specific and controlled applications. The provision of a governmentally provided means of sheltering income from taxation is a means of stimulating savings by individuals. Pension plans operate as a type of tax shelter.
Tax shelters are, in some ways, analogous in concept to mutual funds. Many desirable investments are not directly available to the small investor. Through the pooling of the funds of many small investors, however, mutual funds make otherwise unavailable investments available to the small investor. Similarly, many investment tax advantages are directly available only to large institutions and very wealthy individual investors (Goldberg, 1984, p.69). Tax shelter vehicles bring many of these tax advantages within the reach of the small and medium investor, and, thus, encourage personal saving. Pension plan investments provide such benefits to millions of persons who could not otherwise participate in large institutional-level investment operations. Thus, pension plans provide benefits beyond simply retirement income.
Tax shelters are permitted by the Congress, because they are (when properly used) beneficial to the economy. They tend to lower the cost of capital, and they make investment funds available to socially desirable capital-intensive activities (such as housing projects for the poor, energy exploration, and some research and development projects), which might otherwise be unable to generate such funds. Most tax shelters, of any kind, involve one or more of the following three characteristics: (1) the deferral of an income tax liability; (2) the conversion of ordinary income into capital gains; (3) and the use of financial leverage in an investment (Brennan, 1984, p. 237).
A tax shelter may be defined as an investment vehicle that permits the "tax benefits inherent in an investment to flow through directly to the investor and which also permits the cash-flow inherent in ...