Eyeing the golden goose - proposal to tax income from whole life insurance - Column

National Review, June 27, 1994 by Ed Rubenstein

Theeey're back. One year after the unsuccessful effort to tax pension contributions, Washington has the itch again. This time it's your life insurance.

Under current law people who buy whole life insurance pay no tax on the investment income generated by the premiums. This makes perfect sense. "Inside buildup," the term for such income, is held within the policy and is therefore not available to pay taxes. Policyholders who redeem their policies prior to death are taxed on this income. But to impose a tax on future insurance distributions is like asking homeowners to pay taxes on the unrealized capital gains in their home.

The argument against taxation goes beyond mere convenience. People buy insurance (and, for that matter, stocks, bonds, and other investments) with dollars that have already been taxed. When Washington taxes the income generated by such investments it is, in effect, taxing the same income twice. This double taxation affects most forms of investment income in the United States. It explains much of our anemic personal savings rate.

Yet the Congressional Budget Office scores the inside-buildup provision as a "tax expenditure" that costs the government $10 billion a year. Budget Director Leon Panetta reportedly proposed restricting the "loophole" to help pay for the Clinton welfare plan.

The tax-preferred status of life insurance and pension plans has helped make them the largest and fastest-growing form of household savings - which is what caught the eye of the tax-and-spend crowd. In 1992 the then Federal Reserve economist Alicia Munnell suggested levying a 15 per cent tax on employer contributions as well as on the annual earnings of pension plans, transferring $51 billion from pension recipients to the Federal Government.

That's just the start. Miss Munnell, now assistant Treasury secretary for economic policy, worries that in the switch to her system, existing pension-fund assets might escape taxation entirely. Her solution? A one-time 15 per cent tax on all existing private pension-plan assets in the United States. At current levels, this would yield a whopping $720 billion.

So far these are only the personal views of Alicia Munnell. They are consistent with the class-warfare themes developed by the Clinton Administration, however. Pension coverage is concentrated among higher-income workers. In 1988, for example, 73 per cent of salaried workers earning over $50,000 were covered by a plan, compared to only 30 per cent of those earning less than $20,000. Pension income accounts for only 3 per cent of the retirement benefits of the poorest fifth of households, compared to 49 per cent for the wealthiest fifth.

But pensions are also the single largest support of the U.S. stock and bond markets. They underwrite projects that enhance the productivity of all workers, rich and poor alike. That's the point that Miss Munnell and others of her ilk seem to have missed.

     Household Financial Assets
            ($ Billions)

                               1980      1993   Increase

Cash and Deposits             $1,823    $4,176   129.1%
Pensions and Life Insurance    1,165     5,265   351.9
Stocks and Mutual Funds        1,021     4,093   300.9
Business Equity                1,864     2,221    19.2
Bank Trusts                      219       659   200.9
U.S. Government Securities       217       463   113.4
Other                             90       353   292.2

Total                         $6,399   $17,230   169.3%