The federal “Tax Cuts & Jobs Act of 2017” was a far-reaching tax reform law that made fundamental changes to both the personal and corporate tax codes. One key provision was a reduction in the corporate tax from 35 percent in 2017 to 21 percent in 2018 and thereafter. The change gave firms an incentive to accelerate tax deductions into 2017, including contributions to defined benefit pension plans, as those contributions will be deducted at a higher tax rate.
A new study from the Wisconsin School of Business finds evidence consistent with this incentive, as a review of 414 firms with pension obligations found these firms increased pension contributions by an average of approximately $16 million each. Fabio B. Gaertner, associate professor of accounting & information systems, Daniel P. Lynch, assistant professor of accounting & information systems, and Mary E. Vernon, a Ph.D. student in accounting & information systems, all at the Wisconsin School of Business, document an increase of roughly 23.8 percent over the pre tax reform average corporate pension contributions. The findings suggest firms made $6.6 billion of additional pension contributions in 2017. The study is believed to be one of the first to examine the effect of the 2017 tax law on the behavior of firms.
“Even though the law incentivized increased corporate contributions to defined benefit pension plans, there were some tax practitioners cautioning firms to assess their cash needs before making those contributions to avoid losing out on investment opportunities,” says Gaertner. “There was also some thinking that internal financing constraints might prevent firms from making increased pension contributions in 2017.”
Lynch adds, “Our findings suggest that in addition to some of the high profile firms that increased their defined benefit contributions last year—3M, Caterpillar, and Boeing—a number of companies decided there was a benefit to making these contributions in 2017 due to the scheduled drop in the corporate tax rate in 2018.”
The researchers could identify additional contributions to corporate defined benefit pension plans because under Generally Accepted Accounting Principles (GAAP) in the United States, firms must disclose their expected pension contributions a year ahead in their annual 10-K reports. Gaertner, Lynch, and Vernon calculated additional contributions as the difference between actual pension contributions made in 2017 and the corresponding expected contribution amounts disclosed in the 2016 10-K filings of the sample firms.
To further detail the tax law’s effect on pension contributions, the study examines the association between the tax reform enactment and additional contributions separately for taxpaying and non-taxpaying firms. While firms can deduct pension contributions from their taxable income, firms with positive federal taxable income stand to benefit the most from these deductions. Taxpaying firms made additional pension contributions in 2017 that were six and a half to twelve times larger relative to non-taxpaying firms, a finding that supports the idea that the tax rate change is driving the increase in pension contributions. Finally, the authors also find that firms standing to lose the most from deferred tax asset write-downs for GAAP accounting purposes related to their pensions are the primary contributors. This is consistent with the financial reporting incentives related to the corporate rate reduction also playing a role in the decision to make additional pension contributions in 2017.
According to the federal Pension Benefit Guaranty Corporation, nearly 40 million private-sector workers, retirees, and beneficiaries rely on close to 24,000 defined benefit plans guaranteed by the agency. Because of concerns that many of these plans are underfunded, Congress has enacted several pension reforms to raise the minimum funding requirements and incentivize firms to make contributions, yet defined benefit plans continue to be severely underfunded. One recent study found that defined benefit pension liabilities for the 100 largest corporate defined benefit pensions totaled $1.718 trillion, while over $320 billion of those liabilities were underfunded.
Vernon concludes, “The increase in pension contributions was not a primary consideration in the decision to lower the corporate tax rate, so our results document an important unintended consequence of the tax reform law in the improved funding of defined benefit pensions.”
The recently released working paper, “The Effects of the Tax Cuts & Jobs Act of 2017 on Defined Benefit Pension Contributions,” can be found here.