ty of coverage available, is a heartening illustration of what the private sector can
accomplish in the way of economic security for the wage earner.
The quest for economic security will not diminish in intensity; rather it can be
expected to increase. The solution lies in the hands of private enterprise. That is,
small, as well as large employers, must be encouraged to continue to accept the
social responsibility of adequately protecting their employees against the loss of
income through untimely death or disability.
Since its beginning in 1911, employee group life insurance has enjoyed wide public
support. In the editorial column of the Saturday Evening Post of October 4, 1913,
appeared the following observation: "No married man who has not a fortune has
any business to be without it (life insurance). We should like to see this group-risk
PAGENO="0639"
633
plan elaborated until life insurance and paycheck go together". When the Union Pa-
cific Railroad established its plan in 1917, one well-known religious figure was
quoted, "The system is the practical putting into effect of the principles of Christian
charity. It establishes the most friendly relations in the minds of all and brings
about harmony and sympathy."
The attitude of the individual worker has also generally been favorable to group
life insurance plans. The files of insurance companies are full of grateful acknowl-
edgements from widows and widowers who had no finances other than group life
insurance proceeds to help them over the difficult period of readjustment following
the deaths of their spouses. By opening the channels of insurance to all industrial
workers, regardless of age, sex, physical condition, or character of employment,
group life insurance has performed an outstanding service.
The growth of group life insurance has been prodigious since its introduction in
1911. At the end of 1983, group life insurance in force through employers was $1.7
trillion and more than one-half million employers of all sizes had purchased life in-
surance for their employees. In a 1983 survey conducted among medium and large
employers by the U.S. Department of Labor, 95 percent of all employees were re-
ported to be covered by group life insurance. And, while the numbers are not quite
as dramatic, a 1983 survey conducted by the Life Insurance Marketing and Re-
search Association (LIMRA) among employers of 3-50 employees indicated that
more than 80% had purchased a group life insurance policy as part of a package of
employee benefits. Group life insurance is a near-universal employee benefit in the
United States.
The amounts of life insurance provided through employer-sponsored plans is typi-
cally related to the individual employee's salary. According to a recent survey con-
ducted by Hewitt Associates among major U.S. employers, in 1983 approximately 73
percent of all such employers had purchased group life insurance schedules that
were salary-related, with the most popular salary multiples being 1-times (32% of
the employers) and 2-times (22% of the employers). In a survey conducted by the
Council in April, 1981, more than 50 percent of the total claim payments made
under group life insurance policies were in amounts exceeding $25,000 per benefici-
ary.
Employer-provided group life insurance also reflects the changing nature of the
American work force. It is well-known that increasing percentages of women are en-
tering employment. According to a recent Council publication, nearly 52 percent of
all married women were in the workforce in 1982, up from 41 percent in 1971. A
Council study of trends in death benefit payments under group life insurance poli-
cies indicated that in April, 1981 almost 20 percent of the deaths were female em-
ployees, representing a significant increase over the 13 percent reported in October,
1966.
In recent years, the attractiveness of group life insurance has led an increasing
number of employers to extend such insurance beyond the working years of their
employees. In a survey conducted by The Conference Board in 1979, more than two-
thirds of a sample of large and small employers indicated that they were continuing
some group life insurance protection into retirement. A later survey conducted in
1983 by Hewitt Associates indicated that among large employers the percentage ex-
ceeded 80 percent.
And, as a growing number of states change their restrictive group insurance laws,
employers are extending their group life insurance plans to include spouses and de-
pendent children. Where now permitted, the aforementioned Conference Board
survey indicated that 25 percent of large and small employers were providing some
dependent group life insurance.
As shown by these statistics, employer-provided group life insurance has grown
rapidly in the 73 years since it first became available. There are broad social aspects
to the growth of group life insurance. One great service of group insurance is that it
extends life insurance coverage to a large number of persons with little or no other
life insurance. And, group life insurance also extends protection to persons who
cannot qualify for individual life insurance either because of physical problems or
hazardous occupations. The proportion of employed persons who are uninsurable for
individual policies has been variously estimated between 5 and 10 percent. It is only
through group underwriting that private life insurance can provide protection for
these persons, and it is advantageous both to the individual and to society that in-
surance be made available to them.
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634
EMPLOYEE GROUP HEALTH INSURANCE
Group health insurance is of enormous value to the public and our industry has
been highly successful in meeting the needs of American workers. Federal tax in-
centives played a major role in that achievement. They continue to be essential ele-
ment in the present system for the protection of employees and their families.
The health insurance provided under employee benefit plans falls into two broad
categories. The first is represented by benefits for hospital, physician, dental and
other medical expenses. A great variety of coverages is available from many compa-
nies active in the market, in response to strong consumer demand. We estimate that
at the end of 1982, almost 65 million workers had group health coverage. Including
spouses and children, approximately 162 million persons under age 65 were covered
by one or more forms of private group health protection, either through our
member companies or through other arrangements. That represents 80% of the
under 65 civilian non-institutionalized population, and is a five fold increase since
the end of World War II. Although more remains to be done in expanding the
number covered, we are proud that much has been accomplished.
The second category of health insurance represents income payments to disabled
workers for either short or long-term benefit periods. In 1982, almost 62 million
workers had short-term protection under various private arrangements, of whom 27
million were covered under insurance company group plans. Most commonly, em-
ployees' short-term coverage lasts 26 weeks and income benefits usually equal two-
thirds of salary. Many employees are covered for long-term disability, with benefit
periods of five years or to age 65. At the end of 1982, 17 million persons were cov-
ered under group plans for long-term disabifity. Carriers have continuously explored
every opportunity to further extend disability income coverage to employees, and to
ensure that adequate benefit levels and payment durations are available.
The questions posed related to tax incentives to employers to encourage health
benefits for their employees. The tax incentive to the employer is the deduction al-
lowed for the cost of the benefits. The employer cost is not taxable income to em-
ployees, although disabled employees are subject to tax on income benefits in whole
or in part. Thoughtful issues have been raised, which should lead to a productive
discussion of the subject.
In our view, tax incentives can be justified if desirable public objectives are
achieved through the appropriate response of private enterprise. For many years
there have been tax incentives to encourage employers to provide health benefits to
employees. We believe that a major public objective has been achieved in that 162
million persons-workers and their families-have one or more forms of group
health insurance protection. Secondly, that achievement has been accomplished by
private enterprise, which, through competition in a free economy, has delivered its
product to the best advantage of the consumer. We believe the wisdom of granting
the tax incentives has been well proven for the following reasons.
The protection of the public.-Over the past several years, most Americans have
come to recognize that medical expense insurance is a basic necessity. Today it is
indeed reckless to risk financial devastation on account of accident or sickness. Ade-
quate group health coverage eliminates a major source of fear and uncertainty for
those who are covered, both rich and poor alike. Group medical expense benefits are
the same for both high and low income employees, and provide access to health care
services that might otherwise be unaffordable. The existence of Medicare and Med-
icaid demonstrates government's commitment to coverage for those for whom public
programs are necessary. It is the private sector that has met that same need for the
bulk of the population through employee health benefit plans.
The ability of private companies to offer group insurance goes hand in hand with
the tax incentives for employers and employees. The relationship can be explained
by a brief description of how group insurance is underwritten.
Under current industry practice, medical expense and disability income benefits
can be made effective for an employee group without individual medical evidence of
insurability, if at least ten employees are involved. The usual rules only require
that the employees enroll when first eligible, and that they be actively at work
when coverage is to become effective. Dependents are also covered on a non-medical
basis under similar rules. This liberal approach to offering coverage is of enormous
importance to the public, since many persons become group insured who would have
difficulty obtaining medically underwritten individual insurance.
Insurance companies can appropriately price group health insurance and main-
tain acceptable financial experience, despite the absence of individual evidence of
insurability. The reason is that a high degree of employee participation in the plan
is required. If the plan is contributory, at least 75% of employees must enroll, and
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635
all employees must be covered under non-contributory plans. With these participa-
tion requirements, a reasonable cross section of risks is obtained which provides sta-
bility ot the financial experience. These rules ensure that both young and old em-
ployees enroll, and also the healthy as well as those who have medical problems.
There is usually no difficulty in getting employees to enroll, since the value of
health coverage is appreciated and the employer pays all or nearly all of the cost of
the plan. Furthermore, the employer contribution is not taxable income to the em-
ployee. There is a supportive relationship between tax incentives which encourage
employers and employees to participate in group health benefit plans, and the abili-
ty of insurers to successfully underwrite such coverage without medical evidence of
insurability. This has worked so well that the protection of 162 million Americans
under 65 has been accomplished by the private sector without any need for federal
intervention.
Response of the private sector-As noted above, a justifiable tax incentive policy
should accomplish desirable public objectives through the appropriate involvement
of private enterprise. The protection of the working public through employee health
benefits has been accomplished by private enterprise in a very effective manner. We
believe that our industry has developed group health insurance in the best tradi-
tions of a free economy, further confirming that tax incentive policy was the right
approach for government. Today, the group insurance market place is served by
hundreds of insurers, offering extensive portfolios of health benefit plans to fit a va-
riety of circumstances and employer pocketbooks.
It was insurance company innovation that brought high limit major medical ex-
pense coverage to the market. That form. of insurance, introduced nationally in
1951, covers a wide range of medical services provided both within and outside the
hospital, and was designed to encourage use of out-of-hospital services. It is by far
the most prevalent form of medical insurance today, with over 90% of those protect-
ed by group plans having major medical coverage. A 1980 study showed that for em-
ployees with major medical protection provided by insurance companies, about
three-fourths had a maximum benefit of $250,000 or more. Nearly half had a maxi-
mum benefit of $1 million or an unlimited amount. Insurance company innovation
also brought to the market dental expense and vision care insurance, as well as ben-
efits designed specifically to contain the acceleration in health care costs. Illustra-
tions of such benefits include coverage for skilled nursing facilities, home health
care services, pre-admission testing, second opinions for surgery, ambulatory sur-
gery facilities, preventive care, hispice care and drug and alcohol rehabilitation.
The pluralistic nature of the private health insurance business has resulted in in-
tense competition among carriers. As a result, an insurer must keep its premiums
as low as possible which provides both employees and employers with the most cost
effective protection possible. The consumer interest is also protected through our
system of state insurance regulation, covering such areas as group policy and certifi-
cate provisions, group conversions, and so forth. In fact, due to the flexible nature of
the business, employees may continue to maintain medical expense protection upon
termination of employment by either converting to an individual policy or continu-
ing benefits under the group plan for various periods. In many instances, coverage
is also continued for a specified time for dependents who lose eligibility due to an
employee's death or divorce.
A particularly relevant example of how the competitive insurance market place
served the public interest was the development of group insurance for small employ-
ers with as few as one or two employees. According to Department of Commerce
data, there were 4.3 million firms with one to forty-nine employees in 1980. These
small groups probably provide employment for over 15 million workers. To serve
that market, insurers developed pooling techniques and simplified underwriting
rules and, as a result, small employers today have a wide choice of plans. The stimu-
lus of tax incentives and the willingness of carriers to voluntarily enter the small
group market have been of great benefit to small employers and their employees
and families. As a result, small firms can today obtain many coverages once only
available to large groups, and can fully realize the advantages of the tax incentives
in the law.
Overall, the encouragement of health insurance coverage through tax incentives
has been enormously successful in terms of social and economic accomplishments.
The present system of employment related health benefits was built up over several
decades, and works very well. Americans have come to regard employer-sponsored
health protection almost as an automatic feature of employment, providing benefits
of great value. In our view, no change should be made in tax incentives which might
impair the ability of the private sector to provide essential insurance protection to
the public.
40-046 0 - 85 - 41
PAGENO="0642"
636
The Subcommittees have asked whether the existing tax incentives are effective
in protecting the working public at a lower total cost than alternative mechanisms
or arrangements. The implication is that under such alternatives, there would
either be cutbacks in or the elimination of the present tax incentives.
Let us consider one alternative based upon the supposition that all employer con-
tributions to health benefit plans would be taxable income to employees, either im-
mediately or on a phase-in basis. Our industry stands on record in firm opposition to
such taxes because of the many flaws in that approach. At this time however, we
shall confine our discussion to how such a change could affect the ability of insurers
to offer insurance products and the likely cost to consumers.
A fair allocation of employer contributions to each employee for tax purposes
would be a very complex task. Whatever formula was used, the total cost of group
health insurance would be increased by the amount of tax raised. The cost to a par-
ticular employee to participate in the group plan would become the employee's con-
tribution plus his tax on the allocated employer contribution. For many employees,
the cost to participate would increase sharply, causing both the discontinuance of
coverage and the weakening of the group insurance mechanism through adverse se-
lection. This may be seen as follows:
In the first instance, low income employees, especially those that live in our major
urban areas, would be particularly hard hit by the tax. In our highest cost cities,
annual premiums for small group family coverage can be $4,000 to $5,000 in the
middle age ranges, and higher at older ages. While imputed income would be the
same for high and low income employees, the tax impact on the low wage earner
would be much more severe in terms of affordability. It is likely that low income
employees without health problems would be pressed to drop their group health cov-
erage. That could mean disastrous consequences for such families upon subsequent
illness, and government might have to eventually shoulder an increased burden
under public programs.
There are other employees that might decide to withdraw from group coverage in
addition to low income workers. Examples are young healthy employees that can
secure individual coverage at a lower cost than the group employee contribution
plus income tax. When employees have incentives to either go without group insur-
ance, or purchase individual coverage, the group plan is exposed to adverse selection
through low participation. A good cross section of health risks is more difficult to
maintain. As a result, the average health status of the insured group is poorer and
premiums must rise, which causes more employees to drop out. The resulting spiral
of higher premiums and increased withdrawals can threaten the financial viability
of group plans, especially in the small group range.
The opening of the door to adverse selection could seriously undermine the group
insurance mechanism through which millions have been protected on a non-medical
basis. Overall, the removal of the present tax-free status of employer contributions
could easily result in a drop in the number of people protected, especially low
income employees in high costs cities. Furthermore, more adverse selection would
occur, impairing the financial stability of many group plans and the ability of carri-
ers to underwrite liberally. That indeed would be a heavy price to pay for any addi-
tional tax revenues raised.
Such deterioration of the present system would certainly result in renewed politi-
cal pressure for national health insurance. We estimate that in 1983 the cost of pri-
vate group medical expense coverage was in the range of $105 to $110 billion, with
financing and benefits determined by market place conditions, involving carriers,
employers, and unions. With a government operated plan, Congress would face the
difficult task of raising new taxes each year equal to or greatly in excess of these
amounts. In view of the financing problems now posed by Medicare, Congress would
be ill advised to embark upon such a vast public program.
In our view, any alternative to the present system must be subjected to searching
analysis to determine just what improvements are possible. We know what the pri-
vate sector has been able to accomplish with the stimulus of tax incentives. We are
deeply skeptical that major changes can be made to generate new revenue without
weakening the present employer health benefits structure that has worked so well.
CONCLUSION
As this statement has shown, the private sector has accomplished a great deal in
providing socially valuable benefits to American workers and their families. The
job, however, is not done-there are still gaps in coverage. The private sector is anx-
ious to close these gaps, but it needs help. Tax incentives have worked in the past,
PAGENO="0643"
637
but they must be continued and, where appropriate, expanded, to provide the impe-
tus necessary to complete the job.
APPENDIX 1.-PENSION PLAN RESERVES IN THE UNITED STATES
[Amounts in billions]
Pension reserves of life
insurance companies
Total
Amount Pei~nt of
1970
$211.9
323.8
650.7
993.6
$41.2
71.7
165.8
264.6
19.4
~22.1
25.5
26.6
1975
1980
1983
Average annual compound rate (percent) of increase:
1970-80
11.9
15.2
14.9
16.9
1980-83
1 Includes reserves and assets of pension plans administered by life insurance companies, other private pension plans, and state and local
government retirement plans.
Source: Board of Governors of the Federal Reserve System, Flow of Funds Accounts, and American Council of Life Insurance.
APPENDIX 2.-PRIVATE PENSION PLANS AS A SOURCE OF FUNDS IN U.S. CREDIT AND CAPITAL
MARKETS
[Amount in billions]
Year
Total funds
supplied
Funds supplied by
Pension plans with life
insurance companies
Amount Percent of
Other private pension plans
Amount Percent of
State and local government
retirement plans
Amount Percent of
1978
$390.2
$18.3 4.7
$16.0 4.1
$14.3 3.7
1979
400.1
17.5 4.4
16.0 4.0
19.4 4.8
1980
374.1
20.6 5.5
20.3 5.4
23.4 6.3
1981
377.6
28.6 7.6
21.1 5.6
24.3 6.4
1982
397.0
32.7 8.2
26.5 6.7
26.8 6.8
1983
527.2
37.9 7.2
31.7 6.0
31.5 6.0
1 Preliminary.
Source: Bankers Trust Company, "Credit and Capital Markets 1984", and Board of Governors of the Federal Reserve System, "Flow of Funds
Accounts."
APPENDIX 3.-USES OF FUNDS BY PRIVATE NONINSURED PENSION FUNDS
[In billions]
1978
1980 1982
1983 1
Corporate bonds
U.S. Government and agency securities
$7.4
-.1
5.3
$3.1 $3.5
4.5 10.2
9.6 11.5
$3.6
8.4
18.0
Corporate stocks
Mortgages
Other
2.5
1.8 1.3
1.5
2.0
Total
16.0
20.3 26.5
31.7
`Estimated.
Source: Bankers Trust Company, "Credit and Capital Markets 1984."
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638
APPENDIX 4.-DISTRIBUTION OF ASSETS HELD IN SEPARATE ACCOUNTS OF LIFE INSURANCE
COMPANIES 1
[In milions]
1970
1975
1980
1982
1983
Bonds
$878
$2,553
$12,392
$24,563
$27,294
Stocks
4,041
37
2
9,323
200
563
17,705
687
3,341
20,641
2,556
5,686
25,118
4,372
6,437
Mortgages
Real estate
Other
103
334
1,647
3,835
4,635
Total
5,061
12,973
35,772
57,281
67,856
Memo: Total pension reserves of life insurance companies (billions)
41.2
71.7
165.8
225.2
264.6
1 Assets in separate accounts are valued at market or, in the case of real estate, ap
praised mar
ket value.
Source: American Council of Life Insurance.
STATEMENT OF DR. EMILY S. ANDREWS,* WASHINGTON, DC
SUMMARY
This testimony presents new information on the distribution and the economics of
employer-provided pensions to help in the evaluation of the current system of fringe
benefits. Two basic issues are investigated which focus on the fairness and economic
efficiency of pensions, the keystone of our employee benefits system:
(1) Are employer-provided pensions distributed fairly across the workforce? and;
(2) Have the cyclical costs of the 1982 recession reduced the likelihood of future
retirement income for today's employees?
The data supporting the analysis stem from a new nationwide survey sponsored
by the Employee Benefit Research Institute (EBRI), in conjunction with the Depart-
ment of Health and Human Services, conducted by the U.S. Bureau of the Census in
1983. The survey represents, in part, a follow-up to a similar effort conducted in
May 1979 funded by the Department of Labor and the Social Security Administra-
tion. The EBRI/HHS survey parallels the May 1979 effort but adds new information
on lump-sum benefits, individual retirement accounts (IRAs) and section 401(k)
salary reduction programs.
Analysis of the distribution of coverage and vesting by earnings category indicates
that pensions are broadly distributed among lower- and middle-income workers. In
particular, 76 percent of all nonagricultural wage and salary earners covered by a
pension earn $25,000 a year or less. Similarly, 70 percent of all vested benefits
belong to nonagricultural employees earnings $25,000 or less.
May 1983 EBRI/HHS survey data also show that women are gaining pension enti-
tlement in greater numbers than ever before. Among those women meeting ERISA
standards for plan participation, coverage expanded by 2.2 million workers since
1979 and nearly 1.3 million more women became entitled to pension benefits at re-
tirement.
The 1983 EBRI/HHS survey also provides the first information on entitlement to
lump-sum benefit receipt. The addition of lump-sum benefits increases the total
vesting rate by over 10 percentage points for private-sector employees and by nearly
20 percentage points for public-sector workers. Total vested benefits increase gradu-
ally with age providing greater protection as workers near retirement age. A com-
parison of total vested benefits with utilization rates from IRA and 401(k) plans in-
dicates that coverage provided by employer plans is broader than that selected by
individuals themselves.
Changes in coverage and pension entitlement between the May 1979 and May
1983 surveys are also investigated in order to determine the cyclical costs of the re-
cession on the pension system. At the time of the survey the unemployment rate
was at 10.1 percent, just six months after the business cycle trough. Nevertheless,
*Emily Andrews earned her Ph.D. in economics from the University of Pennsylvania. Dr. An-
drews presently holds the position of Research Associate at the Employee Benefit Research In-
stitute. Before joining EBRI she has held policy research positions at the Social Security Admin-
istration and the U.S. Department of Labor.
PAGENO="0645"
639
employment growth since 1979 among those workers meeting ERISA standards led
to an increase of over one million workers covered by a pension plan or a total of 38
million employees. (Coverage among all nonagricultural wage and salary workers
totaled 49.5 million.)
Furthermore, employer pensions have not undergone a financial crisis comparable
to that suffered by Social Security. The pay-as-you-go Social Security system was
buffeted by the results of sluggish economic growth in which prices rose faster than
wages. As a consequence, indexed benefits exceeded contributions culminating
during a period of double digit unemployment. Funded plans are designed to with-
stand cyclical uncertainties, however. In sum, while the employer-provided pension
system bore certain recessionary costs, its structural underpinnings remained
sound.
5TATEMENT
Introduction
Employer pension plans are frequently regarded as the cornerstone of our employ-
er benefit system. Consequently, any assessment of the effectiveness of employer
benefits must consider the success of pension plans in meeting future retirement
income needs. The nation appears to be approaching a crossroads in pension policy.
While tax incentives for the development of a fair employer pension system have
been a consistent public policy landmark, the current budget deficit has placed pen-
sions on the firing line. Even before our ballooning deficit, some were predicting a
diminution of policy support for retirement. In 1980 William Graebner stated in A
History of Retirement:
"A century after retirement became an important instrument of social and eco-
nomic policy, we are preparing for its disappearance, again in a context established
by the needs of captial and with the acquiescence of most Americans. We expected
too much from retirement. We believed retirement would rejuvenate and stabilize
the teaching profession, the churches, and the factories; spare us the distress of an
aging bureaucracy; allow the payment of lower salaries; distribute work in declining
industries and in an economy that, in many, sometimes lengthy periods over the
last century, has failed to employ all who wanted to work. In our current difficul-
ties, we assume that by reversing the process and dismantling the edifice of retire-
ment, we can reinvigorate an economy that has lost its fine compentive edge. This is
the mirror-image of the historic assumption that retirement is a powerful and inex-
pensive instrument of social reconstruction. A new myth replaces the old."
With today's information technology we need not conduct public policy through
the perpetration of myths. Instead, researchers and legislators can consider facts
carefully before proposing legislative changes. The hearings scheduled by the House
Committee on Ways and Means on the Distribution and Economics of Employer
Provided Frings Benefits happily reflect the Committee's desire to gather informa-
tion to better inform Congress and the public. Work-in-progress at the Employee
Benefit Research Institute Institute (EBRI) provides insights into some of the issues
of interest to the subcommittees' on the distribution of employer provided benefits.
This testimony presents new findings on the fairness and efficiency of the pension
system using data from an EBRI-sponsored survey on pension coverage and entitle-
ment, funded in conjunciton with the Department of Health and Human Services
(HHS).
The survey, conducted by the Bureau of the Census in May 1983, represents a
follow-up to an earlier May 1979 effort funded by the Department of Labor (DOL)
and the Social Security Administration (SSA). The May 1983 survey goes beyond the
scope of the previous study, however, by asking additional questions about lump-
sum, distributions, individual retirement accounts (IRAs) and deferred compensation
plans under section 401(k).'
In particular, data from the May 1983 EBRI/HHS CPS pension supplement are
used to address two policy issues of interest to the Committee on the equity and
economic costs of the system:
(1) Are employer-provided pensions distributed fairly across the workforce? and;
(2) Have the cyclical costs of the 1982 recession reduced the likelihood of future
retirement income for today's employees?
1 Both the 1979 and the 1983 surveys were supplements to the ongoing Current Population
Survey (CPS) which is conducted monthly by the Bureau of the census to collect national statis-
tics on employment and unemployment. Consequently, in addition to information on pension
coverage and entitlement, the survey provides valuable data on labor force status, demographics
and income
PAGENO="0646"
640
In terms of equity, the following topics are pursued. What income groups benefit
from empolyer pensions? Do patterns of benefit entitlement ensure that workers
will be entitled to pension benefits when they reach retirement age? Do men and
women partake equally in the pension system?
Analysis of the EBRI/HHS pension supplement data provides insights into the
fairness of the pension system neglected in earlier studies. In addition, earlier find-
ings on coverage and benefit equity are reevaluated and the extent of vesting is re-
calculated using new information on IRA participation, 401(k) coverage and lump
sum benefits from the updated survey. Pension benefits are found to be broadly
based and can be expected to provide an important source of income support for mil-
lions of future retirees.
Because the May 1983 EBRI/HHS CPS pension supplement was conducted just
after the 1982 recessionary trough, the effect of the worst cyclical downturn in four
decades can be analyzed. The cyclical behavior of coverage measures the cost of the
downturn for pension protection. While the recession adversely affected plan
growth, pensions still covered a majority of the labor force and the number of vested
workers expanded. Private sector coverage rates fell less strongly than public sector
rates suggesting that during the downturn the costs of coverage slippage were less
severe for private sector employees.
Furthermore, employer pensions have not undergone a financial crisis comparable
to that suffered by Social Security. The pay-as-you-go Social Security system was
buffeted by the results of sluggish economic growth in which prices rose faster than
wages. As a consequence, indexed benefits exceeded contributions culminating
during a period of double digit unemployment. Funded plans are designed to with-
stand cyclical uncertainties, however. In sum, although the pension system bore cer-
tain recessionary costs, its structural underpinnings remained sound.
Who benefits from employer pensions
The fairness of the pension system can be analyzed according to information on
the distribution of coverage and vesting by earnings, age and sex through a series of
three core questions from the 1983 EBRI/HHHS pension supplement on pension
coverage and entitlement. These remained virtually unchanged from the May 1979
DOL/SSA survey to ensure comparability. The core questions both pension surveys
(and others of this type) ask about pension coverage, participation and future bene-
fit entitlement.2
Although these questions appear straightforward, many survey respondents
appear to have difficulty interpreting them and provide inappropriate answers from
time to time. This problem has been recognized by other analysts of pension cover-
age and entitlement and is probably a result of the complex nature of the pension
system itself.
In terms of coverage and participation, some employees appear to interpret the
coverage question as their own inclusion in their employers' plan while others deny
participation for no apparent reason. Consequently, the key coverage and participa-
tion responses appear to bracket the "true" number of plan participants. Given a
choice between these two measures coverage was selected as the key indicator of the
number of employees who may become eligible for future retirement benefits. It pro-
vides a relative overestimate of participation rates and an offsetting underestimate
of vesting rates. Only findings on coverage and future benefit receipt are reported in
this Testimony.
Much of the analysis focuses on two groups in the labor force-paralleling previ-
ous EBRI work on this topic.3 The first group consists of all nonagricultural wage
and salary workers. The noncorporate self employed are, excluded as they can pro-
vide their own coverage through Keogh plans. Farm workers tend to be a temporary
low-wage work force whom many believe are better covered through federal pro-
grams such as Social Security and Supplemental Security Income (SSI).
The second group consists of those workers with sufficient labor force attachment
to accrue meaningful retirement benefits if covered by an employer pension plan.
This group is referred to as the ERISA work force and is composed of employees
meeting ERISA participation standards in 1983. These workers are between twenty-
2 In the case of the 1983 survey, the questions are (1) Does your employer contribute to a pen-
sion or retirement plan. . .? (2) Are you included in the employer or union sponsored plan? and
(3). . . Could you receive some benefits at retirement?
See Sylvester J. Schieber and Patricia M. George, Retirement Income Opportunities in an
Aging America: Coverage and Benefit Entitlement, (Washington, DC: Employee Benefit Research
Institute, 1981).
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641
five and sixty-four years of age who work at least 1,000 hours annually and have
been with their employer for one year or more.
A middle income benefit
Table 1 provides information on the distribution of benefit entitlement from three
perspectives. The top panel shows the absolute number of nonagricultural workers
employed, covered or vested in a public or private pension plan. Of the 88.2 million
nonagricultural wage and salary workers, 49.5 million were covered by a pension
plan and 28.7 million had accrued vested benefits. Both statistics far exceed the 13.7
million employees who earn over $25,000. The majority of employees who have a
pension plan never see an expense account or a golden parachute.
TABLE 1.-EMPLOYMENT, COVERAGE AND VESTING: DISTRIBUTION BY EARNINGS FOR
NONAGRICULTURAL WAGE AND SALARY WORKERS, MAY 1983
Earnings
.
Number of workers (thousands)
Total vested
Employment Coverage benetits
Total
88,214 49,530 28,703
$1 to $4,999
$5,000 to $9,999
10,014 2,433 358
15,323 5,747 2,023
17,827 10,328 5,484
13,101 9,422 5,874
10,283 8,159 5,641
5,515 4,365 3,048
6,611 5,547 4,072
1,615 1,371 1,106
7,924 2,158 1,105
$10,000 to $14,999
$15,000 to $19,999
$20,000 to $24,999
$25,000 to $29,999
$30,000 to $49,999
$50,000 and ever
Not reported
Percentage distribution within earnings group
Employment Covered Vested
to employed to employed
Total
100.00 56.15 32.52
$1 to $4,999
$5,000 to $9,999
100.00 24.29 3.57
100.00 37.51 13.20
100.00 57.93 30.76
100.00 71.92 44.83
100.00 79.34 54.85
100.00 79.14 55.26
100.00 83.91 61.57
100.00 84.90 68.50
100.00 27.23 13.94
$10,000 to $14,999
$15,000 to $19,999
$20,000 to $24,999
$25,000 to $29,999
$30,000 to $49,999
$50,000 and over
Not reported
.
Percentage distribution across earnings groups 1
Employment Of Ot total
coverage vesting
Total
100.00 100.00 100.00
$1 to $4,999
$5,000 to $9,999
$10,000 to $14,999
$15,000 to $19,999
$20,000 to $24,999
12.47 5.14 1.30
19.08 12.13 7.33
22.20 21.80 19.87
16.32 19.89 21.28
12.81 17.22 20.43
6.87 9.21 11.04
8.23 11.71 14.75
2.01 2.89 4.01
$25,000 to $29,999
$30,000 to $49,999
$50,000 and over
1 Percentages exclude 90% of employees whose earnings are not reported.
Source: Preliminary Employee Benefit Research Institute tabulations of the May 1983 EBRI/HHS CPS pension supplement
The tabulations in the second panel of table 1 have traditionally been used to ana-
lyze pension coverage. They show that coverage and vesting rates generally rise
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with higher earnings. The ratio of covered workers to employment rapidly increases
from less than one out of four workers earning under $5,000 a year to nearly two
out of five earning between $20,000 and $24,000 a year. Coverage rate increases tend
to moderate by the $20,000 level.
The third panel of table 1 shows the distribution of employment, pension coverage
and vesting across income groups: in other words, the ratio of all workers within a
particular income bracket who are employed, covered or vested in a pension plan to
the total number of employed, covered or vested workers. These statistics clearly
show the prevalence of pensions among middle-income workers. More than half the
work force, 51 percent of all nonagricultural employees, earns between $10,000 and
$25,000 per year. A greater proportion of penson coverage is directed towards these
middle-income workers, however. Covered workers within those income categories
constitute nearly 59 percent of pension coverage. Furthermore, almost 62 percent of
all vested workers fall within the $10,000 to $25,000 per year range.
Another way to examine the distribution of pension benefits is through statistics
on the cumulative distribution of employment, coverage, and vesting by earnings.
The data in table 2 are presented in this manner. In this case, the proportion of
employment, coverage, or vesting held by employees earning less than a specific
amount is calculated. Nearly 83 percent of all nonagricultural wage and salary
workers earn less than the $25,000 cut off. Pension coverage and vesting roughly
parallel the income distribution with 76 percent of covered workers and 70 percent
of those holding vested benefits earning less than $25,000 as well. These roughly
equivalent distributions are found despite the fact that many workers earning less
than $5,000 a year do not meet ERISA participation standards.
TABLE 2.-CUMULATIVE DISTRiBUTION OF EMPLOYMENT, COVERAGE AND VESTING BY EARNINGS'
FOR NONAGRICULTURAL WAGE AND SALARY WORKERS AND THE ERISA WORK FORCE, MAY 1983
[Employees in thousands, distribution in percent]
Ea *
rmngs
Employment
distribution
Coverage
distribution
Vesting dis
Total vesting
tributions
en~i~nt
Nonagricultural wage and salary workers:
Total employees
88,214
49,530
28,708
22,217
Less than $5,000
Less than $10,000
12.47
31.55
53.75
70.07
82.88
89.75
97.98
5.14
17.27
39.07
58.96
76.18
85.39
97.10
1.30
8.63
28.50
49.78
70.21
81.25
96.00
1.26
7.78
26.30
47.13
68.12
79.77
95.51
Less than $15,000
Less than $20,000
Less than $25,000
Less than $30,000
Less than $50,000
Total earnings
100.00
100.00
100.00
100.00
ERISA work force:
Total employees
54,363
38,058
25,480
20,027
Less than $5,000
2.50
16.21
39.46
59.54
76.48
85.89
97.13
1.05
9.67
30.70
52.39
71.98
82.86
96.48
0.61
6.54
25.45
46.98
68.40
80.08
95.71
0.54
5.98
23.82
44.85
66.67
78.85
95.23
Less than $10,000
Less than $15,000
Less than $20,000
Less than $25,000
Less than $30,000
Less than $50,000
Total earnings
100.00
100.00
100.00
100.00
Percentages eoclude 9 percent of nonagricultural wage and salary workers and 4.1 percent of the ERISA work force whose earnings are not
reported.
Source: Preliminary Employee Benefit Research tnstifute tabulations of the May 1913 EBRt/HHS CPS pension supplement.
The May 1983 EBRI!HHS CPS pension supplement expanded the definition of
vesting to include workers expecting lump sum distributions as well as those antici-
pating future pension benefits. The proportion of vested workers earning less than
$25,000 a year is raised two percentage points, to 70 percent, above the rate posted
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when only future pension receipt is considered. In fact, 77 percent of those expecting
only lump sum distributions earn less than $25,000.
IRA's and earnings-The cumulative distribution of vested benefits by earnings
under employer pension plans can be compared to the cumulative distribution of
IRA participation using tables 2 and 3. Table 3 shows that 61 percent of nonagricul-
tural employees using IRAs earn less than $25,000 per year in comparison to 70 per-
cent of those vested in a pension plan. Spousal IRAs are less well distributed toward
middle-income workers with only 40 percent of spousal IRAs held by those earning
less than $25,000. Those eligible to contribute to a spousal IRA are more likely to be
found in the upper income brackets. Only 47 percent of those contributing to an
IRA with a nonworking spouse earn less than $25,000 a year. (The eligible popula-
tion represents about 20 percent of all IRA participants.)
TABLE 3.-CUMULATIVE DISTRIBUTION OF IRA AND SPOUSAL IRA PARTICIPATION BY EARNINGS 1
FOR NONAGRICULTURAL WAGE AND SALARY WORKERS AND THE ERISA WORK FORCE, MAY 1983
{Employees in thousands, distribution in percent]
.
Earnings
Employment
distribution
IRA
distribution
Distribution among those eligible
for sisoosal IRA
Contributes to Estabflshed
IRA spoosal IRA
Nonagricultural wage and salary workers:
88,214
14,972
2,988 1,718
Total employees
Less than $5,000
12.47
31.55
53.75
70.07
82.88
89.75
97.98
5.08
14.45
28.91
45.98
61.47
73.40
92.76
2.91 (~
7.98 5.39
17.47 11.30
31.93 25.57
47.48 40.36
60.35 51.58
84.87 79.98
Less than $10,000
Less than $15,000
Less than $20,000
Less than $25,000
Less than $30,000
Less than $50,000
Total earnings
ERISA work force:
100.00
100.00
100.00 100.00
Total employees
54,363
11,900
2,373 1,413
Less than $5,000
2.50
1.11
0.88 1.30
Less than $10,000
16.21
39.46
59.54
76.48
85.89
97.13
8.86
23.52
41.07
57.58
70.96
91.87
4.17 3.09
13.76 9.39
28.63 21.99
43.61 38.34
57.81 50.31
83.65 79.05
Less than $15,000
Less than $20,000
Less than $25,000
Less than $30,000
Less than $50,000
Total earnings
100.00
100.00
100.00 100.00
1 Percentages exclude 9.9 percent of nonagricultural wage and salary workers and 4.1 percent of the ERISA worktorce whose earnings are not
reported.
2 Number of workers too small for reliable rates to be calculated.
Source: Preliminary Employee Benefit nesearch Institute tabulations of the May 1983 EBRI/HHS CPS pension supplement.
Employer provided pensions are concentrated toward the lower three-quarters of
the income distribution and provide more broad-based coverage than the coverage
employees provide themselves through individual retirement accounts.
Women are gaining
Table 4 provides comparative statistics on coverage and vesting for men and
women. Women made considerable employment gains between 1979 and 1983 grow-
ing by 3.3 million nonagricultural wage and salary earners. Women's employment
gains were translated into improvements in coverage and vesting. The number of
female wage and salary earners covered by a pension plan increased by 660,000
workers, while the number of women entitled to future retirement benefits jumped
by 1.2 million.
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TABLE 4.-THE STATUS OF COVERAGE AND VESTING AMONG WOMEN AND MEN, MAY 1979 AND
MAY 1983
Women (thousands) Men (thousands) Percent female)
1979 1983 1979 1983 1979 1983
Nonagricultural wage and salary workers:
Employment
Covered workers
36,704
20,355
(1)
6,790
40,015
21,015
10,884
8,018
48,477
31,664
(1)
. 14,609
48,199
28,515
17,824
14,199
43.1
39.1
(`)
31.7
45.4
42.4
37.9
36.1
Tetal vested workers
Workers entitled to future benefit
ERISA work force:
18,847
22,970
30,888
31,393
37.9
42.3
Employment
Covered workers
Total vested workers
Workers entitled to future benefit
12,972
(1)
5,778
15,207
9,427
7,065
23,918
(1)
13,164
22,851
16,053
12,962
35.2
(1)
30.5
40.0
37.0
35.3
Data not available for 1979.
Source: Preliminary Employee Benefit Research lnsbtote tabulations of the May 1983 EBRI/HHS CPS pension supplement and May 1979 DOL/SSA
CP5 pension supplement.
By contrast, male employment edged down by 278,000 employees in the face of the
most severe recession since World War II. Pension protection for men slipped
through layoffs, dismissals and plant closings in many of the high coverage manu-
facturing industries.4 As a result, the proportion of women among covered wage and
salary workers increased from 39.1 percent to 42.4 percent. Similarly, the proportion
of future pension benefits claimed by women jumped from 31.7 percent to 36.1 per-
cent. (The proportion of total vested benefits accrued by women was 37.9 percent in
1983.) These gains were in keeping with the increase in the share of female employ-
ment from 43.1 to 45.4 percent of all workers.
The number of women meeting ERISA standards for plan participation also grew
considerably as full-time employment became more prevalent. In 1979 only 51.3 per-
cent of all female wage and salary workers were in the ERISA work force, compared
to 63.7 percent of men. By 1983 the female percentage rose to 57.4 percent, as the
proportion of men meeting ERISA standards edged up to 65.1 percent. The increase
in the proportion of women in the ERISA work force represented a gain of 4.1 mil-
lion workers. Coverage for this group expanded by 2.2 million workers and nearly
1.3 million more women gained entitlement to future pension benefits.
These improvements in pension protection increased the proportion of women
among covere and vested workers within the ERISA work force. By 1983 over 40
percent of all covered workers and 35 percent of all future benefit recipients were
women. (Women made up 37 percent of those entitled to total vested benefits, in-
cluding lump-sum distributions.) The relative gains in pension coverage and benefit
entitlement allocated to women stem from increased female employment and from a
larger percentage of that work force meeting ERISA standards.
Despite these gains, the most striking difference in labor force characteristics be-
tween men and women has been the persistence of the wage gap. A large body of
economic literature tries to explain the existence of wage differentials between men
and women. Leaving these unanswered questions aside, table 5 provides greater
detail on the distribution of earnings for the ERISA work force. Women are more
than four times as likely to earn less than $10,000 and over twice as likely to earn
less than $15,000 than men. Those earning less than $10,000 are less likely to be
covered by a pension plan and more likely to have a higher Social Security replace-
ment rate. Nonetheless, 76 percent of pension coverage is allocated to the 81 percent
of the women within the ERISA work force who earn less than $20,000 a year, rein-
forcing the conclusion that pensions are a middle income benefit distributed closely
in accordance to the income distribution.
~ The next section of this Issue Brief discusses the effect of the recession on coverage and vest-
ing.
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TABLE 5-CUMULATIVE DISTRIBUTION OF EMPLOYMENT AND COVERAGE BY EARNINGS' FOR
WOMEN AND MEN IN THE ERISA WORK FORCE, MAY 1983
[Employees in thoosands, distribution in percent]
Earnings
Distribution o
Employment
f women
Coverage
Distribution
Employment
of men
Coverage
Total employees
22,970
15,207
31,393
22,851
Less than $5,000
4.84
2.10
0.76
0.35
Less than $10,000
28.56
60.81
18.32
51.51
7.01
23.56
3.88
16.77
Less than $15,000
Less than $20,000
Less than $25,000
81.28
92.30
76.28
90.23
43.35
64.70
36.40
59.77
Less than $30,000
96.62
99.66
95.61
99.54
77.89
95.23
74.33
94.44
Less than $50,000
Total earnings
100.00
100.00
100.00
100.00
Percentages exclude 4.8 percent of men and 3.1 percent of women whose earnings are not reported.
Source: Preliminary Employee Benefit Research Institute tabulations of the May 1983 EBRI/HUS CPS pension supplement.
New evidence on vesting
Table 6 shows that the percentage of private-sector workers with vested benefits
generally increases with age. Around two-thirds of all covered wage and salary
wokers forty-five years of age and older are vested. Vesting rates fall again once
workers reach sixty-five years of age. The proportion of vested public-sector workers
follows a similar age pattern with vesting peaking in the early 60's at 88 percent of
coverage.
Using the May 1983 EBRI/HHS CPS pension supplement, vested benefits can be
broken down into two complementary components for the first time: (1) entitlement
to future retirement income and (2) entitlement to a lump-sum payment. The addi-
tion of lump-sum benefits increases the total vesting rate by over 10 percentage
points for the private sector and by nearly 20 percentage points for public sector
wage and salary workers. Comparable vesting gains are found for the ERISA work
force as well. Furthermore, the age profile of entitlement to future retirement
income charts a steeper path than that exhibited by total vested benefits. As a con-
sequence, the addition of lump-sum benefits totally changes our conception of the
degree of vesting provided by employer pensions.
Employees anticipate the receipt of lump-sum benefits in several ways: (1) as cash
outs of their own contributions, (2) as distributions of defined contribution plan bal-
ances upon separation from the firm, or (3) through cash-out provisions for very
small vested benefits from defined benefit plans. The age profile of lump-sum enti-
tlement is the opposite to that found for benefit entitlement at retirement. A great-
er percentage of younger workers anticipate lump-sum cash outs. Although the ex-
pectation of lump-sum recipiency jumps at age twenty-five to 13 percent of covered
private sector employees and 27 percent of covered public-sector workers, it dimin-
ishes thereafter. Private-sector rates tumble at age sixty to just 5 percent. This de-
cline may reflect two factors. First, younger workers are more likely to change jobs,
and their expectation of lump-sum entitlement probably reflects this reality.
Second, younger workers may be more likely to be employed by expanding firms
who have recently instituted defined contribution plans.
Lump-sum entitlement among public sector employees is nearly twice as high as
that in the private sector. Within the ERISA work force, more than one-fifth of all
covered public employees expect to receive only a lump-sum benefit, compared to
less than one-eighth of those covered under private-sector employment (see table 6).
The higher public-sector rate reflects the greater prevalence of contributory plans
which may be cashed out upon termination of employment.
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TABLE 6.-VESTING AMONG NONAGRICULTURAL WAGE AND SALARY WORKERS AND THE ERISA
WORK FORCE BY AGE AND SECTOR, MAY 1983
Age Covered
workers
Percent vest
ed of covered
Total percent
vested of
Percent
entitled to
Percent
entitled to
(thousands)
covered
future benefit
lump sum only
Nonagricoltoral wage and salary workers:
Private sector 36,458 51.02 40.32 10.69
Less than 25 5,285 19.63 11.87 7.77
25 to 34 years 11,516 42.80 29.47 13.34
35 to 44 years 8,576 59.77 48.61 11.16
45 to 54 years 6,185 67.41 56.45 10.96
55 to 59 years 2,912 69.88 62.53 7.35
60 to 64 years 1,520 69.97 64.88 5.08
65 years and elder 465 51.28 45.82 5.46
Public sector 13,072 77.33 57.50 19.45
Less than 25 1,092 45.67 28.25 17.43
25 to 34 years 3,723 73.66 46.56 27.10
35 to 44 years 3,656 82.89 61.50 21.39
45 to 54 years 2,552 83.32 68.33 14.99
55 to 59 years 1,159 84.05 72.43 11.62
60 to 64 years 664 88.07 76.56 11.51
65 years and older 227 67.17 59.25 7.92
ERISA work force:
Private sector 27,550 60.11 48.21 11.90
25 to 34 years 9,883 46.81 32.33 14.48
35 to 44 years 7,779 63.07 51.38 11.69
45 to 54 years 5,756 70.11 58.72 11.39
55 tn 59 years 2,708 73.13 65.38 7.75
60 to 64 years 1,424 70.98 65.91 5.07
Public sector 10,507 84.90 64.20 20.69
25 to 34 years 3,184 78.08 49.72 28.36
35 to 44 years 3,261 88.22 66.30 21.92
45to 54 years 2,365 86.39 71.36 15.03
55 to 59 years 1,082 87.81 76.29 11.52
60 to 64 years 616 91.70 79.29 12.40
Source: Preliminary Employee Benefit Research Institute tabulations of the May 1903 EBRI/HHS CPS pension supplement.
Public-sector rates of future benefit entitlement within the ERISA work force
avarage over one-third higher then private-sector rates. These factors lead to nearly
a 25 percentage point spread between private sector and public sector total vesting
rates. Public sector vesting runs at just under 85 percent of coverage and that of the
the private sector just passes 60 percent. These higher vesting rates, however, mask
one characteristic of many public plans. Public pensions are often the only source of
coverage for government employees. At the tome of the survey, no federal workers
participated in Social Security and neither did 43 percent of the state and local
work force.
Vesting vs. voluntary contributions.-A comparison of total vested benefits for pri-
vate nonagricultural wage and salary earners (from table 6) with seciton 401(k) and
IRA utilization rates (from table 7) shows the relative difference between coverage
selected by the individual worker and that provided by employer pension plans. Uti-
lization of IRAs for every age group is far below the proportion of vested benefits
provided by private-sector employers. The utilization of 401(k) plans among wage
and salary workers is comparable at very young and very old ages to vesting rates
provided by private sector pension plans. Private plans provide considerably greater
vesting for workers between twenty-five and sixty years of age than workers provide
for themselves under 401(k) arrangements. Pension plan vesting rates exceed section
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401(k) participation rates by over 15 percentage points for the ERISA work force
between thirty-five and fifty-nine years of age.
TABLE 7.-UTILIZATION OF VOLUNTARY RETIREMENT PROGRAMS AMONG PRIVATE
NONAGRICULTURAL WAGE AND SALARY WORKERS BY AGE AND TYPE OF PROGRAM, MAY 1983
Age
Section 401(k) deferred
compensation
Number
offered plan ~
Individual retirem
Number of
(thousands)
ent acceunts
Percent
ufiflzafion
Nonagricultural wage and salary workers:
Total employees
4,822 39.31
72,465
16.49
Less than 25
555 19.79
16,415
2.30
2500 34 years
1,627 30.71
1,364 43.04
795 49.51
302 56.90
21,553
14,681
10,627
4,723
11.00
18.51
30.25
39.90
35 to 44 years
45 to 54 years
55 to 59 years
60 to 64 years
65 years and over
ERISA work force:
139 68.13
(~) (~)
2,834
1,630
37.13
20.30
Total employees
3,833 43.68
42,458
21.96
2500 34 years
3500 44 years
4500 54 years
5500 59 years
6000 64 years
1,404 33.75
1,262 44.42
749 50.96
281 58.35
138 68.65
15,977
11,479
8,781
3,919
2,302
11.87
19.57
30.55
41.21
38.32
1 Number of workers toe small for rates to be calculated reliably.
Source: Prebminary Employee Benefit Research Institute tabulations of the May 1983 EBRI/HUS CPS pension supplement.
In sum, new findings from the May 1983 EBRI/HHS CPS pension supplement
show that vested benefits for employer plans exceed previously reported vesting
rates by 10 to 20 percent when lump-sum distributions are added to benefit entitle-
ment at retirement. Furthermore, comparisions with new data on voluntary partici-
pation in IRAs and 401(k) plans suggest that employer pensions provide a greater
degree of coverage for workers at younger ages than they would provide for them-
selves.
The costs of the business cycle
The timing of the May 1983 EBRI/HHS CPS pension suppiement provided the
first opportunity to analyze the sensitivity of employer pension plans to business
cycle conditions. The predecessor survey, the May 1979 DOL/SSA CPS pension sup-
plement, was conducted during relatively boyant economic times. According to the
National Bureau for Economic Research, a 58 month economic expansion was in full
swing in May 1979 as the economy surged toward its January 1980 cyclical peak
just eight months later. By contrast, four years later in May 1983, the economy had
just passed the November 1982 cyclical trough marking the most severe recession
since World War II.
The period between the surveys was not one of strong economic growth. Real
Gross National Product expanded at less than a 1 percent annual rate between the
second quarter of 1979 and the second quarter of 1983. Furthermore, the consumer
Price Index increased at an average annual rate of 8.2 percent between May 1979
and May 1983. Although prices moderated considerably by 1982, the sequence of
double digit inflation and severe recession would be expected to have a marked
effect on every sector of the economy.
A sharp economic downturn is unlikely to lead to robust plan growth. As the
economy headed toward the recessionary trough, employers would be unlikely to
add to compensation costs by instituting new pension plans where none were previ-
ously available. Similarly, employees who had suffered real wage losses during the
inflationary spiral would be unwilling to agree to trade current comepensation for
future pension benefits. While some employees might choose tax-sheltered deferred
compensation from a second plan in lieu of current salary increases, probably most
PAGENO="0654"
648
would not. A priori, growth in pension coverage could not be expected between May
1979 and May 1983.
The fate of employer pensions is closely linked to the labor market. The difference
in unemployment rates between the two pension supplement surveys is striking. In
May 1979, the civilian unemployment rate reached its lowest point since the pas-
sage of ERISA, at a seasonally adjusted rate of 5.6 percent. By contrast, the civilian
unemployment rate for May 1983, at 10.1 percent was one of the highest since
before World War II. (Nationwide double digit unemployment had disappeared in
this country after the Great Depression ran its course.) while the unemployment
rate eased to 7.1 percent by June 1984, the EBRI/HHS May 1983 CPS pension sup-
plement took place in mid-1983 before the beginning of the recent robust expansion.
The aggregate figures
Table 8 presents data on employment, pension coverage and future benefit receipt
for five employment groups in May 1979 and May 1983. The figures range from the
broadest definition of employment, that of all civilian employees plus the self-em-
ployed, narrowing to the ERISA work force, those employees meeting ERISA stand-
ards for plan participation in 1983. This latter group is most likely to represent
workers who will have enough years of service to build an adequate employment-
based pension. In table 8, the ERISA work force is gradually augmented to include
those on their current job for less than a year, those working fewer than 1,000
hours, those workers under age twenty-five and over age sixty-five, and, finally, ag-
ricultural workers and the self-employed.
TABLE 8.-EMPLOYMENT, COVERAGE AND FUTURE BENEFIT ENTITLEMENT BEFORE AND AFTER THE
RECESSION, MAY 1983 AND MAY 1979
[Employment in thousands and percent of employment in parentheses]
Employment
coverage
Futibene1it
1983
Civilian employment (all employees and self-em-
ployed)
Nonagricultural wage and salary workers
Nonagricultural wage and salary workers age 25 to
64 only
Nonagriceltural wage and salary workers age 25 to
64, working 1000 hours or more
ERISA work force (age 25 to 64, working 1000
hours or more, one year of tenure or more)
98,964 (100.00)
88,214 (100.00)
68,252 (100.00)
61,586 (100.00)
54,363 (100.00)
51,530 (52.07)
49,530 (56.15)
42,463 (62.21)
40,702 (66.09)
38,057 (70.01)
24,095 (24.35)
22,217 (25.19)
20,934 (30.67)
20,476 (33.25)
.
20,027 (36.84)
1979
Civilian employment (all employees and self-employed..
Nonagricultural wage and salary workers
Nonagricultural wage and salary workers age 25 to
64 only
Nonagricultural wage and salary workers age 25 to
64, working 1000 hours or more
ERISA work force (age 25 to 64, working 1000
hours or more, one year of tenure or more)
95,372 (100.00)
85,181 (100.00)
63,201 (100.00)
58,009 (100.00)
49,736 (100.00)
53,445 (56.04)
52,019 (61.07)
42,576 (67.37)
40,830 (70.39)
36,890 (74.17)
22,633 (23.73)
21,399 (25.12)
19,836 (31.39)
19,522 (33.65)
18,941 (38.08)
Source: Preliminary Employee Benefit Research Institole tabulations of The May 1903 EBRI/IIHS CF'S pension supplement and May 1979 D0L/SSA
CF'S pension supplement.
The data show that the coverage rate for the ERISA work force, at 70 percent, is
higher than that of any of the expanded employment groups. This finding is consist-
ent with the economics of the labor market and retirement planning. ERISA partici-
pation standards were set on the following premises: (1) the labor force attachment
of many part-time employees and those with less than a year on the job may be too
weak to build up meaningful pension benefits; (2) workers less than twenty-five
years of age are likely to have high turnover rates as they start their careers; and
(3) those over sixty-five are more likely to be retired and employed at a part-time
job. Farm workers are segmented out because they tend to have low wages and tran-
sient employment. Although the non corporate self employed may establish a Keogh
plan, more than 95 percent do not, probably preferring the reinvest their funds in
the growth of their own company.
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The comparative findings of the May 1983 and the may 1979 surveys are thought-
provoking. Employment of nonagricultural wage and salary workers (the second row
on table 8 for each year) increased by 3 million employees between the 1979 and
1983. On the one hand, pension coverage did not keep up with this trend and fell by
nearly 2.5 million workers primarily through a drop in coverage among employers
under age twenty-five and sixty-five years and older. On the other hand, the
number of workers who anticipate benefit entitlement at retirement increased by
over 800,000. In other words, even though aggregate coverage among wage and
salary workers fell after the 1982 recession, benefit entitlement remained strong.
Nevertheless, because of the labor force expansion, coverage and vesting rates both
declined regardless of increases in the number of covered and entitled workers.
Changes in the ERISA work force (the last row in table 8 for each year) between
1979 and 1983 tell a different story. Employment gains between the two years were
even stronger with 4.6 million workers added to the ERISA work force. The number
of covered workers also grew by over one million employees to 38 million workers.
Gains in vesting surpassed one million to total 20 million workers. (And, of course,
these figures omit the additional 5.5 million employees who anticipate receiving a
lump-sum benefit.) Nonetheless, both coverage and vesting rates declined from their
1979 rates. By 1983, the coverage rate for the ERISA work force was 70 percent with
53 percent of covered workers of all ages anticipating future benefit receipt. In 1979
coverage for the ERISA work force had reached 74 percent, although only 51 per-
cent of covered workers anticipated benefits at retirement.
The reasons behind these changes are not easily analyzed. The first apparent co-
nundrum is the issue of declining coverage among nonagricultural wage and salary
workers during a period of increasing employment. As table 8 shows, most of the
decline in the number of covered nonagricultural workers falls among workers
under twenty-five years of age and sixty-five years and older. The most perplexing
question arising from the EBRI/HHS May 1983 CPS pension supplement findings is
why gains among the ERISA work force did not keep pace with increases in employ-
ment.
An industrial analysis
Part of the explanation for the fall in pension coverage rates despite expanding
employment lies in the effect the recession had on employment by industry. Typical-
ly, manufacturing has been considered a high coverage industry and the service
sector a low coverage industry. Industrial shifts between services and manufactur-
ing could bring about the decline in the coverage rate observed in 1983.
Tables 9 and 10 present statistics on employment and coverage for the ERISA
work force for May 1979 and May 1983 and data on certain employment-related
characteristics.5 Industries are presented in two groupings: recessionary sectors and
growth sectors. In general, the recessionary sectors are comprised of the older indus-
trial infrastructure, including manufacturing, which exhibited employment losses.
The growth sectors are heavily weighted toward those service-related industries
which experienced employment growth.
TABLE 9.-CYCLICAL CHANGES IN EMPLOYMENT AND COVERAGE IN THE ERISA WORK FORCE BY
INDUSTRY, MAY 1979 AND MAY 1983
[Amounts other than percent in thousands~
Industry Employment
1983
Employment
change
1979-83
Ceverage
change
1979-83
Percent
1979
covered
1983
Recessionary sectors:
Government 11,905 750 93 93.36 88.26
Durable manufacturing 8,492 (446) (795) 84.74 79.84
Primary metals 702 (257) (251) 91.98 89.81
Automobiles 823 (190) (155) 90.48 92.56
° Changes in the 1970 and 1980 Censuses mean that employment totals for the May 1979 CPS
and the May 1983 CPS are strictly comparable. In particular, the 1980 Census corrected a previ-
ous undercount, so that were the 1979 CPS benchmarked to the latest Census, the population
totals would be somewhat higher. That implies that employment increases may be slightly too
robust and employment decreases may be slightly underrepresented. Thus the recessionary
impact on coverage may be understated. The effect of this undercount on calculated rates should
be minimal.
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650
TABLE 9.-CYCUCAL CHANGES IN EMPLOYMENT AND COVERAGE IN THE ERISA WORK FORCE BY
INDUSTRY, MAY 1979 AND MAY 1983-Continued
[Amounts other than percent in thousands]
Industry
Em In ment
~
Employment
change
1979-83
Coverage
change
1979-83
Percent co
1979
vered
1983
Nondurable manufacturing
5,862
321
(1)
77.08
72.56
Apparel
697
970
(175)
(104)
(84)
(109)
46.21
93.17
45.82
91.89
Chemicals
Transportation (ox-railroads)
1,454
2,130
(1)
(102)
(82)
(295)
72.64
55.75
68.98
44.56
Construction
Growth sectors:
Public utilities
811
1,200
660
3,444
6,401
159
277
177
581
1,578
129
215
117
435
961
96.06
92.04
88.73
71.94
64.96
93.11
88.75
82.72
72.42
63.95
Communications
Mining
Finance, insurance, and real estate
Professional service
Wholesale trade
Retail trade
Business and personal services
2,682
5,833
3,184
403
503
668
138
182
225
68.36
46.89
33.87
63.26
45.96
33.83
1 Number of workers too small to be statistically significant.
Source: Preliminary Employee Berefit Research Institute tabulations of the May 1983 EBRI/HHS CPS pension supplement and May 1979 DOL/SSA
CPS pension supplement.
TABLE 10.-CYCLICAL CHANGES IN EMPLOYMENT CHARACTERISTICS OF THE ERISA WORK FORCE BY
INDUSTRY, MAY 1979 AND MAY 1983
Average tenure with Covered by union Large company: 500
employer (years) contract (percent) or more workers
Industry (percent)
1979 1903 1979 1983 1979 1983
Recessionary sectors:
Government 10.54 10.59 50.05 52.54 (1) (~)
Durable manufacturing 12.12 11.42 45.18 35.49 77.32 72.38
Primary metals 15.65 14.06 64.97 55.17 83.93 85.79
Automobiles 13.02 15.22 72.70 59.21 92.41 88.28
IodouIeo.wI'ug 11.76 10.68 39.96 32.39 71.24 69.10
Apparel 9.21 7.90 43.03 34.83 48.93 57.31
Chemicals 13.54 12.12 32.09 22.35 85.41 88.24
Transportation (ox-railroads) 10.89 9.57 52.00 40.72 59.74 57.94
Construction 9.04 8.24 42.08 31.07 26.79 24.07
Growth sectors:
Public utilities 14.95 13.96 50.34 42.58 85.42 81.96
Communications 14.39 13.08 59.56 58.49 87.07 84.02
Mining 11.14 10.27 41.87 28.57 80.40 76.57
Finance, insurance and real estate 9.74 8.23 6.78 5.10 56.45 59.21
Professional services 7.63 6.87 12.22 13.04 42.66 41.81
Wholesale trade 9.60 9.45 15.38 13.82 39.97 36.99
Retail trade 8.49 7.49 16.37 14.43 42.86 45.74
Business and personal services 8.68 6.27 13.02 10.80 34.74 31.81
1 Data on firm size not applicable to Federal Gov~rnmont emp!oymont.
Source: Preliminary Employee Benefit Research Institute tabulations of the May 1903 EBRI/HHS CPS pension supplement and May 1979 DOL/SSA
CPS pension supplement
The recessionary sectors-The recessionary sectors include manufacturing, trans-
portation (excluding railroads),6 construction and government. Between 1979 and
Following past survey practices, respondents were instructed to exclude Social Security and
Railroad Retirement from their responses.
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651
1983, most of these industries exhibited strong across-the-board declines in employ-
ment or significant downturns within major components. Government is the only
sector with growth in employment and coverage. It is among those affected by the
recession, however, since weak economic growth and high inflation undoubtedly in-
fluenced the public's desire to reduce taxes and government spending.
The bulk of employment in the recessionary sectors of the economy is typified by
pension coverage rates of over 70 percent. Employment and coverage losses were sig-
nificant. Led by construction industry declines of over 11 percentage points, these
sectors all showed coverage rate reductions of 3 to 5 percentage points. Yet in each
industry the complex set of factors influencing the decline in the coverage rate dif-
fered.
For instance, two primary sources of employment and coverage loss among the
durable goods manufacturing industries were primary metals (representing the steel
industry, for the most part) and automobiles. Coverage losses in these industries
alone accounted for more than half the total losses in durables manufacturing. Yet
the coverage rate for auto workers did not decline because of significant plant clos-
ings and broadly based layoffs and permanent separations. The rest of durables
manufacturing provides an example of a more standard recessionary adjustment
process. As many workers in large unionized firms were laid off during the 1982
recession, employment fell but coverage fell even more leading to lower coverage
rates. Coverage rates today should be higher to the extent that laid-off workers were
rehired as the recovery gained momentum.
While many other industries were affected by a variety of special factors, cover-
age rates in government were particularly depressed in comparison to the private
sector. Whereas the government coverage rate fell 5.1 percentage points from 93.4 to
88.3 percent, the coverage rate for all private sector industries only slipped 3.7 per-
centage points from 68.6 to 64.9 percent. In particular, the federal government ap-
pears to have hired more workers outside of the Civil Service Retirement System.
Although specific recessionary and growth industries, such as construction and
mining, also posted large coverage rate losses in percentage terms, the government
figures are particularly striking in view of pension coverage rates that traditionally
have been nearly universal.
Table 10 provides part of the framework for a more general analysis of these
changes. Three factors found to influence coverage rates are provided by industry
for 1979 and 1983. These factors consist of average on-the-job tenure, the likelihood
of being included in a union contract, and the likelihood of being employed by a
company employing 500 or more workers. Industries with long-tenure workers tend
to have greater pension coverage both because employers want to provide benefits
for long-tenure employees and because employees want to work longer at firms with
pension benefits. Large firms tend to establish pensions more readily because of
scale economies in personnel and asset management. Unionization is closely tied to
pension protection. Benefits have been a subject of collective bargaining for many
years and multiemployer agreements increase the scale economies of pension provi-
dion by banding together smaller contributions within the Taft-Hartley plan.7
Within the recessionary sectors, declines have taken place in average tenure,
unionization and the extent of employment in large firms. Shifts in unionization
and firm size are probably a result of layoffs in larger more highly unionized plants.
Unionized firms appear more ready to reduce costs through temporary layoffs
during a recession rather than through across-the-board wage cuts. In May 1983,
those laid-off workers were either collecting unemployment insurance, or, if reem-
ployed, working at smaller less-unionized firms.
The growth sectors.-With the exception of mining, sectors exhibiting employ-
menit gains were all within the service-providing industries. Table 8 shows that
these 8 major industry groups led to an increase in employment of 4.3 million work-
ers between 1979 and 1982. The number of covered workers in these industries ex-
panded by 2.4 million employees. While the service sector is typically regarded as a
source of low-wage low-benefit employment, 6.1 million workers, or 25 percent of the
growth sector, are in industries with coverage rates of over 70 percent. Another 9
million workers, or 37.5 percent of this work force, are in industries with coverage
rates of over 60 percent. Two patterns of change are exhibited: coverage rates for
half the industries fell while those for the other half held constant.
Public utilities, communications, mining and wholesale trade exhibited declines in
coverage rates despite an increase of nearly 600,000 in the number of covered work-
Olivia S. Mitchell and Emily S. Andress, "Scale Economies in Private Multi-Employer Pen-
sion Systems", "Industrial and Labor Relations Review," July 1981, pp. 522-530.
40-046 0 - 85 - 42
PAGENO="0658"
652
ers in those industries. In the mining and public utilities, significant declines in the
extent of unionization, combined with a shift toward smaller companies, may have
led to the decline in the coverage rate. Nevertheless, in 1983, coverage rates for
three of these four industries surpassed 80 percent even during this recessionary
period.
Coverage rates held virtually constant in the financial sector (finance, insurance,
and real estate), in the services (professional services and business and personal
services) and in the retail trade. The number of covered workers increased by a
hefty 1.8 million employees. In other words, depsite a variety of factors militating
toward lower coverage, including the recession and some tendency toward shorter
job tenures, coverage rates did not decline. Over three-quarters of these workers
were found in the financial sector and in professional services which posted cover-
age rates of 72 and nearly 64 percent respectively.
In summary, losses in employment and coverage stemming from a recessionary
economy differed significantly according to industry. In some industries, the survey
missed enumerating out-of-work covered workers who did not experience a break-in-
service. By now, pension coverage has rebounded in those sectors as manufacturing
workers returned to their jobs during the expansion.
Employment growth in the service-related sectors was robust in view of the reces-
sionary conditions. In absolute numbers, millions of covered workers were added to
that sector alone, taking up much of the loss suffered in manufacturing. Many serv-
ice sector coverage rates were remarkably stable. Slower pension coverage growth
would be expected during a recession. New employers would be less likely to provide
a pension in their compensation package; old employers would be less likely to insti-
tute a pension if they did not have one. Furthermore, some argument could be made
that lower cost employers, those without pensions, may find it easier to expand
during a cyclical downturn.
Statistical quirks
Unfortunately an industrial analysis does not seem to answer all the questions
about what happened to pension coverage between the two surveys. A number of
purely statistical issues make the data difficult to interpret and perhaps suggest
that pension coverage remained more robust than indicated by the raw percentages.
While changes in coverage appear to be associated with the extent of unionization,
average job tenure and firm size, the decline in coverage within the ERISA work
force appears surprisingly broad in view of the relatively small compositional
changes in many of those variables affecting coverage rates.
For this reason a preliminary statistical analysis was conducted for those mem-
bers of the ERISA work force with valid responses for all items used in the analy-
5is.8 The regression included factors likely to affect pension coverage to explain the
change in the coverage rate. Variables similar to those in table 9 were found to in-
fluence the extent of pension coverage as well as industry, earnings and to a lesser
extent, age and geographic region of the country.
In addition to service sector growth and a contraction in manufacturing, changes
took place in the distribution of age, tenure and earnings within the ERISA work
force between the two survey years. This preliminary analysis indicated a down-
ward shift in the structure of the determinants of pension coverage not related to
differences in the compositional shifts in the work force. This may represent the
effect of the recession on pension growth.
Imputed responses.-A further explanation for the shift in the structure of the
coverage equation and the coverage rate may lie in the distribution of unreported
responses in the survey. In 1980, the President's Commission on Pension Policy con-
tracted with ICF, Inc. to allocate missing answers to the May 1979 DOL/HHS CPS
pension supplement resulting from question refusals, skipped questions and `don't
know' responses.9
Table 11 presents statistics on employment, coverage and future benefit receipt
for 1979 and 1983 comparable to those presented in table 8 but using imputations to
fill in missing or incomplete data. For both years, the imputed responses for items
that were not reported leads to an increase in the number of persons covered by a
pension plan and in the number of persons who anticipate the receipt of future pen-
sion benefits. The survey findings using the imputed data differ for coverage and for
benefit receipt because of different patterans of nonresponse for the two questions.
8Final findings will be presented in Emily S. Andrews, "The Changing Profile of Pensions in
America," (Washington, DC: EBRI, forthcoming).
9 ambitious imputations for those individuals who were eligible for the survey but did
not respond to any of the pension supplement questions were not included.
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Many more employees did not know whether they were entitled to future pension
benefits.
TABLE 11.-EMPLOYMENT, COVERAGE AND FUTURE BENEFIT ENTITLEMENT BEFORE AND AFTER THE
RECESSION, MAY 1983 AND MAY 1979 1
[Employment in thousands and percent of employment in panentheses]
Employment
coverage
F~eI~~it
1983
Civilian employment (all employees and self-employed)
Nonagricultural wage and salary workers
Nonagricultural wage and salary workers age 25 to 64 only
Nonagricultural wage and salary workers age 25 to 64, working
1000 hours or more
ERISA work force (age 25 to 64, working 1000 hours er more,
one year of tenure or more)
98,963 (100.00)
88,214 (100.00)
68,252 (100.00)
63,833 (100.00)
56,153 (100.00)
56,018 (56.60)
53,932 (61.14)
45,379 (66.49)
43,723 (68.50)
40,441 (72.02)
30,850 (31.17)
28,894 (32.75)
26,569 (38.93)
26,143 (40.95)
25,326 (45.10)
1979
Civilian employment (all employees and self-employed)
Nonagricultural wage and salary workers
Nonagricultural wage and salary workers age 25 to 64 only
Nonagricultural wage and salary workers age 25 to 64, working
1000 hours or more
ERISA work force (age 25 to 64, working 1000 hours or more,
95,372 (100.00)
85,181 (100.00)
63,201 (100.00)
59,217 (100.00)
50,562 (100.00)
55,515 (58.21)
54,079 (63.49)
43,907 (69.47)
42,252 (71.35)
37,803 (74.77)
29,309 (30.73)
28,005 (32.88)
26,009 (41.15)
25,512 (43.08)
24,494 (48.44)
one year of tenure or more)
Figures include imputations for missing data.
Source: Preliminary Employee Benefit Research Institute tabulations of the May 1983 EBRI/HHS CPS pension supplement and May 1979 D0L/SSA
CPS pension supplement using imputations provided by ICF Inc.
While the number of covered workers increased for both years using the imputed
variables, the increase in coverage is greater for 1983 than 1979. Analysis suggests
that more high salaried workers, more employees in government, and more persons
working in large firms were among those without reported responses in 1983. The
reason for this shift in nonresponse has not been identified. Suffice it to say that
although more wage and salary workers were covered in 1979 than in 1983, using
the imputed responses, the gap in coverage fell from 2.5 million workers to under
150,000. Coverage increased to 53.9 million workers in 1983 or 61 percent of all non-
agricultural employees.
Between 1979 and 1983, coverage rose by 2.6 million employees for the ERISA
work force using the imputed data, compared to an increase of just over 1.1 million
based on the CPS raw counts. Part of this greater coverage growth resulted from
the addition of 1.8 million workers to the ERISA work force for May 1983 after im-
putations were made for missing responses to job tenure and annual hours worked.
This raised the proportion of employment in the ERISA work force from 55 to 57
percent. Furthermore, even though the coverage rate fell between 1979 and 1983,
the decline was smaller using imputed data.
Imputations improve the status of future benefit receipt within the population
even more. This results from the large fraction of the population which reported
that they did not know whether they were qualified for retirement benefits. In 1979
nearly 15 percent of covered nonagricultural employees and the covered members of
ERISA work force had not reported whether or not they would be entitled to a bene-
fit at retirement. Although the figure fell to around 12 percent in 1983, suggesting
greater employee information about pensions, the degree of nonresponse remained
substantial.
Imputed data on future benefit receipt increased the number of workers vested
for retirement benefits for both years but did not greatly alter the relationship be-
tween the two years. Concentrating on May 1983, the data indicate that the imputa-
tions increased the number of workers expecting retirement benefits by 6.7 million
to a total of 28.9 million workers. Within the ERISA work force the number of
workers looking forward to a pension rose by 5.3 million to 25.3 million workers.
Thus 63 percent of covered workers of all ages were eligible for retirement benefits.
If the 5.5 million persons in the ERISA work force who expect lump-sum benefits
are added to this sum, the number of total vested workers rises to 30.8 million or 76
percent of all covered employees of all ages meeting ERISA participation standards.
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The full picture
Evaluating changes in coverage and future benefit receipt between the May 1979
DOL/SSA CPS pension supplement and the May 1983 EBRI/HHS CPS pension sup-
plement is a complex task. The dual effects of unfavorable economic conditions and
changing patterns of survey response must be considered. On the one hand, changes
in response patterns between 1979 and 1983 appear to minimize the growth in the
number of covered workers and maximize the decline in the coverage rate.10 On the
other hand, even using imputed responses, pension coverage did not keep up with
employment gains during a period of massive unemployment and low economic
growth. This resulted in a decline in the ratio of covered workers to employment
between May 1979 and May 1983.11
Coverage rates posted in May 1983 were adversely affected by the 1982 recession
in several ways. First, many workers in manufacturing were on layoff lowering the
overall coverage rate. Second, this effect may have been compounded to the extent
that unionized employment responded to the recession through layoffs rather than
wage cuts. Third, employers without a pension plan would have been unlikely to
institute one during a period of high unemployment and lagging demand. Plan
growth among employers without coverage should accelerate during the current ex-
pansion to a rate more in keeping with a long run expansion path.
Even though the expansion of coverage was not proportional to the expansion of
employment causing the coverage rate to edge off from 75 percent in May 1979 to 72
percent in May 1983 using imputed responses, the number of covered workers ex-
panded by 2.6 million workers for the ERISA work force. This expansion indicates
that even during adverse conditions employer pensions have continued to provide
protection for the majority of employees meeting ERISA participation standards.
Even during a recession pension plans continue to cover predominantly lower-
and middle-income workers. Table 12 compares the distribution of employment, cov-
erage and pension receipt by earnings for the ERISA work force in 1979 and 1983.
Although the proportion of workers earning less than $25,000 (in 1983 dollars) in-
creased from 74 percent in 1979 to 76 percent in 1983, the proportion of covered
workers earning less than $25,000 also increased from 70 percent in 1979 to 72 per-
cent in 1983. Furthermore, the proportion of workers expecting future retirement
benefits (excluding lump sum distributions) and earning less than $25,000 increased
from 63 percent of all workers in 1979 to 67 percent in 1983. In other words, pension
coverage continues to protect middle-income employees even as the income distribu-
tion worsened.
TABLE 12.-CUMULATIVE DISTRIBUTION OF EMPLOYMENT, COVERAGE AND VESTING BY EARNINGS 1
FOR THE ERISA WORK FORCE, MAY 1979 AND MAY 1983
[Employment in thousands, distribution in percent]
Earnings 2
Employment
distribution
Coverage
distribution
Benefit
entitlement
distribution
1913
Total employees ° 54,363 38,058 20,027
Less than $5,000 2.50 1.05 0.54
Less than $10,000 61.21 9.67 5.98
Less than $15,000 39.46 30.70 23.82
Less than $20,000 59.54 52.39 44.85
Less than $25,000 76.48 71.98 66.67
Less than $30,000 85.89 82.86 78.85
Less than $50,000 97.13 96.48 95.23
Total earnings 100.00 100.00 100.00
`°There is also some evidence that a change in the wording of the key coverage question may
have led to a decline in reported coverage. The 1983 survey substituted the phrase "contribute
to a pension plan" for "have a pension plan."
5' Other surveys of pension coverage also show coverage rates edging off since 1979. These
include calculations of prior year pension coverage among employed workers from the annual
March Current Population Survey and pension coverage among large and medium-sized firms
from the Bureau of Labor Statistics' Level of Benefits Survey.
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TABLE 12.-CUMULATIVE DISTRIBUTION OF EMPLOYMENT, COVERAGE AND VESTING BY EARNINGS l
FOR THE ERISA WORK FORCE, MAY 1979 AND MAY 1983-Continued
[Employment in thousands, percenti
Earnings 2 d~~'t
d~rihut~on
e~i?~r~nt
1979
Total Employees 49,736
1.86
36,890
0.82
8.74
28.72
50.59
69.95
82.57
97.07
100.00
18,941
0.26
Less than $5,000
Less than $10,000 14.33
Less than $15,000 36.19
Less than $20,000 57.18
Less than $25,000 74.22
Less than $30,000 85.17
Less than $50,000 97.43
Total earnings 100.00
5.06
21.15
42.76
63.34
77.45
96.09
100.00
1 Percentages excluded 4.9 percent of employees in 1979 and 4.1 percent of employees in 1983 whose earnings are not reported.
2 In 1983 dollars.
Source: Preliminary Employee Benefit Research Institute tabulations of the May 1983 EBRI/HH5 CP5 pension supplement and May 1979 D0L/SSA
CPS pension supplement.
Furthermore, the employer pension system did not suffer the financial difficulties
experienced by the Social Security system in recent years. Between 1979 and 1982
Social Security trust fund assets fell from $24.7 billion to $22.1 billion and would
have run out had interfund transfers not taken place and had the 1983 Social Secu-
rity Amendments not been passed. This unfortunate situation was a direct result of
sluggish economic growth with wage rates lagging prices over an extended period.
By contrast, assets held by private, state and local government plans continued to
grow. Accumulated holdings in these employer pension funds were $522.9 billion in
1979 and $815.8 in 1982 despite a sluggish economy. While no employed workers lost
Social Security coverage during the recession, the costs to maintaining benefit enti-
tlement for a system that was not self-regulating at the time were borne by workers
and retirees alike through the 1983 Amendments.
Conclusion
Pension coverage appears to be sensitive to business conditions, exhibiting less
rapid growth during cyclical downswings. Employer pensions continued to provide
coverage, however, to the vast majority of workers who are most likely to accrue
meaningful benefits no matter the state of the economy. These employees vest in
their pension plans as they grow older, probably accruing benefits at a faster rate
than they would on their own. Furthermore, more and more women have become
entitled to pensions in their own right as they enter the labor force in greater num-
bers. Finally, the vast majority of employees benefiting from employer pension
plans continue to be middle income workers earning less than $25,000 a year. All
these benefits are observed in a system with strong financial reserves enabling it to
weather the worst depression in four decades.
STATEMENT OF THE ASSOCIATED GENERAL CONTRACTORS o~' AMERICA
The Associated General Contractors of America AGC represents more than .0,000
firms, including 8,400 of America's leading general contracting companies which are
responsible for the employment of more than 3,400,000 individuals. These member
contractors perform more than 80 percent of America's contract construction of
commercial buildings, highways, industrial and municipal-utilities facilities and of
the contract construction performed by American firms abroad. We appreciate the
opportunity to submit written testimony regarding the federal tax treatment of em-
ployer provided fringe benefits.
AGC supports the long established national policy of excluding fringe benefits
from taxation at the employee level while allowing employers to deduct the cost of
the benefits as a business expense. AGC also believes that the tax treatment of non-
statutory fringe benefits has been more than adequately addressed in recent legisla-
tion. Rather than imposing more restrictions, traditional provisions of the Code such
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as Section 127 education expense deductions should be renewed. The reforms and
the numerous restrictions covering statutory fringe benefits in the Tax Equity and
Fiscal Responsibility Act of 1982 (TEFRA) and the Tax Reform Act of 1984 (TRA)
have made the present tax treatment of fringe benefits the most restrictive in
modern history. Any further restrictions of employer provided fringe benefits will
only serve to dismantle the efficient private sector benefit program. This system has
no rival in any public sector system.
TEFRA dramatically reduced and froze the maximum contribution amounts for
pension and profit sharing plans. This freeze was extended in the 1984 TRA. New
"top heavy" plan rules were incorporated into the Code to limit the benefits of
senior corporate officials. Severe restrictions were placed on voluntary employee
benefit trusts in the 1984 Act. Reserve account restrictions were also established for
a variety of benefit categories by the 1984 Act. The 1984 Act also required extensive
recordkeeping and compliance requirements for employers furnishing general fringe
benefits, such as merchandise discounts and working condition fringes.
AGC continues to believe that the traditional national policy of encouraging em-
ployer provided fringe benefits should be followed. This policy correctly attempts to
develop and foster a private employer benefit system. The clear acknowledgement of
the superiority of a private system is well founded. The needs of a local workforce
are best met at the employer level. This system allows employers to tailor their ben-
efit programs to their employees specific needs on a local basis. For example, if the
workforce is relatively young, medical insurance covering family needs may be a
high priority of the employees. These needs can be easily adjusted for by the em-
ployer in designing a benefit program. This flexibility enhances the efficiency of the
private sector system in a way that no public system can match. Restricting this
flexibility with limitations on maximum medical insurance benefits as has been sug-
gested recently does not serve the public interest. If two similar workforces requir-
ing the same level of benefits are located in areas where the service costs very sig-
nificantly a cap will restrict the benefits of one group more than another. We do not
believe the marginal revenue gains of the federal treasury justify the discriminatory
effects on benefits and employees.
The clear superiority of the private sector delivery systems versus public systems
represents revenue savings to the federal government which are far more signifi-
cant than the tax revenues which could be raised by taxing fringe benefits. The
present system has been extensively reformed in recent years and no further re-
strictions of the system are in the public interest.
STATEMENT OF THE ASSOCIATED SPECIALTY CONTRACTORS, INC.
INTRODUCTION
The Associated Specialty Contractors, Inc., is an "umbrella" organization of eight
national associations of construction specialty contractors, whose combined member-
ship totals about 25,000 firms. The member associations are the Mason Contractors
Association of America (MCA), the Mechanical Contractors Association of America
(MCAA), the National Association of Plumbing-Heating-Cooling Contractors
(NAPHCC), the National Electric Contractors Association, Inc. (NECA), the National
Roofing Contractors Association (NRCA), the Painting and Decorating Contractors
of America (PDCA), and the Sheet Metal and Air Conditioning Contractors' Nation-
al Association (SMACNA). All chapters, local and regional affiliates and contractor
members of the affiliated associations are regarded as affiliates of ASC.
The segments of the industry represented by ASC affiliates, as reported in the
1977 Census of Construction Industries, consist of about 165,000 business establish-
ments with annual sales of about $63 billion and 1,300,000 employees.
OVERVIEW
The purpose of these hearings, fringe benefit taxation, should not come as a sur-
prise to those in the business community after reviewing the recent tax debate. Con-
gress and the Administration are in pursuit of budget revenues and no stone will
remained unturned. This is not necessarily construction investment, and the eco-
nomic health of our industry.
The Economy
Clearly the greatest problem for the construction industry is interest rates that
are too high. While below the temporary peaks of the late 1970's the average inter-
est rates of the early 1980's have been far too high, especially in relation to the
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much lower inflation rate. In short, the record real interest rates inhibit investment
and construction from reaching its potential. While the nation's overall construction
economy has improved from the depths of the recent recession, business is still not
as good as in years before the recession. It is important to remember that many
large urban areas' economic conditions for our industry have yet to improve from
recession conditions. With interest rates again on the rise to the levels that brought
on the last recession, our industry is greatly concerned with the tax and budget
policy promoted by the Congress and the President.
Briefly, the policies that have given our nation record trade deficits, record budget
deficits, and record real interest rates must be changed before we find our economy
again in a deep recession. The new recession will be caused by too large a federal
government debt. Without trying to assess blame for the current economic dilemma,
ASC agrees with economic policymakers who demand we shrink the federal budget
deficit as soon as possible. However, higher taxes are not the only answer. They can
short-circuit the construction recovery just as fast as can higher interest rates. The
formula should include no less than equal cuts in spending and revenue increases if
the task is to succeed. It is important that business not be asked to bear a far great-
er burden through higher taxes as has been the case in the last two tax bills.
Taxes and small business
Beginning in 1982, the federal government has passed at least one major tax bill
each year designed solely to increase federal revenues. The merits of each bill have
been questionable but in the rush to cut deficits, inadequate attention to detail is
becoming all too common. That trend continued this year with a tax package that is
expected to raise over $50 billion, after subtracting new spending initiatives, during
the next three years. The construction industry was especially hard hit in the
recent tax bill as Congress, with the President's approval, cut investment incentives
for construction projects of various types. The reason for the tax hike was not that
the incentives were unnecessary for stimulating investment but because the budget
debt is out of control and more revenues are needed. Indeed, there is a general per-
ception that a huge tax hike will be first on the agenda in 1985 no matter which
party's candidate is successful in November.
While high interest rates and a high federal debt harm construction, so do higher
taxes resulting from short-sighted tax legislation. We disagree with those who are
suggesting far higher taxes on construction and business in order to balance the
budget. It can't be done on the back of small business. One member of Congress re-
cently remarked that business is the goose that lays the golden eggs-jobs, profits,
higher wages, and improved living standards, etc.-and that Congress has been all
too interested in the fruits of business and not in the health of business. Without
reasonable care it is too easy, and politically expedient, to hike taxes on construc-
tion and small business without making the tough decision to cut spending and in-
equitable income tax breaks.
Separately or in combination, the elimination or restriction of tax incentives to
rehabilitation or new construction will hurt the construction industry just as it ap-
pears that the recovery is forthcoming. Recent Congressional testimony has docu-
mented that the sectoral distribution of capital spending has been concentrated in
equipment rather than investment in structures. The seriousness of the unbalanced
capital formation picture will only be worsened by removing the incentives current-
ly available. While ASC clearly understands the Congress' desire to raise tax reve-
nues, it seems inequitable to reduce or eliminate construction tax incentives during
a time of fragile recovery and rising interest rates. Large tax hikes on the construc-
tion industry will not improve the construction economy or general economic
growth. The fragile economic recovery in the construction industry needs continued
investment incentives and lower interest rates. The Committee should recognize the
importance of the contribution of the construction industry and the tax incentives
that are needed for its growth. The Congress and the President should promote con-
struction incentives to stimulate investment and jobs. Higher taxes on small busi-
ness are simply counterproductive to the expressed goals of a strong economy.
Fringe benefits
Specifically, the Associated Specialty Contractors (ASC) opposes taxes on fringe
benefits. As our statement has outlined, taxing small business cannot be viewed in
isolated terms. When depreciation incentives, industrial development bonds, leasing
incentives, and other tax incentives are cut or eliminated, it hurts the construction
economy. To add to the small business tax burden with fringe benefits taxes further
strains the fragile business recovery.
If Congress believes that there is wide-spread abuse in the area of fringe benefits,
it should say so, identify specific abuses, and make recommendations to correct
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them. But to tax fringe benefits, many of which are part of the social contract be-
tween the nation, employers and employees, solely to compensate for over-spending
or unwise tax policy is unfair. ASC welcomes a Congressional or Administrative
review of fringe benefit packages to seek out potential abuses. If found, these abuses
should be acted upon by Congress with support from the business community. But,
again, we emphasize there cannot be abuses in defense contracts or other areas of
the budget that are ignored if employer-employee fringe benefits are offered up for
revenue purposes.
In a recently released report from its Small Business Administration Office of Ad-
vocacy, researchers examined the extent of coverage, characteristics, administrative
practices and costs of pension and health care plans in small businesses. The SBA
study found that benefits coverage is far less extensive for employees in small busi-
ness than for workers in large businesses. Only 30 percent of employees in small
firms (10 employees or less) have both health and pension benefits. In firms larger
than 2,500 employees, over 95 percent of workers have both types of coverage. Insuf-
ficient profitability, benefit plan complexity, and plan costs all inhibit small busi-
ness from providing or expanding benefit packages. Taxing the benefits will only
cause businesses to reduce the number, extent, and variety of fringe benefit pack-
ages.
Most of our members assemble their benefit packages based on collective bargain-
ing agreements. While these agreements vary from contract to contract, region to
region, there are some similarities. They types of benefits range from job training
assistance, education benefits, health and welfare benefits. In some areas travel ben-
efits, journeyman upgrading, and scholarship funds are available. No matter what
the benefits, it is very probable that if the benefits are taxed, employees acting
alone or through their union representatives will seek greater benefits or higher
wages to offset losses to income. The management-labor agreement may be subject
to challenges as workers try to maintain an agreed upon wage and benefit package.
Clearly, taxing fringe benefits will be an added financial burden on small business
as labor passes on the costs of tax increases through to the business. The consumer
then pays for the tax if the small business is able to pass on the added cost. Other-
wise, it will become another burden for the business to absorb through reduced eco-
nomic activity or lower profitability. Whatever is the result, cutting federal spend-
ing is preferable to starting a chain reaction of inflationary pressure through the
overburdened small business community.
CONCLUSION
ASC believes that the driving force to tax fringe benefits and to increase taxes on
a whole range of other small business activities is the desire to increase revenues.
Taxing fringe benefits is not a proposal to increase the equity of the tax code or
correct abuses but is simply a move to raise taxes to offset federal deficit spending.
Therefore, until the case can be made that spending has been cut in an equitable
manner in defense, social services, and the many other areas within the federal
budget, we consider it premature to endorse further tax increases on small business
and their employees. We feel that most policymakers would agree that Congress has
a long way to go in income tax reform and spending cuts before new tax hikes are
proposed in employee personal benefit packages.
The Associated Specialty Contractors and its members have been vocal partici-
pants in the current tax debate. We offer our assistance and counsel as the revenue
picture is examined by Congress in its attempts to reduce the budget deficits. How-
ever, to view tax proposals piecemeal, separate from budget cuts, rather than in a
comprehensive budgetary manner, will produce results counterproductive to tax
code reform and small business equity.
STATEMENT OF THE ASSOCIATION FOR ADVANCED LIFE UNDERWRITING
SUMMARY
Tax-favored fringe benefits provide a mechanism for Congress to accomplish im-
portant, necessary social goals such as increasing the life, health and retirement
coverage of workers.
Many fringe benefit and other compensation provisions discriminate against small
business by providing special limits that impact negatively on small business groups
and have no significant impact on large business.
Numerous benefit distinctions continue to exist between self-employed individuals
and corporate employees. These distinctions should be eliminated.
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Small businesses are unfairly affected by the complexity of laws and the frequen-
cy with which those laws are changed. Small business is less able to handle the ad-
ministrative burden this complexity generates.
Congress should act to prevent federal agencies, such as the Internal Revenue
Service, from manipulating laws through the issuance or nonissuance of regulations.
Recent examples, such as the Internal Revenue Service's six-year failure to issue
regulations for cafeteria plans, the created difficulties for businesses, especially
smaller businesses, in utilizing statutory provisions authorized by Congress.
The limits for group-term life insurance set at $50,000 in 1964 should be increased
to at least $100,000.
STATEMENT
AALU is a nationwide organization of approximately 1,100 members specializing
in one or more fields of advanced life underwriting. Collectively, AALU members
are responsible for annual sales of life insurance in excess of $2 billion, mostly in
circumstances involving complex factual situations and often dealing with qualified
retirement plans and other employee compensation techniques. Much of the work
performed by AALU members is with small businesses. Consequently, AALU is in a
position to speak with authority concerning the problems of the small business com-
munity with respect to fringe benefits and the private pension system.
I. Introduction
A. Importance of small business
Because much of AALU's work is with small businesses and because AALU is
particularly knowledgeable concerning the use of fringe benefits by small business-
es, this statement will focus primarily on the availability and use of fringe benefits
by that vital segment of the economy. It should be noted at the outset that histori-
cally America has always been a community of small businessmen.
Even today small business accounts for between 39 and 50 percent of our gross
national product. Over 14 million small businesses employ 60 percent of the entire
national workforce and create more new jobs by far than any other sector of the
economy. Of 16 million jobs added to the economy over a 10-year period, 12 million
were created by small business.'
B. Need to address small business concerns
There is an urgent need for the direction of Congressional attention to a number
of major problems concerning the provision of fringe benefits by small business. A
recent study has demonstrated that pension and health care coverage is less exten-
sive for workers in small business than for workers in large business. Only 30.9 per-
cent of employees in small firms with fewer than 10 employees have both health
and pension coverage, whereas for large employers, 95.3 percent of workers have
both types of coverage. This study has indicated that, among the principal reasons
for the lower pension coverage, are the high cost of setting up the plan, plan com-
plexity, the need for costly expert advice and the constantly changing governmental
regulations that create uncertainly about future costs and benefits.2 The implicit
conclusion of this study (a conclusion to which Congress has frequently failed to give
legislative credence) is that small businesses are less able to cope with complex
standards and administrative costs than are large businesses. The inherently costly
nature of changing legislative rules imposes on small business a burden that may be
intolerably high when compared to the employee benefits that are thereby generat-
ed. If, for example, a large plan spends $10,000 on expert advice to gain understand-
ing of complex new rules, that $10,000 is a relatively low cost per employee. For a
company with 10 employees, however, the cost per employee is much more substan-
tial and often prohibitive. When one considers the added fact that the cost may be a
repetitive annual one because of the frequency of new laws and regulations, the
problems become even more intractable.
The importance of small business in the American economy and in the American
workforce mandates that Congress change its focus regarding the development of
1 These statistics are primarily derived from the Small Business Administration. See SBA,
"Facts About Small Business and the U.S. Small Business Administration" (February 1981).
2 See Coverage, Characteristics, Administration, and Costs of Pension and Health Care Bene-
fits in Small Businesses, Final Report, submitted to the Office of Advocacy, Small Business Ad-
ministration, James Bell and Associates, Inc. and ICR Incorporated (March 1984).
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laws and regulations on fringe benefits. The focus should be centered on the prob-
lems and concerns of small business. As is discussed in greater detail below, many
of the newer Congressional approaches to fringe benefits often operate to discrimi-
nate against small business by denying such businesses that availability of such
benefits on a reasonable parity with larger businesses. Thus, a substantial portion of
the American workforce is being denied equal access to tax-advantaged employment
benefits.
C. Importance of fringe benefit tax incentives
Tax-advantaged fringe benefits are undeniably of major importance in accom-
plishing worthwhile social goals. It has clearly been demonstrated that tax incen-
tives will cause employers to alter their economic behavior.3 Special tax incentives,
such as the availability of tax-free educational expenses or day care, have played a
major role in stimulating employers to adopt such programs. tax incentives for
qualified retirement plans constitute a classic example of this behavioral change
phenomenon, with between 50 percent and 80 percent of the workforce now receiv-
ing pension coverage.4 Without tax based motivation, the life, health and retire-
ment coverage of our workforce would be subtantially diminished and the workers
in this country would be far less secure than they are today.
Recent actions by Congress have indicated that, through pension and fringe bene-
fit statutory amendments that are designed to capture relatively insignificant
amounts of revenue, short-term budget considerations are undermining the long-
term security of workers' benefits. It is important that, before there is a change in
any major aspect of the employee benefit system, there should be placed on the pro-
ponents of the change a heavy burden to demonstrate need for its implementation.
The laws underpinning this system reflect inherently long-term planning goals for
employers and employees that will be adversely affected if changed frequently.
II. Areas requiring congressional consideration
A. Trend toward discriminatory treatment of small business employees
1. Description of trend
AALU is alarmed at an unfortunate trend in legislation involving a departure
from the historic discrimination standards used in the employee fringe benefits
area. The trend which is both recent and appears to be gaining momentum, in-
volves the effeci ive denial to the small business management level of various tax-
advantaged fringe benefits that are otherwise available to their counterparts with
large corporations. Recent changes to the Internal Revenue Code have denied bene-
fits to the executives of small firms where more than a certain percentage of the
total benefits are made available to them, whether or not there has been a pro rata
allocation of benefits to rank and ifie employees or, in fact, whether or not there are
rank and file employees to whom an allocation can be made. Essentially, Congress
has imposed a new layer of restrictions (effectively applicable only to small busi-
ness) that function in addition to the traditional nondiscrimination rules for quali-
fied plans and selective statutory fringe benefits.
This layer of restrictions creates a situation in which executives of large corpora-
tions and of small businesses that earn the same rate of pay are not treated equiva-
lently for fringe benefit purposes. Such discrimination is not desirable from either
and economic or social point of view and is contrary to articulated public policy fa-
voring the initiation and development of small business. If the trend is permitted to
grow, the cost of operating a small business will increase while, at the same time,
small business recruitment of first class talent will be severely impeded.
The trend is best exemplified by the qualified group legal services plan provisions
added to the Internal Revenue Code (hereinafter, Code) by the Tax Reform Act of
1976, child care plan provisions added to the Code by The Economic Recovery Tax
Act of 1981 (ERTA), the pension top-heavy rules added by the Tax Equity and Fiscal
Responsibility Act of 1982 (TEFRA), and most recently, the cafeteria plan rules in
the Tax Reform Act of 1984. The education assistance plan provisions of section 127,
which expired at the end of last year, also exemplify the trend. The following is an
explanation of these provisions and their impacts.
~ See Feldstein and Clotfelter, "Tax Incentives and Charitable Contributions in the United
States: A Microeconomic Analysis," published in ifi Commission on Private Philanthropy and
Public Needs 1393 (Dept. Treas. 1977).
~ See, e.g., Munnell, "The Economics of Private Pensions"; (Brookings 1982).
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a. Qualified group legal services plan
With the enactment of the Tax Reform Act of 1976, Congress adopted for the first
time in the history of the Internal Revenue Code, restrictions on a fringe benefit
that denied plan benefits to owners if they received more than a certain percentage
of benefits.5
Under Code § 120, an employer is permitted to establish a prepaid, nontaxable
personal legal services plan for its employees if certain qualification requirements
are met. The provision contains standard nondiscrimination requirements with
regard to eligibility and coverage, benefits and the operation of the plan. In addi-
tion, it contains a requirement that no more than 25 percent of the amount contrib-
uted during the plan year be used for the benefit of 5-percent owners. In effect, if
more than 25 percent of the benefits go to this group, no one in the group may ex-
clude the benefits received. For many small firms, this is a virtual impossibility due
to the ratio of owners to common-law employees. On the other hand, a large corpo-
ration with such a plan and with hundreds of employees can easily meet the restric-
tions, thereby permitting corporate executives to participate and receive benefits
that their small business counterparts are effectively denied.
b. Educational benefit plans
Until December 31, 1983, when Code section 127 expired, amounts paid for ex-
penses incurred by an employer for educational assistance provided to an employee
were excluded from the employee's gross income if paid or incurred pursuant to a
written plan that met certain requirements and that was for the exclusive benefit of
the employees. Excludable amounts included tuition, fees, and similar expenses, as
well as the cost of books, supplies, and equipment paid for or provided by the em-
ployer. The provision contained certain standard nondiscrimination requirements
with regard to eligibility and coverage, benefits, and the operation of the plan. In
addition, section 127, which was effective for taxable years beginning after Decem-
ber 31, 1978, contained a requirement denying the exclusion where more than 5 per-
cent of the benefits were paid to 5-percent owners of the business. Under these con-
straints, in order for a small employer to receive the advantages of an educational
benefit plan, ninety-five percent of the benefits had to go to nonowners.
c. Child care plans
Under section 129 of the Code, enacted in 1981, an employee who receives depend-
ent care assistance payments provided under an employer's written plan may ex-
clude the payments from his or her gross income subject to an earned income limi-
tation. The provision contains nondiscrimination requirements rules, however, the
section also contains a requirement similar to that for qualified group legal services
plans that not more than 25 percent of the amounts paid or incurred by the employ-
er during the year be provided to individuals who are 5-percent owners. In effect, if
more than 25 percent of the benefits go to this group, no one in the group may ex-
clude the benefits received. Thus, once again, because it is far more difficult for a
small firm to conform to this top-heavy limitation than a large one, small entrepre-
neurs may be effectively denied the benefit.
d. Pension plan top-heavy provisions
In 1982, TEFRA added to the Code § 416 which contained a new set of broad scale
qualified plan requirements which effectively limit benefits for key employees of
top-heavy plans. Essentially, under these rules, in order to remain qualified, plans
that are top-heavy must meet more rapid vesting schedules, provide a minimum
benefit or a minimum contribution for all non-key employees, restrict the amount of
compensation that may be taken into account by the plan in determining contribu-
tions or benefits and reduce the overall limits on contributions of benefits under an
employer's defined contribution and defined benefit plan. The rules automatically
apply where 60 percent or more of the benefits provided under the plan go to key
employees who are defined as certain owners, officers and the highly paid. Since a
disproportionately large share of top-heavy plans are small plans consisting of an
owner and several common law employees, the rule leaves a small employer with a
~ Although the H.R. 10 plan rules contain limitations that appear similar, they did not evolve
out of an effort to limit benefits to smaller employers, but rather, they evolved from a Congres-
sional reticence (now generally accepted to be misplaced) to extend corporate tax benefits to the
self-employed segment of the economy. See II, C, infra.
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series of unpalatable choices. He may cut back his own benefits so that they are
proportionately lower than the benefits of his employees, or he may bear cost of pro-
viding proportionately large benefits to this employees. If, as if often the case, nei-
ther choice is acceptable, the employer will have no viable alternative but to termi-
nate the plan and cut off benefits to all employees.
e. Cafeteria plans
On July 18, the President signed into law the Tax Reform Act of 1984 which con-
tains new fringe benefit rules affecting cafeteria plans. Under these rules, not more
than 25 percent of the total nontaxable benefits of the plan can be provided to em-
ployees who are key employees as defined in the section 416 top-heavy rules. If the
25 percent limitation is exceeded, key employees will be taxed as though they re-
ceive taxable benefits to the extent possible under the plan. Thus, under these new
rules, many small business executives may not be able to participate in a cafeteria
plan because there would be no way to avoid the 25 percent limitation. For example,
in the situation where a plan consists of a key employee and two common law em-
ployees, and the benefits are distributed on an equal basis, the key employee will
receive benefits that are in excess of the statutory 25 percent limit.
2. Inequitable application
The limiting provisions in all of these arrangements essentially reach only execu-
tives of small businesses. Whenever these executives receive more than a certain
specified percentage of benefits under their plans, they are precluded from obtain-
ing for themselves any of the tax-advantaged benefits of the established programs.
This is the result whether or not there are other employees to be considered, or
where, if judged under the traditional nondiscrimination rules, the benefit arrange-
ment would be considered to have provided a fair percentage of benefits to common-
law employees.
The special limiting provisions of Code §~ 120(c), 125(b), 129 and 416 should be
viewed in contrast to the traditional nondiscrimination rules that apply uniformly
regardless of the size of the business involved. For example, in order to satisfy the
requirements of the traditional nondiscrimination standards of Code §~ 401 (quali-
fied retirement plans), 79 (group term life insurance) and 105 (medical costs), contri-
butions and benefits must be equally allocated on the basis of compensation to all
employees in the covered group. As a general rule, provided every covered employee
receives a percentage of benefits equivalent to his percentage share of total compen-
sation, there is no discrimination. The special limiting rules in Code §~ 120(c), 125(b),
129 and 416 apply over and above these traditional nondiscrimination rules and
create more stringent requirements that effectively deny benefits to executives of
small firms.
AALU seeks uniform treatment for all employees across-the-board regardless of
the size of the organization for which they work. If in a given set of circumstances,
Congress feels it necessary to limit the economic group to which tax benefits are
granted, there is ample precedent for doing it in an equitable fashion which does
not discriminate against small business. Code § 415, for example, limits contribu-
tions to qualified plans by reference to a certain level of compensation that applies
to all participants based on a flat percentage of salary or a set dollar limit regard-
less of the size of the business involved. One might take issue with the social policy
on which section 415 is based, however, once that policy is accepted, section 415 goes
on to generate a tax neutral rule as between large and small businesses. In a like
way, the social security laws contain an across-the-board limit on the amount of
compensation that will be considered for those purposes.
3. Need for neutrality
The tax laws should be tax-neutral respecting incentives for employment with
large versus small business. To favor large business in the manner that has recently
occurred severely hampers the ability of small business to develop and grow. Small
businesses are typically service-oriented and are designed around the creative skills
of a single individual or a small group of individuals. If the tax laws favor employ-
ment with large firms over small firms, talent will be drained away from existing
small businesses and creative individuals will be discouraged from taking entrepre-
neurial steps to establish small businesses. Further, the lack of ability to retain
qualified executives will encourage small businesses to be acquired by and merged
with large businesses, thereby further diminishing the pool of small business talent
in this country.
Real tax-neutrality would lead to special incentives for small businesses. Small
businesses are at an automatic disadvantage compared to large businesses because
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663
of administrative costs, limitation of cash resources and other inherent problems.
For example, it should be remembered that large corporations have opportunities,
not available to small firms, to dispense to their employees tax-advantaged equity
benefits such as stock-options. Real equality necessitates special incentives to offset
these inherent disadvantages. Tax credits (limited to small businesses) for the set-up
costs of fringe benefits programs for employees, for example, would reduce the ini-
tial costs that are particularly burdensome for small businesses.
AALU strongly urges Congress to recognize that there is a growing trend involv-
ing the denial of benefits to small business management level executives. The trend
is both arbitrary and unfair and we recommend that Congress correct the course by
imposing only those limits that are applied uniformly to all employees whether they
work for a small firm or for the largest corporation.
B. Unnecessarily large administrative burden on small business
Major pension legislation has, in recent years, unfortunately, become too fre-
quent, including, for example, the Retirement Equity Act of 1984, the Tax Reform
Act of 1984, the Tax Equity and Fiscal Responsibility Act of 1982, the Economic Re-
covery Tax Act of 1981, the Multiemployer Pension Plan Amendments Act of 1980,
the Revenue Act of 1978, and the Tax Reform Act of 1976. Following each of these
legislative enactments, the Internal Revenue Service (Revenue Service) develops,
over an extended period of time, temporary, proposed and final regulations that con-
tained additional changes not clearly envisioned as part of the statutory structure.
Further, the Revenue Service, in its administration of these laws, changes its inter-
pretation through Revenue Rulings and other announcements that require further
plan changes.
Plans are expected to be continually updated and submitted to the Revenue Serv-
ice for approval of their qualified status under the tax laws. This has become a most
difficult burden for employers and plan administrators. Yearly keeping up to date
with regulatory changes is a substantial burden, but the added impact of the fre-
quent legislative changes, especially the major changes included in this year's Re-
tirement Equity and Tax Acts and TEFRA, have seriously exacerbated this problem.
Coupled with this is the fact that most of the substantive employee benefit changes
made by the Tax Reform Act of 1984 and TEFRA impact primarily on small busi-
ness, a group that is less capable of accommodating these changes than are other
segments of the business community.
The result is the creation of appreciable administrative burdens and an increase
in operating cost for pension and profit sharing plans, especially those of small busi-
ness. These cost increases arise not only from the substantive impact of the changes
in the rules, but also from the administrative necessity of keeping the plans abreast
of applicable legal requirements. Especially in the case of small plans, this burden
may be very substantial indeed.
By and large, big businesses are better equipped to handle the complexity of the
new laws than are small businesses. Large firms typically have their own special-
ized in-house staff familiar with employee benefits and have the resources to hire
outside counsel for any additional expertise, as needed. Small firms, on the other
hand, infrequencly retain in-house benefits experts and, due to their size, typically
use outside consulting, accountant, actuarial, and legal firms for advice, which may
cost more than retaining in-house expertise.
According to a recent study prepared for the Small Business Administration by
James Bell and Associates, Inc. and ICF, Incorporated, per capita pension costs are
substantially higher for small firms than for large. This study indicates that per
capita costs declined from approximately $1,080 for firms with one to ten workers to
$574 for establishments with 500 to 999 workers. Further the study shows that per
capita pension administration costs, which are highest for very small firms (one to
ten employees), decrease as firm size increases.6
The study also showed that about half of the small firms studied administer their
plans themselves and about one-third use outside plan administrators and the re-
mainder rely on insurance companies.7 The study also documents that the ongoing
administrative costs for small firms (under 100 employees) are an estimated $500 to
$1500 per year (depending on the type of a plan and the number of participants).8
6 Coverage, Characteristics, Administration, and Costs of Pension and Health Care Benefits in
Small Business, Final Report, submitted to the Office of Advocacy, Small Business Administra-
tion, by James Bell and Associates, Inc. and ICF Incorporated (March 1984).
Id. page 75.
8 Id. page 75.
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With regard to the source of these costs, many small employers included in the
study observed that it was not so much the regulations that were a burden, but
rather the constant changes in laws and regulations which often impose substantial
costs on the firms when they made plan amendments.9 Among those areas of regu-
lation and reporting requirements that were considered most burdensome by small
employers were parts of the Form 5500, "Controlled Group Requirements", Percent-
age Coverage Requirements, some regulations under the Multiemployer Pension
Plan Amendment Act, and "Merger and Spin-Off Rules".1°
C. The need for full parity between corporate employers and the self-employed
One of the major beneficial aspects of TEFRA was a move to establish partial
parity between corporate and noncorporate employers. Particularly in the treat-
ment of qualified retirement plans, TEFRA largely eliminated the distinction that
had existed between the two types of employers-a distinction which at this point is
almost entirely one of form rather than of substance. To perpetuate it through the
income tax laws does not serve to further any valid purpose. Instead, such a distinc-
tion merely adds unnecessary complication to the laws and encourages incorpora-
tion of businesses that would otherwise continue to operate in noncorporate form.
The net result has been a proliferation of corporate entities motivated by the desire
to utilize tax benefits available only to corporations when there is, in fact, no valid
policy reason to treat corporate and noncorporate employers differently.
Because TEFRA has taken substantial steps towards full parity, Congress should
now take the fmal step and complete the process. Congress should eliminate the
other distinctions that exist in the law between corporate and noncorporate fringe
benefits. Two of the most important of these are the treatment of group-term life
insurance and the treatment of medical benefits for employees. Under the statutory
rules of §~ 79 and 105, respectively, these benefits are only available through corpo-
rate form even though on policy grounds, self-employed individuals, as well as cor-
porate employees, are equally entitled to the benefit of these rules.
Section 79 permits the exclusion of up to $50,000 of group-term life insurance pur-
chased for an employee by a corporate employer. Where a self-employed individual
purchases life insurance for himself, he does so with after-tax income and receives
no deduction.
Section 105 generally provides that amounts received by an employee as reim-
bursements for medical care and payments for permanent injury or loss of bodily
function are excludable from gross income. Under § 105(g), a self-employed individ-
ual is not treated as an employee for purposes of § 105. Therefore, for example, ben-
efits paid under an employer's accident or health plan under § 105 to or on behalf of
a self-employed individual will not be treated as received through accident and
health insurance for purposes of the exclusions found in § 105.
Similarly, section 404(a)(8) limits the amount of contributions to qualified plans on
behalf of self-employed individuals in a way that contributions on behalf of corpo-
rate employees are not limited. Section 404(a)(8)(C) permits a deduction for contribu-
tions only to the extent that such contributions do not exceed the earned income of
the individual and to the extent that the contributions are not allocable to the pur-
chase of life, accident, health, or other insurance. This provision tends, without a
rational basis, to hamper the purchase of life, accident, health or other insurance
through a qualified plan for self-employed individuals. Such a limitation does not
apply to corporate employees.
AALU recommends that Congress promptly enact legislation eliminating all fur-
ther distinctions in the tax laws in the employee benefit area between corporate and
noncorporate business entities so that any benefits that are available for corporate
employees should be equally available for self-employed individuals.
D. Manipulation of system by agencies charged with administering the tax laws
Congress frequently leaves to the Revenue Service responsibility for carrying out
the laws through the promulgation of regulations. In some instances, the Revenue
Service and the Treasury Department have used the issuance (or nonissuance) of
regulations as a way to promote their own policy objectives whether or not those
objectives reflect Congressionally propounded policy. A notable and recent example
involves the 6-year delay in the issuance of the proposed cafeteria plan regulations
under § 125. In the six years since the enactment of the section in 1978, numerous
Id. page 76.
10Id. page 76.
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corporations had adopted cafeteria plans based on a reasonable interpretation of the
statute and its legislative history. When the Revenue Service finally issued a news
release and proposed regulations earlier this year, it took a very restrictive ap-
proach to what would be permissible under § 125. To add insult to injury the Reve-
nue Service also proposed to apply these regulations retroactively even though it
was well aware that the practices it proposed to prohibit had been employed in a
large number of cases. The employment of those practices were not only arguably
permitted under the statute, but were in fact encouraged by the government's fail-
ure to issue regulations during the six year period. In effect, the lack of action by
the Treasury and the Revenue Service had the effect of enticing taxpayers into ac-
tivity which those same agencies subsequently and retroactively said was impermis-
sible.
AALU believes that an agency should not be permitted to use the issuance or
nonissuance of regulations as a way to promote policies that have not been enacted
by Congress. Congress can avoid this problem in the future, by requiring the issu-
ance of regulations within a reasonably short period of time after enactment of any
new provisions affecting employee benefits. Failure to issue those regulations within
the allotted time should preclude the issuing government agency from applying
them with retroactive effect.
E. Section 79 nondiscriminatory life insurance exemption should be raised to
$100,000
Section 79 provides that the cost of up to $50,000 of group-term life insurance paid
by an employer shall be excluded from the income of the employee. Section 79 was
enacted in 1964 and the $50,000 limit has not been changed since that date. AALU
respectfully submits that the amount should be adjusted to reflect increases in the
cost of living.
The legislative history of § 79 reveals that in setting the $50,000 limit, Congress
considered whether the dollar amount was adequate to keep a family unit together
when a breadwinner dies prematurely." The House of Representatives had initially
set the limit at $30,000 but the Senate, indicating its concurrence with the policy to
protect family units, adopted a higher limit, $70,000. (In conference, the conferees
settled on $50,000 without further explanation.)
In 1964, the dollar had the purchasing power of $1.08 (compared to the value of
the dollar in 1967). In May, 1983, that same dollar had a purchasing power of only
344~. 12 In other words, in the nineteen years from the enactment of section 79, the
purchasing power of a dollar has dropped by more than two-thirds and the value of
the $50,000 limit today is the equivalent of only $15,741. In order to restore the limit
to its original purchasing power and to carry out the Congressional intent to permit
the exclusion of an amount paid to purchase a sufficient amount of insurance to
keep the family together at the time it loses its breadwinner, the $50,000 limit
would have to be increased to $158,821.
The $50,000 limit in § 79 is grossly out of date because it has never been changed
to reflect current economic realities. AALU is not suggesting that Congress apply
automatic cost of living increases over which Congress has no control once enacted.
Rather, AALU recommends that Congress increase the limit by setting an amount,
perhaps $100,000, that takes into consideration the loss in the dollar's purchasing
power since 1964. AALU suggests that the new limit be at least $100,000.
STATEMENT OF DwAINE H. SMITH, SENIOR VICE PRESIDENT, EMPLOYEE RELATIONS,
ATLANTIC RICHFIELD Co.
My name is Dwaine Smith and I am Senior Vice President, Employee Relations,
of Atlantic Richfield Company. My Company is a diversified resource company and
is among the twelve largest industrial corporations in the United States. It sponsors
a comprehensive package of employee benefits that provides a "safety net" of pro-
tection against economic hazards to employees. Most of the employee benefit plans
that are offered are made possible only because of enabling provisions in the Inter-
nal Revenue Code. These tax favored provisions allow employees, particularly lower
and middle income employees, to build upon the basic level of protection afforded by
11 Revenue Act of 1964, House Report No. 749, 88th Cong., 2d sess. 39-40 and S. Rep. No. 830,
88th Cong., 2d sess. 45-46.
12 Statistical Abstract of the United States 1984, U.S. Department of Commerce, Bureau of
the Census, P. 484.
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Social Security and Medicare. We believe very strongly that tax preferences for wel-
fare benefit plans and pension plans are critical in achieving broad employee par-
ticipation in these programs. Our experience with the implementation of a Section
401(k) CODA Plan provides ample evidence that employee participation significantly
increases with increased tax benefits. The abolition of these preferences will very
likely cause employees to elect significantly reduced coverages, especially for those
employees at lower income levels. In addition, since defined benefit and defined con-
tribution plans constitute the major source of savings for middle and lower income
employees, the restriction or elimination of tax preferences for these plans will have
a significantly detrimental effect on the already low rate of personal savings. Be-
cause we believe that employee benefits serve useful social needs, I am submitting
for the record Atlantic Richfield Company's position on tax policy and its effect on
employee benefits. The submission focuses on my Company only and is structured as
follows:
(1) Level of Tax Exempt Tax Deferred Employee Benefits; (2) Cap on Tax Favored
Benefits; (3) Treatment of Tax Deferred vs. Tax Exempt Benefits; (4) Relationship
Between Private Pensions, Social Security and IRA's; (5) Private Health Care Plans
and Medicare; (6) Tax Treatment of Fringe Benefits; (7) Income Level of Employees
Who Utilize Benefits; (8) Effect on Employee Benefits if "Tax Reform" Proposals
Adopted; and (9) Maintaining a Viable FICA Tax Base.
APPROPRIATE LEVEL OF TAX EXEMPT/TAX DEFERRED EMPLOYEE BENEFITS
Our tax deferred benefits are paid from the Atlantic Richfield Retirement Plan
(ARRP), the Savings Plan, a Capital Accumulation Plan (CAP), and a payroll based
Stock Ownership Plan. The tax-exempt benefits are paid primarily from the Medical
Plan, the Dental Plan, the Life Insurance Plan (up to the IRC. Sec. 79 maximum),
and partially, from the Long Term Disability Plan. In addition, employees have the
option, like other taxpayers, to open personal IRAs. Thus, employees are given
ample opportunity to accumulate, on a tax favored basis, savings for both short
term and long term needs. Given the combination of large federal deficits, and the
fact that IRA deposits result largely from a shift of other savings rather than net
new savings, Congress may want to re-examine the tax favored status of IRAs for
those individuals also covered by employer sponsored plans. As for tax-exempt bene-
fits, we submit that the majority of employers are already deeply concerned about
increasing employee benefit costs, particularly health care costs, and are taking
steps to contain these costs. For example, Atlantic Richfield Company has done the
following:
(1) Taken a very conservative position on the creation of new employee benefit
programs.
(ii) Designed our Capital Accumulation Program with an economic incentive for
employees to participate, causing the generation of significant long term personal
savings to be available only at termination or retirement. Over time, this will allow
the Company to phase out our supplementary retirement program. (This plan
grants periodic ad hoc retirement supplements to compensate retirees for the ero-
sion of retirement income due to inflation.)
(iii) Redesigned our medical plan to contain the rate of increase in health care
costs. Specifically:
Employees have been given a choice between an older, established "first dollar"
plan or a newly adopted (1984) comprehensive plan that requires a greater amount
of cost sharing on the part of the employee. The former costs the employee substan-
tially more in monthly contributions, while the latter requires plan users to assume
a greater share of the costs.
Employees are offered a selection of Health Maintenance Organizations (HMOs)
in a more liberal manner than required by law.
The Company is active in employer coalitions in Los Angeles, Philadelphia and
Houston. A Company executive chaired the Los Angeles Coalition in 1981-1982.
We have initiated a pilot program of utilization review in California.
We have implemented, and are refining a sophisticated claims data base system
that pinpoints areas of over-utilization.
CAP ON TAX FAVORED BENEFITS
A tax cap could be either a percentage of compensation or a dollar limit. The ob-
vious problem with any cap is to determine its appropriate level. If the cap is de-
nominated in dollars, there is the immediate disparity accorded identical groups of
employees situated in different areas of the country. Furthermore, in inflationary
times, the dollar limit may not be increased in a timely fashion to reflect adequately
PAGENO="0673"
667
the increased price level. The problem with a percentage of compensation cap is its
very arbitrariness-lower paid employees may not be able to gain the maximum
coverage of fixed cost benefits, while higher paid employees may often obtain the
benefit and still have an excess available. In addition, those employers with older
more highly compensated workers could be competitively disadvantaged as com-
pared to employers with younger workers. If Congress feels caps are the best alter-
native, our preference would be for a percentage of compensation set at a level be-
tween thirty and forty percent, excluding legally required employer contributions
from the base subject to the cap.
TREATMENT OF TAX DEFERRED VS. TAX EXEMPT BENEFITS
Employee benefits occupy a unique tax favored status in the Internal Revenue
Code. Employer contributions to a qualified plans are deductible to the employer,
earnings thereon are tax exempt, and there is no concurrent recognition as income
by employees. When subsequently distributed, these monies often enjoy tax favored
treatment such as ten year forward averaging and capital gains, or further deferral
because of the rollover provisions in the Code. Perhaps Congress should study this
area comprehensively and examine the integration of personal savings with the
Social Security benefit. The significant increases in personal savings generated by
IRAs and Sec. 401(k) plans should reduce future pressure on the Social Security
system. Any decision to limit these plans, should not be taken lightly. The treat-
ment of tax exempt benefits is a little more complex. Employer provided health in-
surance indirectly provides a form of living expense to employees in a tax subsidized
manner. The same can be said for the provision of child care expenses. Both of these
benefits, however, probably produce significant social benefit. Tax subsidized child
care makes it easier for larger numbers of individuals to be wage earners and tax-
payers. Tax benefited health insurance maintains medical coverage at a significant-
ly higher level than would be the case if individually purchased and provides the
majority of Americans with the best health case in the world. Moreover, tinkering
with the tax favored status of this employee benefit may have the unintended effect
of reducing care and increasing the incidence, severity, and impact of disease, espe-
cially for the lower paid segments of the population. Exhibit I attached shows the
percentage of compensation that the Company's contributions to the Atlantic Rich-
field Medical Plan represent. A review of this exhibit shows that taxing such contri-
butions will be highly regressive for the lower paid employees. It appears therefore,
that in the areas of tax exempt benefits, the best approach might well be to contin-
ue the present statutory treatment of existing employee benefits, and restrict the
creation of new benefits.
RELATIONSHIP BETWEEN PRIVATE PENSIONS, SOCIAL SECURITY, AND IRA'S
Much has been written about the three legged stool of retirement income security
provided by Social Security, private pensions, and individual savings. We present in
Exhibit II certain statistics relating to pre-retirement income replacement ratios of
our employees. (Missing from these statistics is the component attributable to indi-
vidual savings.) You will note that our retirement plan benefit combined with Social
Security provides lower income employees with a proportionately higher wage re-
placement ratio than higher income employees. Our goal is to provide our employ-
ees with a post-retirement income that will afford them a standard of living ap-
proximating their pre-retirement standard. There is, however, an inconsistency in
the taxation of this benefit. If the retirement benefit form the ARRP is taken as a
lump sum benefit it receives favorable tax treatment. In addition, the presence of
favorable taxation of lump sum benefits put pressure on employers to provide this
form of payout even if society interests might be better served by payouts spread
over retirement yeas and taxed as ordinary income. As previously indicated, the in-
tegration of these plans with Social Security and their tax status on payout merits
further examination.
RELATIONSHIP BETWEEN PRIVATE HEALTH CARE PLANS AND MEDICARE
Our Company's philosophy in designing health care plans is to provide a reasona-
ble level of protection to our active employees and retied employees not eligible for
Medicare, in as cost-efficient a manner as possible. We believe that by keeping em-
ployees healthy, the effect is to reduce long term demands and costs associated with
the medical care system. Retired employees eligible for Medicare are provided a
level of protection that supplements the Medicare coverage. The partnership be-
tween private health care plans and Medicare can and should be strengthened. As
40-046 0 - 85 - 43
PAGENO="0674"
668
the largest single purchaser of health care services in the country, Medicare has a
very important role to play in helping the private sector provide appropriate health
care services in a cost efficient manner. It can contribute to this area by careful
screening of new medical technology before permitting Medicare reimbursement for
the use of such technology. In addition, Medicare should frequently review surgical
fee schedules and reduce high reimbursement levels for procedures that, while inno-
vative when first performed, are now routine but continue to be reimbursed as if
they were performed by only a few highly skilled professionals.
TAX TREATMENT OF CERTAIN FRINGE BENEFITS
Over the years, Congress enacted provisions in the Internal Revenue Code favor-
ing specific employer sponsored retirement, health care plans and certain other stat-
utory benefits, based on the premise that extensive coverage of workers and depend-
ents under these plans is desirable social policy. These programs are a supplement
to public programs and lessen pressure for increased Governmental involvement in
such programs, which we believe generally deliver benefits less cost-effectively than
private sector programs. These programs should continue to enjoy tax favored
status. In recent years, however, certain tax advantaged benefits have been provided
that do not meet a defined social objective (e.g. group legal plans.) We do not believe
that this is an appropriate use of the Tax Code for social policy. It may now be ap-
propriate to impose a freeze on the creation of new tax favored benefits. Alterna-
tively, these programs could be removed from tax favored status or a cap set at a
very low level could apply to such programs.
INCOME LEVELS OF EMPLOYEES WHO UTILIZE BENEFITS
Our Company designs our benefit programs to provide financial protection and in-
dividual and family security (alleviating problems which could reduce employees'
productivity) for most of our employees. We attached a series of exhibits to this sub-
mission that show the income distribution of the participants in our employee bene-
fit plans. It is obvious that the great bulk of benefits go to rank and file employees.
The attached exhibits are: Exhibit I, Medical Plan; Exhibit II, Retirement Program;
Exhibit III, Long Term Disability Plan; Exhibit IV, Death Benefit Plan; and Exhibit
V, General Description of ARCO's Employee Benefit Plans.
EFFECT ON EMPLOYEE BENEFITS IF VARIOUS "TAX REFORM" PROPOSALS ARE ADOPTED
Tax Reform measures generally call for including employer contributions for em-
ployee benefits in the employee's adjusted gross income or eliminating employer de-
ductions for such contributions. In the first case, severe problems would arise in im-
plementation.
Group plans are designed without allocating costs on the characteristics of the in-
dividual employee. However, if individual employees are made to pay taxes on con-
tributions made on their behalf, then the pricing and cost allocation structure of
group plans would have to be altered drastically so as to allocate an equitable "tax-
able/economic" value to the benefit provided the individual. In the health care area,
older individuals and young women of child-bearing age would be faced with high
allocations of cost to be included in their income. As we show in the attached exhib-
its, Company contributions represent a higher percentage of compensation for low
to moderate income employees than for higher income employees. It is therefore
questionable whether these individuals will purchase comparable health care cover-
age in the absence of tax favored group plans. Furthermore, since health care "pre-
miums" are derived without regard to employees' compensation, the flatter tax
rates will mean that the tax treatment for lower income employees will be highly
regressive.
Defined benefit program costs are determined on aggregate bases based on demo-
graphics and investment experience. Few plans calculate costs and allocate contri-
butions on an individual basis. However, if contributions were allocated among indi-
viduals, then clearly the older employee would face a substantial increase in imput-
ed income. In the case of our retirement plan which has a final three year salary
average formula, the cost for a sixty year old employee could be twelve times that of
a thirty year old employee. Whether this would result in employees declining cover-
age cannot be predicted.
If, on the other hand, deductions for employer contributions to employee benefit
plans are eliminated, the effects would be different in that many companies might
well decide to scale back or eliminate employee benefit plans.
PAGENO="0675"
669
MAINTAINING A VIABLE FICA, TAX BASE
In order to maintain the viability of the FICA tax base, Congress can increase the
number of participants in the system by:
Adopting policies that will increase the aggregate level of covered employment in
the economy.
Including in the FICA program those classes of workers who are currently ex-
cluded. Expanding the level of coverage is one way to maintain the strength of the
FICA system. Another way is to preclude the further erosion of the tax base by
adopting measures, such as Congress took when it required 401(k) salary deferrals to
be subject to FICA taxes.
PAGENO="0676"
ATLANTIC RICHFIELD COMPANY
MEDICAL PLAN CONTRIBUTION
AS A PERCENT OF SALARY
19.4
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11 1
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Under 10 15-20 - 25-30 - 35-40 45-50 55-60 65-100
10-15 20-25 30-35 40-45 50-55 60-65 OVER lOi
SALARY (THOUSANDS)
PAGENO="0677"
671
[Exhibit II]
RETIREMENT PROGRAM
The Company sponsors a number of defined benefit and defined contribution
plans. The former are designed to replace, in conjunction, with Social Security, a
significant percentage of employees pre-retirement income. The latter are primarily
Capital Accumulation Plans, except for the Sec. 401(k) plan which is designed to
provide retirement income supplements. Our experience shows that moderate
income employees are not inclined to save on their own, an experience similar to
other such employees across the nation. Accordingly, we designed a Saving Plan
that is linked to the Sec. 401(k) plan, whereby employees cannot get the benefits of
the Company's matching contribution to the Savings plan unless they also contrib-
ute to the Sec. 401(k) plan. This approach is apparently successful, as almost 90% of
eligible employees participate in the Savings program. In addition, the Company has
a supplemental retirement program that replaces a portion of retirees income that
has been lost due to inflation.
Attached are examples of replacement rations for the Atlantic Richfield Retire-
ment Plan (ARRP), which is the largest defined benefit plan in the Atlantic Rich-
field controlled group. It should be noted that the benefit formula is such that low
to middle income employees benefit proportionately more than high income employ-
ees.
[Exhibit 11(a)]
ATLANTIC RICHFIELD RETIREMENT PLAN PRE-TAX AND POST-TAX REPLACEMENT RATIOS, JAN. 1, 1984,
RETIREMENT DATE WITH 30 YEARS OF SERVICE
Final pay
AFC 1 8.5
porcent
salary
assumption
Estimated
Federal and
local taxes
Prerelirement
disposable
income
Social
Security
benefit
ARRP
benefit
Total
benefit
Pretax
benetit
as a
percent
of final
pay
Post.
retirement
estimated
Federal and
local taxes
Total post-
tax
retirement
income
Total
post-tan
ot
preretire-
mont
disposable
MARRIED
$25,000
50,000
70,000
100,000
150,000
$23,092.62
46,185.24
64,659.33
92,370.48
138,555.71
$5,572.27
15,699.84
25,568.64
41,895.00
72,207.20
$19,427.73
34,300.16
44,431.36
58,105.00
77,792.80
$13,140
13,212
13,212
13,212
13,212
$9,246.44
19,638.12
27,951.46
40,421.48
61,204.84
SINGLE
$22,386.44
32,850.12
41,163.46
53,633.48
74,416.84
$89.559
65.70
58.80
53.63
49.61
$253.89
2,103.87
4,684.21
11,071.34
20,960.69
$22,132.56
30,746.25
36,479.26
42,562.14
53,456.15
$113.92
89.64
82.10
73.25
68.72
$25,000
50,000
70,000
100,000
150,000
$23,092.62
46,185.24
64,659.33
92,370.48
138,555.71
$6,994.60
19,395.36
30,632.85
49,039.85
80,541.15
$18,005.40
30,604.64
39,367.15
50,960.15
69,458.85
$8,760
8,808
8,808
8,808
8,808
$9,246.44
19,638.12
27,951.46
40,421.48
61,204.84
$18,006.44
28,446.12
36,759.46
49,229.48
70,012.84
$72.03
56.89
52.51
49.23
46.68
$808.71
3,259.71
7,792.32
13,594.63
25,129.05
$17,197.74
25,186.41
28,967.14
35,634.85
44,883.78
$95.51
82.30
73.58
69.93
64.62
1 AFC: A
nonage final co
mpensafinn; lb
at is, average
of the last
3 years salary
figures assum
ing 8.5 p
ercent annual
increase in compensation.
PAGENO="0678"
60
ATLANTIC RICHFIELD RETIREMENT PLAN
RETIREMENT WITH 30 YEARS OF SERVICE AT AGE 65
MARRIED - JANUARY 1, 1964 RETIREMENT DATE
PRE-TAX
><
120
POST-TAX
110
100
w
CD
I-
z
w
C-,
cc
w
ci~
I-
z
w
w
~ 70~
-J
w
a:
50
25
30
40
45
50
55
60
70
100
FINAL PAY ($THOUSANOS)
PAGENO="0679"
ATLANT IC RICHFIELD RETIREMENT PLAN
RETIREMENT WITH 30 YEARS OF SERVICE AT AGE 65
SINGLE - JANUARY 1, 1984 RETIREMENT DATE
POST-TAX PRE-TAX
I
11O~ -
±
100+
I
~
20 25 30 35 40 . 45 50 55 60 70 100 150
FINAL PAY ($THOUSANDS)
PAGENO="0680"
674
[Exhibit 111]
LONG `TERM DrsABIu'rY
Atlantic Richfield designed the long-term disability program to replace a portion
of income lost when an employee becomes permanently and totally disabled. In ad-
dition to receiving monthly payments from the Long Term Disability (LTD) plan,
disabled employees continue their medical coverage on the same terms as when
they were actively employed.
The attached graph shows that 91 percent of those receiving benefits are those
employees who at the time of their disablement were earning less than $40,000.
Note that under the terms of the plan, active employees earning more than $40,000
must contribute towards the cost of the plan. In return, their benefits from the plan
are higher.
[Exhibit ffl(a)]
ARCO LTD REPLACEMENT RAIl OS BY SALARY
Average replacement ratio (percent)
Final salary Ratio of LTD Social Number of
reti~e'~ent Security Total LTD cases
benefit only
Under $10,000 35.8 20.9 56.7 6
$10,000 to $15,000 34.7 17.5 52.2 30
$15,000 to $20,000 35.3 22.6 57.9 104
$20,000 to $25,000 34.6 18.9 53.5 109
$25,000 to $30,000 33.9 15.9 49.8 83
$30,000 to $35,000 42.1 11.1 53.2 27
$35,000 to $40,000 37.4 11.2 48.6 14
$40,000 to $45,000 49.0 6.2 55.2 10
$45,000 to $50,000 53.9 7.0 60.9 8
$50,000 to $55,000 58.4 2.9 61.3 5
$55,000 to $60,000 56.6 7.5 64.1 6
$60,000 to $65,000 55.5 5.8 61.3
$65,000 to $70,000 0 0 0
$70,000 to $75,000 50.5 7.5 58.0
$75,000 to $80,000 0 0
$80,000 to $85,000 60.0 60.0 1
$85,000 to $90,000 0 0 C
$90,000 and over 0 0 C
Total 409
[Exhibit IV]
DEATH BENEFITS
The Company generally provides active employees with life insurance protection
equal to their annual salary. This is given to them at no cost. Additional amounts of
life insurance can be purchased by employees at their option.
The table below shows that 64% of all settlements for the past two years were for
those employees whose salary at death was $40,000 or less.
PERCENT OF ARCO DEATH CLAIMS UNDER OPTION A (ONE TIMES SALARY)
Total number of
Final salary death claims (all
options)
Number of claims
with option A Percent
Under 10,000 0 0 0
$10,000 to $15,000 1 1 100.0
$15,000 to $20,000 7 5 71.4
$20,000 to $25,000 16 6 37.5
$25,000 to $30,000 30 6 20.0
PAGENO="0681"
675
PERCENT OF ARCO DEATH CLAIMS UNDER OPTION A (ONE TIMES SALARY)-Continued
Total number of
Final salary death claims (all with ro~ca~ms Percent
$30,000 to $35,000 20 8 40.0
$35,000 to $40,000 7 2 28.6
$40,000 to $45,000 9 2 22.2
$45,000 to $50,000 7 3 42.9
$50,000 to $55,000 4 0 0
$55,000 to $60,000 8 0 0
$60,000 to $65,000 4 0 0
$65,000 to $70,000 6 0 0
$70,000 to $75,000 3 0 0
$75,000 to $80,000 1 0 0
$80,000 to $85,000 1 0 0
$85,000 to $90,000 0 0 0
$90,000 to $95,000 1 0 0
$95,000 to $100,000 0 0 0
$OverlOO,000 2 0 0
Total 127 33
[Exhibit V]
Plan name Participant 1 Eligibility Benefit
Atlantic Richfield retirement plan 43,000 Employees with 6 mo company 1.15 percent of final average salary
service. (3 yr) up to Social Security tax
base +1.5 of the excess.
Capital accumulation plan (CAP) 25,000 Immediate 1-10 percent salary deferral.
Savings plan 23,000 Employees with 6 mo. company Company match ef $2 for every $1
service and elective deferral of of employee saving to a maxi-
at least 1 percent to CAP. mum of 4 percent of salary.
PAYSOP 36,000 Immediate for all full-time employ- ½ percent of payroll.
ees.
Medical and dental 236,000 Immediate for all employees Medical and dental expenses; re-
quires cost sharing by employee.
Life/survivor income 36,000 Immediate for all employees One times salary.
Short term disability 36,000 Immediate for all employees Depends upon length of employ-
ment
Long term disability 28,000 Immediate for all employees who Represented employees receive 50
are full time and under 69½. percent of predisability salary.
Others receive 60 percent, with
required contributions for em-
ployees earning in excess of
$40,000.
1 Rounded to nearest thousand.
2 Does nsf include approximately 40,000 dependents who are also covered.
STATEMENT OF THE BANKERS LIFE, DES MoINEs, IA
We, The Bankers Life, are a collection of financial companies which, among other
things, serves about 50,000 U.S. employer sponsored pension and welfare plans cov-
ering 2 million participants. We manage between $8-9 billion of pension assets for
these plans and pay out $1 `/~-2 billion dollars per year in benefit payments. We've
been in the employee benefits business over 40 years.
We submit our comments on the strength of our nation's partnership between the
public and private sectors in providing those so called fringe benefits which are
aimed at the major financial hazards for an employee-retirement, disability, cata-
strophic medical expenses, and employee death where dependents survive. Replac-
ing lost employee income is the primary theme of these programs.
PAGENO="0682"
676
First, a couple of facts about our plan for our own employees. We have over 5,000
employees in our welfare programs (medical, disability and life insurance). Three-
fourths of our welfare plan participants earn less than $20,000 per year. And 97%
earn less than $50,000 per year. In our pension plan, which covers about 4,000
people (the 1,000 difference is our under 25 year old employees) 2/3 of the partici-
pants earn less than $20,000 per year and 96% less than $50,000. (Tables are at-
tached showing detail.)
Next some facts about our customers. For most, we don't have employee wage and
salary data in our records. But for 3,700 defined benefit pension plans covering
174,000 workers, we do have wage data in our files and have analyzed it. Sixty-five
percent of these participants earn less than $20,000 per year. And over 97% earn
less than $50,000 per year. These plans average covering about 50 employees each
and many are much smaller.
But are these rank and file workers vested? Yes to a great degree. Almost half
these participants have some vesting, and of these vested people, 56% earn under
$20,000 per year and 96% earn under $50,000 per year. Again a table is attached.
What about retirees? We're paying pensions to over 100,000 retirees who are aver-
aging less than $2,000 in annual pension.
Why is this data useful to you? We keep hearing the Congress thinks these pro-
grams are mostly for the rich, and we want you to know that in our broad experi-
ence with the small and medium size employers in the U.S., their programs are
overwhelmingly providing benefits for rank and file workers, for low income and
middle income workers. Yes the high paid are in there also, but they are a tiny mi-
nority.
During this century, the federal government has built the Social Security, Medi-
care and Medicaid programs, and has maintained tax laws favorable to private
sector development of similar programs. We see first hand in our day-to-day busi-
ness the strength of this public/private partnership in helping the ordinary worker.
Depending on how you measure it, we have perhaps 1-2% of the employee benefit
plan market in the U.S. Our customers are dispersed throughout the U.S. in every
kind of private business imaginable. Our customers are likely a cross sectional slice
of much of employee benefits in the U.S.-primarily small and medium size firms,
but with a good representation of the very large U.S. companies.
All of us together have built a mighty partnership to protect America's workers
against major financial hazards. And we ask you to move cautiously in improving it
that we avoid tipping the scales to start the employee benefits system on a down-
ward path.
The Census Bureau projects our over age 65 population moving from about 12% of
population today to almost 20% some 40 years hence. Even with a significant push-
back of retirement age, we're going to need more than ever a strong public/private
partnership on both retirement income and medical expenses for our retired work-
ers. Private enterprise has built an effective and efficient supplement to public pro-
grams covering employee needs. These needs are there and must be met. The pri-
vate system should not be dismantled in the name of tax revenue. If the private
system doesn't meet these needs, government must-and we believe its cost will be
much higher. We want to caution you that small businesses think it is fair for their
rank and file workers to get a combination of public and private benefits in the
same proportion to pay that key people do. But benefit plan rules have moved to
where they are, in relation to pay, beginning to discriminate against the higher
paid. And as growing numbers of decision makers in small businesses find their ben-
efits held down by dollar limits, we have a concern about the impact-will this
result in an expansion or contraction of the private system? We suspect the answer
is obvious.
Small businesses are very cost conscious. Our customers have rapidly moved over
recent years so that only a small fraction still provide first dollar medical coverage.
The order of the day is deductibles and coinsurance. Small businesses also very
much correlate their retirement programs with Social Security-so public and pri-
vate retirement combined make for a good retirement, but avoid over-pensioning in
relation to preretirement pay. As another indicator of cost concern, most small busi-
ness welfare plans call for employee contributions to pay part of plan costs.
We ask you to think long range across the decades about how to keep the public/
private partnership on employee benefits healthy-and steer away from appealing
short-range actions which damage the long-range outlook. Reach for a stable, long
range policy on a public/private partnership for employee benefits.
PAGENO="0683"
677
TABLE 1.-HEALTH BENEFIT AVAILABILITY, 1984
Total plan Insured part HMO part
Amount Percent Amount Percent Amount Percent
0 to $9,999 447 8.2 423 8.4 24
$10,000 to $19,999 3,627 66.7 3,364 66.5 263
$20,000 to $49,999 1,198 22.1 1,113 22.0 85
$50,000 to $99,999 138 2.5 135 2.7 3
$100,000 or more 25 .5 25 .5 0
6.4
70.1
22.7
.8
0
Total 5,435 100.0 5,060 100.0 375
100.0
TABLE 2.-RETIREMENT PROGRAM AVAILABILITY, 1983
Defined benefit
Participate Vested
Amount Percent Amount
Percent
0 to $9,999 189 4.8 25
1.4
$10,000 to $19,999 2,454 62.3 798
$20,000 to $49,999 1,133 28.8 794
$50,000 to $99,999 138 3.5 130
$100,000 or more 24 .6 23
45.1
44.9
7.3
1.3
Total 3,938 100.0 1,770
100.0
TABLE 3.-RETIREE BENEFITS
he f Total
Benefit Numro distributions or
Year
Defined benefit plan retirees in pay status 289 $1,800,000
Defined benefit plan retirees survivors in pay status 37 175,000
Defined benefit plan survivors of employees who died before retirement 30 100,000
1983
1983
1983
Defined benefit plan vested separated 320 NA
Retiree health 1 283 260,000
1983
1983
Retiree life:
Premium 283 230,000
1983
RLR deposit 283 1,200,000
1983
1 Includes: 227 retirees, 37 survivors of retirees, and 19 survivors of employees who died before retirement
This data is for those 3,662 of our plan sponsor customers where The Bankers Life
has wage and salary data in its records.
TABLE 4.-RETIREMENT PROGRAM AVAILABILITY, 1983
Annual salary
Defined benefit
Participate
Vested
.
Amount
Percent
Amount
Percent
0 to $9,999
$10,000 to $19,999
$20,000 to $49,999
$50,000 to $99,999
$100,000 or more
27,508
85,470
56,221
4,003
722
15.8
49.2
32.3
2.3
.4
9,093
37,672
33,095
3,020
635
10.9
45.1
39.6
3.6
.8
Total
173,924
100.0
83,515
100.0
PAGENO="0684"
678
STATEMENT OF Ro~ B. HOWARD, CLYDE V. MANNING, AND RANDY L. NEW, ON BEHALF
OF BELLSOUTH CORP.
BellSouth Corporation ("BellSouth") greately appreciates the opportunity to com-
ment on the questions discussed in the joint oversight hearings on the distribution
and economics of employer provided fringe benefits held by the Subcommittee on
Social Security and the Subcommittee on Select Revenue Measures on September
17-18, 1984.
As you may know, BellSouth, a Georgia Corporation, is one of the regional hold-
ing companies established as a result of the divestitute of American Telephone &
Telegraph Corporation. Two of our subsidiaries, Southern Bell and South Central
Bell, are corporations Which provide local access telephone services to the American
public in nine states: Georgia, Florida, Alabama, Mississippi, Tennessee, Kentucky,
South Carolina, North Carolina and Louisiana. BellSouth and its eigthy percent or
more owned subsidiaries employ 97,000 people of whom approximately 50% are
female and 19% are minorities. In addition, 25,000 retired employees participate in
some or all of our employee benefit plans. Seventy-one percent of our employees are
covered by collective bargaining agreements. We understand that we would be rated
by Fortune 500 as the twelfth largest corporation in the United States were a rating
based on assets. Our economic viability and employment opportunities are impor-
tant throughout the southeast. The Bell System, of which BellSouth used to be a
part, historically encouraged employees to save for retirement. We have continued
that tradition and appreciate federal tax incentives provided by Congress which
have assisted our efforts.
A variety of employee benefits are provided to employees of the BellSouth con-
trolled group of corporations, although not all of our corporations' employees par-
ticipate in all plans. Among our benefit plans are two qualified defined benefit pen-
sion plans, two qualified thrift plans, a new qualified Section 401(k) thrift plan
which we have adopted on a limited basis, an employee stock ownership plan, self-
funded and insured medical benefit plans, self-funded short-term disability plans, a
self-funded vision care plan, self-funded and employee-paid dental care plans, and
several nonqualified deferred compensation and employee incentive award plans.
Union-eligible employees and the lower-paid two-thirds of all nonunion-eligible
employees constitute 90% of our total employee population. All of our employees
are eligible to participate in all of the plans adopted by their respective employing
corporation on the same basis after satisfaction of minimal service and age require-
ments.
I. OVERVIEWS
We have attempted to answer those questions posed by the Subcommittees in
your press release of August 29, 1984 in the order in which they were presented;
however, three overviews seem appropriate. First, all of the benefit plans which
BellSouth provides to its employees are at some point in time taxable to the employ-
ee except, of course, for our medical benefit plans. At most, the revenue loss which
occurs as a result of affording favorable tax treatment to fringe benefits is a short-
term revenue loss which in large part represents income tax deferral, not income
tax avoidance. This short-term loss "purchases" the creation of a large capital re-
serve which is used to promote investment in the American economy. For example,
in 1983, the Profit-Sharing Council of America estimated that profit-sharing trusts
alone held over $75 billion in assets which were invested in the America economy.
Pension assets totaled $881 billion in 1982. Effect of Tefra on Private Pension Plans:
Hearings Before the Subcommittee on Savings, Pensions, and Investment Policy of
the Committee on Finance, United States Senate, 98th Cong., 1st Sess. 98-172 (1983)
(Statement of Walter Holan, President, Profit-Sharing Council of America); Will
More Flexibility Lead to More Taxation?, Employee Benefit Plan Review, January
1984 at 20. To the extent that Congress decreases the tax advantages of any benefit
plan which is funded in advance by the employer or employee, Congress decreases
the employer's and the employee's incentive to save and the likelihood that employ-
ee benefit funds will continue to be useful sources of investment funds for the U.S.
economy.
Second, BellSouth understands that Congress intends to reexamine all employee
benefits which receive favorable tax treatment. Indeed, the Subcommittees' press re-
lease, Chairman Stark stated that "[i]t is time to examine on a comprehensive basis
all benefits exempted from tax currently in the Code." While BellSouth does not
oppose a comprehensive Congressional review of employer-provided fringe benefits,
employers have suffered over the past two years through several statutory and regu-
latory changes in benefit rules, and an air of uncertainty has been created in the
PAGENO="0685"
679
business community as a result. We encourage a comprehensive review of employer-
provided fringe benefits if, Congress (1) designs a comprehensive, long-term federal
tax policy and (2) implements that policy slowly and incrementally over several
years. The latter condition is important because employers have relied upon current
laws in making significant commitments to their employees in the benefits area.
Large employers like BellSouth are unable to change corporate benefit policies
quickly as we have been asked to do in the recent past because our administrative
personnel and our employees must be educated on the new benefit rules and these
rules then incorporated into agreements and documents. We need sufficient lead-
time to make those changes which Congress determines are necessary, and we need
information concerning Congress' long-term goals so that our incremental changes
will not lead to a BellSouth benefit policy which is adverse to these goals.
Third, we realize that the Subcommittees are especially concerned with Social Se-
curity taxation of employer-provided fringe benefits. While we understand the Sub-
committees' desire to broaden the Social Security tax base and to assure adequate
financing for Social Security benefits, we ask that Congress remember that the ben-
efit plans which BellSouth maintains assist lower-paid employees to the same extent
as, if not more than, higher-paid employees. Subjecting these benefits to Social Secu-
rity taxation will adversely affect only those employees whose taxable compensation
otherwise falls below the Social Security wage base. The questions announced in the
Subcommittees' press release demonstrate concern for the receipt of benefits by
lower-paid employees, and taxation of benefits may undermine that principle. At
least 89 percent of our employees earn less than the Social Security wage base, and
the lower paid in this group, not our more highly-compensated employees, will be
adversely effected by subjecting benefits to FICA or FUTA taxation.
II. PREVALENCE OF FRINGE BENEFITS; AVAILABILITY AND UTILIZATION OF BENEFIT PLANS;
PROJECTED CHANGES
The Subcommittee's questions in this area appear directed to those experts who
have access to economy-wide data on employee benefits programs. While we are un-
aware of the distribution of fringe benefits among the entire U.S. workforce, all of
our tax-favored employee benefits are available to our employees on a nondiscrim-
inatory basis. The vesting, participation, and benefit rules applicable to the chief ex-
ecutive officers of our corporations are the same as the rules applicable to the
lowest-paid employees in those corporations. Our qualified retirement plans provide
a benefit based upon a percentage of the employee's wage or salary; however, our
medical plans provide the same potential benefit to all employees and the medical
benefits are based on the cost of providing the treatment to our employee popula-
tion. All of our regular, full-time employees are eligible to participate in all of our
tax-favored employee benefit plans after short service requirements have been satis-
fied.
We anticipate two general changes in our benefit package3 ~n the future. First,
the amount of our employer contributions to benefit plans depends upon cost consid-
erations and our balancing of the well-being of the employee and the well-being of
BellSouth. The current rate of inflation in health care costs and the escalation in
the costs of our health care benefit plans have a detrimental impact on the econom-
ic viability of the health care plans. We currently are searching for solutions to this
increasing cost spiral, and anticipate some design changes to promote cost-conscious-
ness by our employees.
Second, in view of the change in the workplace demographics (more women and
two wage families) BellSouth hopes to promote employee choice and selection in its
benefit plans so that employees can tailor their benefit choices to match their indi-
vidual needs. For example, we were actively exploring the adoption of a cafeteria
plan under Internal Revenue Code ("Code") Section 125 as a method of controlling
health care costs and promoting employee choice and participation; however, the
Proposed Regulations which were recently issued by the Internal Revenue Service
("Service") have decreased our enthusiasm for that concept. We recently have
adopted a qualified salary reduction plan authorized by Code Section 401(k) so that
a portion of our employee population can contribute towards their own retirement
benefit. While no significant revamping of BellSouth's benefit package is planned at
this time, we obviously will be influenced by costs considerations, by a desire to pro-
vide additional benefit flexibility to our employees in the future, and by the tax ad-
vantages of those benefits.
PAGENO="0686"
680
III. RECEIPT OF BENEFITS BY SALARY RANGE AND OCCUPATION
As noted, BellSouth encourages all employees to participate in our benefit pians
(i) by imposing only minimal service and age requirements in our defined benefit
plans, (ii) by imposing minimal service requirements in our defmed contribution
plans, and (lii) by providing benefits on a percent of pay basis, matching basis, or
cost basis in our deferred benefit plans, savings plans, and medical plans respective-
~We believe Congress should evaluate carefully any proposal to alter the tax treat-
ment of medical benefit plans because these plans especially benefit lower-paid em-
ployees at the time of greatest need. While medical plans receive perhaps the most
favored tax treatment of all benefit plans, medical benefit plans also provide a bene-
fit to employees regardless of income which prevents economically devastating ex-
penses from falling on a totally random group of employees. Thus, employers should
not be discouraged from providing medical care plans by the imposition of disadvan-
tagous tax treatment on such plans or by requiring administratively costly compli-
ance with statutes or regulations governing the tax deductibility of medical plan ex-
penses. Similarly, employees should be encouraged to participate in employer plans
through tax-free receipt of employer-provided medical benefits to the full extent of
the employer's willingness to pay for such benefits. We are concerned about the pos-
sibility that an employee ever will decline employer-provided insurance protection
because receipt of protection would result in income tax liability and subsequently
incur the devastating expenses associated with a heart attack, cancer, or a similar
disease. Presumably any tax owed as a result of an employee's receipt of employer-
provided protection would be paid from the employee's regular salary. We fear that
an employee's willingness to receive taxable medical plan protection would decrease
as the employee's regular wage or salary decreased. For your information, one of
our largest individual claims in 1983, totalling $492,150, was paid on behalf of an
employee earning $27,300. Another employee earning $19,700 faced medical claims
totalling $236,046. As well, 75% of our medical care benefit dollars under our self-
insured program were paid on behalf of represented employees with the highest
rate of pay being $28,860. In 1983, BellSouth has six medical benefit cases paying
over $200,000 each, with total aggregate payments equalling $1,729,672, for six em-
ployees with approximate average incomes of $25,000.
IV. PROCEDURE USED TO DETERMINE THE COMPONENTS OF BELLSOUTH'S TOTAL COMPENSA-
TION PACKAGE; THE EFFECT OF FAVORABLE TAX TREATMENT ON THE SELECTION OF
FRINGE BENEFITS OVER CASH REMUNERATION; EFFECT OF IMPOSITION OF FICA TAX
The allocation of compensation between fring benefit plans and direct pay is a
topic of collective bargaining for a majority of our employees. The union representa-
tives who participate in the bargaining process are well aware of the tax conse-
quences of each fringe benefit and are doubtlessly influenced in bargaining by tax
considerations. For nonrepresented, management employees, BellSouth establishes a
fring benefit package through studies of competitive industries and their compensa-
tion practices. One overriding principle which we follow, notwithstanding our com-
petitors' positions, is that the employee's well-being is the joint responsibility of the
individual, the corporation, and the government. Therefore, we design our total
management compensation package to encourage employee savings and employee
individual selection of benefits, given (i) the corporation's ability to contribute to the
costs of benefit plans, (ii) the ability of the individual under the Code and applicable
law to select an individually-tailored benefit program, and (iii) the existence of gov-
ernment tax advantages for certain benefits.
Given this decision making process, the fact that tax favored treatment of fringe
benefits markedly affects benefit selection is not surprising; however, we believe
there could be a misunderstanding of the true influence of the Code on our benefit
planning. Large, publicly-owned employers such as BellSouth suffer from the per-
ception that tax-favored benefit programs are merely disguised shareholder divi-
dends or tax shelters for the wealthy-a perception which may suggest to Congress
that favorable tax treatment of a benefit merely encourages the selection of a bene-
fit for its tax advantages. Perhaps this perception arises in part from a failure to
understand the economics of employee benefits in a large, unionized employer. If
BellSouth receives a credit or advanced deduction for providing an employee bene-
fit, the tax savings really do not ever inure to the benefit of our shareholders.
Before the credit or deduction is received, we have made an irrevocable commit-
ment to spend a sum of money to provide a benefit to our employees. A tax credit
never exceeds our cost in providing a particular benefit. An advanced deduction for
a benefit to be provided in the future only compensates BellSouth for a real current
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payment of an equal amount of money since our unions and our status as a public-
ly-traded employer prevent any money committed to a benefit from reverting to
BellSouth or its shareholders. If a benefit is made taxable to the employee, in whole
or in part, we generally will be pressured by our union and our employees either (i)
to "gross-up" the employee's salary or wage to neutralize the tax effect on his or her
gross income or (ii) to eliminate the benefit. For example, we "gross-up" most of our
payments to all of our employees for their relocation expenses (i) because most of
their expenses will be in excess of the Code Section 217 dollar limits on deductibility
of moving expenses reimbursements and (ii) taxation of expenses in excess of those
limits may block relocations and impair resultant operational efficiencies.
The proposal to impose FICA tax on specific benefits (that is, Section 125 plan
benefits) which currently are not subject to the tax would not be vigorously opposed
by BellSouth from a corporate standpoint; however, Congress should consider that
the imposition of FICA tax will adversely effect lower-paid employees and that some
additional administrative costs to BellSouth will accompany the change. As noted,
the tax advantages of most fringe benefits insure to the benefit of the employee ot
the employer. As the tax advantages of a particular benefit decrease, unions and
unionized employers will resolve the benefits versus cash compensation issue differ-
ently than they currently do. We cannot advise the Subcommimttees of the exact
point at which any particular benefit will be abandoned because of the combination
of increased administrative costs to the employer and decreased tax advantages to
the employee; however, at some point, abandonment becomes the only viable course
of action.
V. EFFECTS OF UTILIZATION OF FRINGE BENEFITS; HORIZONTAL AND VERTICAL EQUITY
ISSUES
We believe that three macroeconomic effects of the current tax treatment of
fringe benefits are important to consider in any comprehensive review of fringe ben-
efit taxation. First, as noted, the advance funding of fringe benefits and, in particu-
lar retirement benefits which is encouraged by the existence of tax-exempt trusts
promotes savings in the economy, thereby creating needed sources of investment
capital. Second, retirement benefits in particular are a complement for Social Secu-
rity. Congress' ability to moderate the rate of increase in Social Security expendi-
tures ultimately will be dependent upon the income security which the private re-
tirement system provides to millions of Americans. Without the private retirement
system "leg" of the oft-cited three-legged stool of retirement income security in
America, pressure would increase on the federal government to assure that retired
persons have adequate income security through tax incentives for personal savings
or government funded programs. As a general proposition, BellSouth believes that
tax incentives should be provided for those benefits which inherently would be pro-
vided by the federal government if they are not provided by the employer. These
benefits include retirement, disability, medical and death-type benefits, the last of
which the federal government would be called upon to replace by providing survi-
vors' benefits.
Third, a final, important effect of the promotion by Congress of those tax-favored
benefit plans whch require advanced funding is that Congress also has encouraged
employers to be fiscally responsible in providing employee benefits. Advanced fund-
ing of retirement benefits such as medical and death benefits and advanced funding
of nonretirement benefits promote fiscal responsibility by employers; yet a trend to
decrease employers' abilities to fund benefits in advance is evident from the reduc-
tion in the Code Section 415 limits contained in the Tax Equity and Fiscal Responsi-
bility Act of 1982 and the complex rules limiting advanced funding of welfare bene-
fits contained in the Deficit Reduction Act of 1984.
Advanced funding is a fiscally responsible action by BellSouth in particular be-
cause current ratepayers and not future generations of ratepayers should pay the
cost of employee benefits to current employees. Moreover, demographic trends
which suggest that more retirees will be supported by fewer working employees in
the future indicate the need for advanced funding since advanced funding offsets
the slow but steady increase in our liability for future employee benefits which
occurs each year. Finally, the real danger of the welfare benefit plan funding limita-
tions mentioned above will appear when employers experience low-profit and no-
profit years and, as a result, decrease those employee benefits which would have
been unaffected had advanced funding been allowed to occur through favored tax
treatment.
Tax-favored treatment of fringe benefits does affect the horizontal and vertical
equity of the income tax system. We believe fringe benefit plans are perceived to be
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a tax subsidy to higher-paid employees, an incorrect assumption in the case of large
corporate employers such as BellSouth. Indeed, lower-paid employees' receive a pro-
portionately greater benefit from our medical care plans than higher-paid employee
since the payment of medical claims for a lower-paid employee who suffers a heart
attack, for example, represents a greater percentage of that employee's regular
salary than our payment of similar expenses for an higer-paid employee. As ex-
plained, our medical plans do not discriminate between employees.
The Subcommittees also have asked about the allocation of the tax benefits of cer-
tain fringe benefit plans among employers or among employees throughout the
American workforce. While we have no data upon which to base a comparison of
the tax benefits we receive or our employees receive with the tax benefits received
by other employers and their employees, we design our compensation package to
assure that we remain competitive with other employers. To the extent that Bell-
South takes advantage of tax-favored employee benefit plans to the same degree as
other employers who compete for our specially trained employees, tax benefits are
distributed more equally throughout the economy. Congress should consider that
employers such as BellSouth must have a sophisticated, tax sensitive benefit pack-
age since we must attract and retain highly specialized, technical employees.
VI. EFFECT ON FICA RATES AND SOCIAL SECURITY WAGE BASE OF FRINGE BENEFIT PLANS
This series of questions as stated in the Subcommittees' press release requires in-
formation unavailable to BellSouth. However, if we can be of assistance to the Sub-
committees or Congress in generating information of this type we gladly will assist
you.
VII. EFFECT OF FIXED DOLLAR CAPS, EXCISE TAXES OR LIMITS ON PERCENT OF
COMPENSATION ON BENEFIT PLANS
Individual limits already exist on most benefits which receive favorable tax treat-
ment. For example, only the cost of the first $50,000 of employer-provided, group
term life insurance is provided tax-free to the employee. I.R.C. § 79(a)(1). While cur-
rent limits seem to us to balance adequately the need for tax revenues against Con-
gress' desire to encourage employee benefits, we can envision even more percentage
limitations, fixed dollar caps, and excise taxes. Congress should realize that the
adoption of a fixed dollar cap above which benefits would be taxable or the adoption
of an excise tax will effectively set the level at which a particular benefit will be
provided by most employers. As explained, our benefit package in large part is nego-
tiated with our employees and otherwise is governed by competitive pressures. As a
general rule, we do not believe our represented employees would be as interested in
receiving a benefit, including medical care insurance protection, which would be
subject to full income taxation or to excise taxation. Moreover, to the extent that
other employers responded to these effective limits on benefits prior to our benefit
planning decision, the competitive pressure on us to provide a greater albeit taxable
benefit would disappear.
If Congress adopts fixed dollar caps or exicse taxes which are applicable to specific
benefits, we believe Congress should also consider adopting more liberal cafeteria
plan rules than those stated in the Proposed Regulations recently promulgated by
the Service. As a final note on the fixed dollar cap proposals and as an illustration
of the principles we espoused in our overviews, if a cap on any benefit is adopted by
Congress under the assumption by Congress that the dollar limit will be frozen or
decreased in the future despite inflation in health care costs, that assumption
should be communicated to employers in advance so that they will understand in
designing their benefit plans Congress' long-range goals and so that they may begin
to respond to these realities in a timely fashion.
VIII. RELATIONSHIP BETWEEN FRINGE BENEFITS AND GOVERNMENT-PROVIDED SOCIAL
PROGAMS; COMPARISON OF EMPLOYER-PROVIDED BENEFITS WITH PUBLIC PROGRAMS
We realize that credits, current deductions, and exclusions for employee benefits
are perceived to have short-range, negative net revenue effects. However, reliance
on employers to provide fringe benefits has at least two positive, offsetting effects.
First, benefits are delivered by employers more economically than by the federal
government because (1) employers are in a better position to tailor benefit programs
to specific employee needs, depending upon the ages, working conditions, socioeco-
nomic status, and other characteristics of their employees, (2) the volume of busi-
ness generated by a large employer of our size provides us with the purchasing
power to buy benefits at the lowest possible cost, yet (3) as the number of persons
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who belong to a particular benefit plan grows smaller, each persons benefit costs
affect benefit prices to a great degree, and each person becomes more sensitive to
the need to avoid wasteful overutilization. The latter reason for favoring employer-
provided benefits is important since employees too often fail to discern the cause-
effect relationship between overuse and abuse of federally-funded benefit programs
and their individual tax liability.
Second, if nothing else, providing tax incentives for employer-provided benefits
saves the federal government the expense of administering federally-provided bene-
fits. In providing employee benefits for approximately 122,000 people, BellSouth ben-
efit planning and administrative costs, excluding pension trust fund management
costs, on an estimated annualized basis for 1984 equal $17.1 million. Our pension
fund administration costs are $10.5 million. While these costs are significant, the
benefit administration costs are less than 2% of the total cost of benefits delivered
to participants, and our treasurer's administration costs are less than .2% of the
value of the trust fund. Our administrative costs are minimized as much as possible
and the federal government's experience in providing replacement benefits probably
would not be as favorable.
Ix. SUMMARY
We appreciate the opportunity to express our views to the Subcommittees on the
taxation of employer-provided fringe benefits. If you have specific proposals or ques-
tions, we would appreciate the opportunity to express our views again.
STATEMENT OF THE BLUE CRoss & BLUE SHIELD ASSOCIATION
The Blue Cross Shield Association, the national coordinating organization for the
96 Blue Cross Shield Plans, appreciates the opportunity to submit this statement.
Today, Blue Cross and Blue Shield Plans provide health care coverage for more
than 80 million Americans. Most of our subscribers maintain this coverage through
group policies offered by their employers, although a substantial number-13 mil-
lion-are covered under individual health benefits contracts.
The Committee has posed a number of questions concerning the availability and
scope of fringe benefits. Based on our experience, we would like to comment on
those that relate to the tax treatment of employer-provided health benefits and
what would be the effect of changes in their tax status.
Current tax policy clearly establishes incentive for employers to provide certain
employee benefits-particularly those that protect workers and their families
against loss of income or high expenses due to retirement, disability, illness, and
death. There are two major principles underlying this policy. The first is that assur-
ing the economic security of active, disabled, and retired workers and their depend-
ents is beneficial to society as a whole. The second is that government-operated pro-
grams alone cannot and should not be expected to achieve the goal of economic se-
curity for this population.
We believe these principles are as valid now as they were 30 years ago when the
basic tax treatment of employee benefits was codified. In our view, the fundamental
issue is not whether government should be involved in protecting workers and their
families from loss of income or the high costs of illness but how the government
should be involved. Government involvement can be through incentives in the tax
code for the private sector to establish and operate benefit programs, or through the
expansion of benefit programs operated directly by the government. We believe that
the encouragement of private sector benefit programs is the better alternative.
Therefore, we recommend that the current tax incentives for certain employee bene-
fits be preserved.
TAX TREATMENT OF HEALTH BENEFITS
Current tax policy encourages the provision of health benefits through employ-
ment by not treating the costs an employer incurs to provide these benefits as tax-
able income to the employee. In addition, the employer does not pay payroll taxes-
such as FICA and unemployment-on these costs. These tax policies have been a
major factor in the growth of employment-related health coverage. Three quarters
of the labor force have employment-related health coverage. This coverage provides
protection for about 177 million employees and their dependents.
We believe that this country's extensive group health benefit coverage has had
substantial value for workers, employers, health care providers, ghe government,
and society as a whole. Workers, including those who could not afford to buy insur-
40-046 0 - 85 - 44
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ance, or who would otherwise fail to purchase it on their own, are protected from
the unexpected and major costs of illness. Health benefits administered and fi-
nanced through a group of employees are less expensive than if comparable insur-
ance were purchased by individual workers. Moreover, the employer can serve a val-
uable role in the health insurance marketplace as a well-informed bargaining agent
for his or her employees. Through this bargaining and negotiation, employers can
tailor a unique health benefits program that meets the often diverse needs of work-
ers and their families as well as the needs ofretirees and their dependents. In addi-
tion, employers are able to attract and retain workers through the provision of
health coverage and the inclusion of particular benefits. Finally, employee morale
and productivity are enhanced as a result of increased job satisfaction, and this, in
turn, strengthens our economy.
By encouraging private group health benefits, current tax policy also has positive
effects on our health care delivery system. Providers of health care services, particu-
larly hospitals, are assured of payment for their services. Because of this, insurers
play major role in avoidance of hospital bad debts, adn that means a significantly
smaller role for the federal and local governments in support of community hospi-
tals.
Finally, and importantly, existing tax policy reduces the need for expanded gov-
ernment funded and administered entitlement programs.
Because group health coverage is a benefit which is critical to our nation's well-
being and productivity, the present tax treatment of health benefits is particulary
appropriate. Accordingly, the Blue Cross and Blue Shield Association strongly op-
poses the taxation of employer-provided health benefits.
We would now like to address briefly proposals to limit the current tax exclusion
that applies to employer contributions to health benefits plans.
PROPOSAL FOR A TAX CAP ON EMPLOYEE HEALTH BENEFITS
The present Administration and some Members of Congress favor taxing the
value of employer-provided health bemefots above certain levels-the so-called "tax
cap." While, to some, a tax cap may seem to represent a convenient shortcut in
dealing with the federal deficit or an effective way to control health care costs, in
our opinion the adverse consequences for millions of Americans would be serious.
We believe that the adoption of this type of proposal would be both bad tax policy
and bad health policy for the following reasons.
A tax cap would diminish the government's commitment to use tax incentives to
have the private market provide protection against health care costs.-A major objec-
tive of our tax system is to encourage the private sector to undertake socially useful
activities in order to minimize the need for tax-supported government programs. A
tax cap on health benefits would send a signal that government had reduced its
commitment to protecting the health of the work force and their families. Enact-
ment of even a high level tax cap would be deceptive. Once in place, the temptation
to "ratchet down" the cap each year-in search of new revenues-would prove irre-
sistible.
A cap would impose a "sick tax" on older and cronically ill workers, and on their
employers.-Different employee groups have different health care needs. Because
older and chronically ill workers tend to use more health benefits, the cost of pro-
viding health benefits to a group in which these workers are heavily represented
will be higher than the cost of health benefits for a group of young healthy workers.
Consequently, if a cap were imposed on the amount of employer-provided benefits,
or for that matter if all of the health benefits were taxed, employees of companies
with a relatively high percentage of such workers would have to pay more taxes
than workers of other companies.
A tax cap could also have other serious, although more indirect, adverse effects on
older and chronically ill workers. If employers responded to the tax cap by offering
employees a choice of plans-a low option which is non-taxable and a high option
which is taxable, those who perceive themselves as healthier likely would choose the
lower-cost, minimal coverage plan. Less healthy workers would want the protection
of a more comprehensive, higher-cost plan. Over time, the cost of providing services
to the high users would drive up the premium of that group and consequently the
healthier workers would drop out. This "adverse selection" would put the cost of the
more comprehensive protection out of reach for those who need it most.
While we do not have precise estimates of the financial effect of a tax cap on
groups with "high risk" workers, Blue Cross and Blue Shield Association actuarial
simulations suggest how the Administration's proposal might affect older workers.
The additional taxable income for family coverage provided by a particular Blue
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Cross and Blue Shield Plan (with a 75 percent employer contribution) is estimated
to be 31 times higher for workers employed in older employee groups (average age
55-64) than in younger groups (average age 35-44). Under the Administration' pro-
posal, this would mean taxable income of $1,306 versus $41.
A cap is not needed to contain health care costs.-Cost containment has recently
emerged as the major factor in the delivery and financing of health care. Purchas-
ers of health care, as well as providers have increased their level of sophistication in
a very short time. Programs have been developed to reduce inpatient lengths of
stay, to determine whether services such as diagnostic tests and surgery should be
performed on an outpatient rather than on an inpatient basis, and to determine
prior hospitalization whether a hospital admission is warranted. For example, by
using hospital utilization review, Blue Cross of Iowa reduced small group premiums
by a total of $24 million, and Blue Cross of Northeast Ohio reduced experience-rated
group premiums by 4 to 6 percent.
Another approach being used to control costs is the offering to employees of finan-
cial incentives to use designated hospitals and physicians in the communtiy that,
through a contract, will provide health care services for a lower price or with more
stringent utilization controls. These new arrangements are called Preferred Provid-
er organizations-PPOs-and have demonstrated significant savings. For example,
by using perferred providers arrangements, Blue Cross of California has cut premi-
ums for large group accounts by an average of 13 percent, while Blue Cross and
Blue Shield of Minnesota reduced rates by an average of 10 percent, saving $10 mil-
lion. A variant on the PPO approach is called "selective contracting," in which an
insurer or employer contracts with selected providers in the community whom they
know provide high quality services at lower costs. Employees are not reimbursed for
their medical expenses if they go to providers not covered under the contract. This
also has resulted in lower health care costs for employers.
In addition, more and more employers also are offering their employees the
option of a health maintenance organization-an HMO-since HMOs have strong
financial incentives to control utilization of services while still providing high qual-
ity of care.
These approaches are helping to contain the cost of group health benefits. The
Business Roundtable's Task Force on Health recently reported that, as a result of
various steps taken by its members, average health care spending per recipient for
the first quarter of 1984 increased only 8.4 percent from the first quarter of 1983
compared with 12.7 percent for the same period a year earlier.
A cap would be regressive taxation-Data from the Congressional Budget Office
and the Employee Benefit Research Institute show that, of those employees who
would be subject to additional taxes, the financial burden would fall heaviest on
those with the lowest incomes. For example, under the Administration's proposed
cap, workers who earn less than $10,000 a year would pay an additional 2.8 percent
of their income on average. Workers earning more than $50,000 a year would pay
taxes equivalent to only 0.4 percent of their income. Reducing the benefit package
to a value below the cap could result in dropping important benefits or providing for
significantly greater employee cost-sharing. Furthermore, because lower-income per-
sons are less able to pay, any new cost-sharing requirements or out-of-pocket costs
for non-covered benefits also would affect them disproportionately.
For all these reasons, we believe that Congress should not tax employment-related
health benefits-Some might charge that the current tax status of employer-provid-
ed health benefits is inequitable because it applies only to health coverage obtained
through employment. While it is true that health insurance premiums for those
who must purchase individual coverage are paid for with after-tax dollars, the medi-
cal expense deduction has helped mitigate this expense. If Congress wishes to ad-
dress the differences in tax treatment of employer-provided versus non-group health
coverage, we suggest reconsideration of the 1982 change which raised the threshold
for claiming the medical expense deduction from three percent to five percent of
adjusted gross income, and eliminated the separate deduction for health insurance
premiums up to $150. Restoring the separate premium allowance, in particular,
would represent at least a partial solution to this problem.
SUMMARY
In conclusion, we want to emphasize the value of using tax policy to encourage
the private sector to provide benefits which protect our citizens from economic inse-
curity. With respect to health benefits, we strongly recommend that Congress not
impose a tax cap or other form of tax on employee health benefits. Such a tax is not
needed and would hurt those most in need of health care.
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STATEMENT OF YUNG-PING CHEN, PH.D.,* BRYN MAWR, PA
I appreciate the opportunity to submit a statement on the distributional effects of
employer-provided fringe benefits, a topic that has not gained but merits attention. I
also wish to commend the Subcommittee on Social Security and the Subcommittee
on Select Revenue Measures for holding a hearing on fringe benefits, a subject with
far-reaching implications for Social Security and individual income taxation, as well
as for the role of workers employers and government in the provision of economic
security and material well being for individuals and families.
The incidence of fringes is uneven among workers in different industries. Some
are "fringe-rich" and others "fringe-poor."
According to a 1980 survey of 983 companies by the Chamber of Commerce of the
United States, among the "high-fringed" industries were petroleum (the highest),
primary metal, chemicals and allied products, public utilities, banks, finance compa-
nies, and trust companies. Among the "low-fringed" industries were textile products
and apparel, wholesale and retail trade, and hospitals (the lowest).'
Chamber estimates for the economy as whole in 1980 also showed substantial in-
dustry-by-industry variations in fringe benefit levels. Utilities and communications,
mining, finance (including insurance and real estate), transportation, and manufac-
turing were industries that paid fringe benefits higher than the national average,
whereas trade (including wholesale and retail), construction, and services were in-
dustries with lower-than-national-average fringe benefits.2 The annual average
number of workers employed in these three low-fringed industries numbered almost
43 million, constituting more than than 57 percent of all employment in nonagricul-
tural private-sector establishments. (See table 1.)
TABLE 1.-NUMBER OF WORKERS IN TRADITIONALLY LOW-FRINGE INDUSTRIES AND THE PROPOR-
TION OF SUCH WORKERS IN THE TOTAL PRIVATE-SECTOR NONAGRICULTURAL EMPLOYMENT:
ANNUAL AVERAGES FOR SELECTED YEARS, 1950-1980
1950
1960
1970
1980
Trade (Wholesale and retail)
9,386
11,391
15,040
20,573
Construction
2,364
5,357
2,926
7,378
3,588
11,548
4,469
17,740
Services
Total
17,107
21,695
30,176
42,782
Proportion of workers in low-fringe industries in total private-sector employment
(in percentage):
Trade (wholesale and retail)
24.0
6.0
13.7
24.9
6.4
16.1
25.8
6.2
19.8
27.6
6.0
23.8
Construction
Services
Total
43.7
47.4
51.8
57.4
Source: Calculated from data in table C-i in Employment Training nepert of the President, Washington: U.S. Government Printing Office, 1981, p.
211.
During the last three decades, the number of persons on payrolls of these three
"low-fringed" industries increased substantially, from 17.1 million in 1950, to 21.7
million in 1960, 30.2 million in 1970, and 42.8 million in 1980. Moreover, in the same
period, employment in these industries as a proportion of all private-sector nonagri-
cultural employment also increased: from 43.7 percent in 1950 to 47.4 percent in
1960, 51.8 percent in 1970, and 57.4 percent in 1980.
Because it is levied only on cash wages, the FICA tax takes a larger percentage of
these fringe-poor workers' compensation. Unless they increase their share of the
growing total fringes, they wifi suffer an increasing relative disadvantage as com-
pared with the fringe-rich
This relative disadvantage will occur despite an OASDI weighted-benefit formula
which favors low earners, who are most likely fringe-poor. Even though the formula
* The Frank M. Engle Professor in Economic Security Research, he concurrently serves as
professor of economics and research director of the McCahan Foundation, The American Col-
lege, Bryn Mawr, Pennsylania.
Chamber of Commerce of the United States, Employee Benefits 1980, Washington 1981, p. 9.
2 op. cit., p. 2.
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yields more OASDI payments to low earners relative to their FICA taxes, they re-
ceived more OASDI payments long after they have paid their FICA taxes. Mean-
while, during the years in which they are working, they must pay for the protection
out of their taxable cash wages. In contrast, the fringe-rich receive sizable current,
as well as old-age benefits, either tax-free or tax-deferred.
Thus, I urge that the distributional effects of fringe benefits on the fringe-rich
versus the fringe-poor be seriously taken into account when considering legislation
on fringe benefits.
STATEMENT OF HARTZEL Z. LEBED, EXECUTIVE VICE PRESIDENT, CIGNA CORP., AND
PRESIDENT, CONNECTICUT GENERAL LIFE INSURANCE Co.
CIGNA Corporation, formed in 1982 through the merger of Connecticut General
and INA, is the second largest stock insurance company in the United States, with
over 45,000 employees worldwide, and nearly 40,000 employees in the United States.
CIGNA's Employee Benefit and Financial Services Group provides life and health
insurance products, pension and retirement savings products and investment vehi-
cles, as well as related services to employers and individuals. We are the fifth larg-
est commercial insurer in the medical coverage marketplace, second largest in
dental insurance, and first in long-term disability coverage. We insure over 5 mil-
lion employees and their dependents for medical coverage. We manage over $15 bil-
lion in pension assets, representing over 20,000 retirement plans that cover over 1
million individuals. My statement reflects CIGNA's views both as a major provider
of employee benefits and as an employer sponsoring a complete program of benefits
for its own employees.
We commend the Subcommittees' initiative in holding hearings to gather infor-
mation on the important subject of fringe benefits and the tax policy issues that
relate to them. The Tax Equity and Fiscal Responsibility Act and this year's Deficit
Reduction Act made numerous and significant changes in the federal tax laws that
affect employee benefits. These changes were made primarily because of revenue
considerations, and, in many cases without sufficient understanding of the issues in-
volved. Many members of Congress have indicated that proposals to reduce or fur-
ther limit the favorable tax treatment of employee benefits will be seriously consid-
ered in the next Congress. These hearings are an important opportunity for con-
structive dialogue and education on the social and economic purposes for employee
benefits, their distribution throughout the workforce and the true costs and value
provided by these benefits. CIGNA believes there is a pressing need at this time to
develop a comprehensive and cohesive long-term national policy on employee bene-
fits. Therefore, we appreciate the opportunity to participate in the hearings.
This statement addresses four questions raised by the Subcommittee in the an-
nouncement for these hearings:
(1) What social purposes are served by employee benefits?
(2) Are employee benefits available and received by workers at all income levels?
(3) What is relationship between fringe benefits provided by employers and social
programs provided by the government? If certain fringe benefits are not provided by
employers, would there be an increased dependency on federally funded social pro-
grams?
(4) Which is the most efficient use of resources: encouraging employers to provide
benefits through preferred tax treatment or direct provision through public pro-
grams?
SOCIAL VALUE OF EMPLOYEE BENEFITS
Employee benefits, although known for many years as "fringe benefits", have
evolved into something much more than a peripheral component of employment.
They now represent an important form of compensation, which helps employers at-
tract and retain productive employees, offer valuable services in an economical and
efficient manner, and meet important social needs for health and income protection
and family security. Through changes in the economic environment, demographics
and family structure, and changing perceptions of the role of government in pre-
serving the social fabric of America, employee benefits have evolved as the most im-
portant single non-wage vehicle for the long-term economic security of workers and
their families.
Access to health care, through adequate health insurance benefits, is an impor-
tant and long-standing social goal of our nation. Health care is considered to be a
vital necessity by the American public. In the minds of most people, it is not a ques-
tion of whether benefits will be provided, but rather how and who will provide
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them. The widespread availability of private health insurance benefits removes a
significant cause of economic uncertainty from an individual's future, ensuring
greater worker productivity and overall well-being. The greatest single fear of the
individual American is that of catastrophic medical expenses; a corresponding com-
fort is achieved when American workers know that their employers have estab-
lished and maintain properly structured and cost effective health benefit programs.
Equally long-standing has been the national commitment to providing incentives
for private pensions and capital accumulation plans. They are critical components
in the three-legged stool of retirement income security-Social Security, private
pensions and individual savings. In addition to concerns with health care, employees
are concerned about adequate retirement income. These concerns drive much of
their savings and investment behavior. As it is, we save too little as a nation, and
individuals often wait too long before starting to save for retirement. We need great-
er encouragement for savings and investment, not less. The advance-funded private
pension system provides needed long-term funds for capital formation. These are not
insubstantial sums, and are particularly important given the influx of foreign in-
vestment in the U.S., which has begun to shift the balance of ownership of produc-
tive capacity from U.S. to foreign firms.
DISTRIBUTION OF EMPLOYEE BENEFITS
An appropriate goal of employee benefits tax policy is, and should continue to be,
the broad distribution of benefits throughout the workforce. This goal is being
achieved. Recent research findings complied by the Employee Benefit Research In-
stitute (EBRI) indicate that benefits are widely distributed across all income levels
throughout the workforce. In 1983, 76 percent of all workers covered by an employer
pension plan under ERISA standards, and 78 percent of all workers covered by an
employer group health plan with their employer, earned less than $25,000. These
findings are detailed in EBRI's statement and we urge the Subcommittee to consid-
er them carefully.
More specifically, at CIGNA benefits are available generally to all regular em-
ployees without distinction of age, sex, marital status, or salary. Virtually all
CIGNA employees enroll for the medical insurance plan or an HMO and share in
the cost of these benefits. The CIGNA pension plan automatically includes all em-
ployees, including temporary employees. We also provide a matched savings plan in
which all permanent and temporary employees are eligible to participate after one
year of service.
To be sure, the current system of employer-provided benefits could be further im-
proved. In the pension area, for example, there are gaps in coverage, particularly in
certain industries and among mobile employees. We believe broader pension cover-
age should be encouraged by providing incentives specifically targeted to these prob-
lem areas. Similarly, where abusive situations are identified, they should be elimi-
nated through carefully targeted measures, either legislative or administrative. But
I do emphasize again that the privately provided employee benefits system is gener-
ally working well, and as Congress intended. Specific problems should be addressed
by specific solutions.
With respect to pension benefits particularly, it is also important to note that the
private pension system is still maturing. The importance of private pensions as a
source of retirement income will increase significantly in the future. Research spon-
sored by the American Council of Life Insurance (ACLI) and conducted by ICF, Inc.
indicates that benefit receipt at age 67 for the group aged 35-44 in 1979 will be 25
percent higher than benefit receipt for the group aged 45-54 in 1979. Pension bene-
fit levels for this age group will increase similarly. These findings are consistent
with research conducted by EBRI.
RELATIONSHIP BETWEEN EMPLOYER-SPONSORED PROGRAMS AND DEMAND FOR
GOVERNMENT PROGRAMS
The long standing national policy of providing incentives through the tax laws for
employer-sponsored employee benefits has encouraged the growth of the private em-
ployee benefit system. The benefits provided meet real economic security needs of
workers and their families. The elimination of tax incentives for employee benefits
will erode employer sponsorship and result in increased dependency on government
programs. More specifically, reduction on elimination of the tax incentives would
have the following effects:
Substantially raise the cost of providing benefits to either employer or employee
or both.
PAGENO="0695"
689
Cause employers to cease offering some benefits, with the result that employees
will have to obtain coverage individually at much higher cost.
Increase demand for government provided public benefit programs, which will
probably not be as effective or efficient.
In the health care area, the widespread availability of private health insurance
reduces government expenditures. As an example, through recent legislation, Medi-
care became the secondary payor for actively employed individuals over age 65.
High medical bills, lengthy disabilities, or the death of a spouse all represent finan-
cial burdens that can quickly eliminate an individual's personal resources and re-
quire government's financial assistance if no other support is available. Any signifi-
cant reduction in the level of private sector health benefits would certainly be ac-
companied by a demand for government to increase its role in financing these bene-
fits.
Modest levels of employee cost-sharing contribute to containing health care costs.
If, however, changes in the tax laws encourage employers to require excessive em-
ployee cost-sharing for health insurance benefits, many employees, especially low
income employees, will drop their benefit packages completely. This will increase
costs for other insureds through adverse selection, and for all Americans if health
care services are not paid for by those who use them.
EFFICIENCY OF EMPLOYER-SPONSORED EMPLOYEE BENEFITS VS. GOVERNMENT PROGRAMS
We believe that employer-sponsored programs provide benefits in the most effi-
cient and economical manner. In the area of health care benefits, the group insur-
ance mechanism is the most cost-effective way to provide a variety of benefits.
Through the financial mechanism of group insurance, certain personal costs which
generally fluctuate widely by individuals, are translated into moderate level ex-
penses funded by employers and employees and payable on a regular basis. In group
insurance, risk is transferred from the employer to a third party, thus protecting
the employee from the adverse consequences of employer insolvency. The economies
of distributing benefits through a large employer group reduce the cost for all indi-
viduals, making insurance affordable for most of the American public. The employer
acts as an advocate for the employee, and is better able than the individual to nego-
tiate cost-effective benefit plan design and to control claim costs. Administrative
costs for group plans are normally less than one-third of the cost of similar individ-
ual plans.
Because the cost of employee benefits is a direct cost of doing business, employers
are very interested in holding down the costs of providing benefits. Throughout the
nation, employers have formed business coalitions to promote cost containment.
CIGNA is supporting the efforts of these coalitions through a two-year $1 million
matching grant program. In addition, we offer affordable benefit programs designed
to contain costs. As an example, Connecticut General's REMEDI plan design pro-
vides first dollar coverage for several cost containment benefits, while subjecting
higher cost or over-utilized services to coinsurance and deductibles. Overall plan
costs are controlled through coordination of benefits and reasonable and customary
fee limitations. The flexible benefit plan and flexible spending account are other ex-
amples of benefit design to contain costs. These types of plans create an incentive
for employees to utilize their entire benefits package more judiciously by making
trade-offs among the individual benefits in the package. Flexible benefit programs
have the potential to control costs in a way that does not deprive the employee of
any benefits which she/he may individually perceive as essential. The employee
thus becomes a more active participant in controlling his or her benefit costs.
Well designed health benefits encourage preventive health care and enable indi-
viduals to secure assistance at a time when it can be done economically with a mini-
mal loss of productivity. An individual without health benefits is more likely to
delay soliciting medical/dental assistance until the health situation is so severe that
it becomes life threatening or more expensive to treat.
In the area of pension and retirement savings benefits, employer-sponsored plans
are not only more cost-effective because of the economies of group coverage, but, for
many lower and middle income employees, savings for retirement through an em-
ployer-sponsored plan is the only way to assure that an adequate retirement income
will be available. Social Security is intended to provide only basic income replace-
ment and needs to be supplemented by private pensions and individual savings.
Data compiled by EBRI indicates that pension coverage constitutes the major source
of savings for more than half of current pension participants.
Finally, the private sector can adjust to the needs of individuals and accommodate
them much more quickly and with more flexibility than public programs. Thus, for
PAGENO="0696"
690
example, the emergence of coverage for alternative health delivery mechanisms,
along with alternative financing mechanisms and flexible benefits packages recog-
nizes the differing needs in our more mobile and diverse workforce.
A NATIONAL EMPLOYEE BENEFITS POLICY IS NEEDED
We strongly believe that now is the time to begin a full and open debate on em-
ployee benefits issues and to develop a national employee benefits policy. The issues
involved in such a policy are very complex. We urge that they be better understood
before any additional employee benefits legislation is enacted. Some of the issues
which need to be further explored are:
The interrelationships between public and private programs.
The true costs of employee benefits programs:
The tax expenditure estimates for employee benefits programs are frequently mis-
understood or misused. For example, the large tax expenditure for pensions serious-
ly overstates the amount of revenue which would be gained if the tax deduction for
employer contributions to pensions were eliminated.
There is much concern over "erosion" of the taxable wage base due to the growth
of tax favored employee benefits. It is necessary, however, to clearly distinguish
among the growth of legally required employer payments, fully taxable employee
benefits, tax deferred benefits and tax exempt benefits to understand the extent of
tax base erosion.
The economic contribution of private pension plans to capital formation.
The social goals of employee benefits and how well they are being met.
In the past few years, much needed research on these subjects has been undertak-
en and is beginning to yield results. Too often, employee benefit legislation has been
enacted in a data vacuum. We strongly urge members of Congress to proceed cau-
tiously in considering any further legislation affecting employee benefits. We offer
our assistance. Our interest in a national employee benefits policy is not new. As
indication of this interest, we are a co-sponsor this year of a series of four roundta-
ble discussions, sponsored by the Government Research Corporation, on the topic of
retirement policy and U.S. tax policy. The purpose of these discussions is to begin a
national debate on retirement policy. Participants in the roundtable discussion in-
clude representatives from private industry, government policy and academic com-
munities and represent a broad spectrum of views on employee benefits issues.
These hearings represent an important first step along the path we recommend.
We look forward to assisting the Subcommittees in their efforts.
STATEMENT OF DEBORAH J. CHOLLET, PI!.D.,* WASHINGTON, DC
Mr. Chairman, I am pleased to submit this testimony on the importance of em-
ployee benefits to the economic security of workers and their families. The tax pref-
erences accorded particular kinds of employee benefits-pensions, health insurance,
disability insurance and life insurance-have been instrumental in achieving broad
participation among workers and important economic security for workers and their
families. This was the purpose for which Congress granted tax preferences for these
benefits and legislated nondiscrimination rules for qualifying plans. Today, most
workers participate in pension and insurance plans through their employers. They
have come to consider these benefits, and their tax status, as part of the same social
contract that assures their entitlement to Social Security benefits, unemployment
insurance and workers compensation insurance.
This testimony described the prevalence, distribution and importance of three dif-
ferent employee benefits: health, long-term disability, and life insurance. These ben-
efits, together with employee pension plans, are the major elements of most employ-
ee benefit packages. Unlike pensions that provide for the future economic security
of workers, however, health, disability, and life insurance provide current economic
security for workers and their families. For most workers, these benefits are their
only private insurance against the economic disruption of illness, permanent disabil-
ity or death.
*Deborah J. Chollet is a Research Associate of the Employee Benefit Research Institute, a
non-profIt, non-partisan public policy research organization. Before joining EBRI, she was a
Senior Research Fellow at the U.S. Department of Health and Human Services, National Center
for Health Services Research, and served on the faculty of Temple University.
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691
I. EMPLOYER-PROVIDED HEALTH BENEFITS
Most people who have private health insurance receive all or part of their cover-
age from an employer group health insurance plan. In 1982, employer plans provid-
ed health insurance coverage to 80 percent of the total population that reported pri-
vate insurance coverage from any source. These people include workers and their
families at all levels of earnings and income.
A. Coverage.-Health insurance is the most common employee benefit provided to
workers in the United States. In 1982, 84 million civilian nonagricultural workers
reported coverage from an employer group health insurance plan. These workers
represented nearly 78 percent of the nation's total civilian nonagricultural work-
force (see Table 1).
TABLE 1.-DISTRIBUTION OF WORKERS COVERED BY AN EMPLOYER GROUP HEALTH INSURANCE
PLAN BY LEVEL OF WORK FORCE ACTIVITY, 1982 ~
Work force activity
Em
a
0
p1 oyer coverage
Direct
coverage 2
Indirect
coverage 2
No
employer
coverage
PERSONS IN MILLIONS
All workers
Full-time workers
Full year
Part year
Part-time workers
Full year
Part year
Self-employed
83.7
65.1
49.4
15.8
13.6
5.1
8.5
5.0
65.3
58.3
46.1
12.3
4.1
2.1
1.9
2.9
18.4
6.8
3.3
3.5
9.5
3.0
6.5
2.1
24.2
11.8
5.3
6.5
8.1
2.5
5.6
4.3
22.5
PERCENTS
All workers
Full-time workers
Full year
Part year
Part-time workers
Full year
Part year
Self-employed
77.6
84.7
90.4
70.7
62.3
66.7
60.3
53.6
60.5
75.8
84.3
55.0
18.8
27.9
13.8
30.8
17.1
8.9
6.1
15.7
43.8
38.8
46.5
22.8
15.3
9.6
29.3
37.4
33.3
39.7
46.4
1 Includes civiflan nonagricultural workers, except those living in families in which the greatest earner is a member of the Armod Forces or an
agricultural worker.
2 Direct coverage is defined as coverage provided by the worker's own employer plan at any time during 1982; indirect coverage is coverage
received as the dependent of another worker in 1902.
Note-Items may not add to totals because of rounding.
Source: EBRI tabxlations of the March 1983 Current Population Survey (U.S. Department of I~emmerce, Bureau of the Census).
Rates of employer group health insurance coverage are particularly high among
workers who are employed full-time throughout the year, the largest sector of the
workforce. In 1982, more than 90 percent of full-time full-year workers were covered
by an employer group health plan.1
Although most workers (60 percent) have coverage from their own employer plan,
dependents' coverage is an important source of coverage for many, particularly for
workers who are employed only part-time or during part of the year. In 1982, 29.4
million part-time or part-year workers were covered by employer group health
plans. About half (44 percent) of these workers were covered as the dependents of
other covered workers.
Dependents' coverage from employer health plans is also an important source of
health insurance coverage among nonworkers, and particularly among children. In
1982, more than half of all nonworkers under the age of 65 (52 percent) were coy-
1 By comparison, 56 percent of all workers, and 70 percent of the ERISA workforce, participat-
ed in an employer pension plan in 1983. Employee Benefit Research Institute, "New Survey
Findings on Pension Coverage and Benefit Entitlement, EBRI Issue Brie/ No. 33 (Washington,
D.C.: Employee Benefit Research Institute, August 1984).
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692
ered by an employer group health insurance plan (see Table 2). Most of these people
(77 percent of covered nonworkers) were children under age 18; the rest were non-
working adults, including a small number of retirees under age 65.
TABLE 2.-DISTRiBUTION OF NONELDERLY PERSONS COVERED BY EMPLOYER GROUP HEALTH
INSURANCE PLANS, BY WORKER STATUS, 1982 1
Worker status
Number ~
~
millions)
Percent of
persons with
coverage
Percent of aS
persons with
coverage
All persons 2
Workers ~°
130.8
83.7
47.1
40.4
11.0
67.5
77.6
54.9
64.2
37.7
100.0
64.0
36.0
27.6
8.4
NonWorkers
Children
Others
Includes all civilians except those lying in families in which the greatest earner is a member of the Armed Forces or an agricultural worker.
2 Items may not add to totals because of rounding.
"Includes civilian nonagricultural wage and salary workers and self~employed workers.
Source: EBRI tabulations of the March 1983 Current Population Survey (U.S. Department of Commerce, Bureau of the Census).
B. Tax incentives.-High rates of worker participation in employer group health
plans is encouraged by both the tax code and the way that group health insurance
is priced. Employer contributions to health insurance have been statutorily exempt
from individual income and Social Security taxation since 1954. These exemptions
have encouraged worker demand for employer-provided health insurance at all
income levels. In additions, the Social Security tax exemption has provided a finan-
cial incentive for employers to offer health insurance benefits in lieu of wage com-
pensation to workers who earn less than the Social Security ceiling on taxable
wages. In 1983, nearly 95 percent of all workers earned less than the Social Security
ceiling. The combination of these tax incentives for workers and employers has pro-
duced high rates for worker coverage at all income levels.
Aside from the tax code, other incentives have also encouraged wide participation
in employer group health insurance plans. The pricing of employer group health in-
surance has app:irently been an important factor in expanding employee coverage
by encouraging larger employee pooling arrangements. In general, the package of
benefits that insurers are willing to underwrite for a small employee group is less
generous (per premium dollar) than the benefit package available to members of a
larger plan. By offering health benefits to all employees, employers who purchase
insurance (either primary coverage or stop-loss coverage for a self-insured plan) may
find that the incremental cost of providing health insurance is low relative to the
value of improved coverage to all workers. To maximize employee participation in
the plan, and to enhance the plan's cost-efficiency, however, employee contributions
to the plan are generally kept low.
Greater participation in employer health insurance plans has also been encour-
aged by the rising cost of individual coverage. As preferred health insurance risks
(prime-age working adults and their dependents) have been absorbed into employer
group plans, the cost of individual private health insurance coverage has risen.
Recent changes in the tax code have further reinforced the attractiveness of employ-
er plan participation relative to the purchase of individual coverage. While employ-
er contributions to health insurance remain tax-exempt, the 1982 Tax Equity and
Fiscal Responsibility Act (TEFRA) reduced tax preferences for individual insurance
purchase, widening the disparity between the tax treatment of employer-based cov-
erage and the purchase of individual coverage.
C. Equity-Employer group health insurance coverage is possibly the most egali-
tarian employee benefit provided to workers in the United States. Employer health
plans include the spectrum of workers at all levels of earnings; rates of coverage
among all workers except those at the very lowest annual earnings level-generally
with fragmented employment patterns-are highand roughly equal. Furthermore,
the value of health insurance benefits shows little variation among workers.2 As a
2 Employer contributions to health insurance, as reported in the 1977 National Medical Care
Expenditures Survey, showed no significant variation by worker earnings. Gail R. Wilensky and
Amy K. Taylor, "Tax Expenditures and Health Insurance; Limiting Employer-Paid Premiums,"
Public Health Reports (July/August 1982), table 2.
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693
result, employer-provided health insurance is a particularly valuable beneift for
low- and middle-income worker: for these workers, employer contributions to cover-
age represent a proportionately larger real income supplement than they do for
higher-income workers.
Most workers covered by an employer group health plan are low- and middle-
income workers. In 1983, more than 80 percent of all workers covered by an employ-
er group health insurance plan earned less than $30,000; and more one-third earned
less than $15,000 (see Table 3). Only 5 percent of all workers covered by an employ-
er group health insurance plan in 1982 earned more than $40,000.
TABLE 3.-DISTRIBUTION OF WORKERS COVERED BY AN EMPLOYER GROUP HEALTH INSURANCE
PLAN BY PERSONAL EARNINGS, 1982 1
Workers with Percent of Percent of all
Personal earnings coverae2(in workers within workei1svnth
mil~ons) earnings group coverage
Loss 0.4 43.4 0.5
$1 to $4,999 15.2 56.2 18.2
$5,000 to $7,499 6.6 65.9 7.9
$7,500 to $9,999 6.6 74.8 7.9
$10,000 to $14,999 15.8 85.1 18.9
$15,000 to $19,999 12.7 90.4 15.2
$20,000 to $24,999 9.6 92.8 11.4
$25,000 to $29,999 6.3 93.9 7.6
$30,000 to $34,999 93.3 4.6
$35,000 to $39,999 2.1 93.6 2.5
$40,000 to $49,999 2.1 91.7 2.5
$50,000 to $59,999 1.0 92.3 1.2
$60,000 to $74,999 .6 89.4 .7
$75,000 or more .7 86.9 .9
Total, all workers ° 83.7 77.6 100.0
Summary:
Loss to $14,999 44.7 68.2 53.4
$15,000 to $24,999 28.6 91.9 34.2
$25,000 to $39,999 6.0 93.4 7.2
$40,000 or more 4.4 90.7 5.3
Includes nonagricultural civilian workers who reported employer group health insurance coverage at any time during 1982; excludes workers in
families in which the greatest earner is a member of the Armed Forces or an agricultural worker.
2 Includes coverage from the worker's own employer group plan or from the plan of another worker.
Items may not add to totals because of rounding.
Source: EBRI tabulations of the March 1983 Cement Population Survey (hIS. Department of Commerce, Bureau of the Census).
The common allegation that employer health insurance primarily benefits high-
income workers is not supported by national population survey data. Rates of
worker coverage by employer plans are high and stable at all levels of earnings
above $15,000. Even though workers who earned less than $15,000 reported some-
what lower rates of employer coverage in 1982, the number of workers in that earn-
ings group is very large. As a result, more than half of all workers who were cov-
ered by an employer group health plan in 1982 earned less than $15,000.
The income distribution of all people covered by an employer group health insur-
ance plan-covered workers and their dependents-mirrors the distribution of cov-
ered workers by earnings. Table 4 presents the family income distribution of all
people covered by an employer group health insurance plan in 1982. More than half
of these people lived in families with total family income less than $30,000; nearly
three-quarters lived in families with income less than $40,000.
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694
TABLE 4.-DISTRIBUTION OF PERSONS COVERED BY AN EMPLOYER GROUP HEALTH INSURANCE
PLAN BY FAMILY INCOME, 1982 1
Family income
Persons with
employer
millions)
pe~0~i~lo
Percent of all
persons with
coverage
Loss
0.1
5.5
0.1
$1 to $4,999
1.3
2.1
9.2
21.2
1.0
1.6
$5,000 to $7,499
$7,500 to $9,999
3.4
12.2
36.4
56.2
2.6
9.3
$10,000 to $14,999
$15,000 to $19,999
14.8
17.8
68.2
78.2
11.3
13.6
$20,000 to $24,999
$25,000 to $29,999
17.3
15.0
83.9
86.3
13.2
11.4
$30,000 to $34,999
$35,000 to $39,999
11.8
15.9
86.9
81.0
9.1
12.2
$40,000 to $49,999
$50,000 to $59,999
8.3
5.7
87.1
86.2
6.3
4.4
$60,000 to $74,999
$75,000 or more
5.2
84.6
4.0
Total, all persons 2
Summary:
130.8
67.5
100.0
Loss to $14,999
19.1
49.8
33.4
76.7
14.6
38.1
$15,000 to $29,999
$30,000 to $39,999
26.8
35.1
86.6
86.5
20.5
26.8
$40,000 or more
Includes civilians who reported employer gruup health insurance coverage at any time during 1902, encept civilians living in families in which
the greatest earner is a member of the Armed forces or an agricultural worker.
2 Items may not add to totals because of rounding.
Source: EBRI tabulations of the March 1903 Current Population Survey (U.S. Department of Commerce, Bureau of Census).
The income distribution of workers and their families who receive coverage from
an employer group health plan is important for several reasons. First, since most
people covered by an employer health plan are members of low- and middle-income
families, employer-provided health benefits probably substantially raise rates of pri-
vate health insurance coverage throughout the nonelderly population. Research con-
ducted by the Employee Benefit Research Institute (EBRI) and others indicated that
income is an important determinant of individual health insurance purchase among
people without access to coverage from an employer; if employers did not provide
health coverage, most low-income workers would not purchase private health insur-
ance.3 Economic research has consistently found that the lack of health insurance
poses a significant barrier to health care access among low- and middle-income fam-
ilies.4
Second, the income distribution of people with employer coverage suggests that a
tax on employer contributions to health insurance would, in effect, target low and
middle-income workers who constitute more than 80 percent of all workers covered
by an employer group plan.
Because employer contributions to health insurance are not significantly related
to income, taxing employer contributions to health insurance would also be regres-
sive. That is, the additional tax payment of low-income workers relative to their
income would be much higher than the additional tax payment of high-income
workers. EBRI tabulations of data produced by the Congressional Budget Office
(CBO) indicate that a tax cap on employer health insurance contributions would be
regressive at every income level; as a precent of income, people with the lowest in-
3Deborah J. Chollet, Employer-Provided Health Benefits: Coverage, Provisions, and Policy
Issues (Washington, D.C.: Employee Benefit Research Institute, 1984), p. 94. An EBRI simulation
of private health insurance suggests that 56-87 percent of all covered workers with 1979 family
income less than $15,000 would not have purchased private health insurance, if an employer
had not offered and contributed to their health insurance plan.
~ See, for example, Alan C. Monheit, Michael M. Hagan, Marc L. Berk, and Gail R. Wilensky,
"Health Insurance for the Unemployed: Is Federal Legislation Needed?", Health Affairs 3:1
(Spring 1984), pp. 101-111.
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695
comes would pay more than six times the amount of additional tax paid by people
with income above $5O,0O0.~
D. Efficiency of tax preferences: What are the alternatives?-Proposals to revise or
eliminate tax preferences for employer group health insurance have come from sev-
eral quarters. The Administration has proposed a cap on the tax exemption of em-
ployer contributions to health insurance, both to raise revenue and to discourage
generous health insurance benefits in employer plans. The most recent Advisory
Council on Social Security also advocated a tax cap, suggesting that Congress ear-
mark part of the general revenue from the new tax to Medicare's Hospital Insur-
ance trust fund. Those who have proposed comprehensive tax reform (for example,
the Bradley-Gephardt bill) suggest that all employer contributions to health insur-
ance be fully taxed as employee earnings.
These proposals raise several issues. They would potentially enhance federal reve-
nues by broadening the tax base. The prospect of worsening federal tax regressivity
among middle-income workers, however, is a major argument against including em-
ployer health insurance contributions in taxable income. There is, however, an addi-
tional issue to consider: whether current tax preferences, given their public cost in
foregone tax revenues, is a better system for ensuring wide access to health care
than alternative systems might be.
Proposals to establish a national health insurance plan have been introduced in
virtually every session of Congress during the last fifteen years. These proposals
have differed in the populations they sought to serve, the kinds of health care ex-
penses they would cover, and their method of financing health care. Last year, the
Congress considered legislation that would provide basic health insurance for people
who lose employer coverage as a result of unemployment. All of these proposal
failed in Congress because their projected public cost was prohibitive. Even so, most
proposals for a national health insurance plan-including both major proposals to
provide health insurance to the unemployed-rely on employer health insurance
plans as the primary providers of health insurance.
The level of tax expenditures associated with the tax exemption of employer con-
tributions to health insurance (estimated at $17.6 billion in 1984) 6 may be a very
low price to pay for a system of health insurance that serves more than 60 percent
of the population. Federal spending for Medicare, by comparison, is estimated at
$62.2 billion dollars in 1984; 1984 federal-state spending for Medicaid is estimated at
another $37.8 billion.7 Together, these public programs finance health care services
for only about 18 percent of the population.
Moreover, the cost of public insurance programs-in particular, the Medicaid pro-
gram-may be substantially reduced by employer coverage of low-income workers.
A simulation of private health insurance coverage among workers and their depend-
ents in the absence of tax preferences for employer contributions to coverage sug-
gests that the rate of private health insurance coverage among the working popula-
tion might be significantly lower-and the rate of Medicaid coverage significantly
higher-were low-income employees required to pay the full cost of health insur-
ance for themselves and their dependents.8
The central position of employer-provided plans in our system of health insurance
is illustrated by the low rates of alternative health insurance coverage-private or
public-reported by the nonelderly population without coverage from an employer
plan. Only 26 percent of all people living in families of civilian nonagricultural
workers without employer group coverage reported coverage from another private
health insurance plan in 1982 (see Table 5). Another 29 percent reported public pro-
gram eligibility, predominantly for Medicaid. Nearly half (48 percent) of all people
living in worker families without employer coverage reported no health insurance
coverage from any source during the year. These people-totalling 30 million in
1982-are the largest segment of the uninsured in the United States.9
Deborah J. Chollet, Employer-Provided Health Benefits, p. 100.
6 Budget of the U.S. Government, Fiscal Year 1985, Special Analysis G.
Figure includes estimated total 1984 Medicare HI trust fund disbursements and 75 percent
of estimated 1984 SMI trust fund disbursements reported in: U.S. Department of Health and
Human Services, Health Care Financing Administration, Bureau of Data Management and
Strategy, "Summary of the 1983 Annual Reports of the Medicare Board of Trustees, Health
Care Financing Review 5:2 (Winter 1983), pp. 3 and 8. Unpublished Medicaid spending.estimates
were provided by the U.S. Department of Health and Human Services, Health Care Financing
Administration.
8 Deborah J. Chollet, Employer-Provided Health Benefits, p. 93.
Estimates of noncoverage among the civilian nonelderly population generally range between
14 and 16 percent. Members of civilian nonagricultural worker families without private health
insurance coverage or public program eligibility accounted for more than four-fifths of all people
without health insurance coverage in 1982.
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696
TABLE 5.-DISTRIBUTION OF PERSONS WITH PRIVATE HEALTH INSURANCE OR PUBLIC PROGRAM
ELIGIBILITY BY EMPLOYER HEALTH INSURANCE COVERAGE, 1982 1
Other source of coverage
Persons without employer
coverage
Persons with employer coverage
Numtzrof ~ ~
`~lions' employer
coverage
Num~r of Percent of all
persons without
(millions) employer
coverage
All persons
130.8 100.0
62.9 100.0
Other private coverage
7.8 5.9
5.3 4.1
16.1 25.6
18.3 29.1
Any public coverage
Medicaid
1.9 1.5
.4 .3
13.6 21.6
2.4 3.8
Medicare
CHAMPUS 2 3.1 2.4
No coverage, any source
3.3 4*9
30.3 48.2
Includes all people under age 65 thing in famites of civiflan nonagricultural workers in 1982.
2 The Civilian Health and Medical Plan of the unformed Services.
Source: EBRI tabulations of the March 1903 Current Population Survey (U.S. Department of Commerce, Bureau of the Census).
E. Summary and concluding remarks.-Employer group health insurance plans
are the basis of most private health insurance in the United States. In 1982, 80 per-
cent of all people with private health insurance coverage were covered by an em-
ployer plan; half of all people without coverage from an employer plan are unin-
sured from any souce. These people living in worker families without employer cov-
erage represent most of the uninsured population in the United States.
Most of the workers who are covered by an employer health insurance plan are
low- and middle-income workers. In 1982, more than half of all workers with em-
ployer health insurance coverage earned less than $15,000; 88 percent of all covered
workers earned less than $25,000. This distribution of covered workers by earnings
is mirrored in the distribution of all people covered by an employer plan by family
income. More than half of all people-workers and their dependents-covered by an
employer plan in 1982 reported family income less than $30,000. The primary alter-
native source of coverage among workers and their dependents without employer
coverage was Medicaid.
The tax exemption of employer contributions to health insurance are currently
being reevaluated as a potential source of new federal revenues. The tax revenues to
be gained, however, may be small compared to the potential costs of jeopardizing a
system of private insurance that protects more than 130 million workers and de-
pendents. Econometric estimates of private health insurance purchased among
workers and their dependents suggest that significant numbers of people now cov-
ered by an employer plan would not purchase private health insurance if it was not
offered-and largely paid for-by an employer.
Further, potential revenues from the taxation of employer health insurance con-
tributions must be compared to potential increases in public insurance program
spending-particularly by Medicaid. In 1982, 86 percent of nonworkers covered by
employer plans were dependent children under age 18. In all states, recipients of
AFDC benefits 10 are categorically eligible for Medicaid; furthermore, in some
states, dependent children in any low-income family are categorically eligible for
Medicaid.11 The loss of employer coverage among low-income workers, therefore,
could impose significant costs on state Medicaid programs. Potential increases in ex-
isting public program costs, and the potential for significantly higher rates of
noncoverage in worker families, are important considerations in the debate over re-
ducing tax preferences for employer contributions to health insurance.
II. EMPLOYER-PROVIDED DISABILITY AND LIFE INSURANCE BENEFITS
Employer group disability and life insurance plans provide income replacement
for workers and their dependents in the event of the worker's total disability or
10Aid to Famifies with Dependent Children (AFDC) is a state-based, federal matching pro-
gram that provides income assistance for low-income families with dependent children. Eligibil-
ity criteria are established by the states within broad federal guidelines.
iu In 1982, 20 states provided Medicaid coverage for all financially eligible persons under age
18. Deborah J. Chollet, Employer-Provided Health Benefits. pp. 22-24.
PAGENO="0703"
697
death. Although no population survey data exist to document the prevalence and
distribution of life and disability insurance benefits among workers, published data
from a national survey of medium-size and large establishments suggest that life
and disability insurance benefits are about as widely held among workers as health
insurance. The data presented in the following sections are drawn from the Level of
Benefits (LOB) Survey of full-time employees in medium-size and large establish-
ments. This survey is conducted annually by the Department of Labor, Bureau of
Labor Statistics, and reflects plan participation as of January 1 of the survey year.
A. Long-term disability insurance-The purpose of long-term disability insurance
is to provide earnings replacement for workers who become permanently and totally
disabled. Long-term disability coverage can be provided through an insurance
policy, or through the worker's pension plan. In 1982, about 43 percent of full-time
workers in medium-size and large establishments participated in an employer group
disability plan; 49 percent participated in a pension plan that would provide imme-
diate retirement benefits if the worker became disabled (see Table 6). In total, about
92 percent of all full-time workers have disability coverage provided by an insurance
or pension plan.
TABLE 6.-Percent of full-time employees participating in employer health, long-term
disability, and life insurance plans, medium-size and large establishments, 1982 2
[Participants as a percent employee benefit plan of all full-time employeesj
Health insurance for employee 2 97
Noncontributory ~ 71
Health insurance for dependents 2 93
Noncontributory 44
Long-term disability insurance 43
Noncontributory 33
Retirement pension with immediate disabillty retirement provision 49
Noncontributory (4)
Life insurance 96
Noncontributory 82
1 Participation is defined as coverage by a time off, insurance, or pension plan to which the employer
contributes. Employees subject to a minimum service requirement before they are eligible for a benefit are
counted as participants even if they have not met the requirement at the time of the survey. In contributory
plans, only employees who elect and contribute to coverage are counted as participants. Benefits to which
the employer does not contribute are outside the scope of the survey. Only current employees are counted as
participants; retirees who participate in the benefit program are excluded.
2 The employee or dependents may be covered by a working spouse's plan instead of, or in addition to,
participation in the surveyed employer plan.
`All coverage in the benefit program is provided at no cost to the employee. Supplemental life insurance
plans, not tabulatod here, may be contributory.
Published tabulation not available.
Source: U.S. Department of Labor, Bureau of Labor Statistics, Employee Benefits in Medium and Large
Firms, 1982, Bulletin 2176 (August 1983), pp. 6 and 16.
Since earning replacement is the goal of disability insurance coverage, the contri-
bution amounts (from either the employer or employee) and the amount of plan ben-
efits vary by employee earnings. In 1982, two-thirds of full-time employees with dis-
ability insurance plans contributed to the plan; employee contributions for disability
insurance, however, were low-usually les than one percent of employee earnings.
Private pension plans are seldom contributory.
Long-term disability insurance plans usually integrate Social Security, workers'
compensation, or other disability-related public program payments. That is, the plan
subtracts the amount of these payments from the insurance benefit paid to the dis-
abled worker. Social Security DI is an income-redistributive program. The rate of
earnings replacement in the DI program is substantially higher for workers at
lower earnings levels than for those with greater earnings.12 Because DI replace-
ment rates, in particular, are inversely related to income, the integration of public
program benefits probably raises the value of employer-provided disability insur-
ance coverage relative to predisability earnings among higher-wage workers.
12 Social Security replacement rates vary inversely with the individuals covered wages. For
an average-age disabled person with lifetime covered earnings at the minimum wage, 1984
Social Security Disability Insurance payments would replace 62 percent of predisability earn-
ings. With lifetime covered earnings at the average wage, earnings replacement is 43 percent.
With lifetime covered earnings at the Social Security ceiling ($37,800 in 1984), earnings replace-
ment is only 24 percent.
PAGENO="0704"
698
Integration of public program benefits in private disability plans, however, have
at least two additional effects. First, the integration of DI and other public disability
transfers may rationalize the assistance provided by independent public disability
programs. Integration of public assistance payments assures a more uniform level of
earnings replacement for all workers, reducing the higher rate of earnings replace-
ment from DI among low-wage workers.
Secondly, integration avoids "excessive" cumulative earnings replacement from
independent public programs. In general, public-program benefits (DI, workers' com-
pensation, and a variety of other cash and noñcash programs conditioned on disabil-
ity) are independent and tax-exempt. The accumulation of these benefits can equal
or even exceed predisability after-tax earnings. The accumulation of public program
benefits, therefore, together with private disability insurance programs, can provide
a strong incentive for the disabled to remain outside the workforce. The integration
of public program benefits in employer disability plans mitigates the potential work
disincentives created by overlapping disability assistance, reducing both private and
public disability insurance costs. Integration is likely to be most effective in encour-
aging low-wage disabled workers to return to work, since integration particularly
reduces "excessive" earnings replacement among these workers. The work incentive
effects of integration, however, have not been carefully investigated in existing re-
search.
In 1982, two-thirds of all workers who participated in an employer disability in-
surance plan were guaranteed long-term disability benefits, after integration, of 50
to 60 percent of pre-disability earnings, subject to maximum payment limits or ceil-
ings on disability income.'3
B. Employer-provided life insurance.-Nearly all full-time employees in medium-
sized and large establishments participate in an employer-sponsored basic life insur-
ance plan. Like disability insurance, basic life insurance benefits are generally in-
tended to provide income to replace lost earnings. The amount of basic coverage pro-
vided by employer plans, therefore, is usually a multiple of the worker's earnings.
In 1982, about two-thirds of plan participants in medium-sized and large establish-
ments belonged to plans that paid 100 percent or 200 percent of the deceased work-
er's annual earnings. One third of plan participants belonged to plans that paid a
flat dollar amount, usually between $2,000 and $15,000.
In addition to providing death benefits for worker's families, some basic life insur-
ance plans provide a form of disability insurance by continuing coverage or paying
immediate benefits to workers who become disabled. Life insurance plans may pay
disability benefits in two ways. First, some plans provide a lump-sum or periodic
distribution of the policy's face value to workers who become disabled. Second, some
plans pay the face value, or a multiple of the face value, of the policy for accidental
death or dismemberment; in cases of accidental dismemberment, disability is pre-
sumed. In 1982, nearly all full-time workers (99 percent) who participated in an em-
ployer group life insurance plan were entitled to extended coverage or distribution
of the policy's face value if they became disabled. Nearly three-quarters (72 percent)
had coverage that provided accidental death or dismemberment benefits.
Lacking population survey data, the importance of employer-provided coverage as
a source of life insurance coverage for workers and their families is difficult to
evaluate. Certainly, the wide participation by full-time workers in medium-size and
large employer plans suggests that these plans are a major source of life insurance
coverage among workers. Furthermore, although employer-provided basic life insur-
ance is not intended to provide adequate life insurance coverage for most workers,
only a small proportion of employees in medium-size and large establishments elect
supplemental group life insurance coverage-even when the employer contributes.
Low participation rates in supplemental plans by full-time workers suggests that
many employees may have no private life insurance coverage outside of the basic
plan paid by the employer.
C. Efficiency of tax preferences: What are the alternatives?-Employer contribu-
tions to disability and life insurance are treated somewhat differently in the tax
code; both, however are tax-favored. Employer contributions to disability insurance
"Private pension plans do not integrate Social Security benefits as commonly as long-term
disability insurance plans. In 1982, only 45 percent of all private pension participants in
medium-size and large establishments belonged to plans that integrated or offset Social Security
benefits. In general, white-collar employees (professional-administrative and technical-clerical
workers) are more than twice as likely to have an integrated pension plan as are blue-collar
(production) workers. Published data do not indicate whether pension plans that provide for im-
mediate disability retirement are more likely to integrate Social Security and other public pro-
gram benefits.
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699
are tax-exempt. Individual income taxes are paid, however, on benefits actually re-
ceived from a disability plan, including disability retirment, at the time of receipt.
Like employer contributions to pension benefits, employer-paid disability insurance
is tax-deferred.
Employer contributions to life insurance valued at less than $50,000 are also tax-
exempt.14 In general, distributions from life insurance plans are exempt from indi-
vidual income taxation as well. Neither employer contributions to disability or life
insurance (under $50,000), nor the benefits ultimately paid by these plans, are tax-
able by Social Security.
The level of foregone federal revenues, or tax expenditures, associated with the
exemption of employer contributions to accident and disability insurance is estimat-
ed at $120 million in 1984. Tax expenditures associated with the exemption of em-
ployer contributions to group term life are higher: $2.2 billion in 1984.15
For most workers and their families, public disability assistance and survivors'
benefits are the most important alternative to employer-provided disability and life
insurance plans. Several public-sector programs provide income security benefits
comparable to private disability and life insurance. Social Security Disability Insur-
ance (DI) is the largest public-sector program that pays benefits to permanently and
totally disabled workers. Because entitlement for DI benefits, however, depends on
the worker having a sufficient work history in covered employment, many workers
are not currently insured by the DI program. In 1983, only about 62 percent of all
workers were insured by Social Security for disability benefits. Estimated 1983 bene-
fit disbursements from the DI trust fund were $17.9 billion
State workers' compensation programs are also an important source of disability
insurance coverage for most workers: coverage by workers' compensation plans is
nearly universal. However, these plans pay benefits only for work-related disability.
These apparent gaps in public insurance program coverage suggest that employer-
provided disability and life insurance plans are the primary source of disability and
life insurance coverage for large numbers of workers.
Despite coverage by employer disability plans, Social Security, workers' compensa-
tion and other disability-related public plans most people who report being severely
disabled-that is, unable to work at all or regularly because of a chronic health con-
dition or impairment-report no income from any private or public disability plan.
The 1978 Disability Survey conducted by the Social Security Administration found
that only 42 percent of the 10.7 million persons who reported severe disability also
reported receipt of public or private disability benefits.'6 More careful investigation
of this apparent gap in income security for the disabled may be a starting point for
reevaluating the adequacy and effectiveness of tax incentives for employer-provided
plans, and the efficiency of employer plans as an alternative to public disability as-
sistance.
The Social Security Old Age and Survivors Insurance (OASI) is the most promin-
ant public-program alternative to employer-provided life insurance. In 1983, about
55 percent of all workers were insured (either permanently or currently), by OASI.
Survivors' benefit payments from the OASI trust fund in 1982 totaled nearly $34
billion.
The level of Social Security expenditures for disability and survivors' benefits,
given the share of all workers currently insured for these benefits, offers a rough
idea of the potential public cost that might be associated with an essentially public
system of disability and life insurance. It is likely that the additional cost of such a
system would be far greater than the level of tax expenditures associated with cur-
rent tax preferences for employer-provided plans.
Whether a revision of tax preferences for employer-provided plans would jeopard-
ize private insurance coverage is an important issue in considering revised tax pref-
erences for these benefits. In terms of potential coverage loss, the arguments against
revising or eliminating tax preferences for employer-provided disability and life in-
surance plans may be weaker than the arguments against taxing employer-provided
health insurance benefits. At the same time, the estimates of federal revenue loss
associated with tax preferences for employer-provided disability and life insurance
benefits are substantially smaller.
Like employer-provided health insurance, basic life insurance benefits appear to
be evenly distributed among workers-particularly among full-time permanent em-
`~ Employer contributions to life insurance in excess of $50,000 are fully taxable as current
income to the employee.
15 of the U.S. Government, fthcal year 1985, Special Analysis G.
16 Congress of the United States, Congressional Budget Office, Disability Compensation: Cur-
rent Issues and Options for Change (June 1982), p. 18.
40-046 0 - 85 - 45
PAGENO="0706"
700
ployees of larger establishments. When the immediate disability retirement provi-
sions of pension plans are included as a source of long-term disability coverage for
workers, employer-provided disability insurance is probably also quite evenly dis-
tributed among workers. As a result, taxing employer contributions to these benefits
(including employer contributions to pension plans) as employee earnings would
probably target the low- and middle-income workers who constitute most of the
working population.
Unlike employer contributions to health insurance, however, employer contribu-
tions to disability insurance, pensions, and basic group life insurance are usually
calculated on the basis of employee earnings. Since employer contributions vary di-
rectly with earnings, taxation of these contributions is likely to be less regressive
than taxation of employer health insurance contributions. A less regressive tax
burden, in turn, suggests that coverage loss among low-income workers might be
low relative to the loss of health insurance coverage anticipated from full or in-
creased taxation of employer contributions to health insurance. Nevertheless, em-
ployer-provided disability and life insurance-including disability coverage provided
by private pension plans-are an important supplement to the insurance offered by
public disability and surviviors' insurance programs. Existing research has not in-
vestigated the coverage loss that might result from reducing tax preferences for em-
ployer disability and life insurance contributions, or the implications of private cov-
erage loss for the economic security of workers and the cost of public insurance pro-
grams.
D. Summaiy.-Employer-provided disability and life insurance benefits are
common components of employee benefit plans. Although fewer than half of all full-
time permanent workers in medium-size and large establishments are covered by an
employer-provided disability insurance plan, about 49 percent participate in a pen-
sion plan that provides immediate disability retirement benefits. Together, disability
insurance and pension plans provide long-term disability coverage for about 92 per-
cent of full-time permanent workers in medium-size and large establishments. Simi-
larly, nearly all full-time permanent workers (96 percent) in these establishments
participate in an employer-provided basic group life insurance plan.
Nearly all disability insurance plans integrate disability income from Social Secu-
rity, workers' compensation insurance, or other public disability assistance pro-
grams. Integration of public-program benefits rationalizes total disability income, as-
suring more uniform levels of earnings replacement among workers and mitigating
the work disincentives associated with very high earnings replacement. Because
earnings replacement by Social Security, in particular, is greater for low-wage work-
ers, however, integration probably also raises the relative value of employer-provid-
ed disability insurance for high-wage workers.
Like disability insurance, the goal of basic group life insurance plans is earnings
replacement. Plan benefits are usually calculated as a multiple of the worker's
earnings. As a result, the value of employer contributions to group life insurance is
higher for employees at higher earnings levels.
The earnings replacement goals of employer-provided disability and life insurance
plans might make the argument against revising their tax treatment somewhat
weaker than the argument against reducing tax preferences for employer-provided
health insurance. At the same time, the potential federal revenue gains are substan-
tially smaller. Because the value of disability and life insurance benefits-and the
level of employer contributions-varies with employee earnings, taxing employer
contributions to group disability and life insurance plans is potentially less regres-
sive than taxing employer contributions to health insurance. In turn, the loss of dis-
ability and life insurance coverage among low-income workers is potentially lower.
An important caveat is in order, however. No research exists that documents (1)
the distribution of employer-provided disability insurance (including pension cover-
age that provides immediate disability retirement) or basic life insurance among all
workers, or (2) the importance of employer-provided plans relative to other private
and public sources of insurance coverage. Circumstantial evidence suggests that em-
ployer-provided disability and life insurance plans may be a critical source of
income security for most workers. As the basis of our private system of income secu-
rity for workers, employer-based disability insurance, pensions and basic life insur-
ance are probably worth preserving. Maintaining effective tax incentives for em-
ployers to provide these benefits to workers at all earnings levels may be the most
efficient means of assuring a successful private alternative to public assistance.
PAGENO="0707"
701
COMPREHENSIVE ACCOUNTING SERVICES,
Gates Mills, OH, September 10, 1984.
JOHN J. SALMON,
Chief Counsel, Committee on Ways and Means, House of Representatives, Longworth
Office Building, Washington, DC.
DEAR MR. SALMON: With respect to the forthcoming hearings on employer-provid-
ed fringe benefits, I would like to express my feelings on what I believe to be one of
the most inequitable aspects of our current tax provisions.
Having worked in private industry for twenty five years prior to establishing my
own business, and as a result of servicing many other small business such as my
own, it has made me aware of how employer-paid medical plans is so discriminating
against the sole proprietor, the unemployed widows raising families, and employees
not fortunate enough to receive this wonderful fringe benefit.
Those people who have to provide their own overage are faced with monthly pre-
miums of as much as $300, and sometimes even more, of after-tax dollars, whereas
employer-provided hospitalization (including in many cases dental and eye care) is
in effect non-taxable income and furthermore a deductible expense of the employer.
True, the small person can include these premiums as a deductible medical expense
if they are fortunate enough to accumulate enough deductions to qualify for the
extra reduction of taxable income. But really, with the increased restrictions in ar-
riving at allowable excess medical deductions, and the allowable itemized deduction
exclusion ($3400 for family) it produces at best the possibility only of a severely wa-
tered-down benefit.
I trust that this specific item will be given strong consideration in your upcoming
hearings.
Very truly yours,
PAUL W. GIESLER.
STATEMENT OF DR. ERIK D. OI~sEN, CHAIRMAN, GOVERNMENT PROGRAMS COMMITTEE,
DELTA DENTAL PLANS ASSOCIATION
Mr. Chairman, I am Dr. Erik D. Olsen, President of California Dental Service, the
Delta Dental Plan of California, and Chairman of the Government Programs Com-
mittee of Delta Dental Plans Association. Delta Dental Plans Association is the na-
tional coordinating agency for the country's not-for-profit dental service organiza-
tions.
We appreciate the opportunity to testify and want to say at the outset that we
believe that the existing tax incentives for health care benefits are responsible for a
system that is fundamentally fair and that has ensured that the average employee
has adequate health care coverage. Moreover, we believe that any change in the tax
treatment of these benefits, for example, the proposal to limit the amount of em-
ployer-paid health insurance premium that would be considered tax-exempt could
cause a serious diminution of the health care benefits of a large number of employ-
ees and their families.
Delta Dental Plans are separate, autonomous prepayment orgamzations under the
jurisdiction or regulation of state insurance commissioners or attorneys general. As
a result of Delta's support by the dental profession, and unique contractual relation-
ships with participating dental practitioners, Delta Plans provide true "service"
benefits, in contrast to indeminity payments, for the cost of treatment to covered
subscribers.
An estimated 70,000 dentists, over two-thirds of the approximately 100,000 active
practitioners in the United States, are presently contracting participants in Delta
programs.
Delta Dental Plans design their programs to provide maximum dental care bene-
fits to subscribers at reasonable cost to the program purchaser and the covered sub-
scriber. Since all Delta Plans are not-for-profit, no portion of the benefit dollar is
held for dividends to shareholders. All funds received by Delta Plans, therefore, are
used to pay for services rendered to covered subscribers and eligible dependents and
the administration of the program. Dental consultants are designated by the Plans
to review the necessity, appropriateness and adequacy of care provided by partici-
pating dentists.
Delta plan administrative techniques, which have evolved from a first-hand
awareness of the "elective" nature of most dental treatment, embody a cost contain-
ment concept most visible in such program design elements as deductibles, copay-
ments and maximums, and in the determination of covered benefits by Pland dental
directors and consultants. Basing their claims processing policies on professionally
PAGENO="0708"
702
accepted standards of dental care, Dental Plan dental directors and consultants are
able to effectively control areas of program over-utilization and other potential
abuses.
Dental disease is the most extensive health problem in the United States today,
and is almost pandemic with respect to its occurrence in the population. Dental dis-
eases are not self-healing and cannot be cured by professional advice or medication
alone. Without treatment, dental diseases continue their damage and proceed to
become more severe. Some oral health problems have become so widespread that
many people have accepted tooth loss and other complications of dental disease as
inevitable.
A major difference between the public's view of medical and dental payments is
that all too often people fail to relate oral disease to their general systemic health
and well-being. Frequently there is a tendency to accept dental disease complacently
because of the undramatic nature of most dental problems in their early stages.
This casual acceptance of dental disease contributes greatly to the postponement of
treatment.
Although the cumulative dental health problems of this nation are huge, remark-
able progress can be made, and has been made, if the existing knowledge and sci-
ence of dental treatment are put to use and made available to our citizens. The
most economic and efficient way to improve the nation's oral health is to prevent
dental disease. From the econimic standpoint, regular and routine preventive care
and maintenance is the most cost-effective and efficient way to overcome both the
human suffering and the hours of productive work time lost through the disabilities
caused by the poor oral health of countless millions of Americans.
In recent years it has become widely accepted by health care professionals and
economists that prevention might be used, not only to improve the health of Ameri-
cans, but also to help contain the cost of their health care.
The basic idea is a simple one: relatively low cost investments in disease preven-
tion and health education will prevent or postpone the onset of illness and disability
requiring more expensive treatment. Thus, prevention succeeds as a cost contain-
ment mechanism if the dollars saved in future years exceed the current cost of the
prevention effort, whether the savings are due to expenditures completely avoided
or only delayed.
The experience of recent years in dental care through programs of preventive
treatment and the mechanism of dental prepayment and insurance has been per-
haps the most dramatic example of the principle of prevention in action.
Once thought "uninsurable," dental care has now joined hospital and medical!
surgical coverage as a standard benefit in the employee benefit package in virtually
all segments of the American work force. Dental prepayment has enabled and/or
motivated a far greater number of people to obtain dental care than would other-
wise have been possible. it is a demonstrated fact that a larger proportion of cov-
ered patients regularly seek dental care than do those without dental benefit pro-
grams.
Less than 20 years ago, nearly 65 percent of the population did not visit the den-
tist during a given year. Today, more than half of the population has one or more
dental visits annually. Two factors have been critical to this improved picture: the
emphasis on preventive measures, health care education and early diagnosis and
treatment in the dental office and the growth of prepaid dental benefit programs to
the point where 90 million Americans have dental care coverage today.
This expanded coverage has been made possible by the current tax policy toward
fringe benefits. The existing tax incentives for employer provided health care bene-
fits must be continued, in our judgment, if this pattern of improved health is to con-
tinue.
When the Congress was initially considering whether to place a limit on the
amount of tax-exempt, employer-provided health care benefits last year, Delta com-
missioned a survey on the public's attitudes toward health care coverage. The
survey was conducted by the nationally recognized Roper Organization, Inc. Eleven
questions were asked of a nationwide cross-section of 4,000 men and women 18 years
and older in face-to-face interviews in respondent's homes. This resulted in inter-
views with 2,242 employed people. A summary of the survey is attached to our state-
ment, but I would like to summarize some of the key findings here today:
The survey confirmed earlier studies that those who have dental coverage go to a
dentist more frequently than those who do not have coverage-nearly 4 in 10 who
have coverage go to a dentist twice a year or more, compared with just 1 in 4 of
those who do not have coverage.
When asked if the proposed limit on tax-exempt health care benefits would make
a difference in reducing health care costs or reducing the federal deficit, a large plu-
PAGENO="0709"
703
rality said it would not make a difference. This opinion was amazingly similar
across the socio-economic spectrum as well as among men and women and conserv-
atives and liberals.
Almost 8 out of 10 people interviewed had some degree of concern about the way
that a limit on tax-exempt status of health benefits would affect their ability to con-
tinue to protect themselves and their families from illness or injury. Respondent's
were asked, in the event of a "cap" on the tax-exempt status of their health bene-
fits, if they would be willing to keep full coverage and pay more taxes or pay addi-
tional cost out of pocket. Using Roper's standard measurement to determine reli-
ability of response, 76% of the respondents were likely to drop some parts of their
health coverage.
This last point is the one we believe this committee should be concerned with, Mr.
Chairman. With minimal encouragement the working men and women of this coun-
try can receive comprehensive health care benefits and we are a better nation be-
cause of it. Health care benefits are truely the universal fringe benefit.
I would like to emphasize that growth in dental benefit programs has been
achieved without the extreme inflation in dental treatment fees that has afflicted
other health care disciplines. While the number of Americans covered under dental
benefits increased dramatically over the past decade from 12 million people, or 6
percent of the population, to 87 million, or over 33 percent at the end of 1982, the
rate of increase in the cost of dental services actually was lower during this same
period than the rate of increase for all services in 1970-82.
The typical dental benefit program differs from the hospital/medical program
model in that the dental program is structured to provide greater benefits for diag-
nostic and preventive services with lesser benefits for restorative and replacement
services. This approach creates financial incentives for program subscribers to seek
preventive dental services on a regular basis and to establish sound home care
habits (as shown by the Roper survey). The level of coverage for restorative services
assures a sharing by the subscriber of the cost of those services, thereby encourag-
ing the active participation and concern of the consumer.
Because susceptibility to dental disease is nearly universal, the need for preven-
tive services to control such disease is highly predictable. Dental benefit programs,
therefore, are not so much "insurance" as they are a means of prepaying the cost of
prevention and treatment. To a large extent, the seeking of dental care at any given
time is a discretionary act by an individual. For a dental care program to be finan-
cially feasible and stable in its operation, however, it is necessary that enrollment of
the subscriber population be accomplished through a single decision by a group pur-
chaser rather than through decisions by each member of the employee group.
As a practical matter, most prepayment organizations and insurance carriers will
not enroll groups of 25 or less employees. Dental benefit programs are sold only on
a group basis, not to individuals.
The key to a dental program's stability is that individuals in the group represent
the entire spectrum of dental care needs including both those who require an exten-
sive amount of dental treatment involving many dental visits and a relatively high
overall cost as well as those individuals who may rarely require dental care serv-
ices. A dental benefit program involves establishing a per-person cost for the entire
group, regardless of the level of need, in order to cover the cost of the services re-
quired by the group. To permit individuals within a group to withdraw on the basis
of their own limited need or desire-as the survey indicates might well happen-
immediately has the effect of substantially increasing the cost of the program for
the individuals electing to retain dental coverage. This effect occurs when individ-
uals, knowing they may not immediately require dental care, or who have recently
had extensive dental treatment, or who wish to postpone necessary health care,
withdraw from the population base. This creates an "adverse selection" situation,
which in turn forces the costs of dental benefit programs to escalate substantially.
As we have intuitively believed, and as the Roper survey now clearly shows,
changes in tax incentives affecting health care benefits will have a materially ad-
verse affect on dental care coverage and, ultimately, the helath of working men and
women and their families.
In closing, Mr. Chairman, I would like to summarize by saying that dental bene-
fits are on the way to becoming universal, significantly improving the oral health of
America and encouraged by the present tax incentives. As the Roper survey demon-
strates, almost half of working Americans do not believe that changing their incen-
tives would have a favorable impact on either health care costs or the federal
budget deficit. Further, that an alarmingly high 76% of working Americans would
drop some health benefits. Therefore, I would urge this committee, in its future de-
PAGENO="0710"
704
liberations, not to change those incentives that are fundamentally fair and funda-
mentally sound in their effect.
ExEctrrlvE SUMMARY OF DELTA DEr~'rAL PLANS ASSOCIATION
ROPER POLL SHOWS WIDESPREAD OPPOSITION TO TAX ON HEALTH CARE BENEFITS
In a nationwide opinion survey, nearly half those interviewed said that a tax on
health care benefits would not be helpful in controlling health care costs (see pages
31-33). In the same survey, nearly 76% of those questioned said that they were not
"very certain" that they could keep their present health care benefits if such a tax
were imposed (see pages 23-25).
The poli was taken by the Roper Organization, Inc. in the late summer of 1983
with the full analysis of results being released now by Delta Dental Plans Associa-
tion, who commissioned the survey. Delta Plans covered 15 millon people and paid
out an estimated $1 bfflion in benefits to covered subscribers.
The possibility of a tax being imposed on health care benefits was raised frequent-
ly during the 1983 Congressional session. Hearings were held on the proposal (5-
640) but no further action was taken. It is anticipated that the measure will receive
fUrther attention in 1984.
A broad range of interests including labor, management, health and insurance
groups-opposed the measure. Organized dentistry offered particularly active oppo-
sition on the grounds that the copayments and deductibles that are typical of dental
benefit programs already limit costs significantly in comparison with other health
insurance benefits and that these co-payments and deductibles offer a model Con-
gress might consider following rather than penalizing.
Widespread opposition
Among those polled who felt that a tax on health would not be purposeful, there
was a striking similarity on this view from all segments of society, as the excerpt
below from the tables on pages 31 and 32 demonstrates:
Percentage saying tax wouldn't help-College graduate, 48; non-high school gradu-
ate, 45; executive professional, 48; blue collar, 48; men, 48; women, 46; conservative,
46; and liberal, 47.
When subtracting those not answering or giving an equivocal answer to the ques-
tion of a health benefits tax being useful, the poll shows a remarkable consensus
across the entire spectrum of society believing that such a tax is ill advised and pur-
poseless.
The national opinion survey commissioned by Delta showed, as well, that a large
majority of people weren't sure they could retain all of their present health care
benefits if such a tax was imposed. As the comments by the Roper Organization in-
dicate, only those who indicated they were "very certain" about their answer can be
fully expected "to hold to these choices" (page 12). On that basis nearly 8 out of 10
people interviewed had some degree of concern about the way in which a tax would
harm their ability to continue to protect themselves and their families from illness
or injury. Once again, this widely held concern was repeated within nearly all the
subsets of the population, as the following excerpt from the tables on pages 23 and
24 shows:
Percentage less than "very certain" about effects of tax.-College graduate, 74; non-
high school graduate, 80; executive professional, 68; blue collar, 79; men, 73; women,
79; conservative, 75; and liberal, 75.
In addition to these questions on the proposed tax on health benefits, the Roper
poll, confirmed for the first time in hard figures a measure of the way in which
dental insurance has become a common, highly valued health benefit and, as well,
the poll makes it possible to draw proffles, again for the first time, of a typical bene-
ficiary of it as well as one of those who do not yet have this benefit.
Ninety million covered
The survey shows that some 42% of the nation now have dental benefits, an esti-
mated 90 million people. Far more people in the western sector of the nation, 51%,
have benefits today while the southern states lag behind with 32%. Nearly half of
those employed full-time, 49%, have dental coverage while 70% of union members
benefit from it. Among the array of health care benefits available through employ-
ment, only hospitalization, physician costs and major medical plans cover a larger
percentage of the population than does dental prepayment.
Among those groups within the population who are least benefitted as yet by
dental prepayment are those with family incomes of less than $10,000, 13%; those
PAGENO="0711"
705
who live in the least urbanized parts of the country, 27%, and, as mentioned, those
who live in the South, 32%.
Though dental coverage was practically unknown on a national scale as recently
as 15 years ago, the Roper poll indicates that it has quickly become a highly valued
benefit. When those surveyed were asked what parts of their total health care cov-
erage they might consider terminating, only 16% of those employed full-time and
15% of those now having coverage mentioned dental prepayment as one of the first
two or three things they would surrender (page 28).
A further indication of the value of this relatively new benefit is shown by the
answers to two questions asked only of those who do not now have dental prepay-
ment. When asked why they didn't have it, 43% said it was because the employer
Delta Dental Plans Association is a national network of not-for-profit State Plans
offering group prepaid dental benefit programs. In 1983, didn't offer it while only
16% had other reasons (page 34). When asked whether they would take it if offered
by the employer, nearly three out of four said they would and nearly half said they
would even if the employer didn't pay the full premium.
Dental health habits
The Roper poll, finally, asked those surveyed about their dental health habits.
Some 74% of those employed full-time and having dental coverage said they saw the
dentist about once a year or more often while 61% of those employed full time but
without coverage said the same. The higher percentage for those with coverage is
believed by dental experts to be good news from a cost standpoint since it means
such people are more likely to have a good state of dental health and are having
problems corrected early, when it is less expensive to do so.
In 1982, according to government figures, the national dental care bill was some
$19 billion out of a total health care bill of $308 billion. Unlike medical and hospital
spending, dental care expenditures are almost entirely from the private sector, with
only some 4% of the total being public funds as opposed to 44% for the hospital-
medical sector. This makes private funding of dental prepayment of particular im-
portance to the workforce since there is essentially no public support for dental care
cost. The Delta Dental System is the oldest carrier of dental benefit programs in the
nation and, in 1982, its benefits payments accounted for some 20% of the total of
such payments made.
HADDON CRAFTSMEN, INC.,
Scranton, PA, September 21, 1984.
JOHN J. SALMON,
Chief Counsel, Committee on Ways and Means, House of Representatives, Longworth
Office Building, Washington, DC.
DEAR MR. SALMON: The following considerations are respectfully submitted in
connection with the points on which your office is seeking expressions of opinion
regarding the Committee hearings on the distribution and economics of employer-
provided fringe benefits. The viewpoint expressed is representative, I feel, of the
way most relatively small businesses view the possibility of completely changing the
existing concepts of taxation in regard to such benefits. In this context, by a small
business I refer to the numerous companies with 500 to 5,000 employees, (somewhat
larger than the SBA definition of small business), with gross revenues in the range
of $25,000,000 to $200,000,000. These companies are large enough to deal beyond
local markets, yet small enough to be close to and responsive to both customers and
employees.
Nontaxable fringe benefits are very prevalent in such companies, though not nec-
essarily in the most complex or newly fashionable forms. Instead, emphasis is on a
wide range of basic benefits, such as medical/surgical coverage, basic group life in-
surance, some form of income continuation in the case of short term illnesses, and
also some provision for benefits to those who encounter long-term disability.
Being basic type programs, they are usually offered to all classes of employees,
without distinction between salary ranges, or type of work. Many times, depending
on industry, these benefits are provided under collective bargaining agreements.
More often than not, when that is the case, similar benefits will also be given to
other employees. Part time or temporary employees may be excluded, where permit-
ted, only because giving them the same benefits would not be fair to full time em-
ployees.,
The tax structure is not a major factor in the selection of benefits, especially
where the benefits are union negotiated. Most coverages are viewed as protection
against undesirable eventualities, rather than as an alternative to taxable compen-
PAGENO="0712"
706
sation. In negotiating situations, wage increases are still the item of choice; addi-
tional fringe benefits are sought when there is a perception that existing benefits
are inadequate, not because of tax considerations. The majority of individuals are
still more concerned with disposable income than with getting income tax-sheltered.
As to the effect on the tax system of making presently nontaxable benefits tax-
able, it is obvious that this would initially raise revenues collected. The effect would
be regressive, since the burden would fall most heavily on middle income wage
earners. However, it is to be expected that such wage earners would seek to restore
their purchasing power through seeking larger wage increases than would otherwise
be the case. To the extent that this succeeded, the tax on benefits would have the
same effect on available corporate funds as would an increase in the corporation tax
rates. Taxing benefits not only runs counter to present benefit policies, but also has
as its main advantage the possibility of getting revenues which would otherwise
come from a tax increase, without actually enacting any increase in the tax rates.
Higher taxes are higher taxes, however derived; taxing of benefits merely makes the
employer community, to some extent, the culprit, rather than the taxing authority.
These observations apply equally to FICA taxes. Why disturb the private insur-
ance system which has brought health and/or life insurance to so much of the work
force? If additional funds are needed, a change on the rate would have the same
effect as a change in the base. From the employer standpoint of those paying half of
the FICA tax on wages in employment, there is no advantage to paying a lower rate
on a higher base if the total tax will be designed to come out the same.
The effect of capping tax deferred amounts would be largely cosmetic. It gives the
appearance of trying to prevent high income taxpayers from getting a disproportion-
ate break. However, the total revenues which would be raised is not really that
great, unless the cap reached down to a figure that affects many, many upper
middle income taxpayers. That would be counterproductive to any attempt to make
the change get broad based support.
As to the question of whether federally funded social programs would be neces-
sary if employers didn't provide fringe benefits, I think the record is clear. Even in
such areas where benefits are provided by employers, as in the private pension
system, there has (beginning with ERISA and continuing with other legislation)
been increasing limitations on what can and cannot be done. Unfortunately, most of
these relate to the question of how to prevent abuses, rather than to the positive
aspects of what things of highest general value should be achieved. The items of
greatest importance will not be the same for all employee groups, depending on in-
dustry, average age, and so on. The present private sector system offers both em-
ployees and employers the greatest opportunity to arrive at the most suitable bene-
fits to a given situation. On a more general level, one need only look outside the
United States to determine if government programs at some level would be re-
quired. Most, if not all, European and Latin American countries have elaborate
social payment systems, including all of the major European industrialized societies.
The only reason similar systems are not found in this country, in my opinion, is
because they are not perceived as being needed, because so many people are covered
for various benefits through the existing employer-financed plans.
I trust that these observations will be of assistance to you in reviewing the alter-
natives.
Respectfully submitted.
WILLIAM H. DUNSTONE, Vice President.
STATEMENT OF RONALD D. PEARSON, PRESIDENT AND CHIEF OPERATING OFFICER,
HY-VEE FOOD STORES, INC., CHARITON, IA
I'm Ron Pearson, President and Chief Operating Officer of Hy-Vee Food Stores,
Inc., Chariton, Iowa. We are an Iowa based company operating 134. supermarkets
and 19 drugstores, 153 retail units. We operate in six states-Iowa Missouri, Minne-
sota, Illinois, Nebraska and South Dakota. Hy-Vee has been in business for 53 years;
last year's sales were $1,100,000,000. At fiscal year end we employed 13,505 employ-
ees; 62 percent were parttime of which many are highschool or college students.
We are a privately held company, employee owned, with the largest stockholder
having no more than 14 percent of the stock.
I'm here today to comment on capital accumulation through profit sharing. Hy-
Vee has both a salary bonus system based on individual profit center results and an
employee profit sharing trust. With both of these systems we like to think we're a
very employee benefit oriented company.
PAGENO="0713"
707
We would like to give some information about our employee trust. We designed
the employee trust to allow our employees to share the company profits, building
more job satisfaction. Also the trust is to cover retirement benefits, if the employee
wishes catastrophic medical expenses not covered by insurance, and dependent edu-
cation in case of parent hardship.
First, some facts about our profit sharing trust plan. At fiscal year end 6,790 em-
ployees were participants, 85.15 percent between the ages of 19 and 44; 15.73 per-
cent between 45 and 70 years of age and .12 percent over 70 years. Out of all these
participants 69.13 percent earned less than $20,000 per year; 81 percent earned less
than $25,000 and over 98 percent earned less than $50,000 per year (table is at-
tached showing details).
Additional details about our plans: We started our plan in 1960 with a company
contribution of $127,606.00 and have now grown to a total value of participants'
equity of $75,675,285.00. The plan has grown through healthy company contribu-
tions, forfeitures, and a good earnings record (table attached showing details).
We felt three things were important for our employees when we were designing
our profit sharing plan:
(1) How soon you can get in:
(2) How long it takes to be 100 percent vested; and
(3) How much you get.
Hy-Vee has elected to make participants eligible at age 19; thus allowing many of
our parttimers to accumulate some capital while in school. We have also elected to
fully vest a participant after ten years by "graded vesting" and have a graduated
scale for vesting between two years and ten years, i.e., five years 40 percent, six
years 50 percent, nine years 80 percent, ten years 100 percent.
We have also elected to establish a fixed formula for company contributions
rather than have the Board of Directors determine the amount each year. We have
averaged approximately 26 percent of pretax company profits contributed to the
trust over the past several years.
Why is this data useful to you? We think our plan demonstrates that rank and
file workers, including our 200 union employees, are provided outstanding benefits.
Also the plan covers predominately low and middle income workers; it is ostensibly
not "top heavy." I would like to give you some of the examples of some of the em-
ployees who have accumulated capital through this plan.
(1) Employee No. 1-Knoxville, Iowa, parttime employee; started 1977 at age 16;
terminated six years later at age 23 after completing college. He accumulated vested
capital of $1,488.37.
(2) Employee No. 2-Marshailtown, Iowa, parttime employee; started in 1972 at
age 19; terminated twelve years later. She was 100 percent vested; she wanted to
spend more time with her family. Her trust account balance was $11,952.54.
(3) Employee No. 3-Clarinda, Iowa, started at age 26, a full time grocery employ-
ee; deceased June, 1984, at age 57; 100 percent vested; trust account to his wife of
$48,851.40.
(4) Employee No. 4-Chariton, Iowa, full time truck driver; started at age 19; de-
ceased March, 1984, age 53; vested 100 percent; trust account to his wife of
$83,449.52.
(5) Employee No. 5-Albia, Iowa; employed June, 1940, at age 20; retired in 1983
at age 64; full time grocery employee; trust account balance of $50,549.88.
(6) Employee No. 6-Sioux Falls, South Dakota, employed June, 1977; age 16; part-
time clerk; terminated in March, 1984; vested trust account balance $1,938.12.
(7) Employee No. 7-Marion, Iowa; employed August, 1977; age 16; parttime clerk;
terminated March, 1984; vested trust account balance $2,148.87.
(8) Employee No. 8-Trenton, Missouri; employed May, 1967; Age 47; full time
grocery clerk; retired January, 1984; vested trust account balance of $38,303.26.
Our plan was designed to help the employees accumulate capital, whether it be a
parttime student or a long time retiree. We believe that any changes which are
made to disturb this accumulation will not be in the best interest of the rank and
file employees of Hy-Vee and may cause them to look to the government for more of
their needs.
PAGENO="0714"
Age group:
0-18
19-44
45-70
Over 70
Total
Wage group:
0 to $5,000
$5,000 to 10,000....
$10,000 to 15,000..
$15,000 to 20,000..
$20,000 to 25,000..
$25,000 to 30,000..
$30,000 to 35,000..
$35,000 to 40,000..
$40,000 to 45,000..
$45,000 to 50,000..
$50,000 to plus
Tntsl
708
TABLE 1.-EMPLOYEES' TRUST, 1983
TABLE 2.-EMPLOYEES' TRUST, 1983
.
Fiscal year
.
Total part
cont°~~
`°°
Percent of
pre-tax
profit
Pe
rcentage for distribution
~~r~nt ~
Forfeitures
Earnings percent
wages
1960
561
127,606
16.383
3.6216989
0
.6514429
1961
654
124,188
15.756
2.9999400
5.7773930
4.6773020
1962
738
827
219,013
414,959
19.569
25.000
4.9065823
7.6603310
7.9091210
4.9749879
(11.1047078)
9.0212214
1963
1964
941
1,024
476,785
558,811
25.000
25.000
7.7313399
8.4152086
4.4422754
3.2570834
6.8161863
8.7542446
1965
1966
1,101
1,206
675,509
695,064
25.000
25.000
8.7462498
7.9638827
4.1579145
3.5774660
7.7548308
12.9451829
1967
1968
1,291
1,338
548,542
900,337
20.669
25.000
5.8996191
8.6607828
2.5204067
3.2026641
8.8470066
6.0150168
1969
1970
1,568
1,827
1,010,975
1,047,413
25.000
23.651
7.6769084
6.4283721
2.4799288
1.7636118
6.7975835
10.4075341
1971
1972
2,007
2,125
1,298,239
1,623,933
25.000
25.000
6.9681312
7.8461822
3.1065323
2.6635361
8.2636359
7.3930474
1973
1974
2,287
2,515
2,276,433
2,614,433
25.000
25.000
8.8340190
8.3029266
2.7051493
1.9216305
(1.5934195)
13.3010669
1975
1976
2,713
3,620
3,447,566
3,222,987
25.000
25.000
9.0131974
6.9390049
2.5289300
.7271988
16.1065776
9.8795616
1977
1978
4,098
4,584
4,024,645
4,394,230
25.000
25.000
7.1723166
6.3896294
.7735060
.7494020
9.9662529
9.3887776
1979
1980
5,081
5,444
4,735,510
5,643,060
25.000
25.000
5.9541113
6.2359841
.6340154
.6385828
7.7457876
3.6703072
1981
1982
6,156
6,790
5,141,420
5,414,405
24.126 4.9050808
24.101 4.7045339
.5563821
.5539783
17.1789124
14.3021840
1983
1983 Participants
Full time Regular
time
Part time
Total
employees
Percent to
total
0 0 0 0 0
2,872 1,031 1,811 5,714 84.15
702 235 131 1,068 15.73
2 0 6 8 .12
..
3,576
1,266
1,948
6,790
100.00
~.
6
23
462
491
7.23
.
124
686
1,405
2,215
32.62
..
517
493
76
1,086
16.00
,.
839
58
5
902
13.28
,.
787
6
0
793
11.68
.
587
0
0
587
8.65
.
389
0
0
389
5.73
.
138
0
0
138
2.03
.
43
0
0
43
.63
.
28
0
0
28
.41
.
118
0
0
118
1.74
.
3,576
1,266
1,948
6,790
100.00
PAGENO="0715"
709
STATEMENT OF SOPHIE M. KORCZYK, PH.D.,* ALEXANDRIA, VA
SUMMARY
Mr. Chairman, I am pleased to submit this statement on tax incentives for pen-
sions and flexible benefits programs. Tax provisions governing pensions and flexible
compensation plans have figured prominently in Congressional debates over the last
three tax bills.
What does pension policy cost?
Tax expenditures are commonly used in public policy debates as a measure of the
social cost of federal pension policy. There is wide disagreement, however about the
proper way to measure these costs and about who benefits from the incentives pro-
vided in these provisions. Measured using the Treasury's approach, about $0.83 out
of every tax-deferred dollar appears to be lost to the Treasury. Such estimates over-
state the amount of revenue lost due to such provisions, however. Because today's
pension-plan participants will have higher retirement incomes than today's retirees,
they will pay more taxes in retirement. Over their lifetimes, those employees now at
the beginning of their pension careers will repay all but $0.25 to $0.40 of every tax-
deferred dollar.
Even this more realistic lifetime measure of tax expenditures probably still over-
states the revenue costs of pension-related tax policy. It ignores the availability of
other tax-favored investment vehicles that could be used for retirement saving in
place of employer pensions as well as the costs of relying on the taxpayer as the sole
guarantor of retirement incomes.
Who receives employee benefits?
The expansion of employee benefits has primarily helped the middle income
worker. Among employees who were covered by pensions in 1983, nearly 28 million
(or 59.0 percent) earned less than $20,000. Among employed persons with employer-
provided health coverage 83.7 million (or 74.3 percent) earned less than $20,000, and
23.2 percent earned between $20,000 and $50,000. Fewer than 3 percent of pension
and health insurance participants earn more than $50,000.
Flexible compensation plans
The labor force is changing rapidly. Flexible compensation plans have emerged as
some employers' effort to respond to the needs of a diverse work force without
adding to compensation costs to accommodate each additional group. Most flexible
compensation plans allow employees to trade benefits in one area for increases in
other benefits. A two-earner couple, for example, can trade redundant health cover-
age for other benefits such as dependent care, increased life insurance, or added va-
cation time.
Employers with flexible compensation plans have found that the ability to choose
increases employees' satisfaction with their benefits even when the dollar value of
the benefits package is unchanged. The ability of employers and employees to use
flexible compensation to contain benefit cost growth suggests that these plans can
have important macroeconomic effects by stabilizing benefit growth and labor costs.
Recent legislative actions and prospects for the future
Employee benefits issues have played a major role in recent tax policy debates.
For example, in the Tax Reform Act of 1984, the Congress made significant changes
in at least sixteen areas of employee benefits. The importance of employee benefits
in tax policy promises to continue as the Congress tries to deal with projected feder-
al deficits. Both the Congress and the Administration have expressed considerable
interest in basic reform of the personal income tax.
In general, basic tax reform proposals would lower marginal tax rates and expand
the income tax base. Basic tax reform proposals offer ways to restructure-not
lower-the nation's tax bill. Three recent legislative proposals illustrate some of the
tradeoffs in basic tax reform.
Comprehensive Income Tax.-Senator Bill Bradley (D-NJ) and Representative
Richard Gephardt (D-MO) have introduced a comprehensive income tax proposal (S.
1421/H.R. 3271). It would raise the same amount of revenue as current law by using
*~phje Korczyk earned her Ph.D. in economics from Washington University (St. Louis). Dr.
Korczyk is presently a research associate at the Employee Benefit Research Institute. Her previ-
ous positions include appointments at the Congressional Budget Office and universith teaching
and research positions. Portions of this statement are based on Sophie M. Korczyk, Retirement
Security and Tax Policy (Washington, D.C.: EBRI, forthcoming).
PAGENO="0716"
710
only a three bracket tax-rate structure: 14, 26, and 30 percent. All employer contri-
butions for benefits other than pensions would be included in the employee's tax-
able income. The Section 415 limits on pension benefits and contributions would be
made much more restrictive than under current law.
Senator Mark Hatfield (R-OR) has also introduced a comprehensive tax proposal
(5. 2158). The Hatfield proposal would retain current-law treatment for employer-
provided pensions, but all other employer contributions for benefits would be includ-
ed in taxable income. There would be six tax brackets, ranging from 6 percent to 20
percent.
Consumption Tax.-Senator Dennis DeConcini (D-AZ) has introduced a consump-
tion tax proposal (5. 557). Under this proposal, all income other than that used for
investment would be taxed at a marginal rate of 19 percent. This tax structure
would be financed by eliminating nearly all current law tax preferences. Contribu-
tions and benefits in retirement-income programs would retain their current tax-
law treatment. The employer's contribution for health, welfare, and "fringe" bene-
fits, however, would no longer be tax deductible as an employer compensation ex-
pense.
All three legislative proposals, though they are based on different tax principles,
would eliminate tax preferences for most employer-provided benefits. Employer con-
tributions for nonpension benefits would be treated as taxable income.
CONCLUSIONS
We ask, Mr. Chairman, that the Congress recognize how much it has already
achieved in safeguarding the economic security of the American worker and that it
renew its commitment to encouraging private provision for economic security.
STATEMENT
Mr. Chairman, I am pleased to submit this statement on tax incentives for pen-
sions and flexible benefits programs. Tax provisions governing pensions and flexible
compensation plans have figured prominently in Congressional debates over the last
three tax bills. In my statement today, I will address the following questions:
What is the revenue cost of pensions and flexible benefits plans?
Who receives these tax benefits?
What does society get for the foregone revenue?
Are tax incentives more effective or less effective in achieving certain goals than
other policy devices aimed at the same goals?
What are the implications for upcoming policy debates?
Trends in employee benefits
Employer contributions for employee benefits have increased steadily as a share
of compensation over the last thirty years. According to Department of Commerce
estimates, cash outlays for employee benefits beyond wages and salaries have grown
from 4.9 percent of total compensation in 1950 to 15.8 percent in 1982. Over a third
of this amount finances employer-sponsored pension plans. Pension contributions in-
creased from 1.8 percent of employee compensation in 1950 to 5.3 percent in 1982.
This growth appears to be slowing, however. Between 1980 and 1982, for example,
employee benefits grew 1.6 percent annually as a share of compensation, compared
with an annual rate of over 4 percent between 1970 and 19780.
The tax-favored treatment of qualified pensions predates even the establishment
of the Social Security system in 1935. Statutes enacted in 1921 and later, covering
income from trusts and pension plans, were designed to encourage the expansion of
pension coverage and increased saving levels and to provide a private soruce of re-
tirement security. The tax treatment accorded more recently developed retirement
and capital accumulation vehicles such as individual retirement accounts (TEAs),
simplified employee pension plans (SEPs), section 401(k) plans, and qualified volun-
tary employee contributions (QVESs) indicates continued Congressional interest in
increasing voluntary individual retirement savings.
The federal tax system is the most important factor influencing benefit growth.
The tax code makes benefits cost-effective as compensation and encourages the
broad coverage of employees. The tax code makes benefits cost-effective by providing
a tax deduction for employers and preferential tax treatment for employees. As a
result, a dollar in benefits may be worth more to the employee than a dollar in cash
wages.
The tax code encourage employers to extend their benefit coverage to lower- and
moderate-income employees. The preferential tax treatment accorded benefits is
PAGENO="0717"
711
contingent upon compliance with the tax code's nondiscrimination provisions gov-
erning coverage of the employer's work force.
Historically, the tax code has also worked with inflation to encourage benefit
growth as protection against inflation-driven increases in real marginal tax rates.
During the past twenty years, inflation has pushed most taxpayer into higher mar-
ginal tax brackets, despite legislation lowering nominal tax rates for the different
income levels. This "bracket creep," the gradual increase in real marginal tax rates,
has prompted the use of noncash benefits to stem the erosion of real income. Up to
30 percent of the benefit growth over this twenty-five period may be attributed to
attempts to alleviate inflation's impact on employee compensation.
While the tax code is a major factor encouraging benefit growth it is not the only
factor. Employee compensation also depends on income growth, employer cost con-
siderations, and employer and employee preferences.
What does pension policy cost?
Tax expenditures are commonly used in public debates as a measure of the social
cost of federal pension policy. The Treasury estimates that pension-related tax pro-
visions cost the federal government over $50 billion each year in lost revenues. Per-
sistent federal deficits have called attention to Internal Revenue Code provisions
that appear to subsidize select groups of taxpayers.
There is wide disagreement, however about the proper way to measure these costs
and about who benefits from the incentives provided in these provisions. Tax-ex-
penditure measures used in the federal budget process are calculated on a cash-flow
or cross-sectional basis, with the amount of the taxes deferred by current pension
plan participants offset against the amount of taxes paid by current beneficiaries.
Measured this way, about $0.83 out of ever tax-deferred dollars appears to be lost to
the Treasury (see table 1). Such estimates overstate the amount of revenue lost due
to such provisions, however. Because today's pension-plan participants will have
higher retirement incomes than today's retirees, they will pay more taxes in retire-
ment. Over their lifetimes, those employees now at the beginning of their pension
careers will repay all but $0.25 to $0.40 of every tax-deferred dollar. As the pension
system matures, the numbers and income levels of pension-plan participants and re-
tirees will differ less than they do today. As a result, in the future, pension-related
tax expenditures measured using the Treasury's approach will be much closer to
lifetime estimates.'
TABLE 1.-HOW MUCH OF PENSION-RELATED TAX DEFERRALS IS LOST TO THE TREASURY?
[In percent]
Method used
Taxes lost
Taxes deferred
Treasury method
Lifetime method:
83
14
28
40
36
0
86
72
60
64
Nominal dollars'
Real dollars 2
Discounted for interest:
At pension rate
At federal rate
1 Beforeadjusting for inflation.
2 adjusting for inflation.
`Interest rate used to discount taxes paid in retirement to the year ef retirement
Source: Sophie M. Korczyk, Retirement Security and Tax Policy (Washington, D.C.: EBRI, forthcoming).
Even this more realistic lifetime measure of tax expenditures probably still over-
states the revenue costs of pension-related tax policy. Taxpayers have access to
many other tax-favored investment vehicles that could be used for retirement
saving in place of employer pensions. In the absence of tax provisions favoring pen-
sions, taxpayers would probably make more use of these vehicles. This would in-
crease the revenue loss attributable to these alternative investments.
Tax expenditure statistics are also misleading because they imply that only ad-
vance-funded plans impose social costs. Tax deferrals are measured only on contri-
`For further analysis of these issues, see Sophie M. Korczyk, Retirement Security and Tax
Policy (Washington, D.C.: EBRI, fortchcoming). See also Issue Brief "Pension-Related Tax Bene-
fits," no. 25 (December 1983) and Issue Brief "Employee Benefits and the 1985 Reagan Budget,"
no. 27 (February 1984).
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712
butions and earnings actually received by plans, which means that a pension plan
must be advance-funded to result in tax expenditures. The Employee Retirement
Income Security Act of 1974 (ERISA) established minimum funding standards for
private-employer defined-benefit plans, enhancing benefit security. In contrast, the
Civil Service Retirement System (CSRS) and the Military Retirement System (MRS),
the two major federal retirement plans, have little impact on tax expenditures be-
cause they are largely unfunded. Underfunded or unfunded plans, however, can cost
the taxpayer much more in the long run. In sum, pension-related tax policy is not
as costly as available revenue-lost estimates would suggest.
Who receives employee benefits?
The expansion of employee benefits has primarily helped the middle income
worker. Among employees who were covered by pensions in 1983, nearly 28 million
(or 59.0 percent) earned less than $20,000 (Table 2). Among employed persons with
employer-provided health coverage 83.7 million (or 74.3 percent) earned less than
$20,000, and 23.2 percent earned between $20,000 and $50,000. Fewer than 3 percent
of pension and health insurance participants earn more than $50,000.
TABLE 2.-DISTRIBUTION OF EMPLOYEES WITH PENSION AND HEALTH COVERAGE BY EARNINGS
Earnings
Employees with pension
coverage, 1983
Percent
Employees with health
coverage, 1983
Percent
Less than $20,000
$20,000 to $49,999
$50,000 and over
27.9 59.0
18.1 38.0
1.4 2.9
83.7 74.3
26.2 23.2
2.7 2.4
Total'
47.4 100.0
73.0 100.0
1 Detail may not add to totals due to rounding. Totals include only those health and pension plan participants who reported their earnings in the
Survey. When those rot reporting their earnings are added, coverage totals are higher.
Source: EBRI tabulations of iS. Census Bureau Current Population Survey, 1983 and EBRI-HHS Current Population Survey Pension Supplement
The distribution of pension-related tax benefits among income groups reflects the
distribution of coverage and participation. The largest share of lifetime pension-re-
lated tax benefits accrues to middle-income employees. In 1979, 34 percent of em-
ployees aged 25 to 34 earned between $20,000 and $50,000. These employees will re-
ceive 53 percent of the group's pension-related tax benefits (table 3). Those employ-
ees age 25 to 34 who earned $20,000 or less will receive 24 percent of their group's
lifetime pension-related tax benefits, while 22 percent will go to those earning over
$50,000.
TABLE 3.-NET LIFETIME PENSION-RELATED TAX BENEFIT SHARES AMONG EMPLOYEES AGED 25 TO
34
Lifetime
Income 1
All persons
(percent)
.
P~nPoflt
~ rce~t2
pe
Lifetime tax
shares by
income class
(percent)
pension
benefit tax
shares by
income class
(percent)
$20,000 o
r less
61
53
42
24
$20,001 t
o $50,000
34
5
41
6
42
16
53
22
$50,001 o
r more
1 Total 1979 income in 1983 dollars.
2 Includes not only those who were pension participants in 1919, but also those in this age group who are projected to acquire pension coverage
later in their careers.
The share of lifetime taxes paid by those with base.year incomes below $50,800 is higher than their share of current.year taxes, because their
lifetime incomes are higher than their current.year incomes. In 1982, taxpayers with incomes over $50,000 paid 35.4 percent of total income taxes.
U.S. Department of the Treasury, Internal Revenue Service, Statistics of Income Builletin, Winter 1983-1984 (Washington, D.C.: lotemal Revenue
Service, 1984), p. 20.
Source: EBRI calculations based on PRISM simulation results.
Employee benefits are now a mainstay of the middle-income worker's income se-
curity, providing hazard protection as well as building assets. As much as a fifth of
PAGENO="0719"
713
all spending on health care is now made through employer-sponsored plans.2 Pen-
sions also result in a progressive redistribution of wealth that favors those at the
lower end of the income scale who do not tend to save much out of current income.
This redistribution can be demonstrated by comparing data on pension coverage
and income from savings as reported in the 1983 Health and Human Services (HHS)
and Employee Benefit Research Institute (EBRI) Current Population Survey (CPS)
Pension Supplement, the best available source of information on pension coverage.
Direct information on savings would be preferable to the data on income from sav-
ings, but it is not available on a current basis.
Accumulated pension benefits constitute the major form of savings for more than
half of all persons with pension coverage. According to the CPS, more than 40 per-
cent of the labor force reported no savings income in 1983 (table 4). This group's
average income was $9,651, just under half the average income of those reporting
some asset income. Some 55 million workers, including almost half of the group re-
porting little or no savings income on the CPS, were covered by employer pensions
in 1983. Pensions thus constituted a net increase in savings for these workers. As-
sessments of pension-related tax policies should consider the net increase and redis-
tribution of wealth that results from expanded pension coverage.
TABLE 4.-SAVINGS, PENSION COVERAGE, AND INCOME, 1983
Employees covered 2
Savings status 1
(mittions) (percent)
Employees n
(mitlions)
ot covered
(percent)
Average aon
(dottars)
oat iocome
(percent)
No savings 18.2
Some savings 36.9
19.0
38.4
20.6
20.3
21.5
21.1
$9,661
19,209
40.5
59.5
Totat 55.1
57.4
40.9
42.6
15,338
100.0
1 Individuals are classified as having some savings or no savings based on whether or not they reported any asset income in response to the
survey questioos. Asset income includes interest, dividends, rents, and royalties.
2 Coverage refers to public- and private-sector pension plans and includes holders of IRA or Keogh accounts.
Includes individuals reporting negative asset income (i.e., decreases in asset values).
Source: EBRI calculations based on preliminary data from the Bureau of the Census, Current Population Survey (May 1983).
What does society get in return?
Tax benefits are not the only advantage received by pension participants. What-
ever the revenue cost of the pension-related tax-code provisions, sould retirement
policy design requires that this cost be measured against the social benefit of in-
creased savings and higher benefit levels.
Increased savings-Pensions both increase and reallocate total savings. If pension
contributions were received as cash income, total saving would decrease. The drop,
moreover, would be relatively greater among lower-and moderate-income employees.
While nonpension saving is concentrated among relatively high-income individuals,
pensions are distributed broadly among income groups.
Pensions also change the distribution of saving among investment vehicles. Non-
pension saving consist primarily of liquid saving deposits and investments in owner-
occupied homes or other consumer durables. Pension funds, in contrast, are invested
in securities that finance productive capacity and employment. Pension funds have
grown to be the single largest supplier of investment funds to financial markets. At
a time when unmet capital financing needs are emerging throughout the economy,
the fact that pension funds provide long-term capital gives them an important role
in economic policy.
Increased retirement income-The availability of a pension often means the differ-
ence between subsistence and the ability to maintain pre-retirement living stand-
ards in retirement. Recent EBRI research projects that over the next forty years
real retirement incomes will more than double. The average annual retirement
income for those reaching age sixty-five in the 1980s is projected to be $13,376 per
household in 1983 dollars. It is expected to increase to $26,802 for those retiring be-
tween 2010 and 1019.~ Average employer pension benefits will increase from $5,315
2 Unpublished estimate, EBRI.
Sylvester J. Schieber, Social Security Perspective on Preserving the System (Washington, D.C.:
EBRI, 1982), p. 100.
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714
for those retiring in the 1980s to $12,417 for those retiring between 2010 and 2019.
The proportion of new retiree households receiving pension income will grow from
37 percent in the 1980s to 71 percent by 2019.~
Tax payments by retirees will reflect this income growth. Pension beneficiaries
retiring in the 1980s will pay an average of $15,808 in taxes (1983 dollars) on their
benefits over the course of their retirement.5 Pension beneficiaries retiring between
2010 and 2019, in contrast, will pay an average of $44,672 in taxes (1983 dollars) on
pension benefits during their retirement.
Retirees not only receive larger retirement incomes as a result of employer pen-
sions, but their benefits are more secure due to legally mandated advance funding.
This security is all the more important as debates over the fiscal stability of the
Social Security system continue. Social Security benefits and employer pension ben-
efits complement each other. As pension benefits increase, Social Security benefits
become a smaller share of retirement income. If public policy continues to encour-
age increased pension coverage and benefit levels, the pension system could reduce
the pressure for ever-increasing Social Security benefits.
Alternative wasys to accomplish the goals of pension policy
Some have suggested that the goals of employer pensions should be accomplished
using other policy approaches. Two of the alternatives frequently suggested are ex-
panding the allowable deductions for individual retirement accounts (IRAs) and in-
creasing benefits under the Social Security program.
Employer-provided pension coverage is more widespread than IRA participation.
Preliminary EBRI results from the HHS-EBRI CPS Pésnion Supplement suggest
that middle- and higher-income individual were the primary beneficiaries of the
broadening of IRA eligibility. An estimated 31 percent of households reporting in-
comes of $15,000 or higher hold IRS accounts, compared with 9 percent of house-
holds with incomes below $15,000. By comparison, almost five times as many work-
ers earning less than $15,000-43 percent-are covered by employer pensions. Since
IRAs by their very definition do not have any nondiscrimination standards protect-
ing the interests of those at the lower end of the income scale, expanding IRA limits
would provide nothing for these households.
Expanding the Social Security program at the expense of employer pensions
would present a different set of problems. Most researchers agree that the Social
Security payroll tax as it is currently constituted is regressive. The American people
would almost surely demand that the tax be restructured if it were to increase sig-
nificantly. it is unlikely, furthermore, that the federal budget system would be able
to tolerate the spending and tax increases that would be necessary if Social Security
were to become the sole guarantor of post-retirement living standards across the
income spectrum.
Flexible compensation plans
The labor force is changing rapidly. Census data show that over the last decade,
the proportion of single-adult households with children increased by one-third. Over
half of married women are now in the labor force. Single-adult and two-earner
household have different benefit needs then the traditional single-earner, two-
parent family. Many of these households need child care, and may have different
health- and life-insurance needs than either traditional families or single persons.
Flexible compensation plans have emerged as some employers' effort to respond
th the needs of a diverse work force without adding to compensation costs to accom-
modate each additional group.6 Most flexible compensation plans allow employees
to trade benefits in one area for increases in other benefits. A two-earner couple, for
example, can trade redundant health coverage for other benefits such as dependent
care, increased life insurance, or added vacation time.
Flexible compensation plans are a relatively new development in employee bene-
fits that is now becoming fully delineated. While some flexible compensation plans
existed as early as 1972, Section 125 of the Internal Revenue Code was enacted in
1978 to extend the statutory protection from taxation that applies to other employee
benefits to plans that give employees some choice over the mix of employer-provided
benefits they receive. The statutory authority for these plans has been in place for
~ Ibid., p. 90.
5Unpublished EBRI tabulations of PRISM simulation results.
6 background on flexible benefits plans and their relevance to changing employee needs,
see Dallas L. Salisbury, ed, America in Transition: Implications for Employee Benefits (Wash-
ington, D.C.: EBRI, 1982); Issue Brief "Flexible Compensation and Public Policy," no. 24; and
Chapter XXII, "Flexible Compensation Plans" in Fundamentals of Employee Benefit Programs
(Washington, D.C.: EBRI, 1983).
PAGENO="0721"
715
six years, but the Administration issued preliminary regulations governing the im-
plementation of these plans in May of this year.
Cafeteria plans, as they are also called, have grown considerably since they were
first authorized. In a recent variation of these plans, about a third contain reim-
bursement accounts or flexible spending accounts (FSAs). FSAs allow employees to
pay for unreimbursed medical expenses and some other benefits with pre-tax dol-
lars. Such accounts are used to cushion the impact of a change in the employer's
health insurance plan that might otherwise be seen as a benefit takeback. An esti-
mated 1.5 million employees now participate in plans with flexible spending ac-
counts alone, and as many as five million may be participating in cafeteria plans as
a whole.
The Congress and the Administration have recently become concerned about the
potential revenue impacts of flexible compensation programs that incorporate FSAs.
Estimates of the federal revenue effects of FSAs differ widely. This divergence of
estimates stems from differing assumptions about the design of these programs, dis-
tribution of participants among various types of programs, and the elections that
participants make. FSAs instituted in conjunction with a leaner health plan prob-
ably contribute to slowing down the growth of benefits as a share of compensation
because health care costs are the fastest-growing employee benefit.
Employers with flexible compensation plans have found that the ability to choose
increases employees' satisfaction with their benefits even when the dollar value of
the benefits package is unchanged. This can reduce the pressure on employers to
increase benefits to maintain a competitive compensation package. The ability of
employers and employees to use flexible compensation to contain benefit cost
growth suggests that these plans can have important macroeconomic effects by sta-
bilizing benefit growth and labor costs. Stabilizing benefit growth will keep wages
and salaries a constant share of total compensation. This would mean that a con-
stant share of total compensation would be received in a taxable form. Stabilizing
labor costs, in turn, can contribute to reduce production costs throughout the econo-
my.
Recent legislative actions and prospects for the future
Employee benefits issues have played a major role in recent tax policy debates.
For example, in the Tax Reform Act of 1984, the Congress made significant changes
in at least sixteen areas of employee benefits. These included: employee stock own-
ership plans; cost-of-living adjustments in pension plan limitations; individual retire-
ment accounts; group term life insurance purchased for employees; funded welfare
benefit plans; unfunded deferred benefits; distributions in qualified pension plans;
top-heavy plans; estate-tax treatment of qualified pension plan benefits; pension
plan rules for affiliated service groups, employee leasing arrangements, and collec-
tive bargaining agreements; cash or deferred arrangements; treatment of certain
medical and other benefits under section 415; the statutory treatment of certain em-
ployee benefits; pension-plan terminations; voluntary employee benefits associations;
and rules governing multiemployer plans.
The importance of employee benefits in tax policy promises to continue as the
Congress tries to deal with projected federal deficits. Both the Congress and the Ad-
ministration have expressed considerable interest in basic reform of the personal
income tax. At least a dozen basic tax reform proposals were introduced in the 97th
Congress and more were introduced in the 98th Congress. President Reagan has also
asked that the Treasury department analyze basic tax reform options and prepare a
report by December 1984.
In general, basic tax reform proposals would lower marginal tax rates and expand
the income tax base.7 Basic tax reform proposals offer ways to restructure-not
lower-the nation's tax bill. Most proposals do not envision widespread tax cuts, but
would instead change the distribution of tax liability among individuals. This would
be done by expanding the tax base to eliminate many tax preferences in current
law, including those governing the tax treatment of employee benefits. With a
broader tax base, marginal tax rates on income could be lowered.
At the heart of basic tax reform movement is the widespread belief that the tax
system is unfair and inefficient. The proliferation of tax preferences can mean that
differences in tax liability among individuals stem as much from the ability to ma-
nipulate the tax system as from differences in ability to pay. Energy is spent utiliz-
ing tax preferences and loopholes that could be spent on more productive activities.
High marginal tax rates encourage taxpayers to seek out tax-favored sources of
For a detailed discussion of the mechanics of basic tax reform, see EBRI Issue Brief "Basic
Tax Reform: Implications for Employee Benefits," no. 28 (March 1984).
PAGENO="0722"
716
income-capital gains, for example-and tax-favored uses of income, such as hous-
ing. As a result, investment and other economic decisions are often driven by tax
needs as much as by economic returns and productivity considerations. An advan-
tage often cited for expanding the tax base and reducing marginal tax rates is elimi-
nating this effort by making the tax code more neutral in economic decisions.
The arguments for broadening the tax base have attracted a wide range of politi-
cal support. Conservatives support broadening the tax base as a way of eliminating
the income-earning disincentives and market interference of high marginal tax
rates. Liberals support broadening the tax base as a way of eliminating tax-code
provisions perceived to benefit primarily the rich.
Recent tax-reform debates have centered around the comprehensive income tax
and the consumption tax.8 The basic premise behind the comprehensive income tax
is that individuals should be taxed on the value of what they produce, as represent-
ed by income. A comprehensive tax attempts to tax both actual and imputed
income. Comprehensive income tax proposals include in taxable income not only
cash wages but also all other items of value received by the employee as compensa-
tion.
The basic premise behind the consumption tax is that individuals should be taxed
not on the economic value they generate but rather on what they use up-or the
share of income that is not saved. The consumption tax would exclude all forms of
saving from taxable income until the funds were used for consumption. The con-
sumption tax would tax all employer contributions for benefits that do not result in
saving. This includes various employee benefits that provide insurance protection,
hut does not include pension or capital accumulation plans, since they result in
saving.
Three recent legislative proposals implement these principles. These proposals il-
lustrate some of the tradeoffs in basic tax reform. All of them combine tax rate re-
duction with tax base expansion, with implications for most employee benefits.
Comprehensive income tax
Senator Bill Bradley (D-NJ) and Representative Richard Gephardt (D-MO) have
introduced a comprehensive income tax proposal (S. 1421/H.R. 3271). It would raise
the same amount of revenue as current law by using only a three bracket tax-rate
structure: 14, 26, and 30 percent. The reduced rate structure would be financed by
eliminating or cutting back approximately forty current-law tax preferences. Tax
preferences that would be retained include deductions for home mortgage interest,
charitable deductions, state and local property and income taxes, and some medical
and business expenses. All employer contributions for benefits other than pensions
would be included in the employee's taxable income. The Section 415 limits on pen-
sion benefits and contributions would be made much more restrictive than under
current law.
Senator Mark Hatfield (R-OR) has also introduced a comprehensive tax proposal
(S.2158). Under this proposal, most deductions, credits, and exemptions would be re-
pealed, and many items currently excluded from adjusted gross income would be in-
cluded. The Hatfield proposal would retain current-law treatment for employer-pro-
vided pensions, but all other employer contributions for benefits would be included
in taxable income. There would be six tax brackets, ranging from 6 percent to 20
percent. The current structure of exemptions and deductions would be replaced by
five tax credits for the taxpayer, spouse, and dependents; and for portions of charita-
ble contributions, home mortgage interest, taxes paid, and medical expenses.
Consumption tax
Senator Dennis DeConcini (D-AZ) has introduced a consumption tax proposal
(S.557) Under this proposal, all income other than that used for investment would
be taxed at a marginal rate of 19 percent. This tax structure would be financed by
eliminating nearly all current law tax preferences. All income would be taxed once,
and as close to the source as possible. Advocates of such a tax structure argue that
it would eliminate allowing income to escape taxation entirely, while other income
is taxed more than once.
8 Both tax systems would require detailed judgments about the treatment of various sources
- and uses of income. Both would also create some formidable implementation and transition
problems. These problems and issues are treated in detail elsewhere. For a discussion of employ-
er pensions in basic tax reform, see Sophie Korczyk, Retirement Security and Tax Policy (Wash-
ington, D.C.: EBRI, forthcoming). For a wide-ranging discussion of theoretical and practical
issues in basic tax reform, see U.S. Department of the Treasury, Blueprints for Basic Tax
Reform (Washington, D.C.: Government Printing Office, 1977).
PAGENO="0723"
717
Contributions and benefits in retirement-income programs would retain their cur-
rent tax-law treatment. The employer's contribution for health, welfare, and
"fringe" benefits, however, would no longer be tax deductible as an employer com-
pensation expense. Employers would not be taxed on the value of employer contri-
butions for nonpension benefits since the employer would already have paid tax on
these contributions. Since cash compensation would continue to be a tax-deductible
cost of doing business to the employer, the employer would presumbably have an
incentive to offer more compensation in cash than in benefit contributions.9
Comparing major basic tax reform proposals
All three legislative proposals, though they are based on different tax principles,
would result in similar treatment for many benefits. Tax preferences for most em-
ployer-provided benefits would be eliminated. Employer contributions for nonpen-
sion benefits would be treated as taxable income. Had such a provision been in
effect in 1982, an estimated $72.9 billion would have been added to that year's tax-
able employee compensation (Table 5). Federal tax revenues, as measured by the
U.S Treasury's calculations of tax expenditures attributable to these benefits, could
have been as much as $19 billion higher, assuming current-law tax rates.1°
TABLE 5.-EMPLOYER CONTRIBUTIONS AND TREASURY DEPARTMENT TAX EXPENDITURE ESTIMATES
FOR SELECTED VOLUNTARY BENEFITS 1
[In billions of dollars]
E I Federal tax
Benefit cxntributions cost 2~1'982) expenditures
Health insurance $65.7 $16.4
Life insurance 7.2 2.0
Accident and disability insurance NA .1
Other employer-provided benefits:
Child care
Educational aid
Legal services plans NA .6
1 Voluntary benefits are those not mandated by law. Examples of mandatory benefits are Social Security benefits and unemployment
compensation.
2 Totals cover beth private, and public-sector employees.
Sources: Employer cost data from table 6.15 in U.S. Department of Commerce, Survey of Current Business vol. 63, No. 7 (July 1983), p. 74.
Tax expenditure data from Executive Office of the President, Office of Management and Budget, The Budget of the United States, fiscal year 1982,
Special Analysis G.
The primary differences among these proposals are in their treatment of retire-
ment income programs. The DeConcini and Hatfield proposals would continue the
current-law treatment of pensions. The Bradley-Gephardt proposal, however, would
impose more restrictive benefit and contribution limits under Section 415 of the In-
ternal Revenue Code. Limits on allowable benefits in defined/benefit plans would be
reduced from $90,000 under current law to $60,000; contribution limits in defined-
contribution plans would be lowered from $30,000 to $20,000; and indexing of these
limits would be eliminated. The immediate effects of this change would be felt pri-
marily by higher-paid persons. The longer-term repercussions could be much broad-
er, however. As many as 20 percent of younger pension participants could be direct-
ly affected, and many more could be affected indirectly by the adjustments plan
sponsors could be forced to make.11
These proposals, therefore, would change the relative attractiveness of cash and
benefits as forms of compensation. They would also change the relative attractive-
ness of various benefits. In general, tax policy under these proposals would continue
to provide some encouragement for benefits that constitute capital accumulation,
but benefits that provide current protection would be cut back.
~ This argument is advanced in Robert E. Hall and Alvin Rabushka, Low Tax, Simple Tax,
Flat Tax (New York: McGraw-Hill Company, 1983), p. 90.
`°Actual revenue gained from removing tax preferences for employee benefits would be lower
because tax rates would be lower and because employers and employees would change their be-
havior to avoid taxes.
°`See Retirement Security and Tax Policy, Chapter VII.
PAGENO="0724"
718
CONCLUSIONS
Critics of employee benefits allege that benefit-related tax provisions are regres-
sive, providing tax shelters for the wealthy and little or no benefits for anyone else.
EBRI research, using data collected by the federal government and projections
based on these data, shows conclusively that this is not the case. Rather, the distri-
bution of employee benefits follows the overall distribution of income very closely;
the middle class gains the most from employee benefits.
There is much unfinished business in employee benefits, however. The recent re-
cession, combined with long-term interindustry shifts in employment, appears to
have reduced pension coverage rates from pre-recession levels. While the economy is
now recovering, the damage done to benefit coverage levels will take longer to
repair. Employers in low-coverage sectors and in small firms will need time and a
secure economic evironment to establish employee benefit plans. A secure economic
environment means not only a healthy economy but also a stable regulatory envi-
ronment. A pension plan in particular requires a long term commitment from both
the employer and the employee if it is to deliver a meaningful retirement benefit.
Employers will not make this commitment if they expect the terms on which it is
delivered to change with every change in the political and budgetary environment.
Therefore, Mr. Chairman, we ask that the Congress recognize how much it has al-
ready achieved in safeguarding the economic security of the American worker and
that it renew its commitment to encouraging private provision for economic securi-
ty.
JENKENS & GILCHRIST,
Dallas, TX, September 17, 1984.
Hon. J.J. PICKLE,
Chairman, Social Security Subcommittee,
Cannon House Office Building, Washington, DC.
Hon. FORTNEY H. STARK,
Chairman, Select Revenue Measures Subcommittee,
Longworth House Office Building, Washington, DC.
GENTLEMAN: In the past six months we have again had extensive legislation ad-
versely affecting employers' ability to provide qualified and nonqualified fringe ben-
efits to employees. The private retirement plans and health and welfare benefits
program sector are so material to the overall well-being of our Nation's economy
that it never ceases to amaze me how Congress continues to tamper. I know you
both recognize that the federal systems of providing pensions (Social Security) and
welfare benefits (Medicare and Medicaid) have been wholly inadequate to the task. I
need not tell you that the statistics on the diverse coverages that the private sector
provides to employees and the effectiveness of such benefit systems show that the
private sector clearly out-performs the government in the economic delivery of bene-
fits. I am sure that many of the witnesses that you will have speaking at your hear-
ings will testify to these matters.
What I would like to point out to you, however, is so obvious no one may note or
mention it. It came to me last evening while helping my five year old son with his
early spelling skills for his kindergarten class. As we sat and looked at his alphabet,
it came to me that the myriad of recent (often petty) changes in the law with re-
spect to employee benefit plans of late may well do to the private sector's ability to
provide retirement and welfare benefits the same damage as if every six months I
were to change alphabets on my son-first English, then Aramaic, then Russian,
Chinese, etc., etc. How difficult it would be for him to operate in such a continuous-
ly changing environment. Changing "codes" was common during World War II,
when good cryptographers were an ally to our government's efforts. What Congress
is doing to the private system of delivering employee benefits is akin to crytographic
code changes. It can only be that Congress has forgotten that the private sector is
not the enemy.
I call upon you to declare a truce in this area, recognize the coincidental harm
being done to the private sector, so that the resources of the private sector are not
so frequently diverted to the needless expense (tax deductible I might add) of con-
tinuously keeping pace with ever-changing Congressional trends. The American
people face a serious crisis in the ailing Social Security system, but I suggest you
face it head-on and not take down the private security system with it.
Sincerely yours,
GARY B. LAWSON.
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719
STATEMENT OF PETER A. BIGGIN5, DIRECTOR, PERSONNEL PLANNING, LTV CORP.
My name is Peter A. Biggins. I am Director-Personnel Planning for the LTV
Corporation, P.O. Box 225003, Dallas, TX 73265. The purpose of my statement is to
set forth LTV's views on the subject of employee benefits. Since January 1, 1983,
LTV has been providing certain employees with flexible compensation through a
"cafeteria" benefit program, and my statement will focus on this approach to the
design of employee benefits.
DEVELOPMENT OF CAFETERIA PLANS
Historically, there was a time when compensation was perfectly flexible. Salary
was the only source of compensation. The employee had complete freedom to use it
as he or she wished. Both the employer and employee got full value from compensa-
tion.
Then, two things happened. First, employers started to provide employee benefits
instead of salary. Benefit programs were provided because employers felt a responsi-
bility to take care of employees. Second, governments at various levels started to
impose taxes on compensation. In general, however, compensation used directly by
employers for benefits was nontaxable. Group benefits were accorded favorable tax
treatment to keep government-sponsored social security programs to a minimum
and, perhaps, to avoid income measurement problems.
Employer-selected benefit programs flourished and compensation as a whole
became inflexible. Without freedom of choice, the mix of benefits became less than
optimal for most employees. Compensation dollars produced less than full value for
employers and employees.
Inflexible group benefit programs, including employer contributions to govern-
ment programs, got to be 37% of base pay for larger employers. Despite the magni-
tude of this extra compensation, it is less than fully appreciated by many employ-
ees. Based on a recent survey by Opinion Research Corp., 69% of those surveyed
thought their employer spent less than 20% of their pay on benefits. Another 19%
just didn't know.
About ten years ago, a few employers started questioning the system. They saw
that they were getting less than full value for their compensation dollar because the
benefit programs they selected on a group basis were going unrecognized and
weren't exactly meeting the needs of individuals in a changing workforce. They
wondered whether they could trust their employees to design their own benefits.
After holding discussions with groups of employees, they found that their employees
wanted and were able to take care of themselves. They realized that their new com-
puters were well-suited to keeping track of employee-chosen benefits and that their
employees were willing to interface with their computers. Cautiously, they decided
to convert a small part of their inflexible group benefit dollars into a supplemental
source of compensation that employees could use individually to buy the benefits
that they wanted.
These pioneering employers saw that the tax laws were holding them back. Em-
ployee choices had to be limited to just taxable uses or just nontaxable uses. Em-
ployees could not choose between taxable and nontaxable uses without rendering
the nontaxable uses taxable. In 1978 and 1980, Congress responded to the concerns
of these employers by enacting legislation that allowed choice between taxable and
nontaxable uses, thereby enabling a quantum leap in the development of cafeteria
plans.
The trend toward flexibility is in its infancy. Only a hundred or so employers
have converted from inflexible group benefits to a flexible compensation source, and
those that have converted no more than about 10% or 20% of their benefit dollars.
There are signs, however, that a major trend is beginning to develop. Employees
understand and want choices. Employers are becoming more trusting and willing to
let go of their benefit design strings. The experience of the pioneers is very favor-
able in terms of both employee acceptance and administrative capability.
The purpose of this statement is to describe the LTV cafeteria benefit program
and its impact on LTV, LTV employees, and Federal revenues. Before doing so, how-
ever, it will be helpful to establish some basic concepts of compensation.
TWO SIDES OF COMPENSATION
There are two sides of compensation, sources and uses. Sources are where the
money comes from, and uses are where the money goes. Sources of compensation
include base pay, overtime, bonuses, and the dollars spent by an employer on base
employee benefits. Uses of compensation include take-home pay, taxes, payroll de-
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ductions for optional benefits, and the base benefits purchased with employer dol-
lars. The total of uses equals the total of sources.
To make compensation more flexible, some employers have converted part of one
compensation source, base benefit dollars, into a new compensation source that the
employee can allocate to a variety of uses. This new source goes by various names:
flexible credits, company contributions, benefit bank, supplemental pay, etc.
TAXATION DEPENDENT UPON USE
Compensation sources are taxable or nontaxable according to their use. A use
that makes compensation sources taxable is called a taxable use. One that makes
compensation sources nontaxblbe is called a nontaxable use. According to current
Federal income tax law, compensation uses are divided into nontaxable and taxable
uses as follows:
Nontaxable uses.-Health care, Legal services, Day care, Disability income, Em-
ployee life insurance up to $50,000, Accident insurance, Pension, Tax-deferred cap-
ital accumulation-401(k), and Vacation.
Taxable uses-Employee life insurance over $50,000, spouse life insurance, IRA
capital accumulation (tax-deductible), Regular after-tax capital accumulation, take-
home pay, and taxes.
Base benefits provided by employers are of the nontaxable variety with the excep-
tion of employee life insurance over $50,000. Optional benefits historically have
been of the taxable variety because of the tax laws.
Since the Federal income tax laws were changed in 1978 and 1980, nontaxable
benefits retain their tax effectiveness when they are offered as optional benefits, re-
gardless of whether they are offered as an alternative to taxable uses. Before that,
benefits that were nontaxable as base benefits became taxable if offered as an
option along with taxable benefits and cash uses.
SOCIAL SECURITY TAXATION
Social security taxation is the same as Federal income taxation with one excep-
tion. The 1983 social security legislation included tax-deferred capital accumulation
in the social security wage base if the employee has an option. From the standpoint
of those employers who are adopting the new flexible compensation concept, the
1983 law adds another complexity to an already complex subject. Complexity in-
creases the possibility that employees will misunderstand the program and make
mistakes in choosing optional benefits. It also adds to the cost of designing and oper-
ating administrative systems.
INFLEXIBILITY COMPENSATION
Flexible compensation is the absence of inflexibilities in sources and uses. There
are eight kinds of inflexibility: base benefits, source segregation, limited options,
option bundling, benefit maximums, price subsidies, timing restrictions, adverse se-
lection.
Base benefits are inflexible because sources are earmarked for uses. With manda-
tory group benefit programs, the employer's compensation dollars are automatically
spent on specified benefits. This inflexibility can be reduced by converting base ben-
efits into supplemental pay.
Source segregation exists when the source of compensation available for certain
uses is restricted. Without the 1978 and 1980 changes in Federal income tax laws,
flexible compensation programs could not get rid of source segregation. Supplemen-
tal pay, the new source created out of reduction in base benefits, had to be spent on
nontaxable uses only. And, base pay had to be spent on taxable uses only (taxable
benefits and take-home pay). The tax laws no longer produce this inflexibility.
Limited options occur simply when an employer does not offer the full range of
"effective" optional benefits. Optional benefits are effective when, relative to pur-
chase apart from the employer, they have tax advantages, cost less, or can be pur-
chased more conveniently through payroll deduction. Only a few employers offer all
such options that are available.
Option bundling is the putting together of two or more options in one option. This
is done to simplify the administration and communication of the program and to
avoid adverse selection.
Benefit maximums limit flexibility in that an employee cannot purchase as much
of an optional benefit as he or she would like. The most common benefit maximums
are those imposed by law on nontaxable benefits to limit discrimination in favor of
higher-paid employees (health care spending account, nontaxable life insurance, tax-
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deferred capital accumulation, and IRA). Maximums are also imposed when employ-
ers wish to limit overuse of benefits (health care and disability income).
Price subsidies reduce flexibility because, if the price of a benefit is subsidized, the
employee feels more compelled to select it. One example is employer matching of
employee contributions to a capital accumulation plan. Another is pricing that does
not vary by age for an age-related benefit like life insurance. When uses are priced
without subsidy, true flexibility is obtained.
Timing restrictions are a form of inflexibility. If the employee cannot change a
benefit selection when his or her needs change, then there is inflexibility until the
change can be made. Some "flexible" benefit programs operate on an annual basis
with no changes allowed during the year. Some timing restrictions are necessary to
limit adverse selection of health care, disability income, and life insurance.
Adverse selection occurs with insurance options. Flexibility is diminished when
employees can predict the occurrence of the event insured. For example, if eyeglass
insurance were offered and employees could preduct their need for eyeglasses, the
option price would rise to the actual cost of eyeglasses. Those who do not need eye-
glasses would not buy the option. Those who do would buy it. Furthermore, there
would be a tendency for the price to rise to the highest cost of eyeglasses as those
with lowest cost dropped out and bought eyeglasses cheaper without insurance. This
is called adverse selection. It renders this type of "insurance" ineffective as a flexi-
ble use. The result is no flexibility. On the other hand, when the occurrence of the
insured event is not predictable, there can be no adverse use selection, and flexibil-
ity is retained.
Adverse selection can be reduced by packaging the insurance with other uses, by
requiring advance selection before the event can be predicted, by requiring evidence
of good health, or by subsidizing the price. All these methods of reducing adverse
selection, however, create other kinds of inflexibility.
There is no clear-cut definition of flexible compensation. It's a matter of degree.
The fewer the inflexibilities, the more flexible the program.
LTV EMPLOYEE BENEFITS
The LTV Corporation is a diversified operating company involved in three basic
lines of business-steel, aerospace, defense and energy products.
The company is a primary supplier of steel products to the automotive, appliance
and construction industries; missiles, aircraft components, tactical wheeled vehicles
and electronics to the defense and commercial aerospace markets; and tubular prod-
ucts, oil field supplies and drilling and production equipment to the petroleum in-
dustry.
LTV employs approximately 68,000 employees in the United States. About 13,000
are located in Texas, 24,000 in Ohio, 11,000 in Pennsylvania, 8,000 in Indiana, 5,000
in Illinois and the remainder are scattered throughout many other states. Together
with dependents and retirees, over 300,000 Americans are protected by various LTV
employee benefits, including pension, profit sharing, savings, health care, life insur-
ance, disability income, vacations, holidays, day care, and legal services. Some of
these benefits are nontaxable benefits, and some are taxable. While not all employ-
ees have all the benefits, the benefits are available to and used by a broad cross-
section of employees, whether they be low-paid or high-paid, female or male, black
or white, single or married, old or young. Less than 2% of our employees earn over
$50,000 a year. About 70% of our employees have 10 or more years of service and
are vested in an LTV pension.
LTV benefit programs have grown primarily as a response to employee needs for
(1) income maintenance in the event of retirement, death or disability, (2) protection
against unexpected health care costs, and (3) time off for rest and recreation. They
are secondarily a response to income tax advantages made available by Congress
over the years for social purposes. If the tax advantages had not been made avail-
able by Congress, some of the benefit programs would not exist, some would not pro-
vide the same level of protections, and some would not cover as many employees.
LTV CAFETERIA PROGRAM
Like the compensation programs of most other companies, the programs at LTV
became increasingly inflexible, as monolithic benefit programs grew over the years
at a faster pace than direct pay. Today, employee benefit dollars exceed 40% of
direct pay.
These employee benefit dollars are a part of LTV's total compensation resources.
As an economic entity, LTV is very concerned about maximizing the value of its
compensation resources. We believe that employee benefit dollars are better spent if
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722
allocated by employees individually to the benefits that they need. We trust our em-
ployees' abilities to determine their own needs and to select benefits to meet those
needs.
With the changes in the tax laws in 1978 and 1980, LTV has been able to con-
struct a whole new kind of compensation program for its employees. Called "Design
Your Benefits," it provides employees with choice by providing two types of benefit
programs: Base benefits automatically provided by LTV and optional benefits that
employees can select to meet their individual needs.
Supplemental-or extra-pay is provided to employees to help purchase optional
benefits or simply to increase their take-home pay. Supplemental pay was created
by reducing base benefits from the levels formerly provided by LTV. The pay,
whether base or supplemental, that an employee uses to purchase "nontaxable"
benefits is nontaxable (tax-free or tax-deferred). The pay used for "taxable" benefits
or take-home pay is taxable.
Base benefits still provided by LTV are health care (tax-free), disability income
(benefits payments taxable), profit sharing (tax-deferred), retirement income (tax-de-
ferred), and vacations and holidays (taxable). Optional benefits include a benefit
bank for health care, day care, and legal services (tax-free); health maintenance or-
ganizations (tax-free); supplemental disability protection (benefits payments tax-
able); life insurance protection for employees (tax-free up to $50,000, taxable over
$50,000) and spouses (taxable); accidental death insurance protection for employees
(tax-free) and spouses (taxable); capital accumulation under IRS code Section 401(k)
(tax-deferred in whole for Federal income tax and earnings only for social security
tax); Individual Retirement Account (tax-deferred); after-tax capital accumulation
(earnings tax-deferred); and optional vacation (taxable when taken).
Supplemental pay is paid each pay period with base pay. The costs of optional
benefits are deducted from pay each pay period. In general, employees can start,
stop, or change optional benefit selections at any time.
The new "Design Your Benefits" program began on January 1, 1983, for 6,600 em-
ployees in the LTV Aerospace and Defense (Jompany (Vought aero products division
and Vought missiles division) and for 300 employees in LTV's corporate headquar-
ters. It began on October 1, 1983 for 5,300 employees in LTV's steel group (former
Jones & Laughlin Steel Corporation). It began on July 1, 1984 for 2,000 employees in
the LTV Energy Products Company. The program will be introduced elsewhere
within LTV in the future.
LTV CAFETERIA RESULTS
We have now had almost two years of experience with "Design Your Benefits"
and are confident that it is meeting our expectations. The creation of supplemental
pay has shifted an average of 4% of base pay from inflexible base benefit dollars to
the new flexible compensation source. The range is from 2% to 9%, depending on
age, service, and organizational unit.
That employees reallocated the benefit dollar to better serve their needs is con-
firmed by a variety of selection results for the Vought divisions:
45% of employees took more life insurance than they had before and 33% took
less. Only 22% bought back the same amount.
33% of employees who could buy more vacation than they had before did so. Forty
percent of employees who could buy less than they had before did so.
63% of employees who could buy more disability protection than they had before
did so. Twenty-one percent who could buy less did so.
Many employees added entirely new protection under "Design Your Benefits"
that they did not have under the old program.
63% chose the benefit bank. Practically every participant used it for health care,
11% of participants used it for legal services, and 7% of participants used it for day
care. Ninety-one percent received refunds at year-end.
57% chose spouse life insurance.
73% chose employee accident insurance.
50% chose spouse accident insurance.
37% chose tax-deferred capital accumulation.
Some employees even increased their participation in capital accumulation op-
tions that existed already in the old program.
Participation in the IRA increased to 31% of employees from 23%.
Participation in the regular after-tax capital accumulation increased to 40% from
31%.
Two out of three employees participate one way or another in the capital accumu-
lation options.
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723
In offering "Design Your Benefits" to employees, we trusted them to assess their
own needs and make selections. We tried to keep the program as simple as possible.
Seventy-seven percent of the employees thought the program made sense. Seventy-
five percent thought the written materials were easy to read.
Almost everyone made use of a programmed-learning workbook that allowed
them to calculate their first compensation statement in advance. An extra step had
to be added to the workbook for 1984 to deal with difference in Federal income and
social security taxation of tax-deferred capital accumulation (Section 401(k)).
The compensation statement is attached to each paycheck the employee receives
and shows the employee's base and supplemental pay for the pay period and year to
date, the level of optional benefits selected, and the amount of payroll deductions
for the period and year to date. The purpose of the statement is to regularly remind
the employee of the selections. The employee is free to change optional benefits at
any time, subject to health evidence requirements for life insurance and disability
protection.
There is no way to prove conclusively that LTV is getting more for its compensa-
tion dollar with "Design Your Benefits," but it is our considered judgement that we
are getting a lot more not only because employees are better able to allocate our
compensation dollar but also because they are actively participating and helping
themselves.
The average cost of implementing "Design Your Benefits" is about $75 per em-
ployee. As more employees are added to the program, the average cost will decline
due to the spreading of developmental costs.
LTV TAX REVENUE EFFECT
There is concern among some observers about a potentially large revenue loss
that could occur as a by-product of a possible trend toward programs like "Design
Your Benefits" and possible discrimination in favor of higher-paid employees. We
would like to take this opportunity to share certain statistics from "Design Your
Benefits" that indicate what we believe to be minimal impact on tax revenues to
the Federal government.
First, employees are not just grabbing all the nontaxable benefits they can get. In
fact, they are actually using far less than the nontaxable benefits they could poten-
tially select. The average annual payroll deduction selected by employees of the
Vought divisions for nontaxable optional benefits under Section 125 is $1,168 out of
a possible $6,269. Employees are selecting only 19% of the potential nontaxable ben-
efits. The table below shows a summary by type of benefit.
Annual
potential
Annual
actual
ercen
Nontaxable benefit option:
Benefit bank 1
$5,390
43
185
79
572
$584
30
165
56
333
11
70
89
71
58
Disability income
Employee life insurance
Employee accident insurance
Vacation
Total
6,269
1,168
19
1 Actual benefit bank usago is $505 for health care, $53 for dependent care and $26 for legal sorvices.
These figures should allay any fears that employees are selecting benefits with
the sole objective of avoiding taxable income. It should also be noted that employees
are participating equally as much in taxable options. Average annual payroll deduc-
tions for other benefits are: employee life insurance over $50,000 ($231), spouse life
insurance ($109), spouse accident insurance ($10), and regular after-tax capital accu-
mulation ($818). In addition, the average annual payroll deductions for qualified
nontaxable benefit options are as follows: tax-deferred capital accumulation under
Section 401(k) ($657) and IRA capital accumulation ($604).
Second, the estimated revenue loss for nontaxable benefits covered by Section 125
is $1 a year per employee. The average nontaxable income per employee per year
that is related to the availability of Section 125 is as follows:
40-046 0 - 85 - 46
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724
Without With Increase or
section 125 section 125 (decrease)
Nontaxable benefits:
Benefit bank:
Health care $505
Day care 53
Legal services 26
Disabiflty income 1 $26 30
Employee life insurance 185 165
$505
53
26
4
(20)
Employee accident insurance 56
Spouse pension 1 56
56
(56)
Vacation ` 319 333
Base health insurance 2363 1,785
14
(578)
Total 2,949 2,953
4
1 Excludes that portion of the base henefit that has remained the same.
Based on an assumed marginal tax rate of 35% for Federal income taxes, the esti-
mated annual revenue loss per employee is $1. Practically speaking, there is no rev-
enue loss.
In summary, we believe the experience that LTV has had with flexible benefits
indicates that employees in companies like LTV will not substantially erode the
income tax base through cafeteria plans allowed under Section 125. We believe that
Section 125, including the use of salary reduction, should remain as an integral part
of our national tax policy because it enables emplyers to maximize the value of
their compensation dollars by allowing employees to choose benefits that meet their
needs. We ask that programs like LTV's "Design Your Benefits" be allowed to de-
velop without arbitrary limitations and with uniformity in taxation for Federal
income and social security tax purposes.
HEALTH CARE
LTV provides base health care benefits for all employees, retirees and their de-
pendents. To reduce overuse of the health care system, the company has ben replac-
ing its first-dollar insurance plans with a new plan that provides for (1) advance ap-
proval of hospitalization and (2) cost sharing for other health care. There is an
annual deductible for non-hospital medical expenses equal to 1% of annual base
pay, followed by 20% employee co-payments. These co-payments stop, however,
when they amount, in a year's time, to 2% of annual base pay. The design savings
(about 10%) are passed on to the employees through an addition to supplemental
salary. Utilization savings (about 10%) are retained by the company.
The company has not offered optional health insurance plans that have varying
degrees of cost sharing for two reaons. First, we wanted to obtain utilization savings
for all employees now, not just those who happen to select the options that have a
higher degree of cost sharing. Second, we were concerned about the cost of adverse
selection. We felt that employees in poorer health would select lower cost sharing
and that, no matter where we set the price of the options, we would get "out-select-
ed."
BENEFIT BANK
Redesign of health care benefits has had a major impact on employees because it
has shifted risk to them. LTV would probably not have made such a drastic change
had it not been for the availability of a "benefit bank". with a benefit bank, the
employee may make deposits to a personal account and request withdrawals for de-
ductible amounts, co-payments, and other health care expenses. The pay used for
deposits and the amounts withdrawn for health care are tax-free, just as if the com-
pany had provided health care benefits directly. The employee has an incentive not
to use his or her account because the unused balance is refunded at year-end. The
refund is taxable.
REVENUE IMPACT OF LTV'S BENEFIT BANK
The change to the new health care plan and adoption of the benefit bank affect
Federal revenues in two ways.
(1) There is an increase in Federal revenue from corporate income taxes due to
utilization savings. These company savings amountto about $250 per employee per
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year. This increases LTV's taxable income and generates a corporate tax liability of
about $125 per employee per year. Design savings to the company can be ignored
because they have been passed on to employees through added supplemental pay.
(2) There is a decrease in Federal revenue due to the fact that the benefit bank is
used for more than what was cut out of the base health care plan. This added usage
amounts to about $225 per employee per year. It decreases employees' taxable
income and generates a saving for each employee of about $75 per year in Federal
income and social security taxes.
The net effect is to increase Federal revenues by about $50 per employee per year
($125-$75=$50).
The Congress and the Administration are concerned that benefit banks will de-
crease Federal revenue. Though our experience and that of other companies has
been just the opposite, there is a potential for revenue decrease in certain situa-
tions. For example, if a company were to introduce a benefit bank without redesign-
ing its base health care plan, there would be no utilization savings to increase the
company's tax liability. In such a situation, the benefit bank simply would be
making available to employees new nontaxable benefits. If LTV were to make a
benefit bank available without redesigning its base health care plan, there would be
a Federal revenue loss of about $75 per employee per year.
While my experience would indicate that few benefit banks have been established
without redesign of the basic health care plan, it is appropriate to be concerned
about potential revenue loss.
POTENTIAL REVENUE LOSS
Health care expenditures by the 62 million employees who had some form of em-
ployer-provider insurance will amount to an estimated $168 billion in 1984. Of this,
$92 billion will be insured by employer plans and $76 billion will be paid out-of-
pocket by employees. A rough breakdown of the out-of-pocket payments is as fol-
lows:
Billions
Deductibles and co-payments $17
Not covered
Employee contributions to premiums 20
76
In the event that 60% of employee out-of-pocket expenses were to be paid through
benefit banks, $45.6 billion of income could be sheltered from tax. Assuming a 35%
rate for Federal income and social security tax, the potential ultimate revenue loss
from unrestricted benefit banks is $16 billion. Offsetting this revenue loss is a mini-
mum revenue gain of about $4 billion due to employer cost savings from incentives
to increase cost sharing.
"USE IT OR LOSE IT" BENEFIT BANK
Several solutions have been put forth to prevent this potential revenue loss. The
IRS has adopted a regulatory solution which is designed to make benefit banks un-
attractive. The regulations require that deposits that remain unused at the end of
the year be forfeited. This concept is called "use it or lose it". If allowed to continue,
these regulations will discourage the use of benefit banks as a device to ease the
implementation of more cost-effective base health care plans. The trend toward cost
sharing will be halted and perhaps reversed.
Companies will still adopt benefit banks, but employees will tend to use them for
more predictable health care expenses, such as orthodontia, elective surgery and
vision care. Employees will be encouraged to overuse health care at year end be-
cause of the "use it or lose it" requirements, and the IRS will lose tax revenue it
would have received on year-end refunds.
About $57 billion of out-of-pocket expenses, including employee contributions, will
be exposed under the "use it or lose it" approach. If 45% of these expenses were to
be paid through benefit banks (usage would be lower than the 60% estimated previ-
ously due to the fear of forfeiture), $25.7 billion of income could be sheltered from
tax. Assuming a 35% tax rate, the potential ultimate revenue loss is $9 billion.
There would be additional revenue loss due to higher utilization of health care to
avoid year-end forfeiture.
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THE QUALIFIED BENEFIT BANK
Another approach to restricting potential revenue loss is referred to as the "quali-
fied plan" approach. Under this approach, there is no "use it or lose it" require-
ment, but both the company's base health care plan and benefit bank would have to
meet certain cost-effectiveness requirements to be able to offer a benefit bank for
health care. As a suggestion, first-dollar benefits might be allowed in the base plan
only when there is an effective utilization review program, benefits are for preven-
tive care, or benefits are for a mandatory second opinion on elective surgery. Fur-
ther, cost-sharing would have to meet certain minimum requirements. In addition,
certain exclusions and limitations would be applied to benefit banks, similar to
some of those that exist in base health care plans. For example, cosmetic surgery
could be excluded and eyeglasses could be limited to $75 a person every two years. A
more detailed list of the suggested qualifications is attached.
About 30% of out-of-pocket expenses are incurred by employees whose employers
would seek to meet the qualifications. This amounts to $23 billion. If 60% of these
expenses were to be paid through benefit banks, $13.7 billion of income could be
sheltered from tax. Assuming a 35% tax rate, the potential ultimate revenue loss is
$5 billion. This revenue loss would be eliminated by the revenue gain due to em-
ployer cost savings from incentives to increase cost sharing and make other cost-
effective changes.
MEDICAL COST SHARING BANK
Another approach that avoids "use it or lose it" and has man~r of the advantages
of the qualified benefit bank is the "medical cost sharing bank.' This benefit bank
is limited to use for medical deductibles and co-payments. As a result, there is the
same incentive to introduce cost sharing as with the qualified plan approach, but
there is no incentive to introduce other cost-effective changes. The bank would be
less attractive to employees because withdrawals could not be made for non-covered
items.
To avoid the introduction of ridiculously large deductibles or co-payments for ex-
penses not previously covered, it would be necessary to put limits on cost sharing.
For example, the actuarial value of a deductible could be limited to 50% of the ex-
pected value of charges to which it applies, and employee co-payments could be lim-
ited to 50%.
About $14 billion of employee cost sharing is for medical expenses (another $3 bil-
lion is for dental expenses). If 60% of these expenses were to be paid through benefit
banks, $8.4 billion of income would be sheltered from tax. Assuming a 35% tax rate,
the potential ultimate revenue loss is $3 billion. This revenue loss would be more
than offset by the revenue gain due to employer cost savings from incentives to in-
crease cost sharing.
THE IMPORTANCE OF BENEFIT BANKS
Without benefit banks, the trend toward cost-effective health benefits would virtu-
ally come to a halt and might even be reversed. If qualified benefit banks or cost
sharing banks remain nontaxable, however, there will be a significant revenue gain
over the present "use it or lose it" benefit bank and a strong incentive for employ-
ers with first-dollar insurance programs to resume the redesign of their programs.
Employers will increase the use of nontaxable cost-sharing insurance if they can
add benefit banks to ease the transition. They will use the cost saving to reduce tax-
able employee contributions, increase base pay, or create a nontaxable employer
contribution to the benefit bank. And, they will allow employees to add to their ben-
efit bank accounts through nontaxable salary reduction under a "cafeteria" pro-
gram.
The introduction of more cost-sharing (through benefit banks) will increase the
use of nontaxable HMO's and other alternative delivery systems. HMO's are much
more appealing as alternatives to cost-sharing insurance than as alternatives to
first-dollar insurance. They are a way of retaining first-dollar protection. So, em-
ployers will offer more HMO options and more employees will select HMO options.
Employers will allow employees to make nontaxable employee contributions for the
HMO option under a "cafeteria" program through salary reduction or withdrawals
from benefit bank accounts.
SUMMARY
Employers have become increasingly concerned bout the devaluation of their com-
pensation dollar that has come about through the growth of inflexibiities in their
PAGENO="0733"
727
compensation programs. In 1978 and 1980, Congress passed landmark legislation
that enabled employers to restore flexibility to their programs through "cafeteria"
benefit programs. Since January 1, 1983, LTV has offered its employees a state-of-
the-art cafeteria program. It is our considered judgement that we are now getting a
lot more for our compensation dollar because employees are better able to allocate
our dollars than we are. Moreover, they are now actively participating in their ben-
efit programs and helping themselves. Benefits provided under the cafeteria law
have not reduced Federal revenues.
One important part of our program, a "benefit bank," is absolutely critical to our
efforts to manage health care costs. In response to IRS concerns as to potential reve-
nue loss, we suggest that Congress consider a "qualified plan" or "medical cost shar-
ing" approach and would be pleased to work with you to develop the details.
[Attachment]
SUGGESTED QUALIFICATIONs FOR BENEFIT BANKS
(1) First-dollar insurance benefits must meet the requirements of a, b, or c:
(a) Benefits are administered by an employer, an insurance carrier, or a third-
party administrator that has adopted an independent utilization review program
that meets standards established by HHS.
(b) Benefits are for preventive care, such as physical exams, Pap smears, and
teeth cleaning.
(c) Benefits are for the cost of obtaining a mandatory second opinion as to the
need for elective surgery.
(2) Cost-sharing insurance benefits must meet the minimum cost-sharing require-
ments of a, b, or c:
(a) Benefits are subject to an annual deductible equal to at least 24 times the av-
erage straight-time hourly pay rate in effect at the beginning of the plan year.
(b) Benefits are subject to at least 25% employee co-payments, until the co-pay-
ments exceed 48 times the average straight-time hourly pay rate in effect at the be-
ginning of the plan year.
(c) Benefits are subject to both deductible and co-payment:
(1) An annual deductible equal to at least 16 times the average straight-time
hourly pay rate.
(2) At least 15% employee co-payments until the co-payments exceed 32 times the
average straight-time hourly pay rate in effect at the beginning of the plan year.
The same minimum deductible or maximum co-payment would apply to all em-
ployees without regard to family size. A higher minimum deductible or maximum
co-payment could be adopted for larger family units at the discretion of the employ-
er.
The minimum deductible or maximum co-payment could be pay-related at the dis-
cretion of the employer.
The same minimum deductible and maximum co-payment would apply regardless
of the scope of benefits to which they apply.
Separate deductibles could be adopted for separate benefits as long as the deducti-
ble amounts bore a similar relationship to their respective covered expenses and the
total of the deductibles was not less than the minimum requirement.
A schedule of benefits could be used to meet the minimum co-payment require-
ments if the average payment by employees over the scheduled amount is at least
as large as the minimum requirement.
(3) Benefit banks must meet the requirements of a, b, or c:
(a) Health care withdrawals exclude expenses not normally paid by insurance
plans and HMO's: home and vehicle improvements, cosmetic surgery, amounts in
excess of reasonable a~d customary charges, special foods, nursing and special
homes, and transportation other than ambulance service.
(b) When added to insurance benefits, health care withdrawals are limited for (1)
eyeglasses to $75 per person once every two years and (2) orthodontia to $1,000 for
each person.
(c) Unused deposits in benefit banks are non-forfeitable and refunded at year-end
in the form of cash or transfer to a capital accumulation plan.
The entire health care benefit program would have to qualify under these rules
for the benefit bank to be nontaxable.
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728
STATEMENT OF JAY R. SToREY, VIcE PRESIDENT OF PERSONNEL, THE MAYTAG Co.
SUMMARY
Statistical Tables show:
(a) How much is spent for benefits and how much is tax favored.
(b) What the wage levels are of those employees who participate in those benefit
plans.
Benefit levels are set by negotiations.
Negotiated benefits become the model for all other levels in the organization.
Company is not motivated to have too large a portion of its compensation in bene-
fits.
Hypothesis that if benefits ar treated as taxable income, unions and companies
will move towards wage increases and less benefits which will ultimately put more
burden and stress on government to provide the benefit.
STATEMENT
The attached set of statistical tables show that 10% of people receiving benefits
under the Medical and Retirement programs at Maytag earn between $10,000 and
$20,000; 87% earn between $20,000 and $50,000, and only 3% of those in the plans
earn over $50,000 per year.
I want to tell you how benefit levels are established at Maytag. It seems that
some feel management sits around thinking up ways to give new benefits to them-
selves and other employees. In actual fact, they (managment) spend much more
time worrying about the cost of their current benefit plans (medical, dental, vision,
retirement, etc.) and what they can do to control these costs. Any new benefit that
is granted is additional business expense and adds to the cost of our products.
In my 30 odd years at Maytag, our benefit programs have developed as a direct
result of contract bargaining with the UAW. This procedure unfolds like this:
(a) The union submits its demands which includes a long list of improvements to
current benefit plans and for new plans, along with their proposed wage increases.
(b) In typical give and take fashion, negotiations reduce the demands to a level
acceptable to both parties. This settlement level is based on the total amount of
money which the Company is willing to spend for both wages and benefits in that
particular round of bargaining. Each benefit improvement is carefully and meticu-
lously costed and included in the total cost of the package of improvements or con-
cessions as the case may be.
(c) The Company usually says to the union-we don't care how you divide the
money up between wages and benefits, but there is no more money.
(d) The union decides which benefits to select by sampling and/or sensing the
needs and desires of the membership.
The benefit package thus negotiated becomes the model with minor variations for
the rest of the organization, including top management.
At Maytag, the folowing plans are exactly the same for management as union em-S
ployees: (a) Medical, (b) Dental, (c) Vision, (d) Drug, (e) Accidental Death & Dismem-
berment Ins., (f) Holidays, (g) Dependent Life Ins., and (h) Educational Assistance
Program.
The retirement plan for management is based upon a percent of the highest five
consecutive years of earnings out of the last ten, where union employees currently
receive $17.50 per month per year of credited service. This works out that the aver-
age hourly employee gets a higher percent of final wages than management employ-
ees receive. This is common throughout industry.
The Company is motivated to not let too large a portion of compensation (wages
and benefits) to be in the benefit area because in the competitive labor market of
hiring new employees and, to a certain extent, retaining current employees, it is the
wages and salaries that attract and hold good empolyees, particularly the younger
ones. You just don't get full credit for dollars spent for benefits.
The question has been posed-"What would the outcome be if benefits provided
by the employer were treated and taxed as regular income"? It is my belief that if
this was done, unions would more and more opt for negotiating wage increases and
rely on the employee to determine and purchase what benefits they individually
wanted. Since the Company feels that they do not get full value for money spent for
benefits, they also would be willing to let this happen to a great extent. I submit
this would result in employees not uniformly buying the needed level of retirement
and medical benefits. More and more people would then turn to the government
and welfare for relief.
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729
TABLE 1.-EMPLOYEE BENEFIT DOLLAR COST, BY CATEGORY, 1983
[In thousands of dollars]
Benefit
Employer Per
payment employee
Legally required employer payments
Social Security
Unemployment compensation
Workers' compensation
Other payments
Discretionary taxable benefits
Time not worked
Rest periods
Other taxable benefits
Discretionary tax-favored benefits
Defined benefit pension plans
Capital accumulation plans
Disability plans
Group health and life insurance:
Active workers
Retirees
Other tax-favored benefits
38,069 12.2
7,166 2.5
5,303 1.7
1,971 .6
479 .2
13
9,780 3.1
5,877 1.9
3,723 1.2
180
20,523 6.6
10,004 3.2
0
256 .1
6,924 2.2
3,283 1.1
56
TABLE 2.-EMPLOYEE BENEFIT PERCENTAGE COST, BY CATEGORY, 1983
Employer Employer
Benefit payments as payments as
percent of wages percent of all
and salades Iwnefits
Total benefits 44.5 100.0
Legally required employer payments 9.1 20.4
Social Security 6.2 13.9
Unemployment compensation 2.3 5.2
Workers' compensation .6 1.3
Other payments
Discretionary taxable benefits 11.4 25.7
6.9 15.4
lime not worked
Rest periods 4.3 9.8
Other taxable benefits .2 .5
Discretionary tax-favored benefits 24.0 53.9
Defined benefit pension plans iLl 26.3
Capital accumulation plans
Disability plans -~ 2
Group health and life insurance:
Active workers 8.1 18.2
Retirees 3.8 8.6
Other tax-favored benefits .1
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730
TABLE 3.-RETIREMENT PROGRAM AVAILABILITY, 1983
Defined benefit Employer capital accumulation 401 (k)
Participate Vested Participate Vested Participate Vested
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent Amount
Percent
0 to $9,999 NA NA NA NA NA NA NA
NA
$10,000 to $19,999 310 10 144 6 NA NA NA NA NA NA NA
NA
$20,000 to $49,999 2,709 87 2,019 90 NA NA NA NA NA NA NA
NA
$50,000 to $99,999 85 3 79 4 NA NA NA NA NA NA NA
NA
$100,000 or more 6 6 NA NA NA NA NA NA NA
NA
Total 3,110 100 2,240 100 100 100 100
100
TABLE 4.-HEALTH BENEFIT AVAILABILITY, 1983
Group insurance 125 Plan HMO
Amount Percent Amount Percent Amount
Percent
0 to $9,999 NA NA NA
NA
$10,000 to $19,999 310 10 NA NA NA
$20,000 to $49,999 2,709 87 NA NA NA
NA
NA
$50,000 to $99,999 85 3 NA NA NA
$100,000 or more 6 NA NA NA
NA
NA
Total 3,110 100 100
100
TABLE 5.-RETIREE BENEFITS
Tetal distributions
Benefit Numtsr of er cost
ersons (thousands)
Year
Defined benefit plan: retirees in pay states 1,502
1983
Pension benefits paid:
Retirement $8,802
Death 132
Defined benefit plan: retirees survivors in pay states 198
Defined benefit plan vested: separated 225 NA
Capital accumelation plan: retirement age distribetions NA
Captal accumulation plan: termination distributions NA
Retiree health 1,827 3,283
1983
1983
1983
19-
19-
19-
19-
Retiree life 1,515 (°)
Retiree other
19-
19....
1 Cost for this item is not available separately-cost is included in total ~nsion cost of $10,004,000.
NATIONAL ASSOCIATION OF CASUALTY & SURETY AGENTS,
Washington, D~ September 20, 1984.
Hon. FORTNEY H. STARK,
Chairman, Select Revenue Measures Subcommittee, Ways and Means Committee,
House of Representatives, Washington, DC.
DIOAIc CHAIRMAN STARK: The National Association of Casualty and Surety Agents
(NACSA), an association representing the leading commercial property/casualty in-
surance agencies and brokerage firms throughout the United States, would like to
submit for the hearing record on taxation of employee fringe benefits the following
brief comments.
NACSA opposes the Administration's proposal to tax employee health care bene-
fits, whether used to raise funds to reduce the federal deficit or to provide health
care to the nation's unemployed. NACSA opposes in principle this tax as both dis-
criminatory and unfair. We also believe strongly that this proposed tax would not
raise the revenues suggested by its proponents.
PAGENO="0737"
731
A health insurance tax cap proposal would discriminate against older workers,
those in high risk occupations, and those living in areas with a high cost of living
since these groups pay higher premiums than the average for the same health in-
surance. NACSA believes it would be unfair for these workers to pay more in taxes
than others for the same health protection.
NACSA believes further that using a tax on employee health care benefits to fund
the federal deficit or health insurance for the unemployed would be unwise for
other reasons as well:
(1) Revenues from the tax would be unpredictable since employers may shift tax-
able employee health benefits to other non-taxable fringe benefits. Also, if the tax
achieves it objective, many employee will move to health plans with premiums at or
below the proposed tax threshold, eliminating much of the projected revenue gain;
(2) Linking a short-term assistance program to a permanent change in the tax
code would make it difficult to eliminate the temporary program when its useful-
ness ends;
(3) This tax would constitute a form of double taxation. Since the government does
not reimburse hospitals for all costs associated with treating Medicare/Medicaid pa-
tients, the private sector is forced to absorb the difference. In 1982 alone this `cost
shift' amounted to $5.8 billion. This, in effect, is a hidden tax. It would be unfair for
the government to shift these costs to private payors of health care and then tax the
resulting higher premiums!
(4) Greater unemployment may result for the marginally employed (the aged, sick,
and disabled) as a result of such a tax. A tax on employee health benefits would
present a greater disincentive than under current law to employers to hire or retain
these workers whose predictably higher health care costs drive up insurance costs
for all employees in a group.
(5) A tax on employee health benefits may reduce employer incentives to offer and
provide health insurance. Employer plans have broadened the availability of medi-
cal coverage to Americans and improved the health and welfare of the vast majority
of our citizens. It has also lessened the burden on the government to provide nation-
al health benefits above and beyond those provided by Medicare/Medicaid pro-
grams.
(6) Finally, such a tax may remove incentives for employers to continue any
health benefits voluntarily afforded to laid-off workers. To the extent that health
insurance premiums for the unemployed would be counted as taxable income, em-
ployer payroll tax costs (FICA and unemployment) would increase. As these costs
rise, employers might determine that they can no longer afford such voluntary ben-
efits.
Mr. Chairman, NACSA recognizes the breadth of your recent joint hearings on
fringe benefits has gone beyond a tax cap on employee health benefits. Since the
issue of employee fringe benefits will be the subject of further debate in the next
Congress, we would like to reserve the right to submit additional comments next
year on health care benefits and other employee fringe benefits under consideration
by your subcommittee and others.
Sincerely,
JOAN ALBERT DREUX,
Executive Director, Government Affairs.
STATEMENT OF THE NATIONAL EMPLOYEE BENEFITS INSTITUTE
INTRODUCTION
The National Employee Benefits Institute ("NEBI") is an organization composed
of Fortune 1000-sized companies which share a common interest in legislation and
regulations which impact benefit planning. NEBI represents more than $100 billion
in pension assets, and its members employ hundreds of thousands of workers who
are covered by many types of benefit programs.
The NEBI statement was prepared through the combined efforts of benefits man-
agers at the following nine member companies: 3M Company, American Can Com-
pany, Atlantic Richfield Company, Conoco, Inc., First Interstate Bankcorp., Hunt-
Wesson Foods, Inc., Security Pacific National Bank and Southern California Edison.
Although this statement necessarily reflects these companies' experiences as large
employers, the composite employee group depicted in this joint project are an ex-
tremely diverse work force who live and work in all regions of the United States.
The employees described in this statement include the young and old, male and
female, married and single, those who perform manual and clerical jobs and those
PAGENO="0738"
.732
who have technical, professional, managerial or executive positions. The one charac-
teristic they share is their employment by major companies who are actively inter-
ested in the current health and welfare of their employees and dependents, and who
want to provide economic security in the event of their separation from service, re-
tirement, death or disability.
NEBI wishes to express its appreciation to the Subcommittees on Social Security
and on Select Revenue Measures of the House Ways and Means Committee for the
opportunity to present this statement and supporting data concerning policy issues
related to the distribution and economics of employee benefits.
Millions of American workers and their families count on private benefit plans as
a primary or supplemental source of current assistance and future security. To a
great extent, it is anacronistic to characterize such programs as retirement and
health care plans as "fringes." They are, rather, an integral part of the total com-
pensation paid to employees. The Internal Revenue Code and regulations, ERISA,
ERTA, TEFRA and this year's DEFRA, plus innumerable labor laws and regula-
tions have created a complicated, interrelated, regulatory framework upon which
thousands of intricate benefit programs have been built. Public programs have as-
sumed the continued existence and vitality of private ones and vice versa. Congess,
business and labor have all contributed to the final product. It is not surprising that
fringe benefit legislation and regulations, as well as the plans which they govern,
reflect a balance among competing revenue, commercial and social interests.
Our statement will focus broadly on three major areas: the economic and fiscal
implications of the current employee benefit tax policy; a discussion of the labor
force currently covered by employer-paid, tax favored benefits; and the historical
and social medium in which employee benefit plans as we currently know them ger-
minated.
Economic and fiscal implications
Large federal deficits have caused widespread concern in the executive and legis-
lative branches as well as in the private sector. Although there is little dispute that
something must be done to reduce the deficit levels, few programs or persons are
willing to assume the role of "bullet biter" voluntarily. Congress is absurdly pres-
sured to cut spending and increase revenues without raising taxes or disturbing
anyone's favorite program. This cannot be done. A reevaluation of many tax exemp-
tions, deductions and credits is one logical approach, and may provide an opportuni-
ty to eliminate some inadvertent or obsolete exclusions. But before any changes are
warranted, it is appropriate to consider carefully the reasons for creating such "tax
expenditure" and the impact that removal would have on the economic and social
well-being of the American people.
The current focus on employee benefits as a potential source of substantial addi-
tional revenue presupposes two premises: that a significant amount of revenue is
permanently "lost" through benefit programs, and that the losses are not justifiable
in light of the more compelling revenue considerations. NEBI disagrees with both of
these propositions.
1. Only a small portion of Employee benefit-related revenue is permanently lost to
The Treasury. Employee benefits may be divided into three basic categories: tax
free, tax deferred and fully taxable.
(a) Tax free benefits.-Health-related benefits are the primary component in the
"lost revenue" category of tax free benefits. Employers contribute an average of 5%
of payroll to provide health-related benefits. To the extent payments are made to
health services providers who are subject to income tax (such as physicians), the
payments will be taxed to a taxpayer (the physician) soon after employers make the
payments.
(b) Tax deferred benefits.-The second category, tax deferred benefits, includes
pension, profit sharing and other employee savings plans. Although contributions to*
these plans reduce current revenue, the deductible contributions will eventually
return, interest augmented, to the income stream. Even after adjusting for inflation
and tax breaks for the recipient, one study shows that as much as 60% of the contri-
bution amount will return to the tax base as taxable income.' Federal revenues are
reduced to a small extent by tax credit employee stock ownership plans (commonly
called "PAYSOPs"). However, the reduction is arguably offset by the increased pro-
ductivity of workers who become company shareholders.
(c) Fully taxable benefits-The majority of "benefit" dollars do not receive tax-
favored treatment. According to U.S. Chamber of Commerce figures, over two-thirds
1 S. Korczyk, Retirement Security and Tax Policy (Washington, D.C., Employee Benefit Re-
search Institute, forthcoming).
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733
of employee benefits (23.5% of payroll) are fully taxable, discretionary employer-
paid benefits such as paid vacation, holidays, lunch periods and sick leave, most of
which are subject to both income and social security taxes.2 Another 9.5% are in
the form of legally required employer payments (social security, unemployment
compensation insurance and worker's compensation insurance). Accordingly, there
are no revenue enhancement possibilities for the majority of benefit dollars current-
ly spent on behalf of U.S. workers.
2. Lost Revenue is Justified by Balancing Considerations. The tax exempt treat-
ment accorded by Congress to the relatively small amount of fringe benefit pay-
ments that are tax exempt to the worker reflect a policy commitment to ensure the
provision of medical coverage to as broad a cross section of the American population
as possible, and to encourage the private sector to assume much of the responsibility
for this coverage. Thus far, this nation has indicated a strong preference for a pri-
vate health care system over a national health insurance system (such as that in
place in Great Britain.) Actual tax revenues "lost" in implementing this country's
private health care system should be compared to the administrative cost of a gov-
ernment-sponsored program. To imply that taxation of health care benefits would
enhance revenue rolls dollar for dollar overlooks the hidden costs of collecting this
revenue.
3. Employer-provided health benefits are delivered at a relatively low cost. Since
the 1960's, our member companies have experienced a dramatic rise in the cost of
providing health care coverage for their employees. As one example, Conoco reports
that in 1972 its medical plan was funded at 1% of the cost of its payroll. Today it is
6% of payroll. Conoco is only one of the victims of this phenomenon. However, the
private health care system is not the cause of rising health care costs and should
not be looked to as the source of the solution.
In making such a statement we do not intend to imply that the private delivery
system is without fault, nor do we minimize the crisis caused by the rise of health
care costs. NEBI companies, along with large and small employers everywhere, have
begun to implement programs to contain rising health care costs. Current efforts
include greater employee cost sharing, reduced benefits, sophisticated data monitor-
ing systems and employee health incentives. Member companies report plans oper-
ating at a high level of efficiency, with 95% of medical plan dollars being paid out
as benefits.
Our members believe that many factors have contributed to the health care cost
explosion. The high cost of new technology is a primary catalyst of cost increases.
Other factors include overabundant hospital beds, overutilization and failure to
reduce cost of procedures as they become less expensive to perform. NEBI believes
that Medicare, as the single largest health care plan, can and should assume a lead-
ership role in holding down the cost of medical care delivery. However, the compa-
nies represented by this organization do not believe that a more comprehensive gov-
ernment-sponsored health care program would alleviate the health care cost crisis.
In fact, most cost-savings techniques employed by companies today started through
the efforts of a few innovative companies. Without experimentation by many compa-
nies and competition among providers (generated by industry's concern for high
costs), new and more efficient delivery systems would not emerge.
4. Employee benefit plans are major sources of savings for the majority of current
pension participants. It has long been part of our national economic policy to en-
courage savings and investment by American workers. Yet, Japan and the Scandi-
navian countries have personal savings levels which approximately triple the Amer-
ican rate of under 5% of net pay. NEBI member companies indicate that their
profit sharing, savings and thrift plans are the sole or major voluntary savings pro-
grams for most employees. Just as important, company-paid pension and other re-
tirement plans will be the major source of income for future retirees.
One of the chief characteristics of the new industrial age was reduced personal
retirement savings, requiring government to assume an unfamiliar role in providing
assistance for the post-employment years. Tax incentive provided to companies and
their employees in order to encourage retirement self-sufficiency are no less valid
government tax expenditures today than when first established.
5. Current and future employees will retire with larger savings. There is a two-
fold economic consequence of the post-ERISA trend toward greater retirement say-~
ings in company-sponsored plans.
2Employee Benefit Research Institute, Why Tax Employee Benefits?, Table 1. (Washington,
D.C., 1984)
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734
(a) Reduced pressures on government-Future retirees will be less dependent on
Social Security or Medicare due to longer participation in defined benefit and de-
fined contribution plans. The stronger the private retirement system, the more pre-
pared we will be to cope with the huge Social Security deficits which are predicted
for the coming years. At some point in the near future, economics will force us to
take a hard look at our public old-age health and welfare delivery system.
By whatever means, government must pay the cost for retirement benefits. Con-
gress must choose whether the government will take a more active role through the
administration of the gargantuan Social Security System or continue to be an inac-
tive participant which "pays" through reduced revenues. Congress must determine
whether it is in the nation's best interest for government to shoulder more of this
burden.
(b) Assets paid out of retirement plans will be taxed-The second result of having
a nation of better-off retirees is that a much higher percentage of deferred tax dol-
lars will eventually find their way into the Treasury as post-retirement income tax
payments. Drastic drops in income tax brackets between the pre- and post-retire-
ment employee's income will not remain the rule. Our members report that their
retirees are leaving the work force with a retirement income ranging from 40-100%
of their preretirement earnings. The higher percentages are at the lower end of the
wage scale.
Even considering the various tax advantages (such as rollovers and ten year for-
ward averaging) given to the benefit recipient, the Treasury is not permanently
losing, dollar-for-dollar, the amount of money. calculated to be benefit-related tax ex-
penditures. For example, in 1983, Conoco's annual retirement plan contribution (and
tax deduction) was $27 million. The same year over $46 million (all taxable income)
was paid to about 3700 retirees. As the number of vested retirees continues to grow,
and they earn a larger pension benefit due to longer service under the plan, the
government can anticipate more recaptured revenue. In fact, the fairly conservative
funding standards adopted by most corporations, improved retirement benefits to
employees, longer life expectancies for current and future retirees and the changing
demographic distribution which will accompany the aging of the baby boomers will
create an environment in which the difference between tax dollars deferred and re-
covered should narrow dramatically.
6. More Retirement Dollars Will Be Needed. The demographic changes expected
as America enters the twenty-first century should not be overlooked. The retire-
ment planning implications are enormous. What is needed to support a small, post-
retirement population with a relatively short remaining life expectancy is quite dif-
ferent from the resources required to maintain at an adequate income level a far
larger, longer-living group. Although never intended to supply full retirement
income, Social Security and Medicare will be less prepared to cope with the twenty-
first century's population distribution. Inflation is another serious problem. Careful-
ly planned retirement savings must account for dollar dilution in the post-employ-
ment years. Cost of living increases-and the funding necessary to supply them-
will become even more important.
We, as a nation, have given much thought to these and similar issues beginning
with the Revenue Act of 1921 (exempting interest income on trusts for stock bonus
or profit-sharing plans from current taxation) and continuing through to the most
recent tax law. We are only now beginning to appreciate the post-ERISA economic
impact of well-funded, broad-based private pension coverage.
A broad based labor force shUres in employee benefits
One of the most frequently voiced concerns with employee benefits is the asser-
tion that the current tax structure has created a system benefitting the corporation
and highly compensated individuals by providing deductions and tax shelters.
ERISA was the first comprehensive attempt to guarantee that retirement benefits
would be widely available. More legislation followed. Nondiscrimination rules have
been enacted to insure that both use and availability of statutory fringe benefits are
nondiscriminatory. The top-heavy rules of section 416, contribution limitations
under section 415, and relevant sections of the Age Discrimination in Employment
Act, among others, have further assured widespread availability of employee bene-
fits. In fact, there is great concern that Congress has gone too far in assuring non-
discrimination. The complexity of, and disincentives inherent in, recent legislation
threatens the continuation of retirement plans, especially defined benefit plans and
plans maintained by small employers.
The body of laws governing the employee's retirement benefit incorporates such
features as the following: fiduciary responsibilities on all plan sponsors, trustees, ad-
ministrators, consultants, attorneys and others; reporting and disclosure require-
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735
ments; minimum funding standards; nondiscrimination tests; and tax incentives.
Among the plan watchdogs are: the participants themselves; the business communi-
ty; the plan fiduciaries; the Internal Revenue Service; the Department of Labor and
the Pension Benefit Guaranty Corporation. Current and future benefit recipients
should be confident that their employer-funded retirement savings will be available
as expected.
New legislation has focused upon incidental discriminatory impact issues, such as
breaks in service related to maternity or paternity leave and gender-based vesting
gaps. NEBI believes that legislation has been an appropriate remedy where large
numbers of workers have been adversely affected, either willfully or incidentally, by
certain legal requirements or commonly-included plan provisions. It is our conten-
tion, however, that after ten years of operating under ERISA, the benefit plan prob-
lems which deserved legislative solution have been virtually eradicated, and any re-
maining vestiges of discrimination by plan design or administration are more appro-
priately dealt with by market forces.
A competitive advantage in the marketplace is a primary impetus for offering
fringe benefits and retirement plans. Regardless of any tax advantages to the com-
pany or participant, it is illogical to assume that an employer would provide any
benefit in lieu of the more easily understood and administered direct compensation
if there were not pressures from within the work force to do so. And although the
private system may not be perfect in design and delivery, the population participat-
ing in fringe and retirement plans is larger than ever, and is virtually identical to
the composition of the employment force as a whole.
1. Coverage and vesting gaps between men and women are narrowing as more
women enter and remain in the work force. Statistics show that approximately half
of the American work force is comprised of women, with more than one-half of
adult women now workinig outside of the home. The figure rises to 70% for adult
female "baby boomers." With a growing awareness of the political and economic
force generated by this expanding group, both legislative initiatives and market fac-
tors have provided these women with greater and more equitable benefits than ever
before.
NEBI respondents report a closing gender gap in employment and vesting. One
example is First Interstate Bankcorp. This company has a rather atypical gender
mix of approximately 60% female to 40% male. Although an observer might assume
that men would dominate the long tenure positions (executive and managerial),
which would result in a widely disparate male-female mix at the retiree level, this
is not the case. Of the company's 3,603 actual retirees, 58% are female and 42%
male. Women at this company are becoming vested and staying at First Interstate
Bankcorp. until retirement.
Certain fringe provisions are a reflection of the large number of women who
remain in the work force through their childbearing years. Hunt-Wesson cites as an
example its liberal maternity leave policy (offered as part of its disability plan),
which provides 100% of pay for six weeks with an additional six weeks off at full
pay if medically indicated.
Another example is the dependent care assistance program. In many companies
this program has made economically feasible, for many women with small children,
the decision to seek and retain employment outside the home. It is not only the
working mother who benefits from this assistance. The accessibility of quality child
care at more affordable prices is advantageous for the entire family.
There are other benefits, such as educational assistance, which are more widely
utilized by women and lower income wage earners than by the older and higher-
paid employees. Atlantic Richfield's (ARCO) educational assistance program is evi-
dence of this tendency. ARCO reports that its program's primary participants are
young female clerical workers who are at the lower end of ARCO's wage scale.
These women are returning to school with ARCO's assistance in order to obtain the
skills to qualify them for management track positions. Not only are these young
clerical workers benefitted personally by the availability of educational assistance,
the employer reaps the benefits of a more diverse management team in an industry
that has historically tended to be dominated by men at all levels.
2. Lower income individuals would suffer severe economic consequences if re-
quired to purchase or pay for benefits currently provided by employers. Although
anticipated retirement income needs and the size of retirement benefits will vary
along income lines, many fringe benefit programs, including large catastrophic med-
ical and other welfare benefits (such as dental, disability and life insurance) are to-
tally independent of income level.
According to a 1982 Bureau of Labor Statistics survey, corporations paid 65% of
all health insurance premiums, and 93% of all workers are covered by long and
40-046 0 - 85 - 47
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736
short term disability insurance. First Interstate Bankcorp's health insurance plan
requires a premium of up to $246 per month for family coverage, of which the em-
ployee must pay approximately one-third. If the employer did not pay the majority
of this premium, the impact on the $20,000 combined income family would be much
greater than on the $80,000 combined income family. The financial burden of medi-
cal insurance, without regard to any life insurance or disability coverage, could
leave many families unprotected or underprotected, and vulnerable to economic ca-
tastrophe.
Informal polling by some of our steering committee members indicate that there
is an inclination among younger employees to respond that they would terminate
benefits in favor of increased compensation if the employer ceased to provide these
fringes. Although NEBI does not propose that these unscientific samplings are of
any value beyond the anecdotal, certainly they point out certain significant issues
which need to be addressed. We must consider the future scenario in the event that
employer incentives were eliminated or significantly changed.
For example, let us assume the most drastic case, that all tax incentives to em-
ployers were eliminated and Employer X decided to terminate all benefits and re-
tirement programs. Employees would fall into three categories: those who could and
would replace critical benefits out of their own resources (through, for example, the
purchase of high-cost individual coverage); those who financially could, but would
not, duplicate the employer-paid benefit coverage; and those who simpiy could not
afford to replace the benefits in any meaningful way. This last group would consist
of lower paid workers, persons who because of their age, hazardous occupation or
some other factor would be priced out of the health, disability and life insurance
markets. Their other more pressing obligations or higher priorities would force
them to "play the odds." Inevitably, after enough catastrophes, there would be an
increased demand placed upon government assistance programs. Congress would
feel compelled to do something to breach the benefit gap. How much of the burden
would fall on the employees directly and how much would be left in government's
hands is, of course, impossible to state with any certainty.
NEBI's member companies anticipate a wide range of responses to elimination of
tax incentives. The possibilities range from the institution of some degree of employ-
ee cost sharing to the complete elimination of current benefit programs. Although
employers recognize a certain moral obligation towards their employees and depend-
ents, this is not enough to offset completely their fmancial obligation to sharehold-
ers. Neither is it sufficient to withstand the pressure from employees who are un-
willing to share significantly in benefit cost.
Historical coalition for social progress
Throughout this statement, we have made allusions to the important role played
by the private sector in the implementation of the nation's social programs. In 1890,
only 3.9% of the total population of the United States was 65 years of age or older.
That year, 4.3% of the labor force was composed of persons age 65 and older. By
1983, this same age group represented 11.6% of the total population. The projection
for the year 2013 is that persons over age 65 will make up 14.7% of the total popula-
tion. Between the years 1890 and 1976, however, the percentage of the total labor
force over age 65 actually declined. Although a law prohibiting mandatory retire-
ment prior to age 70 may have some effect on the number of persons who remain in
the work force beyond age 65, it is clear that the present and future prognosis is
that the population spread between the younger working segment and older non-
working segment will continue to narrow. Because this latter group continues to in-
crease in number and percentage of the population, Congress must establish its
policy towards the nonworking elderly now.
1. Private employee benefit plans are necessary components in Congressional
social programs such as retirement security, health care, educational assistance, em-
.ployment security and worker's compensation. The Social Security Act of 1935 cre-
ated the first national program of social insurance, the Federal Old-Age, Survivors,
and Disability Insurance (OASDI) program. Social Security was established to be an
emergency adjunct to retirement income, whether derived from employer's-spon-
sored retirement plans or personal savings. Although Social Security was not one of
the most popular enactments of the New Deal program of President Roosevelt at
the start, it quickly gained popularity, and through the next decades additional pro-
grams were added to the original retirement program: supplemental security
income, Medicare and disability benefits.
The unfunded "pay as you go" Social Security system became increasingly prob-
lematic as the number of recipients grew, as the benefits increased and as cost of
living increases were mandated by inflation. The enormous costs incurred by this
PAGENO="0743"
737
program are carried by current wage earners who are taxed on current earnings. As
the percentage gap between workers and retirees narrows and as retirees live
longer, this tax rate must grow. A nationwide attitudinal survey toward Social Secu-
rity prepared for the National Commission on Social Security in 1981 indicates that
the public is well aware of the implications of these facts and numbers: 61% of the
non-retired respondents expressed doubt that the funds would be available to pay
their retirement benefits. Of those between the ages of 25 and 44, almost 75% gave
this response.3 The purpose of this statement is not to discuss the merits of Social
Security, nor to suggest means of reform. Rather, it is intended to show that the
public retirement system has been strained due to economic and demographic fac-
tors. A "pay as you go" system can be disastrous during periods of high inflation.
Increased payments must be made from currently collected dollars. Wage earner tax
dollars must be used directly for administrative costs, so that the tax expenditure
cost to the government is exacerbated. An adequately funded private system must
supplement this "pay as you go" social security system.
Any reform which would discourage private sector retirement plans while increas-
ing demands on public programs ignore certain critical economic facts about the
present retirement income system. Social Security was intended to supplement pri-
vate retirement income sources. Private plans alleviate some of the social and fiscal
pressures on government. From the fiscal perspective, private plans reduce govern-
ment expenditures needed for retirement payments (and provide a pooi of invest-
ment capital for the national economy). Private plans must be adequately funded,
providing additional capital and interest dollars. The interest dollars will help
defray the plan's administrative expenses and provide cost of living adjustments as
they are needed.
Omitting any tax adjustment at payout, the Treasury's eventual recovery may be
expressed as follows: dollars contributed to plan + interest - administrative cost =
dollars returned to income stream.
From the government's perspective, this dollar cycle compares favorably to the
Social Security system. Social Security collects contribution dollars (which are re-
duced by payments of administrative costs) and almost immediately pays them to
the recipient without the intermediate stop in the economy as invested capital. Al-
though this model is simplistic, it demonstrates that the private pension system is
beneficial to the economy.
From the social standpoint, private plans play a key role. At the time it was en-
acted, Social Security was a drastic response to a social and economic crisis. Prior to
the Industrial Revolution, a young, agrarian nation could take care of its elderly.
Extended families jointly operated farms where the few who survived to old age re-
mained productive in some manner so long as he or she was physically able. The
industrialization of America brought about social changes in our work and living
habits which could not accommodate the Great Depression.
2. Social Security was not intended to provide universal retirement income. Social
Security and private retirement plans are intended to supply retirement income to
wage earners. The essential difference between them is that Social Security was in-
tended as "insurance." Henry L. Bowden, a member of the President's Commission
on Pension Policy, commented in 1981, that "the social security system insures
against an inadequate income at the time of retirement. If you have an adequate
income at time of retirement, you have not suffered the loss against which were in-
sured."
Federal policy has been legislatively expressed. There's a commitment to provide
the retired with adequate income. Opinions may differ over how much assistance is
appropriate and who should pay the bill. Some of the "how much?" questions have
been answered by the Congress. The basic Social Security benefit operates within
prescribed limits. For the private sector, Congress has established retirement plan
contribution and benefit limits. The next question is "who provides?"
Congress had hoped that people would voluntarily save without tax incentives
(and, through IRAs, with tax incentives). Because personal savings have not been
sufficient to ensure post-retirement security (and because low income persons, who
need savings most, have not used IRAs as much as higher income taxpayers), gov-
ernment requires that employers and covered employees make mandatory contribu-
tions to Social Security. The private sector employer is induced to do its share with
tax incentives. The government necessarily "pays" one way or another for the im-
~Nationa1 Commission on Social Security, A Nationwide Survey of Attitudes Toward Social
Security (1981).
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738
plementation of its stated policies. Companies, employees and their dependents
await your eventual decisions on the future of employee benefits.
3. Tax incentives to employers have encouraged flexibility and innovation in ap-
proach and design to accommodate different geographic areas, age groups and em-
ployee needs. Let us assume that the government can deliver health, retirement and
disability benefits at no greater cost than the private sector. Even at identical price
there are sound reasons for delegating some of this responsibility to the employer.
The employer is in a position to respond to the individual needs and demands of its
employees. Note that fringe benefits have always been a major subject of collective
bargaining agreements.
Our member companies affirm that employees are not passive recipients of bene-
fits. Rather, competitive forces spur the creation of an attractive benefit package
which wifi induce the best possible candidates to choose and remain with a compa-
ny. While young workers may be less concerned with extensive defined benefit pro-
grams, they may be very interested in generous maternity benefits, dental plans
and child care assistance. An older population mix may demand retirement security
and a savings plan with self-directed investment options. Only a decentralized,
market sensitive benefit delivery system can permit such fine tuning. NEBI does
not believe that total uniformity is in the country's best interest.
4. Tax incentives to employers have encouraged private sector cooperation in
other policy areas. Collecting revenue is only one item on the congressional agenda.
The nation has set certain other goals involving quality of life. Education-ist~ be
readily available to as broad a segment of the population as possible. Therefore, the
government has established low interest loan programs and has historically given
employers the incentive to establish their own educational assistance programs.
Quality of life in congested urban areas is another national interest. The govern-
ment has provided direct aid to local govenment for mass transportation systems
and provides employers with the incentive to set up qualified transportation pro-
grams. These plans are beginning to show results. For example, 52% of Atlantic
Richfield's Los Angeles employees are voluntarily participating in a qualified trans-
portation program. Participants are reimbursed for parking costs if they form a car
pool of three or more riders. The plan also covers van pools and individual use of
public transportation. Such programs are new and relatively untried by most em-
ployers. NEBI asks this Subcommittee to consider this question: Is the cost through
tax loss to the federal government any greater than that occasioned by direct pay-
ment of highway assistance or implementation of an air clean-up program? Even an
employer-provided lunch program has value beyond employer convenience. It allows
some employers to locate in less urbanized areas, perhaps creating needed jobs.
5. Compensation increases in the form of retirement benefits ten_d_to-be lesslilfia-
tionary than direct compensation increases. These c~ tributinhiare properly char-
acterized as savings, and savings do not ad&fuel-tethe inflationary flame. The em-
phasis is on the retirement bene~tsbecaiis~ some benefits are immediately paid into
the economy and are not "saved." Health benefits coverage is the easiest and most
obvious example.
Health benefits are intricately tied to the alarming inflationary spiral in health
care costs. However, this is one instance where the application of the old maxim,
"Don't throw out the baby with the bath water" is appropriately repeated. Employ-
ers have recently been forced into devoting more and more of their available bene-
fits and compensation dollars to provide the same, or in many cases an inferior,
health benefit package. Our member companies, and we believe them to be repre-
sentative of all employers on this issue, are vigorously working to find solutions to
the problem we have described. Employers, who must show profits to their inves-
tors, ~re working to find innovative ways to control health benefits costs. We believe
that thousands of employers, working in competition in the marketplace, will dis-
cover more ways to save costs than one government-mandated program could ever
do. Employers and participants are starting to learn some hard lessons about health
care expectations. A punitive tax structure is not the solution. The private sector
requests the cooperation of Medicare and Medicaid in finding the proper course.
CONCLUSION
Many member companies have asked themselves a very difficult question: In the
event of a major tax incentive overhaul, would they be able to provide the same
protection to their employees, or even adequate protection for the present and
future health and welfare needs of their employees? Respondents report that it is
too early for their companies to actually make decisions, but that they believe that
PAGENO="0745"
739
their companies would have to completely eliminate all benefit programs or severe-
ly curtail the employer contributions to them.
Congress, business and labor have cooperated for over 50 years in setting up a
joint public-private employee benefits system. Before upsetting the balance, the gov-
ernment must rethink a complex structure. Congress has listened to business and
labor and has been responsive to their needs in this area for many, many years.
Look now to the future. We ask the Subcommittee and the full Congress to decide
whether the real social and long term revenue costs of tax revenue increases in the
employee benefits area will be too high.
STATEMENT oi~ MARTIN D. WooD, DIRECTOR, RETIREMENT, SAFETY, AND INSURANCE
DEPARTMENT, NATIONAL RURAL ELECTRIC COOPERATIVE ASSOCIATION
Mr. Chairman and members of the House Ways and Means Committee, my name
is Martin D. Wood. I am the Director of the Retirement, Safety and Insurance De-
partment of the National Rural Electric Cooperative Association (NRECA) and the
Administrator of the various welfare and pension programs sponsored by NRECA
for its members. NRECA is the national service organization of the approximately
1,000 rural electric systems operating in 46 states. These systems bring central sta-
tion electric service to approximately 25-million farm and rural individuals in 2,600
of our nation's 3,100 counties. Our various programs provide pension and welfare
benefits to over 110,000 employees and their dependents in those localities.
We are pleased to have this opportunity to present information to the Committee
on our programs and the social purposes they serve. We know that as Congress
faces the difficult task of reducing the budget deficit, it will rethink many of the
policies that until now have shaped our tax laws. There will be great pressures to
abandon previous, long term commitments and seize upon shortsighted plans to
raise revenues without thought to the long term consequences to the nation. We are
aware that the treatment of employee benefits is one of the policies that has been
suggested for re-examination, especially because of the large amounts of revenue in-
volved.
Employer provided benefits serve essential social purposes. They provide medical
care when the worker or his family is sick, income when he is disabled, a pension
when he retires and an estate to his family when he dies. They collectively involve
very large amounts of money because they assume great social obligations. Any at-
tempt to change the present treatment of benefits for short term revenue gains will
have a drastic effect on the provision of these benefits. These are issues of long term
consequence; changes should not be made for merely short term gains.
Today it is difficult to recall the state of the nation's rural citizens in the 1930's
and 1940's. Social Security was a new, radical innovation and employer provided re-
tirement plans were almost unknown for rank and file employees. Health insurance
(and indeed health care) was not a major concern of government or employees. Basi-
cally, rural Americans were left to fend for themselves so far as life, health, disabil-
ity and retirement needs were concerned. As rural electric cooperatives were formed
throughout the United States in the 1930's and 40's they needed to secure insur-
ance, both to protect themselves and their employees from economic loss covered by
injury or sickness. Because of the newness of the industry and because the coopera-
tives were located in rural areas, rural electric cooperatives had great difficulty in
obtaining insurance. The major insurers, whose business was predominantly urban,
considered rural electric cooperatives as "farmers playing with electricity." The fail-
ure of the insurance community to respond to their needs was one of the principal
motivations for the formation of NRECA. We are proud to say we have come a long
way from the situation in those early years. Employer provided welfare and pension
benefits now provide for the rural electric worker and his family upon illness, dis-
ability, death or retirement. The basic benefit programs discussed below are provid-
ed to most rural electric cooperatives through NRECA.
The typical employee of a rural electric cooperative is a 41 year old electrical
worker living in a rural community. The pay standards are moderate with the aver-
age pay approximately $22,700 but the work involves a degree of risk higher than
the norm for injury or death.
Medical insurance is provided to rural electric employees to cover expenses above
deductible and co-insurance amounts. These coverages are essential to the partici-
pant and family for financial security in the event of illness or injury. These bene-
fits are available to all employees of the cooperative without discrimination.
Two long term disability programs are offered: One which provides 50 percent of
salary without offset for Social Security disability benefits and one which provides
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740
66% percent of salary but offsets for Social Security. In the context of electrical
workers, disability benefits are particularly important because of the nature of the
occupation, which involves a relatively high risk of serious job related injury. These
benefits are available to all employees at the cooperative without discrimination.
Life and Accidental Death and Dismemberment insurance is provided in multi-
ples of one to five of annual earnings. The typical employee is insured for approxi-
mately $53,000 or about two and one-third times salary. This insurance accounts for
a major portion of the typical employee's estate and thus is a primary source of sup-
port for the employee's family in the event of death, often serving to preserve the
family unit. These benefits are available to all employees of the cooperative without
discrimination.
In addition to the basic care welfare benefits described above, some cooperatives
have small amounts of short term disability, dental, vision care and business travel
insurance which serve those needs.
Pension benefits are provided through a defined benefit and a money purchase
pension plan. These programs are available to all employees of the cooperative with-
out discrimination. The typical employee will receive 43 percent of his salary from
the defined benefit plan as a retirement benefit. In addition the employee may re-
ceive benefits accumulated from the money purchase plan.
BENEFITS ARE DISTRIBUTED EFFICIENTLY AND EFFECTIVELY
Rural electric cooperatives are tax exempt cooperative organizations that are fa-
miliar with the advantages of the cooperative principle. It is not surprising that
most rural electric cooperatives have elected to cooperatively pool their resources
through NRECA to utilize their collective purchasing power. The benefits of the
welfare programs are cooperatively provided through a common trust that is tax
exempt under I.R.C. section 501(c)(9). Pension benefits are provided through two
master multiple-employer trusts as defined in I.R.C. section 413(c). The group and
master trusts exist to provide services for the insured individuals in the form of op-
tional benefits at the lowest possible cost. The group trust utilizes self funding of its
welfare benefits (except life insurance) to optimize the return to the cost of the ben-
efit and reduce the cost of outside services to the lowest prudent level. The welfare
and pension programs provided through NRECA are self-administered by profession-
al staff. The cooperative nature of the programs encourages the cooperatives to
reduce costs and prevent injury and disability by peer pressure, educational pro-
grams and professional counseling. In addition, various methods of cost sharing and
provider auditing helps keep down cost and over utilization of benefits.
In the past few years our medical program has been subject to the same escala-
tion of health care costs as other medical programs in the United States. In an
effort to reduce the rapid growth of medical care costs, we began in the early 1980's
to pay for home health care, ambulatory surgery and voluntary second surgical
opinions. We also adopted a cost containment package (elective by the system) that
provides for a hospital confinement deductible, mandatory second opinions for cer-
tain surgery and reduced reimbursement for private duty nursing. These provisions
discourage unnecessary procedures and encourage patients to return home as soon
as possible. When we put the cost containment package into effect in 1983 we ex-
pected it to save about 7 percent on medical costs. Our figures show that the pro-
gram is a great success with savings of about 10 percent. Approximately 20 percent
of our systems have adopted the package and we are encouraging the adoption of
the package by a greater number of systems along with higher deductibles and shar-
ing of the premium cost between the systems and employees.
BENEFITS ARE DISTRIBUTED FAIRLY AMONG PLAN PARTICIPANTS
The welfare and pension benefits are distributed just about evenly across the em-
ployee population. Health benefits are provided on the same basis to all participants
at the time of need. Disability and life insurance benefits are provided as a common
percentage of compensation to all employees. Retirement benefits are similarly pro-
vided to all employees as a percentage of compensation, factored by the length of
service.
The benefits provided are adequate, but not by any standard excessive. They are
designed to provide for the reasonable replacement of lost earnings or reimburse-
ment of expenses.
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741
TAX INCENTIVES ARE IMPORTANT IN ENCOURAGING EMPLOYER PROVIDED BENEFITS
Among employees of rural electric cooperatives, benefits constitute approximately
37 percent of gross salaries paid to employees. This 37 percent figure includes the
cost of all employee benefits, both those that have incentives and those that do not.
When vacation, sick leave, holidays, and other non-tax incentive benefits are ex-
cluded we find that tax incentive benefits contribute only 26 percent of gross sala-
ries paid to employees. Of this 26 percent, approximately 16 percent consists of tax
deferred contributions to pension programs. Approximately 10 percent consists of
truly tax exempt medical and other similar benefits. Because the great bulk of the
tax favored benefits provided to rural electric employees are pension and welfare
benefits our discussion will be primarily directed towards those programs.
Rural electric cooperatives have absolutely no tax motivation themselves for pro-
viding any type of employee benefits. Rural electric cooperatives are almost all tax
exempt under I.R.~. section 501(c)(12) and since tax exempt, derive no tax advantage
from the provision of employee benefits. Employee benefits are provided because
they serve a social purpose-the protection of the employee's health, and the provi-
sion for disability, death or retirement.
Pension and welfare benefits are provided by rural electric cooperatives as a part
of an unwritten but long standing social contract among government, employers
and employees whereby Social Security, Medicare and Medicaid are provided by
government as a mandatory, basic portion of employee protection. A second level of
protection is provided by employers on an optional basis, which government encour-
ages by favorable tax treatment. The final portion is provided by employee savings,
some forms of which are also encouraged by the tax laws.
Of course there is a revenue cost to the Treasury when benefits are provided to
employees on a tax favored basis. The question is whether the cost of foregone reve-
nue equals the social benefit derived from those foregone revenues. There is no
doubt in our minds that the revenue cost of tax favored fringe benefits is more than
adequately paid for by the broad participation of rank and file employees in essen-
tial welfare and retirement plans. Most of the participants in our programs are blue
collar workers, there are relatively few management level or highly compensated
employees. It is simply not realistic to expect the average employee to forego his
immediate income needs to set aside the substantial sums needed for retirement or
for his health and disability needs. It is our experience that the vast majority of
employees do not protect themselves against these eventualities unless the cover-
ages are provided by the employer. A shortsighted philosophy often prevails in
which the employee elects to "take home" pay rather then prepare for contingen-
cies of this nature. It is the employer who recognizes the need and makes the alloca-
tion of resources to employee benefits. Tax incentives represent an essential cost
sharing between government and private industry to encourage the maximum avail-
ability of these benefits.
RECOMMENDATION FOR PUBLIC POLICY DEBATE
In closing, we would like to raise several issues deserving of further consideration
by the Congress and the Administration as debate on the appropriate tax treatment
of fringe benefits evolves.
First, and foremost is the need for a predictable and consistent policy on the tax
treatment of the benefits discussed here. What was once a ten or fifteen year review
and reform of the tax law has now become an annual affair. Frequent changes in
the laws affecting these benefit plans adds significantly to the costs of their admin-
istration and makes planning for future contingencies difficult. If our 1,000 member
cooperatives each administered their own benefit plans, we have no doubt that
many would have terminated them in the face of these yearly changes. This is fre-
quently the choice many small and medium sized businesses are faced with.
Second, we would like to state again that our benefit plans are meeting th~ eco-
nomic security needs of our large rural electric family across the nation. When no
one else would meet the light and power needs to these areas, the rural electric co-
operatives did. Before there were government sponsored plans to care for the dis-
abled employee, plans to provide for his dependents in the event of death, or plans
to provide an adequate income after one's retirement, the rural electric cooperatives
offered this protection to its employees. These benefits are non-discriminatory, offer-
ing a high quality of benefit at the lowest possible net cost. If we were not to pro-
vide these plans for the basic economic security of our 110,000 employees and their
dependents there could be little doubt that each Member of Congress would be peti-
tioned for similar protection to be provided by the Federal government.
PAGENO="0748"
742
With regard to specific policy changes, we would like to recommend three propos-
als for your consideration in the area of salary reduction money purchase pension
plans, the $50,000 limitation on the tax-free treatment of employer paid life insur-
ance premiums, and proposals to limit the amount employers may pay in health in-
surance premiums.
Our national pension policy has encouraged individuals to save their retirement
and has sought to make such pension benefits available to a broad spectrum of
Americans. In furtherance of that policy, the Revenue Act of 1978 added section
401(k) to the Internal Revenue Code permitting profit sharing and stock bonus plans
to adopt special salary reduction features that encourage employee savings. Howev-
er, under present law a plan that is not a profit sharing or stock bonus plan cannot
provide such a feature. The exclusion of money purchase pension plans has denied
the benefits of the increasingly popular salary reduction savings programs or em-
ployees of nonprofit organizations and to employees of for-profit organizations that
have no current or accumulated profits. Apparently, it was simply a matter of over-
sight that Congress did not extend the availability of salary reduction arrangements
to money purchase pension plans. The Treasury Department has twice supported
such legislation in public testimony on June 14, 1982 and September 21, 1983 before
the Ways and Means Subcommittee on Select Revenue Measures. It is our hope that
Congress will soon adopt legislation to promote regular retirement savings through
salary reduction arrangements under a money purchase pension plan.
The present $50,000 limitation on the amount of employer paid life insurance pre-
miums that is tax-exempt was first enacted by Congress in 1962. Since that time the
cost of living has continued to increase significantly, reducing the value of this bene-
fit today to only $14,560. As mentioned earlier, the average coverage for our employ-
ees remains at roughly two and one-third times annual salary or $53,000 per em-
ployee. It is our recommendation that Congress review the present limitation to de-
velop a means of preserving the current dollar value of protection provided.
Finally, we would like to speak against proposals that have circulated over the
last year to limit the tax-free treatment of employer-paid health insurance premi-
ums. It has been our experience that the appropriate level of health insurance cov-
erage is best left to the individual cooperative's management in consultation with
their employees. Differences in geography, availability of health services, and job re-
lated risks would make a national standard difficult to reach and unwieldly to ad-
minister. The record of our members in developing a level of coverage adequate to
meet their employees' needs and in pioneering efforts to control health care costs
has been impressive. We urge the Congress to consider the use of flexible spending
accounts which encourage employees to hold down costs of non-taxable benefits like
health insurance, rather than impose an inequitable and unworkable cap on those
benefits.
This concludes our recommendations for public policy debate and we remain
available to provide this Committee or any other body with any further information
that may be helpful in deliberations on these important concerns.
PAGENO="0749"
ALLOCATION OF WAGES AND BENEFITS FOR
THE AVERAGE RURAL ELECTRIC WORKER
1984
~
TAX-DEFERRED UEN~FITS (1 8~ OF WAGES)IV~
~ON-TA)( NCENTiVF DENEFflS (11% OF WAGES)
* * TAX-EXE~P1 BENEFITS (10% OF WAGES)1
---.--.*+*-*---~--~--~-*-*~-*-.
0 5000 10000 15000 20000 25000
DOLLAR AMOUNT
AVFRACE ~I'OR/(FR /3 4/ YEARS OLD
PAGENO="0750"
744
ROCKFORD, IL, September 5, 1984.
Hon. AL~ DIxoN,
US. Senate, Washington, DC.
DEAR MR. DIxoN: This is to urge action in September to continue fair tax treat-
ment for legal services plans. I am concerned that Congress will not act in time to
prevent Section 120 of the Internal Revenue Code from expiring on December 31.
That section provides tax treatment of qualified legal services plans similar to that
of other statutory fringe benefits.
Section 120 was first enacted in 1976 on a temporary basis to see if it would stim-
ulate the growth of legal services plans without costing much in foregone revenue. I
believe Section 120 has clearly succeeded.
I am currently on the panel of "Cooperating Attorneys" for the UAW Legal Serv-
ices Plan. While I am not an employee of that Plan, I accept referrals of Plan par-
ticipants for legal matters not fully covered by Plan benefits. The Plan would not
have come into existence if Section 120 had not been enacted.
Legal Services plans like this one are so cost effective that they can flourish as
long as they are treated equally with other statutory fringe benefits. Legal services
plans should not be subject to income taxation or FICA or FUTA taxes. Certainly
the minimal revenue loss involved provides no basis for singling out legal services
plans for harsher treatment.
I urge your strong support of 5. 2080, H.R. 5361.
Sincerely,
JOHN M. NELSON.
STATEMENT OF HAL Bom~, VICE PRESIDENT, FEDERAL RElNnoNs, PACIFIC TELESIS
My name is Hal Boel and I am Vice President, Federal Relations for Pacific~Tele-
sis Group. I appreciate the opportunity to submit my remarks on behalf of Pacific
Telesis and its subsidiaries to the House Committee on Ways and Means. The tax-
ation of fringe benefits is a matter that we regard as extremely important to the
Corporation and to our employees.
Pacific Telesis is opposed to any attempt to tax employee benefits for many rea-
sons. Favorable tax treatment for employer provided fringe benefits was implement-
ed to encourage the development of benefit programs that would protect and pro-
vide for employees and their families. Employees have benefitted from these pro-
grams through better medical, dental and vision care that the great majority either
couldn't or wouldn't normally be able to afford. At the same time employers have
benefitted through overall better health of their employees translating to less time
lost to serious or disabling disease and incidental time off for illness. In addition,
employer sponsored tax favored pension plans have provided, and promise to pro-
vide, for the security of American workers past and future. No government pro-
grams approach in scope and generosity the benefits provided by employers.
The advantages of tax favored employer provided fringe benefits are clear. The
advantages and motives of proposals to fundamentally change the tax status of tra-
ditional benefits are not so clear.
If the prime motive of proposals to subject benefits to taxation is raising federal
revenue, the result may be the direct opposite of the intent. It is not at all clear
that employers, including Pacific Telesis, would continue to provide currently avail-
able benefits if favorable tax treatment were substantially modified. Should employ-
ers not choose to continue benefit programs, there would be no benefits to tax and
no additional revenue. Moreover, in the absence of employer provided benefits, the
health and retirement needs of employees would become the responsibility of the
federal government. According to the administration's 1985 budget submission, the
federal government will spend $69.7 bfflion in 1985 on medicare to provide health
care to roughly ten percent of Americans; the revenue loss for the tax exemption of
employee provided health care coverage is estimated to be $28.2 billion for the same
period, but will cover nearly 90% of Americans. Correspondingly, the federal gov-
ernment will provide $190.6 billion in Social Security benefits-a program that does
not provide full retirement income; in 1985 the "tax expenditure" for employer pro-
vided pension plans-providing full retirement income for 75 percent of American
workers-is estimated to be $80.7 billion. it is evident that the tax loss from employ-
er provided pensions and health care, covering a greater number of Americans with
more complete protection, is significantly less costly than the expenditures of corre-
sponding government programs. Thus, the cost to the federal government could be
considerably greater than any revenue enhancement produced by taxing fringe ben-
efits.
PAGENO="0751"
745
If the intent of proposals to tax fringe benefits is directed at overly expansive ben-
efits (in lieu of cash) or at areas of abuse, certainly corrective legislation, if needed,
would be appropriately directed at specific areas. However, imposing too many re-
strictions can cause plan terminations and deliberalization. Management groups
and owner-employees can provide for themselves through other mechanisms even
though they are less tax-efficient. The real losers from overly restrictive legislation
may well be the "average" employees whose coverage is eliminated and who have
no adequate means of replacement. Under present law non-discrimination rules
appear to be adequate. The address not only eligibility but contributions and bene-
fits, as well as exceptions, for good faith collective bargaining. However, also under
present law, if a qualified plan is found to discriminate in favor of officers, share-
holders or other highly compensated class, the otherwise applicable exclusion is gen-
erally denied for all benefits provided under the plan, including benefits provided to
the rank and file employees. The issue of discrimination must be dealt with in its
proper perspective as it occurs. Concepts such as limiting the tax on benefits to the
first 5 percent of adjusted gross income could build in discrimination by providing
advantages to higher income employees. Our work force is expanding and aging and
expenses are increasing. Our planning must accommodate these changes but there
is no one answer. The answer does not lie, for example, in regulations that would
unrealistically limit the amount of prefunding for welfare benefits. By arbitrarily
limiting prefunding deductibles, the long term penalties could be severe. Abuses
should be eliminated but we should stop short of removing incentives that serve a
legitimate social purpose and benefit the larger class of employees. It is unrealistic
to consider the wholesale elimination of programs that represent the considerable
social progress made over the years. if such programs are eliminated serious consid-
eration must be given to what will replace them. The economic security needs of
individuals will not diminish and to the extent that private plan coverage does dis-
appear, it will create pressures for government benefits to fill the gap. Expanding
governmental programs beyond their current level would be wrong. Tax incentives
to business represent a far more efficient method than government control. In fact,
the advance funding concept of many private plans contributes to the formation of
capital-a feature not available with Social Security's pay-as-you-go financing.
The removal of corporate tax incentives or the imposition of too many govern-
ment restrictions on employee benefits would have a direct impact on Pacific's em-
ployees. Where tax incentives no longer exist for corporations they are faced with
several choices. One such choice is the continuation of the programs with the con-
comitant increase in expense to the corporation passed on to the consumer. The
other extreme is to discontinue the programs. It is difficult to say at this point
which alternative or combination of alternatives would present the best economic
choice for Pacific. Several scenarios are being studied. It is safe to say, however,
that the economies of scale would make the cost of benefits less through an employ-
er provided program than if each employee were faced with the prospect of finding
comparable coverage on an individual basis. The cafeteria plan concept, which Pa-
cific Telesis has incorporated into its benefit plan for its subsidiaries, represents a
move toward an effective compromise and ultimate cost containment wherein the
user is required to assume some of the overall costs of care that is more custom
tailored to meet individual needs. The incentive for companies to pursue this kind of
creative planning should not. be discourage by removing the design flexibility that
exists today.
What we need is a stable national policy. Since ERISA was enacted into law 10
years ago, we have had two major Social Security amendments, legislation on age
and sex discrimination, revisions on plan termination liabilities and seven major tax
acts. In such an environment it becomes extremely difficult and expensive to design
plans and appropriate support systems. Without a meaningful, stable policy that
will exist for a reasonable period of time, employers will be hesitant to make posi-
tive changes in plan design and management. In fact many may choose curtailment
or abandonment, moves that can only penalize average employers, rather than deal
with unnecessary, expensive and difficult administrative burdens and the uncertain-
ty of change.
In Summary, Pacific Telesis urges congress to consider the full impact of whole-
sale elimination or restriction of tax incentives on employees benefits before decid-
ing that this is the only answer. Congress and the administration must develop a
thoughtful, coordinated policy that employers and employees can rely on in the
future. I believe that responsible planning of programs, based on some stable, na-
tional policy, with directed corrective action taken on obvious abuses, can achieve
the purpose for which these incentives were originally designed. At the same time
these efforts, if managed properly, can ultimately reduce costs for all concerned, in-
PAGENO="0752"
746
eluding government. What we are spending for our employees to have the opportu-
nity to participate in employer provided benefits should be closely scrutinized and
carefully managed so that it serves a legitimate and cost effective purpose. Benefit
programs are necessary, but the assumption that corporations like Pacific will con-
tinue to offer them without cost incentives to do so could be an erroneous one and
one that needs more in-depth analysis of the long term impact.
PFIZER INC.,
New York, NY September 1.9, 1984.
Mr. JOHN J. SALMON,
Chief Counsel, Committee on Ways and Means,
House of Representatives, Washington, DC.
DE~x Mx. SALMON: I am writing to you in connection with the House Ways and
Means Committee's hearings on employer-provided benefits. Specifically, I believe
that there are several key issues in this area which must be carefully reviewed from
the perspective of the employee, the employer, and of the Government.
Over the years Congress has protected American workers through various stat-
utes and regulations governing employee benefit plans. For example, the Employee
Retirement Income Security Act of 1974 ensures, among other things, that employ-
er-sponsored benefit plans do not favor the highly-paid employees. We are at a
point, however, where there is a risk of regulating employer-sponsored benefit plans
out of existence if the tax treatment accorded employers sponsoring these plans is
made less favorable.
Tax laws should be structured to encourage employers to sponsor benefit plans
that are made available to broad-base groups of employees. Current tax laws pro-
vide these incentives and, in addition, provide adequate safeguards to ensure equali-
ty of treatment for all employees participating in these plans. Since a balance be-
tween providing incentives to employers and providing equal treatment for employ-
ees has been created and maintained effectively by existing legislation, I believe
that it would be unwise to adopt more restrictive measures. Therefore, it is impor-
tant to review the consequences that might result if this balance is changed.
Currently, the costs of most employer-provided employee benefit plans are deduct-
ible by the employer. This affords an important incentive to employers to continue
to maintain the plans. Increased taxation and regulation in this area can result in
employers' decisions to terminate certain benefit plans since it would therefore be
far easier to provide the equivalent cost of the benefits as direct compensation to
the individuals involved. This can result in unfortunate consequences for the vast
majority of American workers.
For example, the current cost to Pfizer of providing medical and dental insurance
is $2,300 per employee per year. This represents approximately 11%of the average
base pay of our non-exempt employees versus less than one-half of one percent for
the highest-paid employees. If Pfizer were to terminate its medical and dental plans
and to add the $2,300 to the pay of each employee several unfortunate results might
obtain:
There is no guarantee that all employees would necessarily use the money to pur-
chase substitute medical and dental coverage. Hence, there is the possibility that a
number of employees may be faced with severe financial hardships should they or
their families incur significant medical or dental expenses.
Since Pfizer, like most employers, provides coverage for large numbers of employ-
ees, it can obtain more favorable rates for this coverage than individuals seeking to
purchase similar coverage. Therefore, even if we could rely on employees to pur-
chase substitute coverage on their own, it would cost each of them far more to
obtain the comparable insurance coverage. Thus, this may be an incentive for em-
ployees to refrain from purchasing medical and dental insurance. Even if they do
purchase it, however, the $2,300 may not purchase enough to afford them adequate
levels of protection.
Some might wonder then whether the Government could provide these same ben-
efits directly at lower costs. To answer this one would merely have to review the
escalation of costs in the private sector versus the greater rise in the cost of govern-
ment-sponsored programs.
We have strongly supported President Reagan's advice that American workers be
provided with incentives to save for their retirement years. Currently we provide an
ideal vehicle for this in both the Pfizer Savings and Investment Plan and our U.S.
Savings Bond program. In the former, employees may save up to 15% of their pay
each year. To provide a strong incentive for employee savings, Pfizer provides a
matching contribution-$l for each $1 on the first 2% of an employee's compensa-
PAGENO="0753"
747
tion, and 504 for each $1 on the next 4% of an employee's compensation contribut-
ed.
This employee savings incentive has produced noteworthy results-over 90% of
our employees participate in this plan. If the current tax treatment of employee
benefit plans is altered, employees may be forced to utilize monies they currently
can afford to save to purchase heretofore employer-provided benefits. As a result,
participation in the Savings Plan may decline-even to the point where the IRS re-
moves its qualified status because the only participants left will be the most highly
paid.
We at Pfizer have always maintained an egalitarian approach to employee bene-
fits-every employee is covered by the same benefit plans. Our most highly paid em-
ployees could probably replace whatever coverage tax changes force us to remove
but the vast majority of our employee may not be able to replace this coverage. It is
precisely for these employees that our benefit plans were implemented, and it is
these employees who will be harmed should the private employee benefit system be
changed in the way proposed.
Accordingly, we would urge that the law not be changed to treat the employer-
paid cost of life, disability, health care, pension or other benefits as income to em-
ployees, or to eliminate the deductibility of companies' expenditures for such pay-
ments.
Sincerely,
EDMUND T. PRArS, Jr., Chairman of the Board.
PICKER INTERNATIONAL,
Northford, CT, September 13, 1.984.
Mr. JOHN J. SALMON,
Chief Counsel, Committee on Ways and Means,
House of Representatives, Washington, DC.
DEAR MR. SALMON: Code Sec. 127 which expired for tax years beginning January
1, 1984, provided that employee benefits under an employer's nondiscriminatory
educational assistance plan were not includable in an employee's gross income and
gave employers an incentive for tax years 1979 through 1983 to add an educational
assistance plan to their fringe benefits package. In addition, the payments were not
subject to FICA, FUTA, or Federal Income Tax Withholding.
Congress did not act to extend this provision beyond the January 1st. expiration
date before it ajourned last fall, and consequently, the payments became subject to
FICA, FUTA, and Federal Income Tax Withholding.
The Senate added a provision to the Tax Reform Bill, H.R. 4170 that would have
extended the program to taxable years beginning before January 1, 1986. However,
the provision was deleted from the bill in conference. The Tax Reform Act of 1984
(Public Law 98-369) contained no extension, and as a result, ~!`~cational benefits un-
related to employment are still subject to FICA, FUTA, and Federal Income Tax
Witholding.
It would be in the best interest of Government to reinstate the benefits under
educational expense plan as nontaxable to the employee for FICA, FUTA, and Fed-
eral Income Tax Withholding. One of the Governments responsiblilities is to seeing
to a better educated public. When a company offers a benefit for an employee to
better themselves, the Government should continue to back up the public. Not take
away an important responsibility of the Government and private sector working
hand in hand to advance the people who would take advantage of the educational
assistance plan. This is a very poor way for the Government to create a very small
revenue producing plan.
It is still possible that you can help by extending the provision retroactively to
January 1, 1984. I appreciate your anticipated cooperation in helping to pass the
above educational assistance plan to have more people pursue their educational
goals under Code Sec. 127.
Yours Truly,
RUSSELL SPECTOR, General Accounting Manager.
PAGENO="0754"
748
SOUTHWESTERN BELL TELEPHONE,
St. Louis, MO, September 20, 1.984.
Mr. JOHN J. SALMON,
Chief Counsel, Ways and Means Committee,
Longworth House Office Building, Washington, DC.
DEL&R MR. SALMON: I would like to take this opportunity to express Southwestern
Bell Telephone's interest in the work of your subcommittee(s). Southwestern Bell
Telephone recognizes the tremendous impact of employee benefits on national social
goals and tax policies as well as its effect on individual financial well-being.
Southwestern Bell Telephone presently provides financial protection through our
benefit programs to over 70,000 employees and to another 25,000 retirees, former
employees, and their beneficiaries. A much larger number of people are dependent
on these 95,000 people for their financial security.
Our benefit programs are structured so that 99.4% of our pension and benefit ex-
penses in 1983 were incurred on behalf of lower and middle level employees. When
combined with Social Security, our pension benefits provide a larger percentage of
pre-retirement income to lower paid employees. Therefore, changes in the tax status
of employee benefits will significantly affect the majority of our benefit plan partici-
pants and their dependents.
Southwestern Bell Telephone provides a comprehensive program of benefits. Fa-
vorable tax treatment has undoubtedly contributed to the steady expansion of our
employer-provided "security net" over the past 71 years since the establishment of
our first benefit plan. Without tax incentives our Company would question the ad-
visability of incurring the substantial administrative expenses associated with em-
ployee benefit programs. We could deliver the same amount of total compensation
to our employees in wages with lower administrative costs to the Company. I think
it is safe to say that many employees would not use such increased wages to provide
retirement income or to provide protection for health expenses or disability. These
same people would then most likely request additional services and protection from
state and federal programs.
Given consistent, long term tax treatment by the federal government, Southwest-
ern Bell Telephone feels strongly that we, in conjunction with collective bargaining
representatives, can best plan for the financial security of our employees. We think
these programs clearly further worthwhile social and economic goals in this coun-
try. On behalf of our employees and retirees, I urge that you preserve the tradition-
al tax status of employee benefits.
Sincerely,
J.F. HAAKE,ViCe President.
STATEMENT OF JANE BARBER, BENEFITS MANAGER, TEKTRONIX, INC.
SUMMARY
Federal tax policy in conjunction with employer self-interest in offering benefits
as part of a human resources strategy, have fostered the development of privately-
managed social programs which have done this country, its communities and its citi-
zens a great deal of good over the years. Before further changes are made to the tax
codes which have stimulated the formation and continuation of benefit plans, Tek-
tronix urges Congress to step back and consider what it wants social policy to be
during coming years.
We believe the policy should be one that fosters self-responsibility and provides
options which will make it attractive for people, in conjunction with the employers
for which they work, to make wise personal decisions and to plan and save for their
own financial futures. Examples of how these goals can be achieved at 401(k) cash
or deferred plans and Section 125 cafeteria plans.
"Cafeteria" benefit programs have, in our opinion, the potential to provide long
term solutions to some problems created by the more traditional design of benefit
plans. We believe they will enable us to better manage our benefit costs, foster a
sense of self-responsibffity on the part of employees and better meet the needs of a
diverse work force. In particular, we look forward to a cafeteria benefits plan help-
ing us with our strategy to restrain increases in the cost of health care.
PAGENO="0755"
749
INTRODUCTION
Mr. Chairman, my name is Jane Barber. I am the Benefits Manager for Tek-
tronix, Inc., headquartered in Beaverton, Oregon. In that role, I am responsible for
designing and administering the company's benefit program.
Tektronix is Oregon's largest private employer with more than 15,000 employees.
We also employ 2,000 people at our Clark County facility near Vancouver, Washing-
ton and another 1,900 people at sales and service offices in 29 states.
Tektronix is an electronics company that manufactures sophisticated test and
measurement equipment, television products, computer graphics terminals and pe-
ripherals, and computer-aided design equipment. Our total sales in the fiscal year
just completed were $1.3 billion. To be successful in our chosen market and to gen-
erate the profits from which tax revenue can be derived, we must attract, retain,
and motivate high-performance employees. They are our most important resource.
They create the product ideas, they design the products, they manufacture the prod-
ucts, and they represent the product in the marketplace.
Benefit programs as part of human resources strategy
Tektronix believes benefit programs have an important role to play in helping us
to have high-performinig employees. Along with cash compensation, they form a
part of the package which attracts employees to our company and through which
we reward performance. They help our employees be more productive by relieving
them from worry about what the financial consequences for themselves and their
families would be if they were to incur large medical or dental bills, or the loss of
income through disability or death. Company provided education programs assist
employees to increase their potential and to adapt to changing job requirements, so
they may continue to be an effective part of a high-performing team. We have a
profit sharing program and an employee stock purchase program, which provide
productivity incentives and allow employees to share collectively in the success of
the company.
Social and economic implications of benefit programs
The tax policy of the United States, as well as employer self-interest in offering
benefits as part of a human resource strategy, have fostered the development of pri-
vately managed social programs which have done this country, its communities, and
its citizens a great deal of good over the years.
Through employer-offered health insurance programs, families have been kept
from becoming destitute as a result of medical bills for serious illness or injury.
And, through the affordability of good medical care, people have been restored to
good health and productive lives. Through disability income insurance programs,
combined with health insurance programs, employees who became so disabled they
could no longer work have been able to maintain a reasonable standard of living
without turning to their communities for charity or to government for more assist-
ance. Group life insurance programs have replaced income for families of deceased
wage earners for a transitional period until they were able to restructure their lives
and find other means to provide for the family.
There is, of course, a cost for these programs. In the fiscal year just ended, Tek-
tronix spent $26 million of its sales on health, life and disability income programs.
Because these programs are tax deductible for the company and tax-exempt for em-
ployees, the government shared in this cost.. However, I believe this was a cost-effec-
tive expenditure for the government, assuming the social needs should have been
met somehow.
To provide an example which I know is over-simplified but which illustrates the
dynamics, last year my company spent $26 million on benefit programs, and the
government lost revenue of approximately $12 million. If we assume that the gov-
ernment, instead of Tektronix, had provided the same $26 million to meet the secu-
rity needs of our employees, then it could be concluded that Tek would have lost a
tax deduction of $26 million which would have yielded the government increased
revenue of $12 million. The net effect for the government would have been a loss of
$14 million. This would seem to be the wrong direction for a country seeking to
reduce its deficit. What would have happened if the company's contribution to these
programs had been taxable income to employees? In the short term, the govern-
ment's share of the cost would have been reduced to something less. However, there
are problems with this approach. Even now, we have employees who receive more
than $50,000 in life insurance calling us and saying, "Look, if I've we got to pay tax
on that amount, I'd rather have it in cash." If all benefit contributions created tax-
able income to employees, I think it's fairly predictable that more and more employ-
ees would begin to pressure their employers to give them cash instead of benefits.
PAGENO="0756"
750
That might be fine from the point of view of raising revenues, but it would encour-
age people to take risks with their security. When they then fell ill, became disabled
or died, society would have to develop the means to take care of them and their
families. In short, taxation of these benefits might create short term revenue solu-
tions, but it most certainly would create long term social problems. Another factor
which must be considered is that the money Tektronix spent on those programs last
year did not just go down a drain never to be seen again. In the case of the health,
life and disability programs, it was paid out in benefits to persons who purchased
goods and services, which in turn, helped maintain or broaden the tax base from
which the government derived revenue. To the degree it contributed to the success
of businesses or institutions who buy Tek products, some part of it will come back to
Tek in the future.
Despite the good these programs and the other social programs of the United
States have done over the years for individuals, employers, communities and the
country, I also believe they have created some problems through their structure and
design. They have shielded people from the economic realities of life, much in the
same way as a parent does who pays all the bills a teenager runs up. As a result,
they have stimulated some undesirable results: uncontrolled costs, particularly in
the case of health insurance; an expectation that government or employers have an
obligation to keep providing more benefits; and a minimal understanding on the
part of individuals that they have a responsibility to participate in providing for
their own security. Just as the current design of programs, with their attendant
messages, have created certain behavior and attitudes, I believe redesigned pro-
grams and appropriate tax incentives can do their part in creating improved results.
The legislation that enabled Individual Retirement Accounts and 401(k) cash or
deferred plans are excellent examples of how tax policy can stimulate positive be-
haviors and desirable social goals. More people are now saving for their retirements
and feeling proud of themselves for doing so. These programs are fostering inde-
pendence and a sense of self-responsibffity. The money which is being saved on a tax
deferred basis is being plowed back into the economy through investment and is
broadening the tax base for national, state and local programs. They do not foster
the notion that people have a "right" to total economic security from the govern-
ment or employers, which creates dependent behavior and an appetite which can
never be appeased. Instead, these programs send a message that the government be-
lieves it's good for people to help themselves.
"Cafeteria" benefit plans and cost management
Another piece of legislation which I believe to be capable of providing some solu-
tions to the problems created by the traditionally designed programs is that which
enabled "cafeteria" benefit plans. My company has just completed a year-long study
of our benefit program for the purpose of identifying changes which would enable
better cost management, better meet the needs of our now diverse workforce, and
better foster a sense of seif-responsibifity on the part of employees. And, we wanted
to do these things while enhancing employee relations. It's our conclusion that a
cafeteria benefits plan will allow us to meet our objectives, while still assuring that
the positive social purposes of current programs will be continued.
The essence of the program we plan to design and implement is to create benefit
"credits" by shrinking the portion of the program which employees automatically
receive down to a minimum core. These credits can then be used to purchase the
same benefits they have now, a different combination of benefits which may be
more appropriate to their needs than the company-designed program has been, or
they may trade them for cash. Conversely, they may spend some of their cash com-
pensation to buy additional benefits (instead of asking the company to provide addi-
tional benefits). The core would assure that all employees still had some level of fi-
nancial security, and that social purposes would be met. Also, the tax exempt
nature of the benefit options, as opposed to the cash option, will provide employees
with an incentive to continue reasonable levels of insurance protection.
This approach to benefits helps employees better understand there is a cost to
benefits, and it sends a message that employees have a personal responsibility for
identifying and planning for their own financial security. It also enhances cost man-
agement in several ways. The company will be able to set a limit on how much it
will spend on benefit programs each year, instead of automatically absorbing what-
ever expense is generated by our current commitment to pay 100% of thecost of
various plans. It will allow us to help meet new benefit needs, such as child care
assistance, without necessarily adding to the total cost of our program. And, employ-
ees will have financial incentives to become better consumers of benefits, especially
health care benefits. They will have a choice of health plans, with varying amounts
PAGENO="0757"
751
of "first dollar" cost for incurred health care expenses, as well as varying costs for
buying the insurance. If they choose a less expensive option than the plan we now
offer, they may buy other benefits or receive cash. We believe this power of decision
and the opportunity to receive cash will begin to cause people to be more cost-con-
scious and self-responsible consumers of health care services. We expect this, over
time, will reduce the current demand on the health care system for all of the most
expensive kinds of services that are available. We even hope it may begin to moti-
vate people to take better care of themselves, since people staying well is the ulti-
mate health care cost management strategy. As a companion to offering financial
incentives to use the health care system more wisely, we will be providing employ-
ees with a great deal more information than we have in the past to help them know
how to do so.
While on the subject of health care cost management, I'd like to say a few words
about the strategy of putting a cap on the amount of tax-exempt contribution a com-
pany can provide for an employee's health insurance. It is my opinion this would do
little or nothing to control the cost of health insurance. It would simply add to an
employee's taxes, without doing anything to solve the underlying problems. It would
be similar to a company deciding to solve its health cost problems by simply shifting
more expense to employees. It would aggravate the employees without providing a
way for them to help find solutions or to lower their expenses. It might increase
revenues slightly, but then the government would be in the strange position of
hoping health care costs didn't go down, because if they did, revenues would be re-
duced.
CONCLUSION
Congress must draw its own conclusions about the social value of benefit plans
provided by the employers of the U.S. and how to structure tax policy. It is my
strong recommendation, however, that Congress decide what it wants the social
policy of the United States to be before more changes are made to the laws which
have stimulated the formation and continuation of the plans serving social needs.
My personal belief is that the policy should be one that fosters self responsibility
and provides options which will make it attractive for people, in conjunction with
the employers for which they work, to make wise personal decisions and to plan and
save for their own financial futures. Through this partnership of government, em-
ployers and employees, a vast segment of our population will have financial security
when serious illness strikes, when wage earners become disabled or die, and when
the day for retirement arrives. Through employer-sponsored plans, the government
is relieved of the need to provide for these same life events which occur in every
family at some time. By fostering a notion of self-responsibility, I believe people will
feel more involved in their own futures, which in turn will play its role in helping
this country of ours to be more productive and competitive in the world market
place.
My personal experience in trying to redesign my company's benefit program to
meet current and future needs, I know that the only way to sensibly decide what
changes ought to be made is to step back and ask, "What are our objectives?", "How
do we want people to behave?" "What are the alternative objectives?" Once you've
answered those questions, it becomes clearer how to structure the programs and
where to place the incentives and disincentives.
Tektronix thanks you for this opportunity to testify.
STATEMENT OF JOHN F. TROY, VICE PRESIDENT, GOVERNMENT AFFAIRS AND TRADE
ASSOCIATIONS, THE TRAVELERS INSURANCE C0S.
The Travelers Insurance Companies are pleased to have the opportunity to submit
a written statement to the subcommittee on Social Security and the Subcommittee
on Select Revenue Measures as they consider tax policies affecting fringe benefits.
We applaud the efforts of Chairman Pickle, Chairman Stark and the subcommittees
to carefully analyze the implications of this issue which is of critical importance to
millions of workers and their dependents.
The Travelers is in a unique position to comment on the beneficial uses of employ-
ee benefit programs. As an employer of nearly 30,000 people across the country, we
offer our own employees numerous life, health and pension benefits. In 1983, the
Travelers contribution to its employee benefit package was over $237,000,000, which
amounted to nearly 74 percent of the cost of all benefits.
In addition, the Travelers is among the largest insurance companies in the United
States. We not only sell policies to individuals, but also underwrite benefit plans for
40-046 0 - 85 - 48
PAGENO="0758"
752
all sizes of employers from international corporations to local small businesses. Our
standard practice is to cover all eligible employees or members of a group. The eligi-
ble persons are typically all full time employees who have been employed for a min-
imum period, such as three months, without regard to age, sex or salary level.
Based on 1983 data, the Travelers provided 15,637,000 of our clients' employees and
their dependents with medical insurance, took in $4.6 billion in premium and
equivalents and paid over $4 billion in claims. Our life insurance policies covered
4,663,000 people, premium volume was over $478 million and claims paid were
worth $433 million. The Travelers pension programs covered over 1,000,000 retirees,
paying out $1.4 billion in benefits while taking in $3.1 billion in premiums. Disabil-
ity insurance plans, including weekly indemnity and long-term disability benefits,
provided nearly 3 million beneficiaries with over $167 million in payments. Total
disability premiums amounted to $220 million.
These roles as both a large employer and a major insurance company enabled us
to draw on a large bank of experience in developing our position on fringe benefits.
The Travelers supports continuation of the existing system of fringe benefit taxation
under which the private sector has been a vital source in effectively providing bene-
fits. Without question, the provision of life, health, disability and pension benefits is
essential to the economic welfare of the employees, dependents and retired persons
covered.
Employment-related benefits can be traced back to their origins nearly a century
ago. A number of private employers and some public entities offered pensions and
other benefits before the turn of the century. The creation and growth of these ben-
efits naturally evolved as the work force became increasingly industrialized and spe-
cialized. This evolution cannot be attributed chiefly to tax advantages offered to em-
ployers or employees, since much of the early development occurred when there was
no personal income tax or when it applied to a very few at low marginal rates. In-
stead, employee benefit plans developed as a means of providing economic security
for employees and their dependents in the event of premature death, disability, ill-
ness or unemployment.
The benefit plan mechanism continues to flourish even more under current tax
policies since it still provides the most efficient and economical means to offer em-
ployees financial security. The informal partnership between the Government, em-
ployees and employers that now exists has been extraordinarily successful in devel-
oping programs that are effective, responsive and least costly to a huge portion of
the population.
The great majority of fringe benefits, such as pensions, medical, hospital and dis-
ability payments, serve important societal purposes. These benefits supplement
Social Security and welfare payments, relieving the burden on these public systems
to a signficant degree. In addition, a number of forces have traditionally worked to
restrict the growth of savings. Installment credit, advertising, periodic high levels of
tax rates and inflation have encouraged current consumption of goods rather than
accumulation of savings for retirement. Benefit plans within organizations, such as
the Travelers, offer employees the effectiveness and ease of the group savings ap-
proach in providing financial security for retirement. Furthermore, as health care
costs have been skyrocketing, the private sector has been actively working to keep
these costs affordable for everyone involved. Businesses have been encouraging
greater employee involvement in holding costs down by instituting preventive
health programs and requiring payment of deductibles.
In addition, the group insurance mechanism is of immeasurable value to the
many employees who, for various reasons, would be unable to obtain individual life
or health policies. Through the use of group, rather than individual underwriting,
these people become eligible for insurance coverage. In the event of a financial loss,
the employees turn to their fringe benefit plan rather than to the Government for
public assistance.
The vast majority of employers do not abuse the employee benefit mechanism. In
only a few instances have employers unfairly used the tax laws to benefit them-
selves in a disproportionate manner. Congress can easily remedy any improper prac-
tices without destroying the majority of fair and healthy benefit programs.
Unfortunately, it appears that some Members of Congress are laboring under the
misconception that benefit plans are designed to add to the incomes of the rich and
therefore cost the Treasury substantial losses of revenue. However, nothing could be
further from the truth. Group health benefits supply, in general, the same amount
of coverage for employees of low, middle and high incomes. In fact, our experience
at the Travelers demonstrates this point. Over 27,000 of our 30,000 employees par-
ticipate in the Travelers contributory group life and health plan. Of these 27,000
plan participants, nearly 96 percent have salaries between $10,000 and $50,000.
PAGENO="0759"
753
These middle and lower income employees comprise the vast majority of the plan's
beneficiaries and are receiving the same benefits as the small percentage of employ-
ees with high incomes. It seems clear that reduction in extent and use of benefit
plans caused by changes in tax laws would have more of an adverse impact on lower
income employees than on those with higher incomes.
The Travelers benefits plans are applied equally and benefit all employees. Like
the group insurance plan, 96 percent of the employees participating in our retire-
ment plan and savings and investment plan have salaries between $10,000 and
$50,000. In order to make certain that our retirees can maintain their standard of
living, the Travelers retirement plan contains a cost-of-living adjustment. Each re-
tiree who has been retired for one calendar year will receive a cost-of-living adjust-
ment to an annual maximum of 3 percent based on the Bureau of Labor Statistics
Consumer Price Index. In 1980 all of our retirees received an extra economic adjust-
ment of 2 percent per calendar year of retirement.
Instituting a tax on employee benefits would work severe consequences on all of
the parties involved.
First, employers are now able to purchase insurance coverage at better rates than
employees could buy on an individual basis. This factor, along with the tax incen-
tives provided by existing laws, allows employers to provide benefits at prices em-
ployees can afford. Increasing the cost of benefits through changes in the tax would
prohibit employers from continuing to provide the same level of protection.
Second, making fringe benefits taxable income to employees would represent a
hardship for them, particularly those in middle and lower income brackets. Those
employees who choose to stay in the group plan would face higher insurance costs
due to the taxation of their benefits. In addition, employees remaining in the plan
would eventually face higher costs in the form of rising premiums and deductibles
as the group insurance plan is weakened by adverse selection. Adverse selection
would result as healthy employees unable to meet their rising insurance expenses
drop out of the plan. Those employees who do leave the group plan would find
prices for individual policies even more prohibitive than their employee plans due to
the lack of group underwriting advantages. For example, Travelers cost per employ-
ee for all benefits during 1983 was $8,476. If an employee tried to purchase this cov-
erage on an individual basis, the cost would be substantially higher since the econo-
mies of group rates would be lost.
Finally, the government would be pressured to increase its responsibility to pro-
vide assistance through public programs. Employees who drop their group coverage
because of prohibitive costs or because they are healthy and decide to take the risk
they will remain healthy could become public charges. The pressures of additional
people requiring public assistance would be an extraordinary burden on the govern-
ment. The consequences of these welfare pressures on the government could be dis-
astrous, particularly in the face of Federal and State budget deficits and the fiscal
difficulties plaguing medicare, medicaid and Social Security.
At a time when Federal funds are moving away from supporting benefits, it does
not make sense to discourage reliance on private sector benefit plans. Instead, ef-
forts must be concentrated on incentives to encourage private plans to develop and
cover as many people as possible.
These distinguished subcommittees have been presented with the complex task of
analyzing the economic effects of fringe benefits on the Federal tax base. It is our
firm belief that taxing employee benefits would not resolve the Federal deficit prob-
lem but would only create new problems. The repercussions of taxing benefits would
be so widespread that the issue deserves intense review over an extended period of
time rather than experimental quick-fix approaches.
Only in this way will a national policy be developed to continue to provide short-
and long-term economic security to employees and their families. While the system
does contain some gaps in coverage, it can be fine-tuned with minor adjustments.
We believe that the extent of the employee benefit plans in the United States is a
national resource which should be nurtured and improved, including changes result-
ing from a complete review of existing laws. It would be unfortunate, to say the
least, if a fair, effective and efficient system of providing benefits for millions of
people were to be abruptly dismantled.
PAGENO="0760"
754
STATEMENT OF THOMAS C. WALKER, CLU, DIRECTOR, PLAN OPERATIONS, AGRI
INDUSTRIES RETIREMENT COMMITTEE, DES MOINES, IA
SUMMARY
(1) Statement limited to retirement plans.
(2) Retirement plans covered by Mr. Walker's statement cover 3,739 individuals
with four (4) plans.
(3) Over 80% of participants earn less than $24,000 annually and 98% earn less
than $48,000.
(4) Comparison charts show AGRI plans replace pre-retirement income at rates
favorable with amounts stated as desirable by the President's Commission on Pen-
sion Policy, 1980.
(5) Restatement of the Treasury Department's estimate of 83% loss of revenue due
to pension related tax deferrals accounting for lifetime collections.
(6) Personal savings aspects of pension plans compared with IRA savings by
income groups.
(7) Chart distinguishing between legally required benefits, fully taxable benefits,
tax-deferred benefits and tax exempt benefits showing distortion created when
lumping "benefits" into a single category and assuming a tax loss on the total.
(8) Table of discretionary tax favored employee benefits, by specific tax treatment,
showing proportion of wages and salaries so allocated to be much less than popular-
ly believed.
(9) Table of Analysis G, Budget of the United States Government, Fiscal Year
1985-must be weighed against the benefits to society.
(10) Comparisons over time of numbers of workers covered-and corresponding
impact on total costs.
(11) Distribution of benefits by employee income categories (over 75% go to em-
ployees earning less than $20,000 annually).
(12) Use of 401(k) to control employer pension costs.
(13) Conclusion: Current law by-and-large serves society well in that the people
most needing the benefits are getting them (75% of pension participants and 80% of
health plan participants earn less than $20,000).
STATEMENT
My testimony will be restricted to the retirement plans we make available to local
co-ops (farmer owned grain elevators and processing plants) for their employees. The
total number of people presently eligible for benefits is 3,739, including currently
employed (3,007), retirees receiving benefits (463), spouses of deceased participants
receiving benefits (60), and terminated employees with vested benefits (209).
In order to meet the needs of employers ranging in size from two (2) employees to
over four hundred (400), we maintain four (4) plans for the local co-op board of direc-
tors to choose from. Two are defined benefit plans (one that the employee contrib-
utes to as well as the employer, and one that is 100% funded by the employer) and
two are defined contribution plans (one is a pure profit sharing plan and one is a
thrift/savings plan).
A total of 145 local cooperatives have their retirement plans with us as follows:
AGRI RETIREMENT PROGRAM, APR. 1, 1984
ASS plan
.
Number of
participating
cooperatives
Number of
participating
employees
Contributory retirement
67
1,436
Noncontributory retirement
76
77
1
2,200
1,576
89
Thrift/savings plan'
Profit sharing plan
Total
221
5,301
1 76 of the employers in this category have two plans and am ala included in the nonconhibutory numbers. This moons only 14 of the
employees in this plan are not duplicated. The thrift/savings plan is optionat for most employees and approximately 71 percent contribute on an
after-tax basis.
The employees covered under our plans fall into the following income categories:
PAGENO="0761"
755
Income
Total by
Number
category
.
Percent
Cumulativ
Number
e total
Percent
0 to $9,000
$9,001 to $12,000
$12,001 to $17,999
$18,000 to $23,999
$24,000 to $29,999
$30,000 to $35,999
$36,000 to $47,999
$48,000 to $59,999
$60,000 to $89,999
70
165
1,007
1,191
313
129
71
42
13
4
2.4
5.5
33.5
39.6
10.4
4.3
2.4
1.4
.4
.1
70
237
1,244
2,435
2,748
2,877
2,948
2,990
3,003
3,007
2.4
7.9
41.4
81.0
91.4
95.7
98.1
99.5
99.9
100.0
$90,000 plus
As you can see, over 80% of the participants earn less than $24,000 annually and
98% earn less than $48,000. Only 13 employees earn over $60,000 and only four earn
above $90,000.
These numbers become very significant when placed side-by-side with the myth
that "benefit programs are only good for the wealthy."
The following table shows the amounts required to replace pre-retirement income
after retirement for married couples retiring in 1980:
RETIREMENT INCOME EQUIVALENT TO PRERETIREMENT INCOME FOR MARRIED COUPLES RETIRING IN
1980
[Selected income levels-red
action in expen
sos at retirement]
Gross preretirement income
Preretirement taxes
Federal 1 State and
*
Dspesable
`
Savings an
Percent
d investments
Amount
Net
preretirernent
$6,000
$549 $29
$5,922
$355
0
0
$5,567
$10,000
1,311 133
2,550 310
8,556
12,140
513
728
3
6
$251
728
7,786
10,684
$15,000
$20,000
3,968 520
15,512
931
9
1,396
13,185
$30,000..~
6,986 1,061
21,950
1,317
12
2,634
17,999
$50,000
15,202 2,622
32,176
1,931
15
4,826
25,419
1 Federal income and social security (OASOHI) taxes.
2 Based on State and local 1978 income tax receipts which were 19 percent of Federal income tax receipts. Does not include property tao.
Estimated as 6 percent of disposable income.
Source: Preston C. Bassett, consulting actuary, President's Commission on Pension Policy, 1980.
Post-retirem
ent taxes 1
Equivalent retir
ement income
Net preretirement income Federal
income 2
State and
local 2
Dollars
Ratio
1 Post retirement taxes are on income in excess of social secudty benefits which are nontaxable. Retirees without social security benefits would
need higher replacement ratios.
2 Federal income and social secudty (OASDHI) taxes.
Based on State and local 1978 income tax receipts which were 19 percent of Federal income tax receipts. Does not include property tax.
Source: Preston C. Bassett, consulting actuary, President's Commission on Pension Policy, 1980.
When combining one of our defined benefit plans with social security, the follow-
ing results are achieved:
$5,567...
$7,786..
$10,684.
iialQc
$17,999...
~nc A1Q
0 0 $5,576 .86
0 0 7,786 .78
0 0 10,684 .71
0 0 ~l3,l85 .66
53 10 18,062 .60
1,651 314 27,384 -
PAGENO="0762"
756
AGRI INDUSTRIES RETIREMENT PLAN AND SOCIAL SECURITY REPLACEMENT RATIOS FOR A
PARTICIPANT RETIRING AT AGE 65 IN 1982 WITH 25 YEARS OF CREDITED SERVICE
Gross preretirement income
Benefit as a
percentage o
f gross preretirement income
Co t b
orj
Social Security
Total
.
~ Soci
al Security
Total
$10,000
34
55
89 20
55
75
$15,000
37
38
48
40
85 20
78 22
48
40
68
62
$20,000
$30,000
39
40
27
16
66
56
25
27
27
16
52
43
$50,000
Contributory Plan benefit formula is 1.1% of average monthly earnings up to
$400 plus 1.65% of average monthly earnings in excess of $400, all multiplied by
years of credited service.
Noncontributory Plan benefit formula is .8% of average monthly earnings up to
$1,250 plus 1.2% of average monthly earnings in excess of $1,250, all multiplied by
years of credited service.
The Noncontributory Plan is used in conjunction with our Thrift/Savings Plan by
all the employers who installed this particular defined benefit plan. This means the
employees have the option of enhancing their retirement income by setting aside up
to 6% of their W-2 earnings on an after-tax basis. The employer matches either
25% or 50% (the employer chooses one for all employees) of the amount set aside by
each employee who chooses to participate. The numbers above for the Noncontribu-
tory Plan do not include any Thrift/Savings enhancement.
What do these number really mean? They mean that Congress should be thanked
for writing laws that have helped to improve the economic security of every single
one of the people served by our plans, and the millions of participants and benefici-
aries of plans all over our great nation. This is particularly true since programs
such as ours, are truly serving the middle and lower income population. Referring
back to the table showing our benefits in concert with Social Security, it is quite
obvious that our people would see a reduction in post retirement income of 20 to
40% without one or the other of our plans being in place. This shows very clearly
that benefits do not principally go to the highly paid and workers will suffer if em-
ployer sponsored benefits do not exist.
We also understand the dilemma faced by our elected representatives in Congress
who must deal with the out-of-control growth of our national debt. They must look
at all possible sources of revenue and would be open to criticism if they did not.
Accurate information is essential and also sometimes very difficult to find. One
piece of information I have a problem with is the Treasury Department's number on
tax losses for pension related tax deferrals. I believe they are overstated. Treasury
statistics imply that 83 cents out of every deferred dollar is permanently lost, with
the other 17 cents accounted for by current tax payments by retirees. When exam-
ined in a lifetime context, the proportion of deferred taxes lost to the Treasury
ranges from 14 cents out of every dollar to 40 cents, depending on whether or not
one adjusts for inflation and interest on deferred taxes and the interest factor used.
PENSION-RELATED TAX DEFERRALS LOST TO THE TREASURY
[In percent]
Method used
Taxes lost
Taxes deferred
Treasury method
83
0
Lifetime method:
Nominal dollars `
14
28
40
86
72
60
Real dollars 2
Discounted for interest:
At pension rate
At Federal rate
36
64
1 Before adjusting for inflation.
2 After adjusting for inflation.
3 Interest rate used to discount taxes paid in retirement to the year of retirement
Source Sophie M. korczk, Retirement Security and Tax Policy (Washington, D.C.: Employee
Benefit Research
Institute, forthcoming).
PAGENO="0763"
757
Pension benefits are not a "today" benefit but rather a long term proposition and
the tax aspects can only be fairly viewed when placed in the same time-frame as the
benefit itself. The table above certainly suggests that changing the taxability of pen-
sion related tax deferrals will not raise the number of dollars that is suggested by
the 83% taxes lost number being used by our Treasury Department.
What are the savings aspects of pension coverage for participants? Pension cover-
age constitutes the major source of savings for more than half of current pension
participants. While 52.2 million persons, or 56.4 percent of the labor force, had little
or no savings of their own in 1979, 26.8 million, or more than half, were covered by
employer pensions. Since these persons had incomes just over half the size of those
with some savings, pensions appear to distribute wealth more equally than would be
the case in their absence.
TABLE 6.-SAVINGS, PENSION COVERAGE, AND INCOME, 1979
Covered 2 Not covered Average annual income
Savings status 1 N he N be
(millions) Percent (millions) Percent Amount Percent
No savings ° 26.8 29.0 25.4 27.4 $7,672 56.4
Some savings 25.9 28.0 14.4 15.6 13,914 43.6
Total 52.7 57.0 39.8 43.0 11,193 100.0
1 Persons are classified as having some savings or no savings according to whether or not they reperted any asset income in the survey. Asset
income includes interests, dividends, rents, and royalties.
2 Coverage refers to employer plans only, both in the public and in the private sector, and does not include holders of IRA and Keogh accounts.
Includes persons reporting negative asset income.
Source: Employee Benefit Research Institute calculations based en Bureau of the Census, Current Population Survey (May 1979).
These numbers become particularly significant when you compare them with the
distribution of earnings and IRA participation. The people most served by pensions
are least able or willing to utilize the IRA.
CUMULATIVE EARNINGS DISTRIBUTION: IRA AND SPOUSAL IRA PARTICIPATION FOR THE CIVILIAN
LABOR FORCE AND THE ERISA WORK FORCE, MAY 1983
[lotal Employees and Labor force in thousands, all else in percent]
Distribution among those eligible
IRA for spousal IRA
Earnings )lp oymen contribution
sri a ion distribution Contributes to Established
IRA spousal IRA
ERISA work force: Total employees 1 52,136 11,204 2,189 1,378
Less than $5,000 1.86 1.11 0.88 1.30
Less than $10,000 16.21 8.86 4.18 3.09
Less than $15,000 39.46 23.52 13.77 9.39
Less than $20,000 59.54 41.07 28.63 21.99
Less than $25,000 76.48 57.58 43.61 38.34
Less than $30,000 85.89 70.96 57.81 50.31
Less than $50,000 97.13 91.87 83.66 79.05
Total earnings 100.00 100.00 100.00 100.00
Civilian labor force: Labor force 1 87,067 14,481 2,905 1,630
Less than $5,000 13.71 5.81 3.91 3.55
Less than $10,000 31.94 15.60 9.81 6.12
Less than $15,000 54.81 30.17 20.9 12.48
Less than $20,000 70.48 46.51 34.27 25.04
Less than $35,000 82.75 61.32 49.05 41.41
Less than $40,000 89.44 72.75 61.41 52.57
Less than $50,000 97.68 91.95 85.00 79.78
Total earnings 100.00 100.00 100.00 100.00
1 Excludes workers without reported earnings. .
Source: Employee Benefits Research Institute, prefiminary tabulations of May 1983 EBRI/HHS CPS pension supplement.
PAGENO="0764"
758
Employee benefits serve a number of purposes. Pensions, profit-sharing plans, and
employee thrift plans provide for deferral of income and encourage private saving
for retirement. Health benefits, disabifity income plans, life insurance, and supple-
mental unemployment benefits provide insurance protection against unanticipated,
catastrophic events. Some programs provide for consumption; these include day care
benefits and, sometimes, routine dental and vision care benefits. Many of these ben-
efits, together with employee vacation time and rest periods, are intended to raise
employee productivity, reduce time lost from work, and build positive employee re-
lations.
Expanded employer pension and welfare plans over the past thirty years have sig-
nificantly improved the income security of current workers and future retirees.
Growth of employer group health insurance coverage among workers and their de-
pendents has promoted wide access to health care throughout the nonelderly popu-
lation. These achievements are, in part, a response to tax incentives.
The growth of employee benefits as a form of employee compensation has attract-
ed increasing attention in recent years chiefly because of a concern that the growth
of benefits occurs at the expense of growth in wage and salary income. Slower
growth of wages and salaries, in turn, implies slower growth of the tax base. Erosion
of the tax base affects the public sector's ability to finance government programs in
general and the Social Security system in particular. In addition, growth of nontax-
able benefits may generate an important redistribution of the tax burden across the
population. These effects of growth in employee benefits, and in tax-exempt benefits
in particular, merit careful attention.
For purposes of analysis, employee benefits can be classified into three categories:
Legally required benefits (including employer contributions to Social Security, un-
employment insurance and workers' compensation insurance);
Discretionary benefits that are fully taxable (primarily payment for time not
worked); and
Discretionary benefits that are tax-favored (including employer contributions to
pension and health insurance plans).
Discretionary employer contributions to tax-favored benefits (those that are not
taxed as current income to the employee) can be further subdivided into two groups:
benefits on which taxes are deferred and benefits that are tax exempt.
Tax-deferred benefits primarily include employer contributions to retirement
income and capital accumulation plans. Taxation of these benefits is deferred until
the employee withdraws funds from the plan.
Tax-exempt benefits include employer contributions to group health insurance
and a variety of smaller benefits that include dental insurance, child care, merchan-
dise discounts, and employer-provided meals.
Discretionary tax-favored employee benefits represent about 28 percent of all em-
ployee benefits and 9 percent of wages and salaries. Since 1950, tax-favored employ-
ee benefits as a share of compensation (table 8) have grown at an average annual
rate of 4.4 percent, compared to somewhat slower growth of legally required benefits
and of taxable discretionary benefits.
TABLE 8.-AVERAGE ANNUAL GROWTH RATES OF MAJOR EMPLOYEE BENEFITS AS A SHARE OF
TOTAL COMPENSATION, 1950-83
[in percent}
Employee t~nefit
Average
annual rate of
growth
1950-80
1970-80
1980-83
Total benefits
2.5
1.8
2.2
Legally required benefits
Discretionary fully taxable benefits 1
Discretionary tax-favored benefits
2.6
1.4
4.4
2.1
49
6.3
2.3
2.1
1.2
3.0
0
45
4.5
-2.2
3.0
1.2
3.0
0
1.9
6.1
0
Government pensions
Private pensions and profit-sharing
Group health
Group life
1 Vacation time and other time not worked. Calculations based on interpolations from Chamber of Commerce data for 1980 and 1982.
Source: EBRI calculations based on iS. Chamber of Commerce, Employee Benefits 1982 (Washington, DC: Chamber of Commerce, 1983).
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Employer contributions to group health insurance are the fastest growing compo-
nent of employee benefits. The expansion of worker and dependents' coverage under
employer group plans, the enhancement of benefits under these plans, and persist-
ent high inflation in health care costs have all contributed to the growth of employ-
er contributions to health insurance as a share of compensation. Between 1950 and
1980, employer health insurance contributions as a percent of total compensation
have risen at an average annual rate of 6.3 percent. Reflecting continued high infla-
tion in health care costs since 1980, employer contributions to health insurance
have continued to grow at an average annual rate of 6.1 percent more than the
growth of compensation.
Failure to distinguish among the growth of legally required employer payments,
fully taxable employee benefits, tax-deferred benefits, and tax-exempt benefits has
greatly distorted the perception of the tax-base erosion that can be attributed to tax-
favored and tax-exempt benefits. This common misperception was highlighted by
Secretary of the Treasury Donald Regan; his May 22, 1983, statement to ABC News
included the following comment:
"I think that when you look at the way our pension systems, our medical systems
and the like are . . . running at full throttle, and are increasing year after year,
that sooner or later they're going to have to be slowed down or else we'll never get
these deficits under control."
The size of tax-favored benefits as a proportion of wages and salaries, however, is
much smaller than such statements suggest. Table 9 summarizes the distribution of
discretionary tax-favored benefits by tax-deferred and tax-exempt status. In 1982,
tax-deferred benefits constituted about 4.5 percent of wages and salaries; tax-exempt
benefits constituted 4.6 percent.
TABLE 9.-DISCRETIONARY TAX-FAVORED EMPLOYEE BENEFITS BY SPECIFIC TAX TREATMENT, 1982
Tax status/benefit group
Employer
contributions as
a percentage of
wages and
salaries
E I
~ oyer
~on~~se ~
j~
a flO i
Employer
contributions as
a percentage of
tao-favored
benefits
All tax-favored benefits
9.0
27.7
100.0
Tax-deferred benefits
4,5
13.8
49.5
Pension and profit-sharing plans 1
Short- and long-term disability insurance 2
Other tax-deferred benefits °
4.0
3
.2
12.3
9
.6
44.0
33
2.2
Tax-exempt benefits
4.6
14.2
505
Contributions to group health and life insurance ~
Other tax-exempt benefits ~
4.1
.5
12.6
1.5
45.1
5.5
1 Includes EBRI estimate of employer contributions to profit-sharing plans based on Chamber of Commerce figures.
2 EBRI estimate based on Chamber of Commerce figures.
Includes EBRI estimate of employer contributions to employee thrift plans based on Chamber of Commerce figures.
Estimate includes fully taxable employer payments for life insurance in excess of $50,000.
EBRI estimate of discounts on merchandise, meals furnished by company, payments for visinn core and prescription drugs, and moving
expenses, based on Chamber of Commerce figures.
Note-Figures may not add to total because of rounding.
Source: EBRI tabulations of U.S. Chamber of Commerce estimates in Employee Benefits 1982 (Washington, D.C.: U.S. Chamber of Commerce,
1983). pp. 11 and 28.
Private retirement program tax expenditures form the single largest category of
tax expenditures in the federal budget. They arise from the deferral of. taxes paid
on: (1)'pension and retirement saving contributions; and (2) earnings on these contri-
butions. Tax deferral of pension and retirement saving contributions represents de-
ferral of current revenue; taxes are paid on withdrawals from the funds after the
worker retires. In a lifetime context, however, gross federal revenue losses are sig-
nificantly lower than current revenue deferrals. As much as 75 percent of the real
(i.e., inflation-adjusted) value of taxes deferred during pension participants' working
careers is ultimately repaid in retirement income taxes.
(Sophie Korczyk, Retirement Security and Tax Policy (Washington, D.C.: Employ-
ee Benefit Research Institute, forthcoming). These simulation results are consistent
with calculations for hypothetical workers reported by Richard A. Ippolito, "Public
Policy Towards Private Pensions" Contemporary Policy Issues, 3 (April 1983): 53-
76.)
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TABLE 10.-EMPLOYER BENEFIT TAX EXPENDITURES IN THE ADMINISTRATIONS BUDGET BY BUDGET
FUNCTION, FISCAL YEARS 1983-1985 1
[In millions of dollars]
Provision 1903 1984 1985
Commerce and housing credit: Exclusion of interest on fife insurance savings $4,335 $4,720 $5,180
Education, Training, Employment, and Social Services:
Employer educational assistance 40 20
Exclusion of employer provided child care 20 40 70
Exclusion of employee meals and lodging (other than military) 680 725 795
Exclusion of contributions to prepaid legal services plans 40 40 45
Investment credit for ESOP's 1,250 1,375 1,875
Health: Exclusion of employer contributions for medical insurance premiums and medical care.. 15,270 17,625 20,165
Social Security and Medicare:
Exclusion of Social Security benefits:
OASI benefits for retired workers 14,035 13,895 12,975
Benefits for dependents and survivors 3,775 3,755 3,765
Disability insurance benefits 1,310 1,225 1,105
Income security:
Exclusion of railroad retirement system benefits 780 615 450
Exclusion of workman's compensation benefits 1,885 2,020 2,215
Exclusion of special benefits for disabled coal miners 160 155 155
Exclusion of untaxed unemployment insurance benefits 2,960 2,305 1,800
Exclusion of disability pay 120 75
Net exclusion of pension contributions and earnings:
Employer plans 46,585 50,535 56,340
Individual Retirement Accounts 8,855 9,190 9,840
Keoghs 1,460 1,475 1,530
Exclusion of other employee benefits:
Premiums on group term life insurance 2,040 2,170 2,380
Premiums on accident and disability insurance 120 120 125
Income of trusts to finance supplementary unemployment benefits 20 20 20
Veterans benefits and services:
Exclusion of veterat.s disability compensation 1,815 1,810 1,855
Exclusion of veteras pensions 345 335 340
107,950 114,295 123,125
1 Budget functions are groups of federal programs or activities that address a common national need. There are 18 budget functions.
Source: Special Analysis G. Budget of the Government of the United States Government, fiscal year 1905.
Employer contributions to group health insurance are the fourth largest tax ex-
penditure in the 1985 budget. These contributions are exempt from Social Security,
corporate income and individual income taxation.
Tax expenditure estimates are a poor guide for setting either federal tax policy or
federal retirement or health policy. Nevertheless, the high tax expenditure esti-
mates for pension and group health insurance plans continue to attract public at-
tention and critical appraisal of these plans' tax-favored status. Measurement of
current versus lifetime tax revenue losses, however, is only part of the task of evalu-
ating tax preferences for employer pension contributions, retirement saving, and
employer-sponsored health insurance. The benefits to society that derive from tax
preferences for these plans must also be appraised. Tax laws favoring employer re-
tirement and health insurance plans were enacted under the premise that broad
coverage of workers and their dependents under these plans is desirable social
policy.
Worker participation in tax-favored employee benefits
Between 1950 and 1979, the rate of worker participation in employer pensions
grew by 23 percent; in absolute numbers, employee pension participation rose by
263 percent. Econometric estimates suggest that, since 1960, 20 to 30 percent of the
increase in employer pension contributions as a share of compensation can be at-
tributed to favorable tax incentives and the growth of real marginal tax rates.
The tax deferral of employer pension contributions and individual retirement
saving provides important incentives for employers and workers to provide for re-
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tirement income. The increasing importance of pensions as a source of income pro-
jected among future retirees is the direct result of past growth in pension plan par-
ticipation among workers. The projected rate of pension recipiency among today's
young workers (ages twenty-five to thirty-four) is nearly twice that of workers who
are retiring today (see table 11).
TABLE 11.-ESTIMATED PERCENTAGES OF FAMILIES RECEIVING PENSION BENEFITS AT AGE 65, AND
AVERAGE REAL BENEFITS, BY CURRENT AGE AND MARITAL STATUS
Cohort age in 1979
All fam
Percentage to
receive benefit
lies
~
benefit 1
Married
Percentage to
receive benefit
couples
amon~of
benefit `
Single pe
Percentage to
receive benefit
rsons
Avera~ef
a~~t
25 to 34
71
$12,417
75
$14,541
65
$8,701
35 to 44
65
11,190
67
12,563
60
8,823
45 to 54
52
8,656
58
9,621
41
6,496
55 to 64
37
5,315
44
5,548
26
4,718
1 Real dollars are calculated using 1982 as the base year.
Source: Social Secority: Perspectives on Preserving the System (Washington, D.C.: Employee Benefit Research Institute, 1982), p. 90.
Partly because of tax incentives, participation in employer pension and health in-
surance plans is high. In 1979, 48 percent of the total work force participated in an
employer pension plan; 74 percent were covered by an employer group health insur-
ance plan. Among full-time, full-year workers, rates of coverage are much higher. In
1979, more than 74 percent of full-time full-year workers participated in an employ-
er pension plan, and 89 percent were covered by an employer health plan (Schieber
and George, Coverage and Benefit Entitlement, pp. 38 and 54; and Chollet, Employ-
er-Provided Health Benefits. Pension coverage rates for full-time full-year workers
include only nonagricultural workers, age twenty-five to sixty-four, with one year of
service and working more than half-time. Health insurance coverage rates include
all full-time nonagricultural workers who worked fifty weeks or more during 1979).
Participation in tax-favored individual retirement saving plans is more modest. In
1982, 13 percent of all households that filed a federal income tax return reported
participation in an individual retirement account (IRA). (U.S. Department of the
Treasury, Internal Revenue Service, "Selected Statistical Series, 1970-1983," Statis-
tics of Income (SOT) Bulletin, 3 (Winter 1983-84): 62).
Employee benefits are widely distributed among workers and their families at all
income levels. Reflecting the concentration of workers at low and middle incomes,
most workers who participate in employer pension and health insurance plans are
low or middle income workers. In 1979, 75 percent of all workers covered by an em-
ployer pension plan under ERISA standards, and 80 percent of all workers covered
by an employer group health plan, earned less than $20,000 (see table 12).
TABLE 12.-DISTRIBUTION OF EMPLOYEES WITH PENSION AND HEALTH COVERAGE BY EARNINGS,
1979
[Amounts in millions]
.
Employees with pension
Employees with health
Earnings
coverage
coverage
Total Percent
Total Percent
Less than $20,000
$20,000 to $49,000
27.8 75.3
8.7 23.7
.3 .9
58.3 79.8
13.9 19.1
.8 1.1
$50,000 and over
Total 1
36.9 100.0
73.0 100.0
1 Figores may not sum to totals because of rounding.
Sources: Pension distribution based en Retirement Income Opportunities in an Aging America: Coverage and Benefit Entitlement (Washington, D.C.:
Employee Benefit Research Institute, 1981). Health distribution from EBRI tabulation of the May 1980 Current Population Survey (U.S. Department
of Commerce, Bureau of the Census).
The growth of new tax-favored employee benefits has alarmed those who see the
emergence of these benefits simply as further erosion of the tax base. In fact, em-
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ployers often have independent motivations for setting up these plans. The growth
of new benefits, in particular Section 401(k) salary reduction plans, generally repre-
sents an effort by employers to contain the cost of tax-favored employee benefits.
Rising employer pension costs have prompted several innovations in the design of
retirement income plans. Section 401(k) plans, authorized by the Revenue Act of
1978, have become an increasingly popular tool for controlling employer pension
costs. Employees are able to supplement employer contributions to a Section 401(k)
plan with tax-deferred contributions of their own. This allows employers to contain
their retirement plan costs. In general, Section 401(k) plans probably represent a
net reduction in employer pension contributions relative to the level that would be
required to ensure adequate retirement income with lower employee retirement
saving.
Section 401(k) plans also reduce the employer's projected cost of indexing retire-
ment benefits. Although pension benefit increases are seldom automatic, most em-
ployers provide ad hoc cost-of-living adjustments for current retirees. Under current
law, sponsors of defined-benefit pension plans cannot reserve funds against future
ad hoc cost-of-living increases, even in cases where the plan has a clear history of
providing those increases. Ad hoc increases, therefore, are funded from current con-
tributions, or offset against actuarial gains, or added to the plan's unfunded liabil-
ity.
Section 401(k) plans-and other defined contribution plans-represent a way to
provide employees with some inflation protection in retirement, at a substantially
lower cost to employers. Defined contribution plans are automatically indexed, since
the asset value of the plan generally rises with inflation. Inflation reserves, there-
fore, accumulate automatically.
Section 401(k) plans also meet the demand for retirement income security among
mobile workers and workers with intermittent labor force participation. Employee
contributions to Section 401(k) plans are, by law, fully and immediately vested.
Short-tenure workers, therefore, may be better served by 401(k) plans than by more
traditional plans. These workers, and workers with intermittent labor force partici-
pation, are protected because they can "roll over" the accumulated contributions
and earnings of the plan into a tax-deferred individual retirement account. As a
result, Section 401(k) plans may particularly benefit young workers with high labor-
force mobility and women who may leave the labor force for protracted periods.
Many observers of the emerging changes in employee benefit plans have claimed
that the development of new forms of employee benefits merely represents further
tax-base erosion. These claims, however, have often been made with little or no sup-
porting evidence. There are several reasons to believe that the growth of nontradi-
tional benefits, in particular Section 401(k) plans, may actually reduce further ero-
sion of the payroll and individual income tax bases.
While employer contributions to traditional pension plans are entirely tax-de-
ferred, employee contributions to Section 401(k) plans are taxable by Social Securi-
ty. Employers have favored Section 401(k) plans as a means of reducing the level of
contributions they might have to make if they offered only a traditional pension
plan. If the growth of Section 401(k) plans does, in fact, substitute for the growth of
more traditional pension benefits, they would represent an addition to the current
payroll tax base.
In conclusion, the tax laws favoring specific employer retirement and health in-
surance plans were enacted under the premise that extensive coverage of workers
and their dependents under these plans is desirable social policy. The growth of
worker coverage by pensions and health insurance since 1950, has been strongly en-
couraged by the tax advantages accorded these plans, and by the growth of real
marginal tax rates.
Employee benefits are widely distributed among workers and their families at all
income levels. Like the labor force as a whole, most workers participating in em-
ployer pension and health insurance plans are low and middle income workers. In
1979, more than 75 percent of all workers covered by an employer pension plan
under ERISA standards, and 80 percent of all workers covered by an employer
group health plan, earned less than $20,000. Contrary to the perceptions of many,
there is no evidence that tax preferences for employee benefits favor only highly
paid workers.
The historic growth of private pension plan participation among workers, and the
current growth of worker participation in Section 401(k) plans and IRAs represent
private saving for retirement income. Considering the increasing cost of Social Secu-
rity and the projected decline in the ratio of workers to retirees, private saving for
adequate income replacement in retirement has emerged as a necessary and desira-
ble public goal.
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The emergence of nontraditional benefits warrants careful and balanced scrutiny.
These benefits generally serve to balance the interests of employers seeking to con-
tain benefits costs and the interests of employees, who demand a more diversified
package of benefits than ever before. The new forms of employee benefits may serve
best those workers whose needs are least adequately met by more traditional bene-
fits-younger workers and employed parents. Further, the growth of nontraditional
benefits may actually contribute to the payroll and income tax bases, to the extent
that the new employee benefit forms substitute for traditional tax-exempt or fully
tax-deferred benefits.
A final note: "Tax deductible" does not mean dollar-for-dollar offset. Even in the
highest bracket, half of every deductible dollar spent could have been retained by
paying the tax on it rather than spending it.
0
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