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In the early part of the twentieth century, most workers died with their work boots on. Employee pensions were regarded as a “fringe” benefit in the true sense of the word. They were not considered to be fundamental to the basic employee-employer relationship but instead were viewed as gratuities or rewards for faithful long-term service and were often contingent on remaining with the same employer until retirement. At least as early as 1913, however, employee pensions were recognized as deferred compensation paid for entirely by the labor of employees, and today pension benefits paid under employer retirement plans are generally considered to be simply one form of compensation for labor.1 The genesis of the tremendous growth of pensions in this century was the favorable tax treatment given to qualified retirement plans compared with other forms of saving; favorable treatment of pensions was provided initially by a set of IRS rulings in the 1920s and then by provisions of the 1942 Revenue Act. The massive growth in pensions began with the sharply increased marginal tax rates introduced in 1942 and with the wage and price controls during and after World War II. Both management and unions viewed the introduction and enhancement of pension benefits as a way around the wage and salary regulations . Many laws regulate pensions, but the Internal Revenue Code has provided the principal legal framework for the last fifty years. Herein lie both the strength and the fundamental weakness of the private pension system. 123 Deregulating the Private Pension System theodore r. groom and john b. shoven 6 1. DeRoode (1913, p. 287). 06-3117-5 chap6.qxd 11/16/05 3:00 PM Page 123 The strength emanates from the fact that amounts that qualify for favorable tax treatment are essentially not taxed until retirement payments are made and income is consumed. For pension savings, the extra layer of personal tax that is otherwise imposed on saving is avoided, and there is neutrality between current and deferred consumption. That is, assets in qualified pension accounts are taxed in a manner consistent with a consumption tax. As a result, qualified retirement savings have become the single largest source of personal savings. Of course, a large fraction of pension assets are corporate equities, whose return has already been subject to the corporate income tax. Therefore, even pension assets are not taxed on a true consumption tax basis. The weakness—the cloud behind this rainbow—stems from the perception of pension savings as a tax preference or tax expenditure, in which the government is considered to be forgoing tax revenue that would have been derived from a tax based on a broad definition of income. In this analytical framework, an attempt is then made to justify the tax expenditure by examining whether the retirement plan serves the general public interest. To ensure that certain public goals are met, policymakers have used law and regulation to impose an extraordinarily complex regime of limitations and restrictions. These restrictions add costs to the retirement system and divert savings from the retirement system to other purposes. The complex regulatory environment has much to do with the decline in traditional defined benefit plans and the lack of progress in pension coverage generally. We believe that the concept of a tax preference or expenditure defined against the starting point of a broad income tax should not be used to evaluate the private retirement system. In our view the appropriate base is a consumption tax, and from that standpoint the current tax treatment of the private retirement system makes perfect sense. Moreover, the existing private retirement system is based on the flawed judgment that the labor force and society at large benefit from retirement savings programs that are highly structured by the government. The private retirement system would be aided by its extensive deregulation, including the elimination of most of the current detailed tax requirements as well as other burdensome aspects of government regulation not necessary to ensure the fundamental integrity of the system. The growth of the private pension system can be stimulated by adopting neutral tax rules within broad limits to promote retirement saving, fostering continued public financial education about retirement income, and allowing Adam Smith’s “invisible hand” to encourage employers and workers to pursue their enlightened self-interest. Social Security and Private Pensions: Two Legs of the Three-Legged Stool An evaluation of public policy toward private pensions is impossible without examining the other elements of retirement income provision in...

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