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by Cynthia L. Moore
NCTR Washington Counsel

July 7, 1999

Ladies and Gentlemen, Start Your Engines

Federal legislative activity will start in earnest when Congress returns from the July Fourth recess next week. Of top interest for state and local government pension plans is a tax cut bill that is expected to serve as a vehicle for pension provisions. The total cost of the package ranges from around $800 billion to almost $1 trillion over 10 years. Budget surplus would pay for the cuts.

The broad elements of the Republican tax plan, as proposed thus far, looks as follows:

Income Taxes

An across-the-board reduction phased in over 10 years that could include gradual cuts in all tax rates, making more income subject to lower tax brackets or adding a line to IRS forms allowing all taxpayers a new flat deduction after they’ve figured their tax.

Capital Gains

Retroactive to July 1, 1999, an unspecified cut in taxes on investments and other passive income. One leading proposal would reduce the top rate for longer-term investments from 20 percent to 10 percent.

Estate Taxes

Cutting taxes on inheritances, either by raising the amount now exempt or gradually reducing the tax rate.

Marriage Penalty

Fixing a part of the tax code under which about 21 million married two-income couples pay more than they would had they remained single. Options include boosting the standard deduction for married couples or adjusting income tax brackets so married people’s earnings are subject to lower rates.

Education

Creating tax-free savings accounts for people to use for education costs and changing rules on revenue bonds to raise more money for school construction.

Health Care

Unspecified tax incentives to enable more people to buy health insurance.

Retirement

Increasing incentives for personal savings, such as raising the annual limit on contributions to individual retirement accounts from $2,000 to as much as $5,000.

Source: Associated Press, Washington Post, 7/2/99

(We are awaiting more details on the extent of the pension provisions.)

The President has proposed cuts more targeted than what the Republicans have put forward. He has expressed his willingness, however, to strike a deal that would give Republicans some tax cuts in exchange for Medicare reform. Because many state and local government plans are involved to some extent in retiree health care, the President’s proposal may be of interest.

Medicare Proposal Highlights

Prescription drug benefit

• Costs $24 per month in 2002; $44 per month by 2008.
  
  
• Matches prescription drug payments up to $1,000 in 2002; $2,500 by 2008.
  
  
• Offers financial incentives for employers to provide a drug benefit to retirees that is at least equivalent to the new Medicare benefit.
  
  
• Excludes premiums and copayments for individuals earning less than $11,000 or couples earning less than $17,000.

Cost: $118 billion over 10 years, starting in 2002.

Deductible and copayments

• Clinical laboratory services would require a 20 percent copayment.
  
  
• Deductibles for doctor visits and other outpatient services, now $100, would be indexed for inflation.

Savings: $11 billion over 10 years.

Preventive services offered by Medicare, such as pelvic exams and prostate cancer screenings, would no longer have copayments or deductibles.

Cost: $3 billion over 10 years (with health education campaign).

Buy-in plan would allow those age 62-65 to purchase Medicare benefits for $300 per month.

Cost: $1.4 billion.

Dedicating $794 billion in budget surpluses over 15 years would extend the life of the trust fund until at least 2027. Source: Washington Post, 6/30/99

Meanwhile, Social Security reform has taken a lower profile because of intense disagreement about how to proceed although the President and Ways and Means Committee Chairman Bill Archer are still hopeful for action. Most Republicans remain committed to "private accounts," i.e., having American workers in the future invest part of their Social Security money in individual accounts. Democrats, including the President, favor letting some entity of the federal government invest the money in a manner similar to the way state and local government plans now invest assets. Rep. Archer has proposed a middle ground that would require Americans to invest in private accounts during their working years, but that would keep the current Social Security benefit structure in place. Mr. Archer has been reportedly meeting secretly with the President about reform. The President knows, however, that he will face a revolt by congressional Democrats if he attempts to make a deal with Mr. Archer and the Republicans.

What cannot be discounted, however, is Mr. Archer’s dedication to Social Security reform. He feels that the budget surplus is large enough to fix Social Security as well as meet other needs, such as Medicare finance reform and tax cuts. He is a strong supporter of the Social Security System and showed that commitment when he served on a 1983 commission that proposed reforms to keep the System financially solvent. Finally, he is retiring and would like a legacy on the issue.

Despite his strong commitment, the prospects for reform are still cloudy. This forecast is good news for opponents of mandatory Social Security coverage. If no Social Security reform comes about this year, no mandatory coverage can be implemented.

Cost of Pension Provisions Vary

The Joint Committee on Taxation has come up with preliminary cost estimates of H.R. 1102, the Portman-Cardin pension legislation. Here are the items of interest to state and local government plans (note the figures are the cumulative cost for fiscal years 2000 to 2009):

Obviously, relatively low cost items such as the rollovers among Section 457, Section 403(b), and qualified plans, will have a greater chance of being included in the final tax cut package than the more expensive items, such as the increased limitations on the exclusion for elective deferrals (amounts to 401(k) and 403(b) plans) to $15,000. It is difficult to predict which provisions will be included.

We should make a comment on two items in H.R. 1102. First, as many people know by now, the bill would eliminate the maximum exclusion allowance (MEA) calculation for 403(b) plans. The annual limit under Section 402(g), which is currently $10,000, would be maintained as would the Section 415(c) limits of the lesser of $30,000 or 25% of the participant’s compensation.

Second, the bill contains a provision relating to "mirror plans." The provision states that Section 457(e) does "not apply to a plan, program, or arrangement maintained solely for the purposes of providing retirement benefits for employees in excess of the limitations imposed by sections 401(a)(17) [relating the maximum amount of compensation that can be taken into account when a pension is calculated] or 415 [relating to the maximum amount of a pension]." H.R. 1102, Section 508(a). It is not clear whether the reference to "mirror plans" includes "qualified governmental excess benefit arrangements." Assuming they do, QEBAs, as authorized by Congress in 1996 under Section 415(m), are a mechanism that allows governmental pension administrators to pay the portion of an individual’s pension benefit which, while legal under state law, exceeds the amount permitted under the Section 415 limits. Under current law, QEBAs are disregarded in determining whether a plan is an eligible deferred compensation plan. Section 457(e)(14). An interesting question exists as to whether the QEBA language is broad enough to cover the portion of a benefit that is in excess of the 401(a)(17) compensation cap. Section 508(a) of H.R. 1102 makes the Section 457 rules inapplicable to plans maintained solely for the purposes of providing retirement benefits for employees in excess of the limitations imposed by sections 401(a)(17) or 415. It implies, therefore, that such plans maintained for 401(a)(17) situations are already permissible.

Public Sector Rallies on Bankruptcy Issue

Public sector organizations will be shortly sending a letter to the Senate in opposition to a cap on the amount of pension assets that are protected from a bankruptcy trustee. Both the House and Senate are working on bankruptcy reform. Included in their bills (H.R. 833 and S. 625) are provisions to make clear that retirement savings (including assets in plans under IRC Sections 401, 403, 408, 408A, 414, 457, and 501(c)) would be exempt from a bankruptcy estate. Senator Charles Grassley (R-IA) is planning to offer an amendment on the Senate floor to cap the amount of retirement savings that may be deemed excludable from the bankruptcy estate. The amount of the cap is not known. The bill may be taken up as early as this month.

The amendment would be detrimental to both plan participants and retirement systems. It would limit the amount of retirement savings that a plan participant who filed for bankruptcy would be able to shield from a bankruptcy trustee. Retirement systems would have to determine which part of the debtor-participant’s pension assets are exempt and which are not and then pay out, in certain cases, some amount possibly in violation of state anti-alienation provisions. Those provisions prohibit the payment of retirement system assets for non-retirement purpose. The payment to a bankruptcy trustee would be such a prohibited payment. The Senate is expected to take up the bill and the amendment later this month. The House passed its version—which has no cap—on May 5.

Ray Lillywhite on Golf, the Internet, and Other Aspects of Life

Did you see Ray’s remarks in the June 28 edition of Pensions & Investments about possible changes in the investment world during the 21st century? We thought we’d give you a flavor of them:

E-mail and video conferencing will eliminate some of the huge costs in time and travel for both sales people and (pension) plan sponsors. Marketing will probably be less personal, less relationship selling—more hard facts and figures—and not as much fun. How can you play a round of golf on the Internet?