NCPA - National Center for Policy Analysis

Repealing The Reversion Tax

September 6, 2002

Historically, pension plans' excess assets "reverted" to the firm if the fund was terminated, and were subject to normal corporate tax treatment. In the 1980s, advocacy groups prompted government action to prevent firms from terminating their pension funds, paying termination benefits to workers and retirees, and using the excess assets for corporate purposes.

  • Lawmakers in 1986 levied a 10-percent (non-deductible) excise tax on reversions from defined benefit plans -- the "reversion tax."
  • In 1988, they made it 15 percent, in 1990 boosted it to 50 percent, and tacked a corporate tax onto the reversion amount.
  • If that tax rate is 35 percent, the firm is left with only 15 cents of each reversion dollar.

Analysts who examined the reversion taxes' impact between 1986 and 1990 concluded they were the root cause of the decline in corporate pension funding. Firms drastically reduced their pension funding ratios despite the fact that investments were yielding record returns.

  • Reversion taxes reduced plan assets in 1995 by about 20 percent.
  • Even in the face of historically high investment returns, plan sponsors reduced their excess pension assets by 60 percent -- a dollar value ranging between $218 billion and $262 billion.
  • Without the reversion tax, after 1986 excess assets would have been at least 2.6 times higher, or about $350 billion.

While defined contribution plans are desirable in their own right, part of their popularity is attributable to tax policies that disfavor defined benefit plans. A more neutral policy would be a more sensible approach, observers say. Eliminating the reversion tax and other regulations that discourage funding would give firms more latitude in designing their pensions in ways that maximize their value.

Source: Richard A. Ippolito, "The Reversion Tax's Perverse Result," Regulation, Spring 2002, Vol. 25, No. 1, Cato Institute.

 

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