Among its many other dubious features, the Biden Administration’s “BBB” (“Build Back Bankrupt”) bill (a/k/a “budget reconciliation”) would add to U.S. tax law a new corporate minimum tax based on book income rather than taxable income. While the new tax would affect only companies with profits over a billion dollars a year, that is a significant segment of the American economy. The Tax Foundation calls it “the most economically damaging provision in the bill”. According to the Foundation’s modeling (to be taken with the same quantity of salt as all other economic modeling), it will reduce GDP by 0.1 percent and employment by 25,000 jobs. The Brandonites probably aren’t bothered by that “minor” impact on the proles. The detriment is not, however, spread evenly, and one big loser will be pension plans.
The American Benefits Council has released a paper describing how a tax on book income will affect pension funding. I’ll try to provide a non-technical explanation. (My entire professional career has been spent in the field of pension law, but yours probably hasn’t.)
At present, tax law and generally accepted accounting principles treat defined benefit pension plans very differently. The Internal Revenue Code allows employers to deduct their contributions (subject to liberal deduction limits and stringent minimum contribution requirements), and income earned by the plans is exempt from tax (with nugatory exceptions). Once made, contributions effectively leave the employer’s control. If a plan accumulates more money than is needed to provide accrued benefits, the employer can recover the surplus only by paying an excise tax that can be as high as 50 percent of the amount recovered.
GAAP takes a different approach. The plan’s finances are combined with the employer’s. Plan assets, liabilities and income appear on the company’s balance sheet and earnings statement. Income that the plan earns thereby is aggregated with corporate income and will be subject to the minimum tax. Contributions have no effect on GAAP incoem at all. They are viewed as money taken from one employer pocket and put into another.
The net effect of a tax on book income would be to turn pension plans into taxpayers. In the remote past, when pensions were in their infancy, that was how they were treated for tax purposes. As a consequence, employers didn’t fund their pension promises. The current system was set up to neutralize the tax effects of funded plans. Minimum required contributions weren’t added until the Employee Retirement Income Security Act of 1974, by which time funding pensions was a familiar and accepted concept.
The new minimum tax can’t help but discourage companies from contributing to their plans. They must, of course, comply with the minimum funding requirements. The Pension Protection Act of 2006 stiffened those requirements markedly, but Congress has since then backed away, most recently in the just-passed infrastructure bill. A return to the era when pension funding was a tax detriment won’t arrest that trend.
One likely effect will be accelerated migration of retirement plans from defined benefit to individual account format. Individual account plans, such as 401(k) plans, won’t be affected by the change in their sponsors’ tax treatment. Ironically, the conventional wisdom among the left-of-center pension community is that defined benefit plans are preferable to individual account plans, because the latter shift investment risk from employers to employees and don’t ensure that retirees won’t outlive their income. That position isn’t unreasonable, even if it can be carried to the point of unreasonable hostility toward individual accounts. There’s a broad consensus that defined benefit pension plans play a valuable role and ought not to be legislated into oblivion.
Doubtless, BBB will wreak much other collateral damage in areas that I know little about. Rarely has so little serious thought gone into so monumental a statute.
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