Congress and the administration made New Year's resolutions to overhaul the Internal Revenue Service and to encourage the growth of private pensions. These seemingly unrelated goals are closely linked: Congress can kill two birds with one stone by ending the IRS' role in regulating pension plans.
Trouble with IRS control
The IRS issues pension rules and forms for two distinct purposes:
* Computing taxes. Taxpayers who receive pension benefits must compute the taxes they owe, while those who contribute to pension plans must compute the deductions they take. Clearly the IRS should be in charge of such tax rules.
* Approving plans. Corporations and tax-exempt nonprofit organizations that sponsor pension plans must satisfy a mind-boggling array of IRS rules controlling plan design, administration and funding. Governmental pension plans follow simpler rules. Plans that get Uncle Sam's blessing qualify for tax deferral that benefits participants. But experience proves the IRS should give up this responsibility for regulating pension plans, a specialty that is far outside the mainstream of tax collection.
The trouble is the IRS is in business to collect revenue, not to help pension plans work effectively. In keeping with its role as the nation's tax collector, the IRS traditionally has regulated pension plans using a "gotcha" approach that involves heavy compliance burdens and nit-picking enforcement machinery. The length and complexity of a typical pension plan document have greatly increased in recent years, largely to satisfy arbitrary IRS rules. The same is true of pension plan actuarial reports, administrative forms and benefit calculations. One can blame Congress for complex pension laws, but the IRS usually makes the compliance rules even worse, as in the current transition to "simplified" minimum benefits after age 70.
As recent congressional hearings publicized, individual taxpayers who have done no wrong sometimes feel the heavy hand of the IRS.
Less widely known is that even the most capable pension plan sponsors risk penalties, excise taxes and disallowance of tax deductions because the IRS pension rules are so complex and demanding, yet often are ill-defined.
For example, actuarial assumptions for pension funding became a cause celebre only a few years ago when the IRS challenged in the courts allegedly "unreasonable" assumptions used by thousands of small firms. The IRS finally conceded defeat after losing an unbroken string of decisions at considerable cost to the government and employers. Meanwhile, the IRS has failed to respond to industry pleas for workable rules for the popular cash balance plans, automated plan administration and coverage of employees who work outside the employer's main line of business.
Because of IRS compliance burdens, many thousands of small employers who can't afford to play this game have terminated conventional pension plans, while few are starting new ones. Such outcomes give new meaning to the adage "The power to tax is the power to destroy." Yet, America's private pension plans must greatly expand their coverage of workers and delivery of benefits as baby boomers near retirement. Recent tax laws have simplified some rules for 401(k) plans and individual retirement accounts -- welcome changes, to be sure, but only a modest step in the right direction. A current proposal gives tax credits to new pension plan sponsors to help defray administrative costs. A better way is to reduce the regulatory overkill that generates such costs.
Also, the IRS has voluntary self-correction programs that let plan sponsors themselves find and fix certain kinds of compliance errors, with penalties reduced or waived. These programs are helpful after mistakes occur, but they relieve pressure on the IRS to simplify compliance rules in the first place.
How to get the IRS out
In considering the House-passed IRS reform bill (H.R. 2676), Congress now has compelling reasons to divest IRS responsibility for regulating pension plans.
IRS officials are mindful that the tax treatment of pension plans defers taxable income, so tension always exists between pensions and revenue, i.e., whatever helps pension plans tends to hurt current tax revenue. Traditionally, the IRS has had to resolve this conflict itself, like the proverbial fox guarding the henhouse. In recent years, input from Department of Treasury officials has greatly improved IRS pension plan rules, but the inherent conflict will go away only when the IRS does.
Unfortunately, the current reform bill takes a giant step backward for pension plans, putting the IRS under an independent board that will weaken the treasury's policy-making role.
Regulation of pension plan design, administration and funding is hardly a core IRS function. According to the General Accounting Office, "Historically, the IRS has not demonstrated a willingness to pursue projects that do not have a potential for collecting additional taxes." Private firms would simply outsource or spin off such a function. Moving pension plan responsibilities out of the IRS surely will help that agency focus on issues critical to its core role, such as modernizing information technology and protecting taxpayer rights.
Congress can achieve all of these worthy objectives by moving IRS pension plan specialists to a relatively small new Employee Benefit Agency within the Treasury Department. No longer driven by a revenue-raising culture and mindset, this agency will have a legal mandate to make the pension system work better, especially for small businesses. It will see that rules get issued when needed, make sense and are followed, working alongside the IRS and letting Treasury officials address any conflicts that might arise with the IRS.
The Employee Benefit Agency's mission and culture would emphasize openness and cooperation with pension plan sponsors, not secrecy and suspicion, even contracting out research and development projects that might benefit from private industry know-how. Policy-makers should consider carefully which of the purely tax-related responsibilities the IRS should retain.
Congress has successfully created other agencies in recent years to handle employee benefit matters, including the Pension and Welfare Benefits Administration, Pension Benefit Guaranty Corp., Health Care Financing Administration, and Federal Retirement Thrift Investment Board. In most of these instances an existing agency might have done the job, or was doing it already, but lawmakers rightly wanted to start afresh with a new orientation. These agencies easily overcame transition problems, and there's no reason the agency won't do as well or better.
As a source of life support for the aged and capital for the economy, pension plans have become too important to be controlled by tax specialists. Moving pension regulation out of the IRS will send a clear signal that policy-makers are committed to cutting through the red tape that otherwise will continue restricting our private pension system.