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The Evolving Pension System: Trends, Effects, and Proposals for Reform. William Gale, John Shoven, and Mark Warshawsky Editors. Brookings Institution Press, 2005, ISBN 0-8157-3117-5, 248 pages.

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The Evolving Pension System: Trends, Effects, and Proposals for Reform. William Gale, John Shoven, and Mark Warshawsky Editors. Brookings Institution Press, 2005, ISBN 0-8157-3117-5, 248 pages.

Published online by Cambridge University Press:  29 October 2007

Thomas Steinmeier
Affiliation:
Texas Tech University
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Abstract

Type
Book Review
Copyright
Copyright © Cambridge University Press 2007

This volume grew out of a Brookings project to analyze pension issues; a companion and earlier volume by the same editors deals with the more technical issues regarding pension research (Private Pensions and Public Policy).

The title of the volume is accurate: after a short introductory chapter, two chapters look at historical trends in pensions, two chapters examine the effects of pensions for labor markets and wealth, and a final set of chapters assesses reform proposals. Past trends are reviewed by Sylvester Schieber who starts out by describing the evolution of US pensions from their roots in the 1800s. Intertwined with the pension story is a long list of federal regulations that affects pensions and in turn is affected by perceived problems with pensions. The rise of pensions in the mid-20th century is attributed to the fact that the introduction of the income tax and Social Security made pensions a relatively low cost way to ease workers out of the labor force and provide an acceptable standard of living in retirement. A few well-publicized bankruptcies with underfunded pensions brought about the Employee Retirement Income Security Act of 1974 (ERISA), after which funding levels rose dramatically. So dramatically, in fact, that the implied loss of tax revenue led to regulations limiting the degree to which firms could average out the funding over the business cycle. The net result was to shift the appeal of pensions, from the firm's point of view, away from defined benefit plans and toward defined contribution and 401(k) plans. The chapter by William Gale, Leslie Papke, and Jack VanDerhei concentrates on the post-ERISA period in somewhat more detail and also considers several non-regulatory reasons for the recent shift toward defined contribution plans.

The theme then shifts to the effects of pensions on economic behavior. Work by Robert Clark and Joseph Quinn examines how pensions affect wages, productivity, turnover, and retirement. Of these, the retirement effect has been found to be the strongest, with fairly convincing evidence of causality. At the other extreme, it has been difficult to find compensating differential effect on wages. William Gale then turns to how pensions affect saving and wealth. This is a much more contentious area, primarily because of its implications for pension policy. If pensions prove to be simply a substitute for other kinds of saving, it becomes harder to justify the tax preferences given to pensions. While Gale mentions research arguing that pensions and 401(k)s are net saving, he comes down squarely on the side that only a minority of pension contributions represents new saving.

Several chapters take up proposals for pension reform. Diametrically opposite ideas about the function of pensions are offered by Theodore Groom and John Shoven, on the one hand, and Daniel Halperin and Alicia Munnell on the other. Not surprisingly, they arrive at diametrically opposite conclusions about desirable directions for pension reform. Groom and Shoven take the view that the tax system should be neutral between current consumption and future consumption. In this framework, the tax preferences given to pensions are not really preferences at all, but rather the taxes imposed on non-pension saving are penalties and presumably should be eliminated. With regard to pensions, they believe most of the regulations should be scrapped, including top-heavy rules, limitations on funding, limitations on contributions and benefits, and so on. Halperin and Munnell, in contrast, think that pensions do not contribute much to national saving nor do they benefit the lower tiers of the income distribution much. Accordingly, as pensions are currently formulated, they are deemed not worthy of the substantial tax benefits given to them, and they argue that additional tax benefits for retirement saving should buy increased retirement income for low and middle income workers.

Pamela Perun and Eugene Steuerle look at defined contribution plans where participants elect their investments, so the pension in their model would simply become a facilitator to move the funds to the chosen asset mix. Under current law, however, the pension plan has fiduciary responsibility, and if some of the choices go bad, the plan sponsor may be held responsible for offering these choices. The authors note that this scenario presents an especially attractive target for class action lawyers (many similarly-situated plaintiffs and large dollar losses). If such a class action case were to succeed, they argue, defined contribution plans and 401(k) plans in particular would become much less attractive, particularly to smaller employers. To avoid this, they argue that the legal environment of the plans must be changed to resemble Individual Retirement Accounts (where the employer bears no fiduciary responsibility beyond conveying the funds from the employee to the fund). Of course, while a successful class action suit would be unsettling, it is unclear that it would lead to a wholesale abandonment of plans as the authors fear, given the tax advantages of the plans. What it might induce is a move away from offering high cost and/or actively managed and risky funds, and toward low cost index-type funds, which it would be much harder to argue are inappropriate.

This book is a very good and (for the most part) non-technical discussion of the general issues surrounding pensions. The list of contributors reads like a who's who of pension experts. Schieber's chapter does a wonderful job of providing insight into the historical context of pensions. The two chapters on comprehensive pension reform allow sharply differing viewpoints to be stated clearly, and they highlight the complexity of the issues. It is a credit to the editors that they were able to present such diverse viewpoints in a single volume. It would have been useful if the editors had been able to accomplish a similar thing regarding the topic of whether pensions are net saving. Although Gale mentions that some believe pensions are net saving, he is clearly on the other side of this issue. This is a relatively minor quibble, though, in a volume that does an admirable job of conveying the essential facts, debates, and issues for pensions and pension reform.