Edward Zelinsky's, The Ownership Society: How the Defined Contribution Paradigm Changed America, provides a useful and readable summary of the legal developments on the path to the expansion of the defined contribution paradigm in private sector retirement benefits in the United States. The book also advances the interesting and more controversial thesis that the expansion of the defined contribution idea beyond retirement benefits may lead to the de facto replacement of the income tax with a consumption tax for all but the highest income taxpayers in the U.S.
As the readers of this journal surely appreciate, the defined contribution approach to retirement benefits involves fixed payments to a retirement investment fund, with employees choosing among investment options for the money paid into the fund on their behalf. This approach differs from the defined benefit approach to retirement benefits, in which the employee receives a promise from the employer to provide a fixed income in retirement, typically based on a formula that weights two factors: (1) years of service and (2) wages in the final years of service. Under the defined contribution approach, the employee bears greater investment risk. Under the defined benefit approach, the employee bears greater risk of the insolvency of the employer and, typically, must work longer for that employer to earn a comparable retirement benefit. A final difference lies in the allocation of longevity risk. Defined benefit plans almost always are annuitized – meaning they provide a defined income until death (and sometimes until the death of a surviving spouse) – while defined contribution plans allow employees to choose whether to annuitize or not, and most do not choose to annuitize.
Zelinsky explains the legal developments, most importantly the U.S. Employee Retirement Income Security Act (ERISA), and incentives that have led to the widespread adoption of the defined contribution approach, especially but not only in the private sector, and especially but not only with regard to retirement benefits. The defined contribution approach protects employee retirement benefits from the risk of employer insolvency, facilitates a dynamic labor market, communicates to rank and file employees the fact that deferred compensation makes them long term investors, and provides employers greater certainty in calculating and projecting employee compensation costs. At the same time, however, the defined contribution approach exposes employees more directly to the changing fortunes of the capital markets, a fact that the recent contraction of those markets has made painfully aware for anyone who is approaching a retirement that is to be funded by a defined contribution retirement account.
From the defined contribution approach to retirement benefits, Zelinsky abstracts a larger defined contribution paradigm that channels government subsidies through individual accounts controlled by individual taxpayers. This paradigm encompasses not only defined contribution retirement benefits but also tax advantaged higher education savings accounts, health savings accounts, and, though he does not focus on this, tax advantaged variable annuities sold by insurance companies. Seen in this way, the defined contribution paradigm is paving the way for a shift from income-based taxation to consumption-based taxation. Zelinsky's plausible claim is that most of the saving done by the middle income U.S. taxpayers occurs in tax advantaged individual accounts and, thus, the federal income tax in the U.S. already in fact operates much like a consumption tax.
Where this reviewer takes issue with The Ownership Society is not with Zelinsky's interesting consumption tax observation, but rather in the sweeping claims about the triumph of the defined contribution paradigm in U.S. society more generally. Taking a broader approach that includes public and private insurance programs, as well as the retirement and other savings programs on which Zelinsky focuses, we can see that the defined benefit approach still thrives. Medicare and Social Security's disability and life insurance programs remain huge defined benefit programs that not even the Cato Institute proposes shifting to the defined contribution paradigm. The Cato Institute does have a defined contribution proposal for Social Security's Old Age benefits, but the recent collapse of the stock market has almost certainly deferred that discussion for at least a generation. The disability and property and casualty insurance industry operates exclusively in the traditional defined benefit insurance model of fixed premiums paid in advance in return for indemnification in the event of loss. The health insurance industry continues to operate almost exclusively in the defined benefit model, notwithstanding the development of tax-advantaged health savings accounts. So, too, the life insurance industry. Term life insurance operates entirely within the defined benefit framework, and most savings-linked life insurance products, including the variable annuities that compete with mutual funds, retain at least some traditional insurance features. Indeed, it is these insurance features, such as minimum death benefits and guaranteed return of premium, which accounts for their survival in the investment marketplace notwithstanding their higher costs and lower expected returns. Thus, while it is undoubtedly true that ERISA led to a major shift toward the defined contribution paradigm, that paradigm has not triumphed to the full extent that The Ownership Society claims.
