Pension contributions and tax-based incentives: evidence from the TCJA

Focus

This paper uses the Tax Cuts & Jobs Act of 2017 (TCJA) as a natural experiment to show that sponsor contributions to corporate defined benefit pension funds respond to tax-based incentives. Pension plan sponsors can deduct pension expenses from corporate tax returns. The TCJA cut the US federal corporate tax rate from 35% to 21%. In turn, this cut resulted in a temporary tax break on pension contributions. As a result, sponsors had an incentive to front-load planned future contributions.

Contribution

Our results suggest that plan sponsors are not constrained - when setting pension plan strategies - by how much cash they have at hand. Tax-based incentives have a significant impact on the time profile of contributions. However, changes to these incentives do not leave a long-lasting footprint on the level of either sponsor contributions or pension plan solvency.

Findings

We find that the TCJA tax break worked exactly as would be expected of a temporary change in tax-based incentives. Sponsors did indeed front-load planned future contributions. In line with the result that the TCJA affected the time profile but not the overall level of sponsor contributions, we find no evidence of a long-lasting impact on plan funding ratios. In contrast with financial press reports of pension fund rebalancing away from equities and into US government bonds during the TCJA tax break in 2017, our estimates show that the TCJA had no impact on plan portfolios. That said, the tax break appears to have narrowed corporate credit spreads.

Abstract

We document that corporate pension contributions respond to tax-based incentives using the 2017 Tax Cut & Jobs Act (TCJA) as a natural experiment. The TCJA cut the U.S. federal corporate tax rate, temporarily increasing contribution incentives for sponsors of defined-benefit retirement plans. We exploit cross-sectional variation in ex-ante exposure to these incentives. We find that the tax break induced an extra $3 billion of sponsor contributions to medium- and large-scale plans in 2017. But we also find strong evidence of a reversal, both in terms of sponsor contributions and plan funding ratios by 2018. We find no evidence of impact on plan asset allocations. Our results suggest that the TCJA did not have a long-lasting impact on corporate defined-benefit pension funds.

JEL classification: H22, H25, H26, H32, J32

Keywords: defined-benefit pension plans, contributions, Tax Cuts & Jobs Act