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Pension Smoothing Is Not the Solution to the Highway Trust Fund (or Anything Else)

By Shai Akabas, Brian Collins

Thursday, July 10, 2014

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As we have written about and has been widely known for some time, the Highway Trust Fund (HTF), which finances federal spending on surface transportation and infrastructure, is nearing insolvency in the coming weeks and will then be unable to fully reimburse states on a timely basis. The HTF finances a variety of projects across the country to maintain and improve surface infrastructure, including roads, bridges, and public transit.1 The HTF is primarily funded by a tax of 18.4 cents per gallon on gasoline and 24.4 cents per gallon on diesel fuel. In recent years, the HTF has needed general revenue transfers because the value of the gas tax has been eroded by inflation since it was last raised in 1993 and because Americans are driving less and driving more fuel-efficient vehicles.

Committees in both the House and the Senate have recently taken up bills to ensure the solvency of the HTF – at least temporarily. There has been increasing talk about using unusual funding mechanisms, including transferring money from a separate fund for leaking underground storage tanks and an accounting maneuver known as “pension smoothing.”

Unlike another recent proposal to fill the HTF by increasing the gas tax and indexing it for inflation, pension smoothing could impact the solvency of many Americans’ pensions. It also doesn’t end up raising much money for the government. On net, a cost-benefit analysis of this proposal seems negative.

The smoothing proposal would allow corporations with traditional defined benefit (DB) pensions to fund their pensions to a lesser extent than mandated by current requirements.2 As companies decrease their deductible contributions to their pension funds, taxable income increases and the government collects more money in the short run. There may be reasons to reexamine the assumptions underlying funding requirements but not on the basis of raising revenue over the ten-year window. Unfortunately, pension smoothing has the potential to harm the security of many Americans’ pensions and doesn’t actually help government finances over the long run.

Pension Smoothing Increases Likelihood of Underfunding Pension Obligations

Implementing a policy that would result in companies lowering their near-term pension contributions increases the likelihood that the responsibility for those obligations will eventually fall on taxpayers. The federal government provides insurance to private-sector DB pensions through the Pension Benefit Guaranty Corporation (PBGC). Underfunded plans are more likely to become insolvent and unable to meet their obligations to retirees down the road. In that case, PBGC would step in and assume payment of those pensions – but only up to certain limits – leaving some retirees with smaller pensions than they were promised.

Furthermore, PBGC already faces significant financial challenges. It is funded by premiums paid by pension plans that depend on how many beneficiaries are in a plan, but those premiums are insufficient to cover expenses.3 PBGC recently reported that it projects a deficit of $58 billion dollars in 2023 and that there is a 90-percent chance that one of PBGC’s two trust funds would be exhausted by 2025.4 When its trust funds are exhausted, the most likely solution will be a transfer from general revenues, meaning that taxpayers will foot the bill.

Pension Smoothing Doesn’t Raise Much Money

Moreover, a delay by businesses in making pension funding payments simply shifts many of these payments into the future; the net increase in revenue for the federal government is small. In January of this year, the Congressional Budget Office (CBO) scored a proposal to use pension smoothing to pay for a reinstatement of extended unemployment insurance benefits. By that estimate, pension smoothing netted an additional $16 billion in tax revenue during the first six years after enactment, but that would be largely offset during the following years – as businesses make additional pension contributions that were not made in earlier years – for a total revenue increase of less than $3 billion over the ten-year budget window. (The net revenue figure would likely shrink further if projections were made beyond that time frame.)

Pension underfunding is already a significant problem. In fact, the Pension Protection Act of 2006 specifically required higher levels of funding from companies with DB pensions to avoid underfunding them. Retirement policy issues – and specifically the question of rolling back these current law provisions – should be decided on their merits and not because of their ability to provide funding for unrelated programs. Just as important, the policy fails to address the ongoing funding shortfall facing the HTF and we need a long term solution.

As part of our Commission on Retirement Security and Personal Savings, we will be further examining the role that PBGC plays in ensuring financial security for retirees and the challenges that the agency faces. Stay tuned for more blogs on the topic.

Alex Gold contributed to this post.

1 The HTF actually consists of two separate accounts: a road construction account, and a mass transit account. A Leaking Underground Storage Tank Trust Fund is also funded by the gas tax.

2 In particular, the proposal would allow businesses to use a longer window when calculating projected interest rates on pension assets, thereby averaging out the last few years of extremely low rates and assuming a higher rate of return in the future.

3 Some of the premiums also depend on the degree to which a plan is underfunded.

4 The deficit projection for 2023 is deflated to current dollars and is the sum of the single-employer trust fund deficit ($8 billion) and the multiemployer trust fund deficit ($50 billion).