Last week the ESOP community was excited about The ESOP Promotion and Improvement Act of 2009 (S. 1612). Not so fast. In February 2007 we discussed how the Congressional Budget Office Recommended Repealing 404(k) and provided updates here and here. On August 6 the Congressional Budget Office released Budget Options, Second Volume. One of the suggested options to increase revenues, Option 22: End the Preferential Treatment of Dividends Paid on Stock Held in Employee Stock Ownership Plans, is very similar to the 2007 proposal, uses the same arguments that are found in the Overly Sensational Anti-ESOP Media Coverage, and highlights the importance of Scheduling a Meeting with your Congressional Representatives sometime during this month's August Recess:

Employee stock ownership plans (ESOPs) are a type of retirement plan designed to encourage companies and their shareholders to contribute or sell stock to their employees. Because they meet certain requirements relating to employee ownership, ESOPs are granted more tax advantages than is the case for other qualified retirement plans. Corporations that sponsor ESOPs typically contribute their own stock rather than cash to the plan on their workers' behalf. Those contributions, like employers' contributions to other qualified retirement plans, can be deducted from the company's taxable income. But employers with ESOPs gain an additional tax advantage: They can deduct the dividends paid on stock held in an ESOP if those dividends are paid directly to the plan's participants or are paid to the plan and either reinvested in additional company stock, used to repay loans with which the stock was originally purchased, or distributed to participants within 90 days of the end of the plan year.

Another tax advantage goes to shareholders: Under certain circumstances, they can defer paying capital gains taxes on the proceeds of sales of the company's stock to its ESOP. For that to obtain, the company must be a C corporation and thus subject to the corporate income tax, the stock cannot be traded publicly, and the proceeds from the sale of the stock to the ESOP must be invested in the stock of another U.S. company.

This option would eliminate ESOPs' tax advantages, effectively rendering ESOPs indistinguishable from other qualified retirement plans. The change would increase revenues by $0.6 billion in 2010 and by $4.9 billion between 2010 and 2014.

Several arguments can be made against giving preferential tax treatment to ESOPs. First, the current treatment causes similar dividend payments to have different tax consequences for different companies. Second, it hampers diversification of employees' retirement portfolios because the assets of an ESOP, by design, consist primarily of shares of the employer's stock. If the price of that stock drops, employees may have much less wealth in retirement than they would have had if they had been allowed to diversify their investments, as participants in a typical 401(k) plan can. A third argument for eliminating preferential tax treatment is that ESOPs occasionally have been used for purposes for which they were not intended, such as to ward off hostile takeovers by placing large numbers of shares in friendly hands.

The main rationale for retaining the tax advantages of ESOPs is that having employees own a company's stock directly links their financial interests to their productivity. Then, greater productivity would translate into higher profits for the company and thereby increase the value of the employees' stock. To the extent that the incentive of stock ownership works as intended, ESOPs help promote increased productivity among workers. However, studies linking employee ownership to productivity have exhibited mixed results, and some of those that report such a link suggest that factors not addressed by the tax incentive, such as employees' participation in management, also are important.

The CBO Director's Blog discusses the purpose of the report:

CBO regularly presents compendiums of budget options to help inform Members of Congress about the effects that various policy choices would have on spending or revenues. For the current budget cycle, CBO has issued Budget Options in two volumes. The first volume, released in December 2008, focused on options regarding health care and its financing. The second volume, released today, includes options that address other areas of federal spending and revenues. Estimates for most of the revenue options were supplied by our colleagues at the Joint Committee on Taxation. In keeping with CBO's mandate to provide objective, impartial analysis, these volumes make no recommendations.

Today's report presents 188 illustrative options that cover an array of programs and policy areas—from defense to energy to entitlement programs to provisions of the tax code. The options include some changes that would decrease spending and others that would increase it, as well as some changes that would reduce revenues and some that would raise them. The options come from legislative proposals, the President's budget, Congressional and CBO staff, other government entities, and private groups, among others. They are intended to reflect a range of possibilities, not a ranking of priorities, and the selection or omission of a potential policy change does not represent an endorsement or rejection by CBO.

The budgetary effects shown for each option span the 10 years from 2010 to 2019 (the period covered by CBO's March 2009 baseline budget projections). Some options would have significant effects beyond that horizon. For each option, a table shows its estimated effect on spending or revenues in each year from 2010 to 2014 and summary projections for 5 and 10 years. The accompanying discussion provides background, describes the policy change envisioned in the option, and summarizes arguments for and against the change.