The Tax Treatment of Workers Compensation Costs and Safety and Health Incentives

Abstract

In 1979 the Interagency Task Force on Workplace Safety and Health recommended a change in deductibility of workers' compensation costs for Federal income tax purposes that was expected to increase the value of experience rating as an economic incentive for occupational safety and health. This paper provides an analysis of that proposal, particularly with regard to firms which have apparent experience that differs from their true experience because of the lack of adequate payroll apportionment into different manual classifications. The paper makes no final judgment on the desirability of the proposal, but it identifies the relevant variables and indicates their relationships to the problem. The Federal income tax laws have long been used not only as revenue measures but also as instruments of social and economic policy. This use is evidenced in many ways including the investment tax credit and special amortization allowances for investment in environmental protection equipment. For corporations, except for very small ones, the effect of taxes can be considerable since currently 46 percent of marginal revenues and expenses are absorbed by the government through the tax system. This tax effect places a wedge between changes in costs and revenues and resultant changes in net income after taxes. Failure to recognize consistently the potential incentive and disincentive effects of the tax structure, however, leads to inconsistent policy. In the area of occupational safety and health, the government attempts to achieve safe and healthy workplaces through regulation while at the same time mitigating the potential effects of existing economic incentives toward that goal. In their draft final report Making Prevention Pay [1], the Interagency Task Force on Workplace Safety and Health recommended that: the Federal Tax Code be modified to allow employers to deduct for income tax purposes the average cost of workers' compensation premiums for their industry and size, regardless of whether the firm's actual experience-rated or self-insured premium is above or below the cost.