STUMP » Articles » Government and your money: GIMME GIMME GIMME » 8 July 2015, 16:20

While everything in the world seems to be melting down, I decided to dredge up a draft post that I started in January.

It seems very timely now.

PUBLIC PENSIONS FOR PRIVATE EMPLOYEES?

Back in January, I saw an article about a plan to make some sort of public/private pension in Illinois:

Illinois is piloting a “mostly mandatory” Individual Retirement Account (IRA) savings program for private sector workers. Though not a DC in that it doesn’t require employer payments, it requires businesses with 25 or more employees without a retirement program to enroll their workers into an IRA that automatically deducts 3 percent from each paycheck. Workers may increase the contribution or opt out entirely.

…..
They could also go some way toward addressing the woeful state of financial education in public schools, where there’s a fundamental disconnect between the classroom and the marketplace. Wealthier families, who often learn financial planning outside the classroom, are much more likely than lower-income families to directly hold stocks and participate in a retirement plan. This exacerbates the cycle of poverty, as poorer families lack access to capital gains, a central argument by French economist Thomas Piketty in his popular Capital In the Twenty-First Century (a book with many critics).

Unintentionally, Piketty’s work shows expanding access to capital markets bolsters the case for privatization of Social Security, as Christopher Demuth argues, pointing out that “Nations such as Chile with capitalized pension systems have employed these and other approaches with little fuss and much success.”

I have tried looking up info on the Chilean pension system, but the information in the Wikipedia article is very stale.

Here is something more recent – from a year ago:

Michelle Bachelet, a Socialist Party politician who returned to the presidency in March, is preparing to embark on the biggest revamp of the country’s pension system in its 33-year history. Arguing that the system leaves too many Chileans without retirement security and carries excessive costs, Bachelet wanted to introduce a new, state-run AFP [something like a mutual fund] to compete with the private pension funds.

The article linked is pretty good, because it does point out that the percentage being saved is insufficient — but that’s not due to private v. public funds. Most people don’t realize that they need to be saving a hell of a lot more than 5% to get a good replacement rate in retirement.

THE PROBLEM WITH PUBLIC FUNDS

However, if the funds are government-run, there are two big problems:

1. Opportunities for corruption — politicians could interfere with fund management and require kickbacks, etc. This has happened in the public fund space for public pensions, and just imagine the level of corruption that could occur when you’ve got so many more people in the system.

This is a huge reason I’m against Social Security privatization (at least the versions I’ve seen). The bigger the pot of money directly controlled by government, the more enticement to corruption.

2. Ease of grabbing assets — mind you, we can see funds being frozen in private banks in Greece right now, and a “bail-in” occurring. But when the government controls the funds, how much easier it is for them to just take the cash away.

And if you object, why they’ll say what did you expect when the government is running the funds?

Also, it’s not really your money, you see. It’s the government’s money.

Again, why I’m against Social Security privatization. You may say it gives personal ownership of funds, but it seems to me the government will argue strongly that the funds are owned by them. After all, they control it.

TAKING WEALTH VIA TAXES

A variant of asset-grabbing is taxing wealth (as opposed to income). Thing is, they do want people to accumulate some amount of capital, so there are all sorts of tax-favored savings vehicles out there.

In January, there were some rumblings over chipping at the cookie jar of college savings and home equity:

Bank robber Willie Sutton is said to have explained his career this way: “That’s where the money is.” Whether Sutton ever really said that, it’s an aphorism that, according to Bloomberg’s Megan McArdle, explains President Obama’s plans to go after middle class assets like 529 college savings plans and home appreciation.

Though millions of Americans have been putting money into “tax free” 529 plans to save for their children’s increasingly expensive college educations, President Obama would change the law so that withdrawals from the plans to fund college would be taxed as ordinary income. So while you used to be able to get a nice tax benefit by saving for college, now you’ll be shelling out to Uncle Sam every time you withdraw to pay for Junior’s dorm fees.

This doesn’t hurt the very rich — who just pay for college out of pocket — or the poor, who get financial aid, but it’s pretty rough on the middle– and upper–middle class. In a double-whammy, those withdrawals will show up as income on parents’ income tax forms, which are used to calculate financial aid, making them look richer, and hence reducing grants.

Likewise, Obama proposes to tax the appreciation on inherited homes. When you sell property at a profit, you pay capital gains on the difference between the basis (what you paid) and what you sell it for. (Obama also proposes to increase the capital gains rate). That’s not a big issue for most middle class people, because right now if your parents leave you their house, you get what’s called a “step-up” in basis.

That means that the basis isn’t what your parents paid for the house decades ago, but rather what it was worth when you inherited it. Thus, the appreciation your property experienced while your parents owned it comes to you tax-free. For many families, that appreciation is their biggest inheritance. Now, subject to some exemptions Obama plans to tax those gains, and other gains via inheritance.

WON’T ANYBODY THINK OF THE POOR GOVERNMENT?!

THEY NEED MONEY!!!!

As Megan McArdle pointed out:

Once you’ve hit your fiscal capacity to tax the rich, a few big sources of tax revenue are left:

1) A value-added tax. Very efficient and generates a lot of money because evasion is very difficult; it is almost self-enforcing. It minimizes economic distortion, and what distortions it does introduce encourage savings over consumption. It is also highly regressive. So it’s hard to see where the political support will come from: Progressives hate the regressivity, conservatives, the imposition of a large new tax that will squeeze a lot of money out of people.

2) Raising income taxes on the middle class. Also raises a lot of money — the middle class mostly have salary income, and they don’t have the ability of the wealthy to shift their income between, say, capital gains and ordinary income. This will raise a lot of money (note that the Bush tax cuts on the middle class, which were made permanent in 2010, cost about three times as much as those on the wealthy.) It will also rile many millions of people, who will make angry phone calls to their representatives.

3) Tax the savings of the middle class. This could take many forms: lowering the dollar value of an estate that is exempted from tax, eliminate the basis-step up that such estates currently enjoy, or start to pare back on tax-advantaged savings like Roth IRAs and 529 educational savings accounts. (Traditional IRAs and 401(k)s already have their withdrawals taxed as ordinary income, which will make it harder for the government to claw back the tax benefit they’ve already extended without outright seizing the accounts.) This will also cause a mass freakout, but of a smaller number of people, since a surprising number of affluent people save very little of their income.

The third option is the worst, from an economic point of view — the last thing we want to do is discourage saving, given how little of it Americans do. On the other hand, it may be the most politically palatable.

….
What it also argues for is saving even more than you are. The government is going to come for its money one way or another, and the best way to deal with that is to have more than you need.

Yeaaaahhhhh, I’ll think on that one.

ALL YOUR MONEY ARE BELONG TO US

The Greek situation is still working its way out (for various meanings of “working its way out”), but one of the proposed actions was a “bail-in” involving a 30% “haircut” on bank deposits.

Here is a post from Mish on this proposal:

30% Bail-In Haircuts Coming Up

I warned countless times over the last six months that Greek citizens need to pull their deposits before it was too late.

Today I report it’s too late. 30% bail-in haircuts on Greek bank deposits are coming up.

….
Why Announcement Now?

The only thing curious is the timing of the announcement. Actually, there was no official announcement. Rather a statement by “bankers and businesspeople” who likely wish to influence the vote to yes.

This news could do it. However, haircuts will come either way.

Yeah, that didn’t work.

Such a grab at bank deposits has happened before:

The recent [2013] bail-in in Cyprus has given the world a glimpse at the future of the banking landscape. Now, as Canada gets set to hardwire the bail-in process into law, analysts like Michel Chossudovsky are warning how the big banks can use this template to further consolidate their monopoly of economic control. This is the GRTV Backgrounder on Global Research TV.

……
After months of negotiations, the government of Cyprus announced it was on the verge of a 10 billion Euro bailout deal with the so-called “troika” of the EU, the ECB and the IMF. But when details of the plan emerged, including the fact that it had the confiscation of both insured and uninsured bank deposits baked into the cake, protests erupted around the country.

The final deal ended up keeping deposits under 100,000 Euros untouched, but uninsured deposits were restructured, wiping out the savings and cash flow of foreign depositors and local businesses alike.

So if you saved above a certain amount, you got cut down. How does that strategy of “just save more” work out in that case, eh McArdle?

Lucky for us, we’re getting to see how it works out elsewhere before it hits us.

‘BORROWING’ FROM PENSIONS

There’s nothing special about pensions versus bank deposits. As far as government is concerned, money is money is money.

A bunch of countries thought it was a good idea to grab pension contributions:

Earlier this month, the Russian government seized its citizens’ pension contributions. Normally, 6 percent of Russians’ salaries is invested in financial markets, earmarked for their retirement. This year that $8 billion in contributions will finance Russian spending instead. Russia is not the first country to confiscate pension assets to pay its bills, and it probably won’t be the last. Argentina, Hungary, Poland, Portugal, and Bulgaria have all done the same in the last six years.

…..
The stealing of pension assets is relatively new. It used to be unnecessary: Governments already had them in their possession. Developed countries financed most people’s retirement with pay-as-you-go defined benefit plans, like Social Security in America. But as people lived longer and populations aged, relying entirely on unfunded promises appeared unsustainable. Starting in the 1980s, it became popular to supplement or even replace government pensions with individual saving accounts invested in financial markets. Latin American countries, notably Chile, led the charge, and in the 1990s and 2000s Eastern Europe followed. Some richer countries such as Australia, the United Kingdom, the Netherlands, and the U.S. all adopted some variant of personal pension accounts.

So think about “privatization” a little more.

Poland grabbed a bit when it was hungering for money:

Around the world, indeed, in places like Hungary and Poland, the roll-your-own pension plan model is being, reversed, and governments are reverting to the “trust us” model. The mechanism has been particularly drastic in Poland, where the government recently confiscated some 150bn zlotys (€36bn) of Polish government bonds and government-backed securities, seizing them from private pension-fund managers. The Poles then cancelled those bonds entirely, which had the effect of reducing Poland’s national debt overnight, by a substantial 8 percentage points. Given debt-ceiling rules, that gives the Polish government a lot more room to run deficits than it had before. In return, the Poles who were counting on the retirement income which was going to be generated by those bonds are just going to have to make do with a standard pay-as-you-go system, where they’ll receive a state pension which is paid for out of general tax revenues.

This is not as dreadful as it necessarily looks at first blush. Governments can always find a way to reduce pensioners’ incomes, through taxes or any other means. And now, at least, those incomes will be less tied to the vagaries of market returns. Indeed, Poland isn’t all that far from the United States: although we do put a lot of government bonds into the Social Security trust fund, it’s entirely up to the government how much money pensioners take out of that fund. It can be less than the fund is earning, or more: the decision is political, and doesn’t bear much relation to the income being generated, or even whether the trust fund has any money in it at all.

Still, the Polish move is a pretty bad one. The pension funds still exist, but now they’ve lost most of their fixed-income component, so they’ve become a lot more volatile. The playing around with the national-debt figures is a silly, and dangerous, trick. And without strong domestic pension funds, Poland has now lost an important source of investment flows — the kind of money that helps to keep an economy innovative and productive.

I will ignore the bit about the supposed government bonds in the Social Security trust fund.

Now, in the U.S. it can be a little more difficult to grab the pension assets outright…so far. But we’re seeing some chipping away at it.

CHICAGO ASKS NICELY FOR MONEY

As far as I can tell, Chicago isn’t yet grabbing at assets, though Rahm did recently ask, pretty please, could they borrow some money from the pension funds?

One day after using borrowed money and savings generated by 1,400 layoffs to make a $634 million payment to the teachers pension fund, Mayor Rahm Emanuel’s administration is asking the pension fund for a five-month, $500 million loan.

At a pension fund meeting Wednesday, Chicago’s newly appointed Chief Financial Officer, Carole Brown, said she’s well aware it’s a “big ask,” particularly after the history of pension holidays and partial payments that created the $9.5 billion pension crisis at the Chicago Public Schools.

But Brown said the loan is needed to avoid even more devastating classroom cuts. The loan would be made in fiscal year 2016, when CPS would shift from a lump-sum pension payment to monthly payments. When the loan is repaid in fiscal year 2017, the Chicago Teachers Pension Fund would get the money back — with interest.

I’ll gladly pay your pensions Tuesday for some cash upfront today.

That’s convincing, right?

I mean, I know I’d want to lend some money to an entity that is going bankrupt.

That means they’re even more likely to pay back the loan, right?

PROGRAMMING NOTE

Tomorrow, I will be going to a public hearing on Public Pensions Actuarial practice, and will be taking notes. I plan on writing some stuff on the situation, but it may take me some time. I’ve downloaded all the submitted comments, and have also been looking at some historical docs.

In the meantime, I will quote my own letter to the Actuarial Standards Board.

When public plans get into trouble, it generally does not emerge suddenly, as a run on the bank. Trouble in public pensions develops over years, sometimes decades. Perhaps the slow-moving nature of public pension disasters makes sponsors complacent, but it is probably expected by sponsors that if there were something terribly wrong, the actuaries would have warned them. It does not matter how many disclaimers we actuaries put into our reports. We are the numbers people; we do the projections; we should have been highlighting cases when current assets cannot cover the liability of not only current retirees, much less future retirees.

This numbers person has some reading to do.