August 14, 2018 | By Dan Lynch | Back to blog
Dan Lynch
Dan Lynch is an assistant professor in the Department of Accounting and Information Systems at the Wisconsin School of Business. Photo by Bruce Fritz

Signed in December 2017, the Tax Cuts & Jobs Act of 2017 (TCJA) was the biggest overhaul of U.S. tax code since the Tax Reform Act of 1986. One of the major changes was a drop in corporate tax rate from 35 percent in 2017 to 21 percent in 2018. This drop gives firms a clear incentive to step up their tax deductions in 2017.

One area where firms can receive tax deductions is with traditional defined benefit pension plans. Historically, these pensions have been highly underfunded. In 2016, the aggregate unfunded liabilities for 100 of the largest corporate pensions totaled $320 billion. Not surprisingly, the federal government encourages companies to contribute more to defined benefit plans through minimum funding requirements.

Against this TCJA backdrop, my colleagues Fabio Gaertner and Mary Vernon of the University of Wisconsin–Madison and I began thinking about the whys and the hows of incentives for firms to increase tax deductions in 2017. Would we start to see an increase in funding due to these new tax laws, a byproduct of change the TCJA proponents hadn’t planned for? What effect would these new regulations have, if any, on firm behavior? As far as we are aware, our study is one of the first to describe this relationship between the TCJA and corporate defined benefit pension plans.

Study and results

Our study questioned whether the TCJA affected defined benefit pension contributions in 2017. We used 1,570 observations from 414 calendar-year firms with pension obligations for the period of 2014 to 2017. Since Generally Accepted Accounting Principles (GAAP) rules require that firms disclose how much they plan to contribute to the pension fund a year in advance, we were able to define the difference between firms’ predicted amount and the amount they actually contributed as the unexpected pension contribution.

We found that unexpected pension contributions increased by nearly 23.8 percent and, aggregated across our sample, equated to roughly $6.6 billion in unexpected contributions in 2017.

An unintended consequence

To be clear, we are not claiming that the changes in tax law gave firms funds to deliberately turn around and put into their pensions. We consider the rise in pension contributions to be an unintended consequence of a rate reduction, more about tax incentives for additional contributions in 2017 versus 2018.

Why would we consider this unintentional? Timing. Back in February and March of 2017, when firms were disclosing what they would put in these accounts, tax reform was far from a sure thing. There was some speculation, but nothing concrete; it’s not likely that the tax reform discussion even factored in. Instead, we can look to the unexpected pension contribution, the amounts that firms put in over and above what they projected in early 2017.

Here are some additional considerations and implications from our study:

  • Cash: It’s true that cash balances are very high for firms in general and that tax reform on top of that will allow many firms to increase those cash balances. Our study teases out some of that issue, but we don’t have concrete evidence about where that cash is coming from. We do know that firms are using internal funds to finance these pension contributions and are not, for example, going back to external capital markets to raise funds.
  • Deduction timing: All deductions must be in service in 2017, although it’s also worth noting that calendar-year firms can deduct up until September 15, 2018 on their 2017 return. Still, if you’re a firm, you’re up against the clock. A simple pension contribution is easier to accelerate into 2017 than, for example, restructuring or increasing your R&D—both time-intensive actions that require infrastructure to complete.
  • Tradeoffs: Within the TCJA, there are inherent tradeoffs. It’s an offshoot and not part of this study, but because of these greater 2017 deductions, the government will likely collect fewer taxes in 2017.

Our study reflects a significant increase in pension funding in the short term. It’s too early to say whether what we’re observing is permanent; it may simply be a shift, taking the money for 2018 and shifting it into 2017. Either way, that’s an important next piece for us to explore. Let’s see what happens in 2018.

Read the working paper “The Effects of the Tax Cuts & Jobs Act of 2017 on Defined Benefit Pension Contributions.”

Dan Lynch is an assistant professor in the Department of Accounting and Information Systems at the Wisconsin School of Business.


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