The Mutuality of Employee Benefits and Tax Expenditures

How policy ensures the vitality of employee benefits-which are crucial to public programs. Employee come in many shapes and sizes. Governmentmandated employee like Social security, Medicare, Unemployment Compensation, and Workers Compensation have been created and expanded since 1937, the year Social security began, with the other programs added in later decades. Voluntary pensions for employees paid for by employers began to sprout in the 1800s, were given special treatment early in the 1900s, and have been the subject of numerous tax-law changes over nearly 100 years. Voluntary employer-funded health saw their primary growth begin in the late 1940s when favorable treatment was granted and wage and price controls allowed increases in such fringe benefits while cash wages were restricted. While employee have received favorable treatment for decades, the government did not begin calculating a tax for those preferences until congressional action in 1974 required an annual accounting. Each year since then, as part of the president's budget, a report is provided on the tax cost to the government of most preferences in the code. Employee for public- and private-sector workers are among the largest tax-expenditure costs in the budget. The preference for employee is directed at the individual worker, not at the employer, a point that is important to note because it is frequently misunderstood. Many simply assume that since the cost of employee is a deductible business expense for employers, that is where the expenditure arises, but it does not. The expenditure arises because the employees are not taxed on the contributions the employer makes to pension plans or the earnings on those contributions until they accept benefit payments, and they are not taxed on the value of health insurance premiums paid by their employer. Because the provision of employee by the employer does not create immediately taxable income for the employee, employers began by requiring that employees participate in the benefit programs. This requirement was generally the case until the growth of 401 (k)-type plans in the early 1980s and the growth of employee premium payments for health insurance in the inflation surge that began in the 1970s. This article describes the treatment of employee benefits, the types of voluntary plans, the concept and level of expenditures, alternative ways of looking at the value they deliver, and the level of participation in employee benefit plans over time, and discusses the possible consequences of changes in the treatment of employee benefits. VOLUNTARY EMPLOYEE BENEFIT PROGRAMS AND TAX TREATMENT Employees value employee benefit programs. They serve to attract, retain, and motivate. Health insurance is the most important employee benefit for more than 60 percent of workers and is second most important for 15 percent. Defined-contribution retirement plans are the most important for 17 percent and second most important for 38 percent. Retiree health insurance is most important for 5 percent, and second most important for 9 percent. Defined-benefit pension plans are most important for 4 percent, and second most important for 9 percent. Twenty-seven percent of workers report being unwilling to leave their current because of job lock created by their health insurance (Helman and Fronstin, 2004). Health insurance is now most commonly found with the employer paying about 80 percent of the cost of single or family coverage. Over time, the employer payment has been getting less and less generous, and some employers are now beginning to pay a far smaller portion of family premiums (Mercer, 2004). Tax law provisions allow workers to pay their share of the premiums on either a pretax basis (if the employer sets up the administrative arrangements to allow it), with some credit (if they meet income tests), or as a deduction on Schedule B (if total medical expense exceeds 7. …