RECOMMENDATIONS

Witnesses at the hearings generally confirmed the conclusion which is often expressed in pension literature to the effect that the least progress in providing private pension coverage has been made in businesses with the fewest employees, most of which are owned and managed by those who are self-employed."

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Some witnesses testified that very few plans have been adopted as a result of the Smathers-Keogh Act, the Self-Employed Individuals Tax Retirement Act of 1962 (Public Law 87-792, Oct. 10, 1962). One witness testified that only 15,000 persons have been covered by plans under that act,18 compared to the 7 million self-employed which the Treasury Department witness estimated could be covered by such plans.19

Recommendations 1, 2, 3, and 4 below are offered to provide maximum assistance in extending coverage to employers and employees of small business and professional units.

Recommendation No. 1. The subcommittee recommends that the Internal Revenue Code be amended to eliminate the 50-percent limit on deductibility of contributions to qualified pension plans by selfemployed persons for their own benefit in their capacity as employers.

Paragraph (10) of subsection 404 (a) of the Internal Revenue Code restricts the deduction which may be taken for amounts contributed by any self-employed individual for his own benefit to 50 percent of such contribution.

Many of the witnesses at our hearings ascribed the disappointing results under the Smathers-Keogh Act to this and other limitations which we recommend to be eliminated.

Statements at the hearings to this effect:

This act has helped somewhat, but its present shortcomings have limited the utilization of its provisions. The major drawback is that only one-half of the contributions toward the self-employed individual's pension is considered a tax-deductible expense. (Dr. Fischer, p. 57.)

The self-employed individual as an employer of his own services occupies the same position as the manager of a small business employed by a corporation. There is no reason, as a matter of equity, why that portion of his compensation which is committed for the provision of retirement income should not be treated exactly alike in both

cases.

17 Hearings, pp. 26 and 27 (Mr. Bernstein); p. 50 (Mr. Clarke); p. 55 (Dr. Fischer). 10 Hearings, p. 89 (Mr. Severance).

19 Ibid., p. 106 (Mr. Stone).

Removal of the present inequitable treatment would do much to encourage the extension of pension coverage to both the self-employed and their employees.

A bill to accomplish this objective, appropriately identified as H.R. 10, has been introduced in the present session of the 89th Congress by Eugene Keogh, of New York. (Dr. Murray, pp. 45–46.)

It can be proven with little difficulty that H.R. 10 as it now stands is a desirable device for only the high income, high tax bracket proprietor and partner.

It has not been bought-I am speaking of H.R. 10—and will not be bought by the medium- and low-income proprietor and partner in large numbers until certain provisions are eliminated.

I am speaking specifically of the $2,500 limit on contributions, and also the 50-percent limitation on the deductibility of contributions. (Mr. Clarke, p. 51.)

I would be willing to predict that as long as these conditions obtain, coverage under the Keogh-Smathers law will be negligible. (Mr. Severance, p. 89.)

We, therefore, strongly support the passage of the present H.R. 10 which will do much to make possible the extension of pension coverage among the self-employed. (Mr. Skinner, p. 194.)

It was difficult to obtain firm estimates of the "revenue loss" which would result from this and other proposed liberalizations of the Smathers-Keogh Act. There were two estimates in the record. One was that of Dr. Roger F. Murray, Columbia University professor of banking and finance, who expressed the belief that amendments which he advocated involve less than $50 million of revenue in either of the next 2 fiscal years.20 The other estimate was that of the Treasury Department, which estimated in 1963 that removal of the 50percent limitation would result in an annual "revenue loss" of $120 million,21

As indicated in the excerpts of the hearings quoted above, Hon. Eugene J. Keogh has introduced a bill, H.R. 10, which would accomplish the purposes of this recommendation and of Recommendation No. 2.

20 Hearings, p. 48.

21 Ibid., p. 109.

Recommendation No. 2. The subcommittee recommends that the Internal Revenue Code be amended to provide that a self-employed person who has employees is not bound by the 10 percent or $2,500 limits on pension contributions for his own benefit, but may exceed those limits under a formula which does not discriminate against any of his employees.

Under existing law contributions to a pension plan for a selfemployed individual cannot exceed $2,500 or 10 percent of earned income, whichever is less (unless the plan permits nondeductible voluntary contributions). Thus, the $2,500 maximum can be contributed only if the owner-employee has an earned income of $25,000 or more for the year unless nondeductible voluntary contributions are permitted.

There are at least two reasons why it is undesirable to limit contributions for the self-employed taxpayer. First, it seriously impedes the extension of pension coverage under this act. The decision to establish a plan is usually in the sole discretion of the self-employed individual who owns and manages the enterprise. By limiting the tax benefits of the plan in providing his retirement security, the act fails to give full recognition to his own self-interest as a stimulus to plan adoption. Without this stimulus, he may not adopt a pension plan, thus failing to provide his employees with private pension benefits. The second reason why these limitations are undesirable is that by restricting contributions for the owner-employee to such a low level, retirement incomes of all employees covered by the plan are minimized. The generosity of the contributions for all employees may be directly related to the level of deductible contributions for the owner-manager of the enterprise. If the upper limits on his deductible contributions are eliminated or liberalized, the code will still require that contributions be nondiscriminatory. For this reason, the owner-manager, in order to raise contributions for himself, will be forced to raise them for all employees. In this way, the plan will achieve its full potential for providing retirement incomes for all the employees.

The most undesirable limitation is the percentage limitation, under which contributions for the self-employed taxpayer cannot exceed 10 percent of earned income. This limits the contributions of taxpayers with annual net incomes of less than $25,000. We submit that these are the taxpayers who should receive the most encouragement to provide for their old age. They are more likely than taxpayers with higher incomes to reach old age with inadequate savings. Without adequate retirement income, they are more likely to be a drain upon old-age assistance, medical assistance for the aged, and other publicly supported programs. Finally, the revenue loss from their plans will be less, since they are in the lower tax brackets. The 10percent limitation keeps their contributions so low it is easy for them to reach the conclusion that it is not worth the time, trouble, and administrative expense to adopt pension plans.

This limitation in combination with the arbitrary 30-percent limitation discussed in our recommendation No. 3, has the practical effect of excluding self-employed individuals in many occupations from the benefits of this legislation and thus denying their employees the advantages of private pension coverage.

One approach which might be taken if it is found not feasible to relax the limitations as we recommend would be to repeal the provisions penalizing contributions over those limits. Under subsection (e) of Internal Revenue Code section 401, contributions to pension plans by the self-employed for their own benefit, which are in excess of the $2,500 and 10-percent limits, not only are nondeductible in the year when made; they will cause the plan to lose its qualification so far as an owner-employee is concerned, resulting in the nondeductibility of all future contributions for that owner-employee and the inclusion in his gross income of the earnings of the pension fund attributable to his interest in it. If this penalty is removed, excess contributions could be made without detrimental results other than nondeductibility of the excess. This would take some of the sting out of the present unreasonably low limits by at least permitting the earnings on these excess contributions to be tax free, both to the plan and to the self-employed individual.

Since the subcommittee realizes that it might be too much to hope that all limits on contributions can be eliminated, it recommends that at least the 10-percent or $2,500 limits be eliminated for selfemployed persons with employees.

Recommendation No. 3. The subcommittee recommends that the Internal Revenue Code be amended to eliminate or liberalize the provision specifying that where both capital and personal services are material income-producing factors in a trade or business, not more than 30 percent of the self-employed taxpayer's net income from the trade or business may qualify as "earned income" (Internal Revenue Code, sec. 401 (c) (2) (B)).

Where this provision is applicable, the self-employed individual's net earnings must be at least $83,333.33 for the year if he is to make the maximum pension contribution of $2,500 (30 percent of $83,333.33 is $25,000; 10 percent of $25,000 is $2,500). One of the largest occupational groups which are severely handicapped by this provision in taking advantage of the Smathers-Keogh Act are farmers. Testimony of the American Farm Bureau Federation showed how unreasonable and inflexible the arbitrary 30-percent provision is with reference to American farms, on many if not most of which the percent of net income attributable to operator labor is considerably over 30 percent.22 The subcommittee feels that this arbitrary concept should be eliminated or that, at the very least, the inflexible percentage should be raised to a more reasonable figure than 30 percent.

Incidentally, making it possible for more farmers to obtain selfemployment pension coverage would assist in solving the Nation's farm problems and in providing better opportunities for younger farmers. In a letter reproduced in the hearings record, Dr. John A. Schnittker, who was then Director of Agricultural Economics of the Department of Agriculture (now Under Secretary of Agriculture), said:

*** the fact that many continue to farm past the age of 65 indicates that more attractive plans are needed. Pension plans based on voluntary contributions of farmers have promise. However, they probably could not be made sufficiently attractive to have much impact unless present tax laws were changed. Only small numbers take advantage of the present tax exemptions permitted for pension plans of the self-employed. If attractive to farmers, this type of plan could make a contribution to releasing resources to other farmers because there would likely be greatest participation among those farmers who have relatively high sales and who control much land * * * a program designed to be attractive to older farmers on larger farms would allow an impressive fraction of farm resources to become available to younger operators, including a small number of "new" farm operators. Your committee might be interested in reviewing the experience of the Netherlands, which relies on programs to induce early retirement of farmers as a major instrument of

Hearings, pp. 145-146. For additional testimony on the importance to farmers of extending private pension coverage, see letter from Dr. Blue Carstenson, National Farmers Union, p. 146.