Compensation and Benefits

Federal Taxation of State and Local Government Retirement Plan Investment Earnings

The Government Finance Officers Association (GFOA) opposes any form of taxation that would reduce the earnings of pension plans. The primary responsibility of a pension plan and its fiduciaries is to provide promised benefits to its members. Part of the funds used to pay for these benefits are derived from investment earnings. Taxation of investment gains or investment transactions would reduce the income of pension plans.

The overwhelming majority of public employers sponsor defined benefit plans, which promise a specified benefit at retirement, and many are legally prohibited from reducing pension benefits. Therefore, if investment earnings are diverted to pay taxes the plan sponsor will be required to increase contributions to meet benefit obligations.

State and local government pension plans support and practice long-term investment policies. They do so, however, with the knowledge that short-term investment strategies are appropriate under certain market conditions. Government investment practices and policies reflect the on-going nature of public entities. The overriding responsibility of meeting benefit obligations through the prudent practices of diversification of investments, and investing funds at a reasonable level of risk and rate of return can only be met through a long-term investment approach.

GFOA encourages federal policymakers to reject proposals to tax public pension plans for the purposes of raising federal revenues or encouraging certain investment behavior because this would:

  • skew investment decisions by discouraging public investment officials from actively managing their portfolios in order to avoid taxation,
  • reduce market liquidity, and
  • reduce investment earnings of public employee retirement systems requiring state and local governments, their employees and taxpayers to make up any revenue shortfall.

  • Publication date: May 1990