THE IMPACT OF THE TAX SHELTERING OF BENEFITS ON EMPLOYER-EMPLOYEE CONTRACTING

Scope and method of study. The purpose of this study was to explore from a theoretical perspective the effect of current and potential tax policy on optimal employer-employee contracting and on government revenue. The research question was addressed using a principal-agent framework.; Findings and conclusions. The analysis demonstrated that the employer can appropriate the tax savings associated with tax-preferred benefits. A conclusion of the analysis was that tax-sheltered benefits are an essential characteristic of optimal employer-employee contracting. A more notable aspect of this study is the determination of the impact of the tax sheltering of benefits on employee effort and on government revenue. As a result of the tax sheltering of benefits, a shift to a higher effort level can occur. With this shift, productivity increases and government revenue may be enhanced. Thus, the study identified an exception to the intuitive conclusion that government revenue decreases as a result of the tax sheltering of benefits. In addition, the study determined that exogenous factors such as an employer purchase advantage and administrative costs impact the employer's decision to provide tax-sheltered benefits. Potential tax policy issues such as an increase in the employee's tax rate; the complete and partial repeal of the nontaxable feature of benefits; and the repeal of the deductibility of benefits by the employer were also addressed. The analysis demonstrated that these potential tax policy issues do impact contracting costs. A cafeteria plan was suggested as an option for an employer to induce the employee to reveal his desired level of benefits.