4 ,aa 4 m.~w .. - :2 , vs a I P <1. '/I I K’) 7 — I‘ “"’.*/:‘.’£*¢"' "' ' ' " j"Aé),~i"1 ‘l’/A /« /- V’? x‘ I , ,r ,A i 9 R R an .,;..a. ,~<‘»V J .1 ,..,~ 1 ,v I ‘ {.1 ‘~_..;,:‘ . r Q O 0- ' I ‘ I 7 I " ‘ A 85-1051 EPW Congressional Research Service The Library of Congress Washington. D.C. 20540 FOUR QUESTIONS ABOUT NATIONAL RETIREMENT INCOME SECURITY Prepared at the Request of the Subcommittees on Oversight and Social Security of the House Committee on Ways and Means WSW by ’ , ra,»i-P;TV Rich Hobbie 05$? f¢1”;: Geoffrey Kollmann ;7*;?e mi Ray Schmitt 3 1. -,;.=.,» ‘~'~ Education and Public Welfare Division ’ July 12, 1985 ~« Government Publications Unfi . AUG 04 £994 niversi Inf Missouri-Colum ‘a iii: in ii i t 010- 03940880 { 3§..i{Qi;!_‘J$L MO: iii ABsTR§cI On July 18, 198i, the House Ways and Means Committee began the first of several hearings to gather information necessary to conduct a comprehensive review of national retirement income policy. This paper provides a framework for discussion of four questions the Committee selected for analysis: (1) What is retirement? (2) What are the major sources of retirement income? (3) How can we define adequate retirement income? (4) What role does Federal tax policy play in retirement income security? A CONTENTS INTRODUCTIONOOOO»OOOOOC0000IOOOOOOOOOOOOOCOOOOOOOOCOOOOIOOOOOOOOOOOOOUOOOOOO RETIREMENT?OOOOOOOOOOOOOOOOOOOTOOOOOOOOOOCTOOOOOOOOOO0000000000000. WHAT ARE THE SOURCES OF RETIREMENT INCOME?................................. Sources of Income..................................................... Pension Coverage...................................................... Amount of Income.......................................,.............. / HOW CAN WE DEFINE "ADEQUATE" RETIREMENT INCOME SECURITY?................... WHAT ROLE DOES FEDERAL TAX POLICY PLAY IN RETIREMENT INCOME SECURITY?...... Tax Treatment of Pension Contributions and Benefits................... EXpenditureSO0OO’IOOOOOOOOOOOO3IOOOOOOOOOOOOOOOIO0=OOOOOOOO a>\1oxo1 10 I 15 15 17 FOUR ABOUT NATIONAL RETIREMENT INCOME SECURITY INTRODUCTION On March 1, 1985, Chairman Dan Rostenkowski announced that the Ways ands Means Committee was beginning a comprehensive review of national retirement income policy and that the Subcommittees on Social Security and Oversight had been directed to gather the information necessary for the Committee to conduct such a review. Over the years numerous commissions, organizations, and experts have argued that, while retirement income issues have been addressed individu- ally, there is a need for a declared overall guiding retirement income policy that takes social security, pensions and personal savings into consideration in a coordinated and comprehensiveway. On the other hand, some argue that we already have animplicit retirement income policy, or that even if an implied policy is lacking, this is desirable because individual preferences and condi- tions differ so greatly and change over time. On July 18, 1985, at the first of several hearings, a number of retirement income experts will address the four topics the Committee selected for analysis: (1) What is retirement? (2) What are the major sources of retirement income? (3) How can we define adequate retirement income? (4) What role does Federal tax policy play in retirement income security? This paper provides a framework for discussion of these four questions. CRS-2_ WHAT IS RETIREMENT? As elementary as it seems, the first question that arises in examining national retirement income policy is what exactly is retirement?" The defini~ tion of retirement takes on different meanings depending on whether it is ob- served from the perspective of individuals or of programs. To individuals, retirement may mean ceasing work, or working irregularly or part-time. To a pension plan, retirement may mean only ceasing to work for a particular employer after becoming vested for benefits. The social security program pays full retirement benefits at age 70 re- gardless of whether a person ceases to work. For individuals under age 70 social security in effect defines full retirement as earning less than a cer- tain amount after attaining the earliest retirement age of 62. By withholding one dollar in benefits for each two dollars in earnings above these "exempt_ amounts,"_l/ social security also incorporates a concept of "partial retire-' ment, in which only a portion of full retirement benefits are paid. Thus, earnings from work, along with private pensions and savings, can provide a limited supplement to social security. Implicitly, the earnings test approach suggests that if-one earns more than the exempt amount, he or she is not fully retired or, if the earnings are high enough, not retired at all. However, it is possible for one to work full time at low earnings and still draw full retirement benefits, e.g., an individ- ual aged 65-69 earning the minimum wage. In essence, the social security earn- ings test represents a compromise between the social objectives of paying bene- fits only to those assumed to have encountered a loss of earnings (presumed to 1/ In 1985, $5,400 for individuals under 65, $7,320 for those aged 65-69. CRS-3 beidue to curtailed work activity), while maintaining some incentive for older people to work if they wish to do so. M? So what is retirement?’ Leaving a job? Drawing a pension? Does leaving a jobwith a particular employer and thereby qualifying for a pension constitute "retirement" if one goes to work full time for someone else or opens his own business? If not, is it leaving the work force? Reaching a certain age? Drawing full social security benefits? Are people on permanent disability re- tired? The Government, as an entity, has not adopted a uniform concept of retire- ment. Persons leaving military service after 20 years receive half pay. Civil servants with at least 30 years’ service receive unreduced retirement benefits at age 55. Most public employees may retire at any age with 30 years’ service. Many union workers may also retire at any age under "30 and out" provisions. Most private sector workers may retire at age 55, although with reduced bene- fl fits. Some companies provide supplements to early pension benefits until so- cial security benefits can begin at age 62. On the other hand, the retirement age for full benefits under social secu- rity, which has always been age 65, will gradually rise to age 67 by the year 2027. Congress is contemplating amending the Age Discrimination in Employment Act to eliminate mandatory retirement at age 70. Mandatory retirement has al- ready been eliminated in the Federal sector. Requiring pension plans to con- tinue to provide pension credit for service past age 65 is another issue likely to be addressed by Congress. So while there is a trend towards "early retire- ment," policies are being developed that encourage, permit or require people to work longer. In effect, the concept of retirement has been tailored, individu- ally, to fit the specific populations that the programs, tax incentives, or regulatory criteria are designed to serve. CRS-4 There also are demographic and economic considerations that will affect the concept of "retirement" in the future. In the next century the ratio of 6 persons age 65 and over to persons of working age is projected to climb, from 20 per hundred today, to 40 per hundred by 2030 and beyond. It has been ob- served that the U.S. economy may find it difficult to support such a large population drawing retirement benefits of one sort or another, so it has been suggested that inducing older people to work longer will reduce this problem. Also, it has been posited that this shift in age distribution of the population may create labor shortages, which could be alleviated by encouraging older peo- ple to be part of the work force. 6 Improvements in health and longevity also can influence what constitutes "retirement." Life expectancy at age 65 for males now is 14.7 years; by 2000 it is projected to be 15.8 years; by 2020, 16.5 years. There has been much discussion about the degree to which such improvements can or should lead to increased participation of the elderly in the work force. The 1983 Social Security Amendments mandate several changes in the way "retirement" will be treated in the future. The age at which full retirement benefits can be paid will rise gradually beginning in the next century, reach- ing age 67 in 2027. Benefits will be reduced by 30 percent for "retirement" at age 62 (instead of by 20 percent). Beginning in 1990, the earnings test benefit withholding rate will decrease to one dollar for each three dollars of excess earnings for people who attain the full retirement benefit age, and the so—called delayed retirement credit will be increased gradually for people who delay receiving benefits to an advanced age. In sum, the concept of retirement is not clear cut. While there may be a general perception that the term means ceasing to work and drawing a pension, CRS-5 prevailing practices and the law provide wide variations of the notion of re-, tirement." WHAT ARE THE SOURCES OF RETIREMENT INCOME? The popular notion of a "three-legged stool" of retirement income under- scores the concept of social security, pensions and asset income working to- gether to provide retirement income. In addition to these three traditional retirement income sources, many newly retired individuals have added a "fourth leg" to the retirement income stool, namely, earnings from another job. In an article appearing in the January 1985 Social Security Bulletin, Linda Drazga Maxfield and Virginia P. Reno present data on income received by newly retired individuals._g/ About 44 percent of married couples and 27 percent of unmar- ried individuals receiving social security benefits reported income from earn- ings. S , Looking at new retirees provides a clearer picture of how retirement in- come programs are working today and how they have changed over the years. The article--Distribution of Income Sources of Recent Retirees-—shows that today's retirees commonly possess pension or asset income to supplement social Security. Moreover, in the past decade the rate of pension receipt among new social secu- rity retired beneficiaries has increased dramatically. Today 56 percent of married couples and 42 percent of unmarried individuals have pension income. However, the article finds that up through the middle of the income distribu- tion, social security remains the main retirement income component. 3/ Maxfield, Linda Drazga, and Virginia P. Reno. Distribution of Income Sources of Recent Retirees. Social Security Bulletin, January 1985. CRS-6 Sources of Income Table 1 shows the sources of income for recently retired married couples and unmarried social security beneficiaries. About 38 percent of married cou- ples received private pensions and 21 percent received public pensions, and fors a large majority of the couples, husbands were by far the primary pension bene- ficiaries. Relatively fewer unmarried persons received a pension, and women and men were about equally likely to do so. Eighty-four percent of married couples and 69 percent of unmarried social security beneficiaries reported some income from assets. Interest on savings accounts is cited as the most common source of asset income, with interest on .other forms of financial assets (such as money market accounts, certificates of deposit, credit union accounts, and checking accounts) also rather common._;/ gj Ibid. CRS-7 TABLE 1. Sources of 1982 Income During the Three Months Preceding Interview for Persons Who First Received Retired-Worker Benefits in June 1980-May 1981 Married men and Unmarried their wives beneficiaries Cou- Hus- lncome source ples bands Wives Total Men Women Total number (in thousands) . . . . . . . 580.0 580.0 580.0 295.9 112.5 183.4 Percent receiving income ' ~ from- Social security . . . . . . . . . . 98.3 97.6 51.0 97.1 97.6 96.7 Pensions . . . . . . . . . . . . . . 55.7 53.1 9.7 42.4 41.3 43.1 Private . . . . . . . . . . . . . 38.3 36.1 5.9 26.8 26.0 27.3 Public . . . . . . . . . . . . . . 21.0 19.0 3.9 16.5 16.6 16.5 Assets 1 . . . . . . . . . . . . . .. 33.3 (2) (2) 59.1 63.0 72.3 Earnings . . . . . . . . . . . . . . 43.7 26.9 26.7 27.1 21.9 . 30.2 Other source 3 . . . . . . . . . . 16.5 (4) - (4) 15.2 l6_.3 14.5 wdmn . . . . . . . . . . ... 20 W E) 11 as 12 ‘ includes receipt of income from at least one of the following: money mar- ket accounts, certificates of deposit, All Saver’s certificates, checking or savings accounts, credit union accounts, stocks, bonds, annuities, IRA or Keogh plans, income from rental property or roomers, loan repayments, and estate, trust, or royalty income. I 2 Data were collected for the combined asset holdings and income of couples. 3 Includes receipt of at least one of the following: veterans’ pensions or com- pensation, workers’ compensation, unemployment insurance, black lung bene- fits, contributions from others within or outside of the household, and welfare (supplemental security income, aid to families with dependent children, and food stamps). . ‘ Not tabulated separately. . _ Source: New Beneficiary Survey, October-December 1982. Pension Coverage While the foregoing data show that about half of newly retired individuals and couples receive pension income, cross-sectional data from the 1983 ¢urrent Population Survey indicate the likelihood of being covered by a pension plan when such factors as income, size of employer and union status are considered. About four out of 5 workers_a£e covered by an employer-sponsored pension plan if they fall into one of the following categories: -- work in a firm with 500 or more employees; -f are members of a union; -- have been on the job 10 or more years; -~ earn more than $25,000 a year, CRS-8 On the other hand, about 7 out of 10 workers are not likely to be covered by a pension plan if they fall into one of the following categories: -- work in a firm with fewer than 100 employees; -- have been on the job less than 1 year; -- work part-time (less than 1,000 hours a year); -- are under age 21; or -- earn less than $10,000 a year. Amount of Income. nTable 2 shows the median and mean amounts of income received from major income sources. For the 56 percent of couples who had pension income, the me- dian monthly amount was $490. The overall median pension income for the unmar- ried was $291--but it was $400 for men and $253 for women. With the excepfiion of social security, there are major differences between the median and mean (average) amounts received from different income sources. For instance, while about half the newly retired married couples had asset income below.$l80 a% month, the average amount received was $539-about 3 times greater. This sug- gests that most newly retired married couples have asset income well below the average, but that a few have substantial asset incomes well above the average. Similar variations are also possible for pension income (depending on the re- tiree's former salary, length of service, and plan provisions) and earnings (depending on the number of hours worked and salary of the current job). 3/ 5/ Ibid. CRS-9 TABLE 2. Median and Mean Income From Major Sources (monthly) Married men and Unmarried men their wives and women Income source Median Mean Median Mean Social security $646 $671 $421 $432 Pensions 490 656 291 426 Asset income iso 539 6 99 299 Earnings 617 9 972 i 392 588 Source: Social Security Bulletin, January 1985. Overall, the January Social Security Bulletin article points out that so- cial security remains the main component of income for beneficiaries up to the middle of the income distribution. Social security accounts for over half of the total income for married couples all the way through about the 45th per- centile, and for unmarried men and women it contributes over half through the 60th percentile. On the other hand, pensions account for less than one-fourth of total income for most couples and unmarried persons. Pension receipt is strongly correlated with earnings, as noted by an article in the May 1985 So- cial Security Bulletin. 2/ Retired workers with high social security benefits were more likely to have private pensions. Fifty—one percent of beneficiaries in the highest quartile and 42 percent of those in the third quartile had §/ Inick, Christine. Income of New Retired Workers by Social Security Benefit Levels: Findings From the New Beneficiary Survey. Social Security Bulletin. May 1985. CRS-10 private pensions. In the bottom quartile only three percent received a private pension. Lastly, as would be expected, assets account for an increasingly larger percentage of total income as total income from allisources rises. At the highest income level assets’are the major source of income, while at the lowest income levels all sources other than social security contribute a relatively small share of total income. gj HOW CAN WE DEFINE ADEQUATE RETIREMENT INCOME? How much retirement income is "adequate" is a question subject to conjec- ture; what income is "desirable" is still another. ‘} If one were to define adequate income as that sufficient to keep individ- uals above the poverty threshold, some might conclude that the retirement income system is performing relatively well. The aged,were the poorest age group un- til 1974, when children displaced them. In 1983, the poverty rate of the aged, 14.1 percent, was more than one-third below the rate of 22 percent for all children. However, the aged's poverty rate was 12 percent above the rate of 12.6 percent for nonaged adults. In order to be classified as out of poverty by the Census Bureau in 1983, an unrelated person aged 65 or over needed $4,775 in money income before taxes. While "adequate benefits may allow people to avoid destitution, some feel this criterion itself is wanting. Some regard a "desirable" retirement income as one that allows a degree of comfort rather than one that avoids deprivation. President Carter's Commission on Pension Policy concluded that "the replacement _6_/ Ibid. CRS-11 of preretirement disposable income from all sources [was] a desirable retire- ment income goal." 1/ However, maintaining preretirement living standards does not require dollar-for-dollar replacement of preretirement gross income for most people. The Commission developed rough data which showed that gross , replacement rates necessary to maintain a constant standard of living were’low-. er for higher-income workers than for lower-income workers. After adjusting for changes in tax liability, work-related expenses, and savings and invest- ments, the Commission estimated that in 1980 retirees needed to replace from 51 to 86 percent of before-tax final earnings, depending on income and marital status. Recent Census Bureau studies of after-tax income by age groups shed some information on the extent to which this standard is being met today. For instance, they show that elderly households tend to have lower after-tax income than younger households, but that on a per capita basis the elderly have ad nhigher after-tax income. Other studies, such as one done by the University of Wisconsin's Poverty Institute, point out that whether the elderly are maintaining their preretire— ment standard of living is not totally reflected in comparisons of direct money income. Comparisons also must take into account differences in an individual's consumption habits before and after retirement (e.g., avoiding child-rearing expenses but incurring higher medical expenses, differences in living arrange- ments, and differences in the availability of in-kind benefits from the Govern- ment). Social security is designed to help provide "adequate" benefits. As was shown earlier, lower-paid workers are less likely to have savings and be cov- ered by a pension plan. The social security program presumes they have greater Z] Coming of Age: Toward a National Retirement Income Policy. Presi- dent's Commission on Pension Policy. 1981. cRsé12 need, and therefore, its benefifi formul& replaces a larger Proportion of their preretirement income. For example, the long-term social security replacement rates-~the ratio of social security benefits to final year's earnings--range from 56 percent for those who always earned the minimum wage, to 41 percent for those who earned average wages throughout their careers, down to 27 percent for those who always earned the equivalent of the social security maximum taxable wage ($39,600 in 1985)., Private pension plans are permitted to coordinate their benefit formulas with social security by essentially "picking up" where social security "leaves off." gThese plans, which must comply with strict IRS guidelines, are said to be "integrated." Generally, a plan will not be considered discriminatory by IRS if the combined pension and social security replacement_rates do not favor the higher paid. Even though integrated plans partially offset social secu- rity's weighted benefit formula and, thus, shift the distribution of pension benefits away from the lower paid, the combined pension and social security replacement rates must still favor the lower paid. A typical plan will reduce or offset the pension earned by a career employee by $0 percent of the worker's social security benefit. i Some charge that social security benefits are inadequate to live on and that companies should not be able to reduce pension benefits by a portion of the social security benefit. Others counter that without integration, lower- income workers may be "over pensioned" while higher income workers will receive "inadequate" benefits, unless the company contributes more into the plan. Thus, the interrelationship of pensions with social security goes to the heart of retirement income policy--what is adequate retirement income? What should be the role played by each component? What is the desirable retirement income mix? CRS-13 Since 1943, the integration of pension plans with social security has been the subject of rules laid down by the Internal Revenue Service under authority of certain provisions of the Revenue Act of 1942. While the last major revi- sion to the integration guidelines took place in 1971, the Internal Revenue Service has not modified these rules to reflect major changes that were made, etc the social security program in 1977 and 1983. Some believe that pension integration should be reexamined today. What may be considered adequate income at the time of retirement may be- fcome "inadequate" later on. While social security benefits are presently fully indexed, inflation can significantly reduce the value of a fixed dollar penf sion. Although private sector plans are not required to maintain real benefit levels, surveys show that many retirees receive periodic adjustments to their pensions that on average offset about one-third of the rise in the Consumer iPrice Index (CPI). Protecting pension benefits against inflation involves dealing with‘both preretirement inflation and postretirement inflation. When a vested employee changes jobs, the pension earned remains fixed. By the time the individual reaches retirement age, the benefits may have lost much of their value. jonce benefits commence, they usually do not maintain their full value. To a large extent our retirement income system guarantees a certain level of protection. Because both social security earnings and benefits are fully indexed, present and future benefits are protected from inflation. To the ex- tent that lower-income earners typically receive a greater proportion of their retirement income from social security, they are less vulnerable to postretire- ment inflation. lMoreover, effective in 1974, the Federal Government established a floor un- der the cash income of the aged. The Supplemental Security Income (SSI) program CRS-14 guarantees an aged person (and a blind or disabled person) with modest liquid assets an annual income of $3,900 in 1985. About half the States pay SSI sup- plementary benefits,fand guarantee levels for an individual living independent- ily exceed $S:COO in five States. In addition, if a worker is vested in a pri- vate sector defined benefit plan, benefits earned are guaranteed by the Pension Benefit Guaranty Corporation (PBGC) up to $1,688 a month in case the plan is terminated with insufficient assets. Concern has been expressed recently about the apparent trend among com- panies to adopt defined contribution rather that defined benefit plans.i Most ypension specialists believe that defined contribution plans offer less retire- ment income secgrity to long-term employees, although these plans possess cer- tain advantages for short-term, mobile, and younger employees. Critics suggest that the rules, regulations, and complexities of the Employee Retirement Income Security Act of;l974 (ERISA) and subsequent amendments provide disincentives for companies to adopt defined benefit plans, and that recent changes in the tax law provide increased incentives for companies to adopt defined contribu- tion plans. Defined contribution plans are coming under attack as not being "true" pension plans. They are being labeled as "capital accumulation" plans--essen- tially tax-sheltered savings plans. Some suggest that increased reliance on defined contribution plans as a primary source of retirement income may be undesirable for two reasons. First, employees participating in defined contri- bution plans bear the risk of investment performance.( Second, money accumu- lated in their individual accounts may be used for purposes other than retire- ment income. Account balances are often furnished to employees in a lump sum when they leave their jobs rather than paid in a lifetime stream of retirement income. CRS-15 On the other hand, some employees and employers find defined contribution plans attractive. In addition to plan simplicity, defined contribution plans generally offer more rapid accrual of benefits and faster vesting schedules. In a sense they afford more tangible benefits because of their greater porta- i bility. WHAT ROLE DOES FEDERAL TAX POLICY PLAY IN RETIREMENT INCOME POLICY? Tax Treatment of Pension Contributions and Benefits Federal income tax policy encourages saving for retirement by providing tax breaks under various qualified pension arrangements. A tax-qualified plan must follow Federal rules aimed at preventing preferential treatment of the high paid. In general, the Federalcovernment does not tax qualified pension benefits as income until the individual receives them. This typically reduces the individual's tax liability below what it would be if the Federal Government taxed pension benefits each year as they accrue. Qualified pension benefits come from three sources: (1) employer contri- butions, (2) employee contributions, and (3) earnings on the contributions. The Federal Government excludes qualified employer contributions from employee income because it is assumed that the employer contribution is not received by the employee until the pension plan actually pays benefits to the employee. Earnings on all contributions are treated in the same manner, i.e., they are not taxed until the employee receives pension benefits. The treatment of em- ployee contributions varies. The Federal Government taxes some employee contributions in the same way it taxes ordinary income each year, and taxes other employee contributions as ~ - -» V‘ 2.-"" ‘:" ~: -’x:';‘~‘ -~~»,\-, L-*w---.L';¢''‘—..'r~ ,. - .: -- Y'“-,«\-- ~.~:- ~.«:.,:=~a "'» '>‘:""=* ‘b-M . “ ' 1: n 4: ..:-w;u.-..r. 3..., ':. “.3 .1-...:;.».--Aw -...~::2:.. .. -4.-.~.:.-._ .i»~‘*.i.~x:;..-,'«r¢v:. ~:-.= ..-.1: .1~:'-."I‘»"<‘Tx.. -.-.L , ..-‘m:-.A.»:;«. mt--'-3'-;.~~’:i. ; .-_. 4;?» .- . .., . . .r . .., .. T - .. CRS-16 iif they were not received until the employee receives pension benefits. For example, under a "salary reduction arrangement," or so-called 401(k) plan, the employee can deduct his contribution up to specified limits. rThis allows him ‘ to avoid Federal income taxes on his contribution until he receives his pension benefits. In contrast, under a "thrift or savings plan" the employee contrib- utes funds on which he must pay income taxes, and hence he does not pay income taxes again on his contributions when he receives his pension benefits. The tax treatment of qualified pension benefits follows logically from the tax treatment of the contributions and earnings. In principle, if none of the contributions and earnings were taxed when earned, the pension benefits would be taxed when received. If some of the employee contributions were taxed, only the portion of pension benefits derived from the untaxed contributions and earnings would be taxed when received. _The tax treatment of civil service retirement benefits is the same as that of a private pension with after—tax employee contributions to a thrift plan. Once an employee receives back his contributions on which he has already paid income taxes, his pension benefits become fully taxable. This usually happens within three years. If it does not, a more complex apportionment rule applies in which a portion of the pension benefit is taxed each year. However, private pension plans generally do not require after-tax employee contributions unless they are made to a supplemental plan, such as a thrift or savings plan. Conse- quently, the full amount of private pension benefits is usually taxable. Some private pension plans allow for the payment of benefits in a lump sum. For example, under qualified defined contribution plans, benefits might be payable in a lump sum before the normal retirement age for an employee who severs his employment. In this case, he may roll over the lump sum into an CRS-17 Individual Retirement Arrangement (IRA) or he may apply 10-year income averag- ing. These provisions can vary, however, depending on the type of plan from which the employee withdraws the lump sum. The taxation of social security and tier I railroad retirement benefits in part reflects a"complex application of pension tax treatment principles. Cur- rent law specifies the taxable portion of these benefits as the lesser of: (1) 50 percent of the taxpayer's benefits, or in other words, the assumed untaxed portion of benefits derived from the social security tax or "contribution" paid by the employer, or (2) 50 percent of the amount by which the sum of the taxpayer's) adjusted gross income, tax-exempt interest income, and half of of his benefit exceeds: (a) $25,000, or 3 3 - (b) $32,000 for married persons filing jointly, or (c) zero for married persons filing separately who lived together at any time during the taxable year. Designating half of the social security benefits as taxable above the specified thresholds allows for three concerns: (1) half of the social security tax or "contribution" is based on employee wages that are already subjected to income tax when received, (2) a judgment that only the "well off" should pay income tax on social security benefits, and (3) a need to phase in the tax instead of applying it fully at and immediately above the thresholds. Pension Tax Expenditures The Congressional Budget Act of 1974 (P.L. 93-344) defines tax expendi-, tures as . . . revenue losses attributable to provisions of Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability . . . Tax expenditures associated with pension plans come from two sources: (1) when taxes are deferred on accrued pension benefits until employees receive CRS-18 them, the present value of the tax revenue eventually collected is less than if it were collected each year on the contributions and earnings; and (2) when a retiree receives his pension benefit, he may be in a lower income tax bracket ithan he was in while working. Table 3 provides the estimates of tax expenditures on pensions in the President's FY86 budget. The estimate for private pensions alone was $55.1 billion, while social security and lRAs each had associated tax expenditures of $13.4 billion. No total is shown because these estimates are not additive. Also, they are not estimates of the amount the Federal Government would collect if the tax expenditures were repealed because: (1) a change would have secon- dary effects as individuals shifted their funds to other tax—favored activi- ~ties, and (2) a change could affect various aspects of economic activity, such as consumption, saving, investment, and economic growth. Tax expenditures on pensions have the goal of promoting additional saving toward retirement. Various reviews of the evidence conclude that the favorable tax treatment of qualified pension plans has increased savings, but by less than a dollar for each dollar of pension contributions. In other words, some saving for retirement purposes in pensions was transferred from other saving arrangement S o CRS-19 TABLE 3. Revenue Loss Estimates for Tax Expenditures on Pensions for FY86 ($ in billions) Pension H A Revenue loss