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The original documents are located in Box 54, folder "1975/12/04 - Economic Policy Board"
of the James M. Cannon Files at the Gerald R. Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
remain with them. If you think any of the information displayed in the PDF is subject to a valid
copyright claim, please contact the Gerald R. Ford Presidential Library.
Digitized from Box 54 of the James M. Cannon Files at the Gerald R. Ford Presidential Library
ECONOMIC POLICY BOARD
EXECUTIVE COMMITTEE MEETING
AGENDA
December 4, 1975
8:30 a.m.
Roosevelt Room
1.
Broadening Employee Stock Ownership
Gorog
2.
Status Report on Tax Reduction and
Gorog
Spending Restraint Initiative
EYES ONLY
MINUTES OF THE
ECONOMIC POLICY BOARD
EXECUTIVE COMMITTEE MEETING
December 3, 1975
ATTENDEES: Messrs. Seidman, Gardner, Dunlop, Greenspan,
Robinson, Cannon, Dent, Dunn, Zarb, Malkiel,
Walker, Jones, Porter, Penner, Hinton, Harper,
Hormats
1.
Regulations on Tax Exempt Financing for Regional Municipal
Power Systems
The Executive Committee reviewed a memorandum prepared by the
Department of the Treasury outlining proposed regulations under
Code Section 103(a)(1). Mr. Walker indicated the regulations took
the most restrictive possible position consistent with the statute,
court decisions, and past regulations. He also noted that they
would not impact on industrial development bonds.
Decision
The Executive Committee approved the proposed regulations and
the Treasury recommendation that they be noticed inthe Federal
Register following compliance with OMB Circular A-85 pertaining
to consultation with heads of State and local governments in the
development of Federal regulations.
2.
Public Debt Limitation
The Executive Committee reviewed a memorandum prepared by the
Treasury on the public debt limitation proposal of the Republican
Legislative Agenda. The discussion focused on whether there
should be a change in the Second Liberty Bond Act to place responsi-
bility for establishment of a statutory public debt limitation with the
Budget Committees. There was general consensus that such a
change would reduce the increasingly frequent reconsideration of the
level of the public debt which currently exists.
EYES ONLY
EYES ONLY
2
Decision
The Executive Committee approved Treasury preparing appropriate
legislation to amend the debt limit provisions of the Second Liberty
Bond Act to place effective responsibility for establishment of the
public debt limit with the Budget Committees.
3. Report of Task Force on Taxation of International Investment
Mr. Jones presented the report of the Task Force on Tax Policy
and International Investment indicating that the Task Force had
focused their attention on the inconsistency in the way U.S. multi-
national companies have handled their research and development
expenses -- some have adopted cost sharing arrangements, some
have allocated research and development expenses on a purely ad hoc
basis, and some have not allocated research and development
expenses abroad at all. Proposed new regulations were placed in
the Federal Register on June 18, 1973, but have not become effective,
creating considerable uncertainty in the business community. This
issue will be considered by the Fiscal Committee of the OECD in
mid-January.
Decision
The Executive Committee requested the Task Force to prepare an
options paper on U.S. tax policy with respect to the allocation of
R&D expenditures to foreign source income for consideration the
week of December 22.
4.
Prospective U.K. Import Controls
The Executive Committee discussed the series of recent statements
by British officials to the effect that Britain may impose selective
import controls. The discussion focused on communications
between U.S. and British officials on this issue, any further action
the U.S. should take, and press reports on the U.S. position. There
was general agreement that the U.S. should make clear that we do
not consider that existing conditions constitute "acute or emergency
circumstances" and that therefore British protectionist measures at
this time are inappropriate and could be detrimental to efforts for a
liberalization of trade.
EYES ONLY
EYES ONLY
3
Decision
The Executive Committee agreed that the U.S. position should be
clarified in any public statements on the issue by U.S. Government
officials. Ambassador Dent will clarify the Administration's posi-
tion in his meetings with the House Ways and Means Committee
today.
5.
Railroad Strike Situation
Secretary Dunlop reported that a nationwide railroad strike involv-
ing four shop craft unions is scheduled for tomorrow at 6:00 a.m.
An emergency board was established and has reported, and efforts
are currently underway by Mr. Usery to resolve the differences
between the parties.
Secretary Dunlop indicated he has prepared legislation, testimony,
and other necessary documents for a 60-day extension of the terms
and conditions of employment while negotiations continue. He indi-
cated that he was hopeful there would be a resolution of the matter
by tomorrow morning.
Decision
The Executive Committee approved submission of a proposal for a
60-day extension of terms and conditions of employment in the event
that there is a railroad strike tomorrow.
EYES ONLY
RBP
THE WHITE HOUSE
WASHINGTON
December 3, 1975
MEMORANDUM FOR THE ECONOMIC POLICY BOARD
SUBJECT:
Broadened Stock Ownership Plans
On December 11, the Treasury Assistant Secretary Walker has been
asked to testify on Expanded Stock Ownership Plans (ESOP) before the
Joint Economic Committee. This Memorandum addresses three
issues:
1. Should the Administration formally commit itself to
the broadened stock ownership plan (BSOP) concept?
2. What is the best BSOP approach?
3. What is the best strategy vis-a-vis Congress?
I. SHOULD THE ADMINISTRATION FORMALLY ENDORSE THE
BSOP CONCEPT?
Pro
Administration support for the BSOP concept would:
Be consistent with American traditions of dispersed
property ownership as the foundation for republican
self-government and individual liberty. (Even though
about 1 in 6 American is a direct shareholder, fam-
ilies in the top one percent of total income own over
half of the value of all individually owned stock).
Be consistent with the Administration's desire to
broaden the political base of support for the free
enterprise system.
2
Be consistent with the Administration's desire to pro-
vide increased savings and financing for needed capital
formation.
Be consistent with the Administration's desire to
improve employee motivation and productivity.
Give needed lift to equity markets.
Build on Congressional interest (including Senator Long)
in expanded ownership and permit possible trade-off for
support of Administration capital formation proposals.
Con
Formal Administration endorsement should be withheld because:
A considerable number of Americans are already direct
beneficiaries of stock held by pension plans and insurance
companies.
There is no firm evidence that employee stock ownership
affects either productivity or political attitudes.
There is little evidence that BSOP incentives will signifi-
cantly serve to broaden stock ownership. (Treasury
estimates a three percent increase in ownership at a
five-year cost of about $450 million)
Existing tax and market incentives have proved effective
to induce adoption by a great many companies of employee
plans, such as profit-sharing, stock bonus and thrift
plans, that provide employees with a stake in the business.
Tax incentives for particular investments (savings bonds,
saving accounts, or corporate stock) do not increase
total savings, but simply redistribute savings. Strong
political opposition from banking, insurance and thrift
industries and labor unions to most BSOP stock purchase
plans can be expected.
3
Exposes Administration to criticism of misguided
priorities. In varying degrees, support for any BSOP
proposal requires explanation of how Administration
can oppose a $1000 exclusion from income for savings
account interest and yet support special tax incentives
to broaden stock ownership.
Recommendation
For Administration endorsement of BSOP concept
Against Administration endorsement of BSOP concept
II. WHAT IS THE BEST BSOP APPROACH?
Several key issues need to be resolved so that governing criteria
can be established for development of a specific BSOP program
acceptable to the Administration.
(a)
Should BSOP eligibility be limited to low and middle
income taxpayers?
Pro
Unlimited eligibility would reinforce the existing
imbalance in stock ownership.
Unlimited eligibility would generate extensive political
opposition and charges of expanding existing "tax loop-
holes" for upper income taxpayer.
Unlimited eligibility would magnify revenue losses but
not increase significantly new savings or stock ownership.
Con
Eligibility for BSOP incentives should be limited to the
income classes currently having the least investment in
stocks as a means of broadening the base of stock
ownership.
4
Cut-off works inequities for income classes above the
cut-off line.
Recommendation
For cut-off
Against cut-off
(b) Should BSOP sponsorship be limited to corporate employers?
Pro
Offers best approach to stimulate widespread acceptance
and coverage as opposed to individual (IRA) sponsorship.
Directly furthers the objective of extending corporate
ownership to employees.
Permits BSops to be a subject for collective bargaining;
obviates union opposition to individual and non-corporate
sponsorship as a by-pass of organized labor.
Con
Unfair to employees of government, not-for-profit, and
non-corporate organizations.
Limits individual choice to the extent investments are
pooled.
Recommendation
For limiting BSOP sponsorship to corporate employers
Against limiting BSop sponsorship to corporate employers
For dual program of corporate/individual plans
5
(c)
Should BSOP be linked to employer's stock?
Pro
Provides employee with potential productivity incentive.
Gives employer an additional source of equity capital.
Con
Places too many investment "eggs" of low and middle income
groups in one "basket", subjecting them to major downside
risks which they can least afford.
Not needed in view of growing number of stock bonus and
profit-sharing plans now being implemented by corporations.
May dilute ownership rights of existing holders.
Creates opportunity for self dealing and manipulation of stock
in closely held corporations.
Recommendation
For linking BSOP to employer's stock
Against linking BSOP to employer's stock
Against mandatory linkage but in favor of special incentives for
BSOP purchase of employer's stock
(d)
Should BSOP investments be long-term, retirement oriented?
Pro
Tax incentives for short-term investment in stock would
simply redistribute savings from thrift and banking
institutions to stocks. Restriction to long-term savings
might reduce dissavings and increase net savings.
Opportunities for capital growth and appreciation are
greatest over the longer-term.
Revenue losses per dollar of stocks held in qualified plans
greater without restriction because of rollovers.
6
Con
Restriction would limit popularity of plan because many
people save for reasons other than retirement.
Reasonably adequate retirement coverage and indirect
capital ownership now exist through retirement plans
and pension funds which hold equities.
Recommendation
For limiting BSOP investments to retirement-type plans
Against limitation on short-term investments and rollover
(e)
Should we explore the use of a Federal insurance or
guarantee program in place of tax incentives for increased
stock ownership?
Pro
An actuarially sound insurance program would not increase
the deficit in the long run.
A pension insurance mechanism is already in place and
could be "tilted" in favor of stock ownership.
Con
Stocks are inherently a risky investment. Any insurance
would encourage even greater risk taking, thus making
it difficult to design an actuarially sound program.
Consequently, the Government would be exposed to large
risks.
Would require a large staff of examiners and very
complicated regulations.
Recommendation
For exploration of a non-tax approach
Against exploration of a non-tax approach
7
The Treasury has developed and compared four specific BSOP options
which highlight the eligibility, sponsorship, investment discretion and
investment term issues presented above. The options are summarized
in the Exhibit following this page. Tab A contains a full description
of the options.
Note that the Kelso type ESOP plan previously advocated by Senator Long
has been rejected as an option in the Treasury paper. It is included,
for comparison purposes, in the Summary Exhibit.
It is recommended that the specific BSOP program options be reformulated
pursuant to decisions and guidance flowing from this memorandum. As
the Treasury options memorandum indicates, there are many possible
combinations and modifications of the four basic options.
SUMMARY OF BASIC BSOP OPTIONS
TAXPAYER
PLAN
PERMISSIBLE
FINANCING
INVESTMENT
TYPE OF
TAX
OPTION
ELIGIBILITY
SPONSORSHIP
INVESTMENT
MECHANISM
TERM
TAX INCENTIVE
COST
Sen. Long (ESOP) :
Corporate em-
Corporate employer
Employer's stock
Corporate guar-
Specified period
Corporate deduction
Not determined
NEW STOCK ISSUANCE
ployees
anteed bank loan
with progressive
for loan and/or
AND TRANSFER TO
to employee trust
vesting
dividend payments
EMPLOYERS (excluded
to purchase new
to employee trust
as an option)
stock issue
Deferred taxation
of gains and earn-
ings
1. INDIVIDUAL
Any taxpayer
Individual
Any stock
Individual's
Retirement except
Deduction for
$90 million
INCOME DEDUC-
with 10 to 25K
contribution, 15%
for death or
contributions
after 5 years
TION
income phase-out
of earnings up to
disability
assuming 1.5%
$1500
utilization
2. INDIVIDUAL
Same as Option 1
Same as Option 1
Same as Option 1
Same as Option 1
Same as Option 1
Exemption of gains
25 million
EARNINGS EXCLU-
and earnings
in 5th year
SION
assuming 1.5%
utilization
3. INDIVIDUAL
Employees, with
Any stock chosen
Salary reduction
Same as Option 1
Exclusion of salary
$90 million
INCOME EXCLUSION
$ 10 to $25K income
Employer
by employee
of lower of $1500
deduction from
after 5 years
(SALARY DEDUC-
phase out
or 15% of salary
income. Deferred
assuming 1.5%
TION)
taxation of gains
utilization
and earnings
4. INDIVIDUAL TAX
Any taxpayer with
Individual
Any stock
Individual stock
2 yrs or less
Tax Credit for 10%
$200 million
CREDIT FOR
$20 to $25K phase-
purchase
results in credit
of stock purchase
after 5 years
STOCK PURCHASE
out
recapture reduced
price up to $200
assuming 1.5%
by amount of any
plus additional 5%
utilization
loss on sale
for employer's
stock with $300
maximum credit
8
III.
WHAT CONGRESSIONAL STRATEGY SHOULD BE ADOPTED?
The Administration could pursue four alternative strategies with
respect to Congress:
(1) Present a specific Administration proposal.
(2) Float a trial balloon or a suggestion that Congress con-
sider specific plans for broadening stock ownership.
(3) Provide general background information and options to
the Joint Economic Committee and work closely
with
Congressmen and Senators (Long, Fannin,
Hansen, Schneebeli, Conable, Frenzel, etc.) who have
expressed interest in promoting broader stock ownership.
(4) Cooperate directly with Senator Long to develop a mutually
acceptable program for broader stock ownership.
Options
Option 1: Present a Specific Administration Proposal.
A specific proposal could be presented, for example, in Administration
testimony before the Joint Economic Committee, scheduled for
December 11, in testimony before the Senate Finance Committee on the
Tax Reform Bill or the tax reduction portion of that bill, or in the
State of the Union Address.
Pro
Facilitates full scale elaboration of rationale for the proposal,
together with background and supporting material, and thus
permits the best affirmative stance and defense of the proposal.
Shows Administration in leadership role on the issue.
9
Con
Continues the proliferation of Administration tax proposals
(fall 1974 tax increase proposal, January 1975 tax reduction
proposal, July 8, 1975, public utility proposals, July 31, 1975
capital formation proposals including ISA and IRA, and
October 6, 1975 tax cut proposal) and may thus undermine
credibility of Administration tax policy.
May be less effective than working with interested Congressmen
and Senators to achieve the same objective.
Option 2: Float a trial balloon or call on Congress to consider stock
investment incentives.
This option could be effected through a speech or through statements in
the testimony referred to under Option 1.
Pro
Opens up possibilities for cooperative development of program
with interested Congressmen, while maintaining public awareness
of Administration interest and involvement.
Allows more time for preparing a specific program.
Con
Permits less full scale elaboration of rationale for special tax
incentives and, thus, may provide less effective defense against
partisan criticism.
May induce unfavorable partisan reaction and make more difficult
working out a common approach with interested Congressmen and
Senators.
Option 3: Provide background information and options to the Joint
Economic Committee, and to groups such as the Labor
Management Committee, interested Congressmen and Senators.
This approach can be implemented immediately, but will require that
documentation be prepared for the Joint Economic Committee prior to
December 11.
10
Pro
Provides less visible Administration involvement or
identity with the issue.
Promotes positive relations with interested Congressmen,
particularly minority members of Ways and Means who have
requested staff assistance over the last several weeks on
the issue.
Con
By diffusing Administration effort, may be less effective
(particularly if several options attract support).
o Risks losing the ball to others.
Option 4: Cooperate directly with Senator Long to develop a mutually
acceptable position.
Pro
Con centrates efforts to work out agreement with the Senator
who has been most active and effective on this issue in
the past and who will almost certainly raise the issue in
the near future in connection with tax reductions and capital
formation.
Con
Special treatment of Senator Long may provoke adverse
reaction from other Congressmen and Senators who have
asked for ideas and assistance on this issue.
Recommendations
Option 1
Option 2
Option 3
Option 4
TAB A
-
TAB A
- 15 -
IV. Alternatives for Broadening Stock Ownership
Four basic options are examined below:
(1) individual income tax deduction for
long-term savings,
(2) tax exemption of earnings on long-
term savings,
(3) individual exclusion from income
(salary reduction), and
(4) tax credit for stock purchases.
Certain features are generally common to all of the options:
(1) a "cap, " or annual limitation, on the maximum contribution, (2) an
earned income phase-out limiting the tax incentives to low and middle
income taxpayers, (3) a restriction of the plan to long-term savings
(not true of Option Four), and (4) the requirement that all investments
be in corporate stock (with an allowance for incidental holding of cash).
1. Option One--Individual income tax deduction. This option has
the following characteristics (which are similar to the Individual Re-
tirement Account (IRA) and Individual Savings Account (ISA) previously
proposed):
-- Separate savings plan would be established
by each participating individual.
-- Tax incentive would be allowance of an income
tax deduction for contributions to the plan.
LIBRARY GERALD SR. FORD.
- 16 - -
-- The maximum contribution would be specified,
for example, the lower of $1,500 or 15% of
salary.
o
Greater simplicity could be
achieved with a dollar maxi-
mum, without any percentage
of salary limitation.
0
The maximum contribution would
be phased out for individuals with
earned income between specified
levels, such as $10,000 to $25,000.
The phase-out would be based on
preceding year's earnings, so as to
facilitate stability of the savings
program on a year-to-year basis.
-- An individual's saving in the plan could be
invested only in stock, but each individual
could determine the stocks to be purchased
by his savings plan.
-- The plan would be a retirement plan, with
the individual being allowed to withdraw
his account only upon retirement, disability,
or the attainment of a specified age (under
IRA, specified age is 59-1/2).
LIBRUSA GERALD ? FORD
- 17 -
The revenue cost of this option is estimated to be approximately the
same as that for Option Three (see section (IV)(6)(c) below), which
ranges from about $ 90 to $380 million after five years.
2. Option Two--Tax exemption for earnings on long-term savings.
This option would be identical to option one, except that tax incentive
would be a tax exemption for both the dividends and capital gains
earnings on investments in the savings plan, rather than an income
tax deduction for amounts contributed to the plan. The earnings of
the plan would be tax exempt even when later distributed to the individual
maintaining the plan. This option is estimated to cost approximately $3
million in the first full year and $25 million by the fifth full year, with
a phase out from $10,000 to $25,000 of earned income.
3. Option Three--Exclusion from income for amounts contributed
to savings plans. This option is the Individual Stock Ownership Plan
(ISOP) option previously discussed in the memorandum of November 11,
1975, and has the following characteristics:
-- It would (like an ESOP) be a qualified employer-
established plan meeting the participation, non-
discrimination and other relevant qualification
requirements.
-- The tax incentive (not available under ESOP)
would be allowance of an exclusion from an
employee's income for amounts contributed
to the plan.
FORD & LIBRARY GERALD
- 18 -
That is, the ISOP would be a
salary reduction plan such as
that currently available to
employees of certain exempt
organizations. Employees would
elect individually whether to par-
ticipate by taking a reduced salary.
-- The maximum reduction in salary would be specified,
for example, the lower of $1,500 or 15% of salary.
Greater simplicity could be achieved
with a dollar maximum, without any
percentage of salary limitation.
The maximum reduction in salary
would be phased out for individuals
with earned income between specified
levels, such as $10,000 to $25,000.
The phase-out would be based on
preceding year's earnings, so as to
facilitate stability of the salary re-
duction program on a year-to-year basis.
-- An individual's account in an ISOP could be
invested only in stocks, but each employee
could elect (which he cannot do in an ESOP)
FORD DERATED OFRALD LIBRARY
- 19 -
how to allocate his account between an in-
vestment in the employer's stock and an in-
vestment in a pool of representative listed stocks.
-- The ISOP (like an ESOP) would be a retirement
plan, with an employee being allowed to withdraw
his account only upon retirement, disability, or
attainment of a specified age (under IRA, the
specified age is 59-1/2).
-- The ISOP would be prohibited from borrowing in
order to purchase employer's stock or other stock,
the leveraged financing aspect of ESOP.
This option would cost from about $90 to $380 million after five years
(see section (IV)(6)(c) below).
4. Option Four--Tax credit for stock purchases. Under this
option, individuals who purchase stock would be allowed a tax credit
equal to a specified percentage of the purchase price of stock held
for at least one year.
-- Basic credit would be 10% of purchase price of
stock up to $2,000 ($200 credit).
-- Investment in employer stock would qualify for
additional 5% credit (bringing maximum credit
to $300).
FORD i GERALD LIBRARY
- 20 -
-- The maximum purchase qualifying for the credit
would be phased out for individuals with earned
income between specified levels, such as $10, 000
to $30,000. The phase out would be based on
preceding year's earnings, so as to facilitate
stability of the savings program on a year-to-year
basis.
-- Credit would be allowed in the year when the one
year required holding period ends.
-- If the stock were sold within two years of purchase,
the credit would be recaptured, but the amount re-
captured would be reduced by the amount of any
loss on the sale.
This option is estimated to cost $50 million in the first full year and
about $200 million by the fifth year.
5. Comparison of options. An assessment of the four options
should include consideration of the following points:
--- Use of an individual account plan (options 1,
2 and 4) as opposed to an employer-sponsored
plan (option 3) tends to identify the proposal
with IRA and ISA, previously proposed by
the Administration, and thus may invite
partisan criticism.
- 21 -
-- Use of individual account plan tends to duplicate
coverage of IRA; that is, the same individuals
who have become aware of IRA and have estab-
lished an IRA are those most likely to respond
to the new incentive.
-- Use of employer-sponsored plan (ISOP option 3)
identifies with and builds on ESOP, which has
already captured substantial Congressional
support.
-- Use of employer plan increases likelihood of
utilization, particularly utilization by persons
not reached by IRA.
O
Employees more likely to be responsive
to employer-sponsored plan than bank or
other solicitation for individual accounts.
O
Employer information and solicitation
should reach additional individuals, not
reached by IRA solicitation.
-- All of the options create potential that individuals will
simply shift existing savings into the new savings plan
and, thereby, reduce tax on current income.
- 22 -
However, in practice the tax shelter--tax planning
potential is greatest under the Option One savings
deduction plan, since an end-of-the-ycar deduction
generates a full deduction. The ISOP salary re-
duction is more likely, partly because of employer
administrative concerns, to follow a pattern of
monthly contributions; the tax exemption benefits
under Option Two will generally be proportionate to
the period savings are held within the plan; and a
stock purchase under Option Four will generally
generate a tax credit only in the following year.
-- All four options would tend to fuel further the tendency
towards the proliferation of special categorical tax pro-
visions that substitute for direct grant programs and
undermine the viability of the tax system as a system for
measuring income and collecting taxes on that income.
-- The tax credit option contains the weakest requirements
respecting the limitation of the tax incentives to long-
term savings and, thus, incurs the highest tax cost in
relation to the amount of new stock ownership or new
savings generated.
Two years recapture permits rollover of stock
investment every two years, with full tax credit.
- 22a -
0
Offset of losses against credit recapture encourages
realization of losses and acceleration of rollover.
-- Under tax exemption option (option two) taxpayer could not
reduce tax on current income; only future earnings from the
savings plan would be exempt from tax.
-- If an individual's marginal tax rate remains constant over
time, the tax incentive afforded by a current deduction for
contributions to the savings plan would be identical to the
tax incentive afforded by an exemption from tax for earnings
of the plan.
O For example, assume an individual contributes
$1,000 to the plan, that the rate of return on
invested funds is 8 percent, and individual has a
marginal tax rate of 20 percent. The annual tax
benefit from the deductibility of contributions to
the plan would be the value of deferring, for one
year, the tax on the amount contributed. The amount
of tax deferred equals the amount of the deduction
times the rate of tax; and the value of deferral is
equal to the
- 23 -
annual rate of return times the amount of tax
deferred. Thus, the tax benefit would be equal
to $1,000 times 20% times 8%. Similarly, the
value of tax exemption of savings plan earnings
is equal to the earnings of the plan ($1, 000 times 8%)
times the individual's marginal tax rate (20%), or
$1,000 times 8% times 20%.
-- The tax exemption option costs substantially less
revenue in early years, and is likely to be perceived
as affording less tax incentives, than other options.
0 The lower revenue cost estimate arises because
the immediate revenue reduction is taken as the
revenue cost to the government, rather than the
true economic (i. e., financial) cost of deferring
tax receipts. However, the actual tax incentives
are a function of the true economic cost to the
government.
--- Because many individuals expect their marginal tax
rates to be lower after retirement, they will prefer
Option One (contributions deduction) and Option Three
(salary reduction) to the tax-exemption option. That
is, Options One and Three permit the shifting
- 24 -
of income from high tax to low tax years, which provides
additional benefits beyond tax deferral or tax exemption.
6. Possible Modification of Options. There are a number of
possible modifications that could be made in these options.
a. Requirement of initial minimum or additional savings.
Options One (contributions deduction) and Three (ISOP) could be
modified to require that an individual make a minimum stock
purchase (or contribution to the plan) before further purchases
(or contributions) would qualify for the tax incentives. For
example, the threshhold savings requirement could be stated as
a percentage (perhaps 5 percent) of earned income.
Alternatively, the options could be modified to provide that
only a portion (perhaps 50%) of contributions (or stock purchases)
would qualify.
Considerations
--Increases likelihood that tax benefits will be
provided only to new savings additional to savings
that would otherwise occur.
- -Introduces substantial complexity by requiring
basis adjustment.
o For example, under Option One and Option
Three, all amounts in the plan are pre-tax
- 25 -
amounts; and all withdrawals are fully taxable.
Under Option Two (tax exemption), all amounts
in plan are either post-tax contributions or exempt
plan earnings; and all withdrawals are fully exempt
from tax. Threshhold requirement or less than
50 percent deductibility under Option One and Three
would mix post-tax and pre-tax amounts and require
basis rules for determining those amounts.
b. Limitation of investment discretion. Rather than giving
participating individuals full authority under Options One, Two,
and Three to determine the stocks in which their account would be
invested, these options could provide that a minimum portion of
the account (say, 50%) would have to be invested in employer stock.
The individual's authority to direct investments would then extend
only to the remaining portion of the account.
Alternatively, could provide the tax incentives for an
additional amount, over and above the base amount, for invest-
ments in employer stock. For example, if maximum contribu-
tion is $1, 500 could allow an additional $750 contribution for
investment in employer stock.
Considerations
--Permits substantial diversification reducing
employee risk while retaining ESOP objective
- 26 -
of providing employee stake in success of employer's
business.
0 Where employer has a declining business,
retains ESOP disadvantage of forcing unwise
investment.
Reintroduces unfairness for government employees
and others to whom employer stock would not be
available.
0
Could have exceptions for such cases allowing
employees to exercise full investment control,
but would introduce complexity and possible
complaints from employees denied full invest-
ment control.
-Under Option Three, increases employer incentive
to establish an ISOP by increasing assurance that
ISOP accounts will be source of employer financing.
c. Changes in contribution limit and phase-out. The
various options can be designed with any desired combination
of contribution limit and phase-out of the contribution limit.
The following table shows the revenue loss for various such
combinations under Option Three (ISOP).
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Rough Estimates of "ISOP" Plan Revenue I osses
(Salary Reduction Only)
1976 Levels After 5 Years
Phase-out range:
Maximum Contribution
(by earned income): $1,000 : $1,500 : $2,000 : $2,500
Revenue Loss (S millions) 1/
10-25
88
89
90
91
15-30
120
142
165
187
20-35
152
196
239
282
25-40
184
249
314
378
Office of the Secretary of the Treasury
November 10, 1975
Office of Tax Analysis
1/ The total annual stock investment varies with the phase-out range
and the maximum contribution limit from about 4-1/2 times the
revenue loss ($10-$25, 000 phase-out rate and S1, 000 maximum
contribution limit) to about 3 times the revenue loss ($25-S40, 000
phase-out range and $2,500 maximum contribution limit).
GERALD R. FORD
- 28 -
d. Employer deduction rather than salarv reduction. Option
Three (ISOP) could be modified to provide for an employer deduction
for contributions to an ISOP rather than an exclusion from the
employee's income for a reduction in salary. The employer would
be required to contribute on behalf of all eligible employees.
To the extent that employers are not already contributing
to pension plans the maximum amount deductible under present
law, the allowance of an employer deduction would not provide
any additional tax incentive beyond that in existing law. Thus,
if an employer deduction is to provide an effective incentive, it
would be necessary to allow the employer to deduct more than
100 percent of the amount contributed. For example, employers
might be allowed to deduct 150% of contributions. (Kelso pro-
poses a similar deduction for ESOPs. )
- 29 -
Considerations:
Direct employer tax benefits increase likelihood
employer will establish an ISOP plan.
O However, if employer increases total compensa-
tion payments, he will have increased cost; and
this will tend to dissuade employer from establish-
ing plans.
Employer deduction more likely than salary reduction
approach, to be viewed as a business tax benefit, which
could attract business support and labor opposition.
O However, tends to induce larger compensation pay-
ments which would affect strength of business
support and soften labor opposition.
-Because of higher corporate than individual average
marginal tax rates, corporate deduction causes
higher revenue loss per dollar of investment and 150%
corporate deduction causes much higher revenue loss.
-Employer deduction is meaningless to tax-exempt
employers (governments, charities, labor unions,
etc. ), so participation effectively limited to non-
exempt sector.
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-Employees may identify less with their stock ownership
if they have less choice in the matter.
0 Such lack of identification partially explains
the lack of awareness of employees' stake in
business through their pension plans.
0 The employees would have reduced choice
regarding both whether to participate and how
their account should be invested. While in
theory the law could mandate that employees
have investment choice, they are less likely
to assert their rights with respect to "employer
contributions' than with respect to "their income"
which they have elected not to receive.
e. Combination of salarv reduction and employer contribution
features. Option Three (ISOP) could be modified to require, or
permit, employer contributions matching all, or part, or the
employee's contribution.
Example: Employees could elect to reduce their
salary by a maximum of $1, 000 (or, if less, 10
percent of salary). Employers would be required to
contribute 25 percent of the amount contributed by
each employee and would be allowed a deduction of
150 percent of the amount contributed.
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Considerations:
--Increase employee incentive to participate.
-- Unlike pure employer deduction plan, does not
exclude tax-exempt sector.
- May increase employer interest in establishing
plan, except to extent causes increased compensa-
tion costs.
- Revenue loss per dollar of investment is greater
than pure salary reduction plan but much less than
pure employer deduction plan.
- - May introduce complexities (e.g., rules for vesting
employee's interest in employer contributions).
O Vesting questions also arise under pure employer
deduction plan but could be resolved under new
1974 pension reform act rules applicable to all
qualified plans. Special rules providing faster
vesting may be required where there is direct
linkage between employee and employer contribu-
tions.