By Geier, Deborah A.
Publication: Virginia Tax Review
Date: Saturday, June 22 2002
자료: Integrating the tax burdens of the federal income and payroll taxes on labor income
VI. INTEGRATION IF THE LINK BETWEEN FUTURE BENEFITS AND TAXES PAID IS ACCEPTED
A. The Old-Age and Survivors Tax as Forced Individual Savings
As indicated in contemporary writings, early notions of "social security" were grandiose, involving funding for almost anything that could contribute to overcoming defective social organization in the modern industrialist state, such as education and vocational training, improved nutrition, planned utilization of the labor supply to adjust for changes in supply and demand, health care, housing-even the creation of enriching (126) forms of entertainment, such as opera. Today, however, many people view the Social Security system, particularly the old-age and survivors portion, as nothing more than a pension fund similar to those provided by private employers. This popular perception is acknowledged in the Interim Report submitted by the commission appointed by President Bush to study and make recommendations with respect to the Social Security system. "Many people believe that Social Security is a national pension fund in which workers make 'contributions' to an investment account called the 'Trust Fund.' When a worker retires, dies or becomes disabled, they believe that his contributions, plus interest, are taken out of an account to pay benefits." (127) And, as indicated earlier, there might actually be instrumental reasons for perpetuating this conception. What might the income tax consequences of this portion of the payroll tax be if it is conceptualized as forced individual savings?
Under a pure income tax, as conventionally described, the tax base consists of amounts spent on (or, in certain instances, the market value of) personal consumption plus net wealth increases (or less net wealth decreases). (128) While contributing to a savings account or purchasing another type of investment asset would be immediately deductible under a consumption tax, since it is an outlay that does not purchase immediate personal consumption, savings under a pure income tax are nondeductible capital expenditures. (129) The contribution to the savings account or the purchase of the investment asset changes the form in which wealth is held but does not diminish wealth and thus is nondeductible under an income tax.
Thus, if the payroll tax is considered to be an instance of forced individual savings, such as a deposit to a passbook savings account, it would be neither deductible under nor creditable against a pure income tax. Moreover, the inside build-up of the account would be taxable as it accrued. We do not, however, have a pure income tax but rather a hybrid income/consumption tax, with a realization requirement to boot, under which much savings goes untaxed, as it would under a consumption tax.
Chief among these favored savings are most contributions to pension plans and similar vehicles that comply with rigorous nondiscrimination, funding, vesting, and other standards. Both amounts contributed by employers and amounts contributed by employees (or eligible self-employed individuals) to these plans are excludable (or deductible), and the inside build-up attributed to the contributions are not taxed to either the employer, the employee, or the trust fund holding the assets. Amounts distributed from the trust are then fully includable when received. That is to say, employees enjoy consumption-tax treatment for this class of savings. Other classes of savings, such as the passbook account or pension-plan contributions to nonqualified pension plans, do not enjoy consumption-tax treatment.
The employer portion of the Social Security tax, the economic incidence of which is most likely borne by the employee, is essentially accorded consumption-tax treatment. The employee excludes the portion of "his" wages that his employer pays in tax, which is economically equivalent to inclusion of those taxes by the employee as wages followed by an offsetting deduction. Moreover, the inside build-up on the investment account is not taxed to either the employer, the employee, or the trust fund itself. Upon eventual payment, the rules in section 86, (130) which require inclusion of a portion of Social Security benefits by taxpayers exceeding certain thresholds of income, can be seen as roughly requiring inclusion of the benefits attributable to the employer portion of the tax. (131)
What about the employee portion, however? From the beginning of the Social Security system, payments of the employee portion of the Social Security tax have never been deductible or excludable from the employee's gross wages for income tax purposes. The inside build-up on the account is, like the employer portion, not taxed to anyone. Why is not the employee portion of Social Security taxes deductible under the income tax, just as are some employee contributions to qualified pension plans and regular individual retirement accounts (IRAs) today? If it were made deductible under this pension analogy, then section 86 should also be amended to require full inclusion of benefits received, just as with other pension distributions. This revision would greatly simplify the law. (133)
One reason, of course, could be that the pension analogy simply is 134 inapposite for the reasons described above. For present purposes, however, if we indulge in the notion that the employee portion of the Social Security tax is analogous to a pension-plan contribution, why is it not deductible?
Such an approach would likely have significant after-tax consequences for most taxpayers. If a taxpayer's tax bracket is constant over time, Daniel Halperin has shown that the
deferral of compensation [under the consumption-tax treatment provided to qualified plans] does not affect the tax burden on the compensation itself. While the tax is deferred, the tax base is increased by the after-tax rate of return on investment. In present value terms, the tax bases and thus the resulting tax are equal. (135)
But many, if not most, taxpayers are likely in higher tax brackets in their earning years than in their retirement years. If this is true, then deduction of the payments in the high-earning years of middle age and inclusion in the low-earning years of retirement can mean a higher total after-tax return than would occur if Social Security taxes were nondeductible during the earning years and benefits were excludable. A slightly different way of looking at it is that, if the taxpayer's marginal rate is lower in retirement, inclusion at that time is the effective equivalent of taxing a portion of the taxpayer's lifetime earnings at this lower rate. Perhaps such a policy is worthwhile as a rough form of lifetime averaging. In short, marginal rates are not typically constant through the lifecycle, and most taxpayers are more likely to be in a higher tax bracket in the years of payment than in the years of receipt.
Several reasons converge to explain why Social Security taxes were not made deductible by analogy to deductible employee contributions to qualified plans. Deductible employee contributions to pension plans and IRAs are a relatively recent phenomenon, beginning in earnest only in the 1980s. There were not many pension plans in the early twentieth century, and employers funded the few that were there. (136) Economic incidence analysis aside, the employer was seen as funding the plan, not the employee. Moreover, most employees did not even owe income taxes, since, as briefly described earlier, income taxes were imposed on only a small minority of the wealthiest citizens. Therefore, an income tax deduction for the few employee contributions that were made would have been a moot point. Finally, the income tax consequences of pension plans were themselves just beginning to be threshed out in the era when the Social Security system was adopted. (137) This combination of facts, explored in more detail below, seems th e most likely explanation of why the employee portion of the Social Security tax was made nondeductible under the income tax.
When Congress adopted the Social Security system, there were few pension plans and few participants.
When the Social Security program was enacted, only about six million persons, 15 percent of those employed, held jobs covered by any sort of retirement system; only a tiny handful--perhaps 100,000 to 200,000--actually were receiving a pension. The poorhouse toward the end of life--with all its horrors--was a very real part of
The most widely accepted estimate of pension plans and participation is that between 1875 and 1929 around 400 industrial pension plans were established, with about that number still in operation on the eve of the Depression.
The companies establishing these plans employed about 10% of the industrial labor force--a force substantially less than the entire work force including agricultural and casual labor. It is not clear, however, how many of those employees were eligible to participate in the plan or would eventually qualify for benefits. According to a recent estimate, although industrial pensions were not uncommon by 1935, no more than 4% of male workers and 3% of female workers met the requirements for receipt of pensions at that time. (139)
Moreover, almost none of the plans that did exist were funded in advance. Rather, they took the form of promises by employers that employees would be paid in retirement if the employee were still employed with the same employer at that time.
At the time of the stock market crash in 1929... , only a small minority of American workers were covered by private pension plans and an even smaller percentage could ever expect to draw benefits because of long vesting periods and eligibility terms that often required the worker to be employed by the firm at the time of retirement in order to receive benefits. Moreover, most pension plans were not funded in advance, or were inadequately funded, as no legal funding requirement was imposed on employers until much later. (140)
Industrial pension plans of large businesses, such as railroads, evolved as an aid to personnel management, to ease the older worker out of the work force
in a manner that economized on labor costs while producing a smooth flow of employees through the firm.... The introduction of the mandatory retirement provision arrangement promised to harness expenses. . . by allowing the firm to replace older, high-wage workers with smaller numbers of younger, lower-paid employees. Managers believed these savings would substantially offset the additional cost of paying pensions to retiring employees. (141)
These early plans were pay-as-you-go plans, with employers paying benefits out of current earnings, and these payments were deductible by employers as ordinary and necessary business expenses under a 1911 ruling interpreting the 1909 corporation excise tax that pre-dated the income tax. Problems with funding crunches soon arose, however, and reformers argued that employers should treat pension costs as accruing during the entire working life of the employee instead of expensing them when paid after retirement. (142) The reformers also encouraged advanced funding of these pension promises. In 1919, the Internal Revenue Service (Service) allowed employers to deduct advanced-funding payments to a trust so long as the trust was "organized entirely separate and distinct from the corporation, having its own set of books, making its own investments, and paying its own expenses, legal title of which does not remain in the corporation . . ." (143) The employees on whose behalf these contributions were made did not hav e to include the amounts in their incomes until actually received, since (with the typically extremely weak rights the workers had in these pension funds) it was not at all certain that the employees would ever, in fact, receive them. (144) Thus, the big income tax issue in the early days of funded plans was whether the separate trust should be taxed on the income earned on contributions in the interim between the contribution and distribution to retired employees. In 1921, Congress provided that stock bonus and profit-sharing trusts were not taxable so long as the trusts were made irrevocable by the companies funding them. While unclear whether irrevocable pension trusts were similarly treated under the 1921 law, even though not explicitly mentioned, the Code was formally amended in 1926 to make pension trusts tax-exempt. (145)
Thus, when the Social Security system was adopted, employer contributions to pension trusts were deductible (if the pension trust qualified), employees did not include these contributions in their gross income, employees did not include the earnings on these contributions in their gross income while they accrued, and they included benefits only when actually received. The employer portion of Social Security tax payments mirrored this treatment to a great extent. Employers were allowed to deduct these payments immediately, the employee did not include as wages that portion paid by the employer, and no earnings on the employer's contribution were includable by the employee prior to retirement. One big difference is that none of the Social Security benefit received in retirement, even that portion attributable to the employer contribution that was never taxed to the employee, was includable by the employee at the time the Social Security program was adopted. As noted earlier, a portion of Social Security benefit s may today be includable for income tax purposes. (146)
As for the employee portion of the tax, it was nondeductible, as were other employee contributions (if any) to pension plans, but most employees did not owe income tax under the "class tax" of the time. Therefore, a deduction by the employee under the income tax for the Social Security tax that he or she paid would not have been a ripe issue for the vast majority of employees.
When the class tax became a mass tax with legislation in the early 1940s, however, the tax treatment of employee contributions to pension plans did become a ripe issue. Writing in 1943 in the Harvard Law Review, Harvard Dean Erwin N. Griswold argued that Congress ought to change the law so that employee contributions to pension funds, including the employee portion of the Social Security tax, would be deductible under the income tax when made, placing them on the same footing as contributions by an employer. Thus, there are two interesting features to his article: the substantive change that he argued with respect to employee contributions to pension plans, and the fact that he assumed, without discussion, that the employee portion of the Social Security tax was properly conceptualized as such a contribution. He described the law at that time as follows:
Where the cost of providing retirement funds is paid entirely by the employer under an approved pension plan, the employee pays no tax until the retirement benefit is actually paid to him. But this is not the case with respect to amounts which the employee himself pays to provide his future pension benefits. The money which he earns is taxable to him when he earns it, and the amounts which he pays to provide retirement benefits are not deductible by him, whether he pays them directly himself or they are withheld from his pay by his employer pursuant to the contract of employment. Thus, the law specifically provides that the amount of social security tax withheld from an employee's wages is not deductible in computing his income tax. There is a similar provision as to amounts deducted from wages under the Railroad Retirement Act. The Treasury ruled some time ago that the amount of employees' contributions under private pension plans is not deductible in computing their tax, and this ruling was applied to deduc tions from the salaries of municipal employees. The same position has long been taken by the Treasury with respect to deductions from the salaries of federal employees under the Civil Service Retirement Act, and this conclusion has recently been sustained by the Tax Court. This rule is in effect legislated into the Internal Revenue Code by the recent pension trust amendments. (147)
He then went on to criticize that law.
From the point of view of the employee, a true pension or retirement allowance is income in the year in which he receives the money.... What the employee earns during his productive years must, for all practical purposes, be spread over the period of his life. What he receives after his retirement is in reality his income then, for then is when it comes in to him. To tax him on it at the top bracket of the graduated rates of his earning years is an unfair failure to recognize the economic facts.
Arguments of the sort just outlined have been adopted in the statute to make pension contributions of the employer taxable to the employees only when the pension payments are actually received. But no such consideration is given to the pension contributions of the employee, and the question may fairly be asked whether there is any sound basis for this distinction.... [I]t is hard to find any substantial reason for making a distinction between amounts paid by the employer to provide future pensions and those withheld from the employee for the same purpose. In both cases, the employee's current productive capacity is being utilized to make provision for his retirement. Neither amount is received by the employee any more than the other, for he does not have any more right to obtain presently the amount withheld from his pay than to obtain the additional amount paid by the employer. Indeed, the distinction between the amounts paid by the employer and those withheld from the employee is almost completely formal. A plan may be set up under which the employee's salary is stated to be $100, and the employer withholds $5 for pension purposes and pays an additional $5 to the pension fund. Under such a plan, the employee actually receives payment of $95 of his salary and $10 is paid to the pension fund. Precisely the same economic result would be reached if the employee's salary were stated to be $105, with $10 withheld by the employer as the employee's contribution to the pension fund, or if the employee's salary were fixed at $95, with $10 paid to the pension fund by the employer. Yet the tax consequences will vary sharply according to whichever one of these formal plans is used.
As long as the plan is really a pension plan, the reasons which have already led to the conclusion that the employer's payment in such a case should not be taxable to the employee until the employee actually receives it, should lead to the same conclusion with respect to the similar payments which are withheld from the employee's wages, either under state or federal law or under the terms of the employment contract. To achieve this result, the tax statutes should be expressly amended so as to provide that amounts paid by an employee to provide bona fide pension benefits after his retirement should be deductible from his current income. (148)
In effect, Dean Griswold argued that the reality of economic incidence ought to be recognized. The distinction between whether the "employer" makes the payment or the "employee" makes the payment is solely formal. The economic incidence will fail on the employee in the form of depressed current wages in an equivalent amount. Whether the payment is nominally said to fall on the employer or employee should not make a difference in tax treatment. If the "employer' s" contribution should be excluded from the employee's wage income for income tax purposes, then so should the "employee's" contribution. (149)
While the Service did approve as "qualified plans" some salary reduction plans in 1956, (150) his argument did not carry the day legislatively until enactment of the IRA provision in 1974 and enactment of section 40 1(k) in 1978. Widespread adoption of section 401(k) plans utilizing employee contributions did not occur until the 1980s (151) So, at least as a practical matter, it has only been since the 19 80s that there has been a noticeable difference in treatment between some employee contributions to qualified pension plans (deductible) and the payment by the employee of the employee portion of the Social Security tax (nondeductible).
One response to the argument that Social Security taxes ought to be deductible because they constitute forced savings analogous to qualified pension plan contributions might be that the Social Security system is technically not a "qualified plan." This argument, however, is not persuasive. To be sure, the precise features regarding vesting, participation, etc., required of qualified plans are not present in the Social Security system, but the "big idea" picture is absolutely present. Under federal law, Social Security participants are vested after a certain number of paid quarters in the work force, there is no discrimination in favor of highly paid participants, withdrawal cannot be made until age sixty-five, etc. In other words, the concerns that led to the strictures imposed on qualified plans are concerns that are dealt with in an equally effective way under the Social Security system.
A more decisive argument for rejecting the qualified-plan analogy, however, is that the decision whether or not to make a contribution to a section 401(k) plan or an individual IRA is typically voluntary on the part of the employee, while Social Security tax payments are mandatory. The argument would be that only voluntary savings need to be made deductible (in deviation from a pure "income" tax) in order to encourage the taxpayer to make the savings decision. Since Social Security tax payments are mandatory, there is no similar incentive effect at play, and tax-favored treatment for certain types of savings (as opposed to all savings) is justified only because of is incentive effect on behavior.
Scholars disagree about whether the origins of the favorable treatment accorded qualified pension plans and similar arrangements were premised on this incentive effect. James Wooten argues that policymakers at the time appreciated that these earnings ought to be attributed to workers, not to the employers, and that most workers owed no income tax at the time. Therefore, the tax exemption of the pension fund was adopted, he argues, in order to avoid a bias against deferred compensation, i.e., to achieve tax neutrality with current compensation (a rate of zero for most workers). (152)
Norman Stein, on the other hand, sees little evidence for such prescience on the part of policymakers. He finds other evidence indicating that the exemption was adopted simply to encourage employers to adopt funded pension plans. He believes that the record suggests that both Congress and the Executive shared an understanding that funded pension and profit-sharing plans served a public virtue and that a tax-deferral regime should be extended to such plans in order to encourage employers to sponsor them. The perspective from which the government viewed the question of tax subsidization, however, would not have been through the modem lens of plans as tax-advantaged deferred wages (and thus as tax savings to the participants), but from the then predominant understanding of plans as corporate commitments to make future gifts. Congress might have seen allowing a current deduction of employer contributions, and exemption of plan income, as a direct tax advantage to the employer rather than to the employee. (153)
[I]t is not at all clear that tax advisors, or legislators, of the day, thought that individuals not subject to tax were subjected to a tax penalty when they invested in a taxable financial intermediary. . . . Most significant though, in a profit-sharing plan with delayed vesting, the employer, rather than the employee, might have been understood as benefiting from the deferral until the employee obtained a nonforfeitable interest. Thus, the exemption of the profit-sharing trust might have been seen as a subsidy to the plan sponsor (tax-exempt advance funding of compensation that did not have to be paid until the future), which might have had the effect of encouraging employers to adopt profit-sharing plans. (154)
But it is probably not necessary to resolve this dispute for current purposes because, regardless of the origins of the tax-favored treatment, the commonly cited reason why tax-favored treatment is continued today is precisely the reason described by Stein: to encourage employers to sponsor plans. Even though we are concentrating on the employee contribution, the voluntariness of the payment remains critical to assessing whether it ought to be deductible under a "forced savings" analytical construct. For example, in 1981, Congress allowed deductions for voluntary employee contributions to certain plans in lieu of a contribution to an IRA but denied deductions "for so-called mandatory employee contributions, i.e., those required as a condition of employment or in order to participate in the plan or to obtain the benefit of employer contributions." (155) The voluntariness of the contribution is thus a crucial ingredient to the current premise underlying tax-favored treatment for only certain kinds of savings, a nd not others, under our income/consumption tax. (156) It therefore can be argued--if this "forced savings" analysis is to be used at all--that the tax consequences of the employee payment of mandatory employee Social Security taxes should mirror the tax consequences of disfavored savings, such as an employee contribution to a nonqualified pension arrangement, which is typically not deductible by the employee. (157)
B. The Medicare Tax as Insurance Premium
As stated earlier, I believe the case for linking the Medicare tax to future medical care to be received is even weaker than is the case for linking the Social Security tax with the receipt of old-age and survivors benefits, since there is no correlation between the amount of tax paid and the benefits received. A reader who once again disagrees with this contention explicitly conceptualizes the payment of Medicare taxes as the payment of an insurance premium to cover future medical care. How would the tax payment and the receipt of medical care be treated under the income tax under such a conceptualization?
If the payment of the Medicare tax is explicitly viewed as a payment for medical insurance that will provide care later in life, then the payment should be treated like any other health-insurance-premium payment for income tax purposes. That is to say, it would generally be treated as a personal-consumption expense but would nevertheless be deductible to the extent that it, combined with other healthcare expenditures for the year, exceeded 7.5% of the taxpayer's adjusted gross income. (158) The receipt of medical care in kind later in life would then not be includable, since it would simply constitute the actual receipt of what was purchased earlier. The fact that a particular taxpayer may have paid total "premiums" that do not approach the fair value of the medical care actually received should not be troublesome, as this happenstance commonly occurs in all fields of insurance, and the government does not tax such gains under the income tax.
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