A Legislative Challenge

The always informative Kevin D. Williamson has a wicked neat idea at NRO.  He recognizes that the feds like to attach strings to aid.  He explains why the attempt to eliminate stock buybacks was so silly.

He recognizes the need for federal aid to states and the problem:

There is a good case for providing some short-term aid to states and cities whose revenue streams are currently smoking ruins in the wake of a global crisis over which they had no control. But that is not the question. The question is whether Washington should bail them out of troubles that are only tangentially related to the epidemic. The answer to that is, No.

We absolutely agree.  Part of the reason we agree is, see below for why, we are from Wisconsin.  He is not quite right when he says:

The main issue here is the unfunded liabilities of the state and local pension systems, particularly in Democrat-run jurisdictions such as the state of Illinois and the city of Dallas. [Emphasis added]

If we look at the map here of the funded ratio of pension liabilities from 2017 it is hard to find a political pattern. Illinois is 50th and KY is 48th.  As a state retiree we feel good that WI is number one.  It is true that Democrats run essentially all of the big cities where there are numerous pension problems.  It is also true that CA has a ratio in the middle (27th) but the size of that state, in both senses, means that unfunded amount for CA is very large.  So it is less of a red/blue problem than Kevin D. suggests.

He gives some ideas to Mitch McConnell and the GOP:

It would be entirely appropriate to encumber aid in such a way as to prevent its being used for any other than a relatively narrow range of specified purposes. But, because money is fungible, that sort of legislative guardrail might not be enough. A better approach would be to condition aid on distressed states’ and cities’ actually addressing their unfunded liabilities, which are the root of the problem here. To that end, Congress could require that states adopt reasonably responsible pension practices in order to participate in ongoing assistance programs; “reasonably responsible” here would mean renegotiating programs with beneficiaries in order to begin to align the promises that have been made with the resources needed to make good on them and seeing to it that states start making actuarially required contributions to pension plans going forward. Of course that assumes a level of credibility and discipline not obviously in evidence in Washington (or in Austin, or in Frankfort, or in Olympia), but so does every alternative.

We think renegotiating pension agreements and making actuarially required contributions is a great solution.  We are not sure if the former is legally feasible.  The GOP might find other good solutions.  We are almost sure it won’t happen.  One reason is that Washington never does anything that smart.  But the other, and more important reason is, Mitch is from KY.  Check the map.  Sadly, we are not going to see a legislative solution that prevents federal aid from being used to pay off unfunded pension liabilities..

Elections Matter

C.J Szafir and Colin Roth from the Wisconsin Institute of Law and Liberty reflect in the WSJ on the challenges and joys of having elected a leftist empty suit as governor (that is our term not theirs).  There is much to be concerned about but C.J. and Colin find a reason to rejoice:

[The new governor’s] budget leaves alone former Republican Gov. Scott Walker’s 2011 collective-bargaining reforms, known as Act 10, revealing that strong fiscal reforms can create a legacy that is practically impossible to unwind even when the political pendulum inevitably swings back.

Mr. Walker and a Republican-controlled Legislature passed Act 10 to solve a $3.6 billion state budget shortfall. The law, among other things, significantly limited public employee unions’ ability to bargain collectively and required public employees to pay more for their benefits—5.8% of pension contributions and 12.6% of health-care premiums.

We will add another reason why there is reason for fiscal joy: retirement incentives.  Long serving employees tend to be the highest paid.  Our department was an exception because of the market but generally a new faculty member (and other state employees) makes substantially less than the person he replaces so there are what we call salary savings.  Where salary savings go is an important budget issue that is beyond the scope of this post.

Wisconsin has strong post retirement benefits that mean a good pension and support for healthcare in retirement.  In our case, at current rates, we will pay for health care until age 115.  Thus, the payments an employee makes for healthcare and retirement disappear in post-employment.  Our computation that the tax on working for our first year of retirement would have been 117 percent.  That is, we had more spendable income from retirement that we would have had from working.

We don’t know if Scott and the GOP did it on purpose but it is a nice example of saving money by getting the incentives right.  And they did it by saving the state money so they ended up with double savings.  It is nice to hear that our current governor is sticking with it.


Pensions, Careers, And Retirement

Pensions and careers have changed.  Ramesh Ponnuru thinks the retirement changes are for the better and we heartily agree.  We will give an example and explain why it matters.  Ramesh thinks Americans should stop mourning the loss of traditional (defined benefit) pensions concludes:

These are changes that would build on, rather than attempt to reverse, the last few decades of developments in the American retirement system. Those developments, especially the rise of the 401(k), have largely been for the better.

Sidebar One: Pensions can be divided into defined benefit and defined contribution.  In a defined benefit plan you typically get a pension equal to then number of years worked * highest salary over three years * a percentage.  So if you work 30 years and your percentage is 1.8 then you get 54 percent of your highest salary.  A 401 (k) is an example of a defined contribution plan where a defined amount is invested and you get the result at retirement.  We often think that the worker takes the risk in a defined contribution plan and the company takes the risk in a defined benefit plan.  That is only true if the worker retires from that employer.  We will show details later.  End Sidebar One.

Sidebar Two: Risk is both upside and downside.  If a worker spends his entire career with one employer then a defined contribution plan is more risky because he might get much more or much less than a defined benefit plan.  End Sidebar Two.

The big reason for changing pensions is that the nature of careers have changed.  Years ago it was bad to have a resume that indicated you were a job hopper.  Now career advice is:

If you are changing jobs less than every three years, you are in the minority.
You may need to have a well-prepared explanation when you front up to your next job interview.

It also true that employers come and go.  Both of these are reasons why we should cheer at the increasing number of defined contribution plans.

MWG has a defined benefit pension plan.  It worked very well for us although it limited our opportunities, as it was intended to do, in the time close to retirement.  It worked very well for us because we spent nearly 40 years with one employer.  Thus, our paltry year salaries in the seventies and eighties were irrelevant and only the years mattered in the computation of benefits.  If we had of switched employers it would have been bad for us because our salary was so low. Another benefit was sick days.  In our case sick days accumulate and can be used to pay for medical insurance after retirement.  The sick day benefit is based on your highest salary but you must retire in order to get it.  Thus, because of both sick days and defined benefit, as retirement approached it was financial suicide for us to leave before retiring.  When we became eligible for retirement, the sick days became a powerful incentive towards retirement because workers had to pay for part of the cost of health insurance but retirees, like us, with lots of sick days did not.

For us and our employer, the defined benefit plan worked.  We got a nice retirement and they got us to work for less than market prices late in our career.  We are not sure if the intent of the pension was to get us to retire.  It was effective at that too.  We retired because the tax on working was over 100 percent.  That is, we had more disposable income in the first year of retirement then we would have had if we worked that year.

Defined contribution was a fair deal for us in another era.  Even then we were a minority in staying with one organization so long.  Now we would be a micro-minority.  Defined contribution is the way to go in the new environment.  We need to find incentives to increase them.  We have three suggestions:

First make health insurance benefits taxable to the recipient.
Second, increase social security benefits for the needy by means testing benefits for high income individuals.
Third, increase the tax benefits of Roth IRAs.  Make the contribution tax deductible and keep the returns not taxable.

The first would help by producing a bit of government revenue and focusing both employer and employee on the retirement issue.  The second would provide a safety net to the really needy.  The third would reduce complexity at retirement because everyone would go Roth and there wouldn’t be any taxes having an impact on decision making.

As Ramesh says, let us build on the success of 401 (k) plans.  Folks are looking for freedom.  The right incentives will help them make good choices.


Accounting Versus Arithmetic

At NRO George Will reminds us of the fiscal problems that we face by starting with pensions for states and municipalities:

Some American disasters come as bolts from the blue — the stock-market crash of October 1929, Pearl Harbor, the designated hitter, 9/11. Others are predictable because they arise from arithmetic that is neither hidden nor arcane. Now comes the tsunami of pension problems that will wash over many cities and states.

The WSJ reports on Illinois where the state has a $130 billion in unfunded pension liabilities.  The Democrats are trying to tax their way out.  Illinois is one of the few states with a decreasing population of less than 13 million.  We’d avoid it too.

Then George concludes with the entitlement crisis:

The problems of state and local pensions are cumulatively huge. The problems of Social Security and Medicare are each huge, but in 2016 neither candidate addressed them, and today’s White House chief of staff vows that the administration will not “meddle” with either program. Demography, however, is destiny for entitlements, so arithmetic will do the meddling.

We agree with George on the severity of the problem but we’d like to add a bit of explanation.  Pensions can be accounted for and the extent of the problem is an accounting result.  Pensions are very long term so they are very responsive to compound interest.  George notes that when Illinois went from an expected return of 7.5 percent to 7.0 percent it added $400 to $500 million to the annual bill.  George thinks 7.0 percent is still imprudent but gives no evidence to suggest why.

Entitlements like Social Security and Medicare are not pensions.  Pensions have assets that will grow and, hopefully, meet the obligations.  MWG’s pension from the state of Wisconsin is nicely funded and gives us great comfort.  Entitlements are paid on a cash basis.  MWG Social Security payment comes from the younger readers.  Thanks!  The probability of the coming disaster for Social Security is approaches 1.0 because only a plague among retirees can stop it unless Congress acts.  The extent of the Medicare disaster depends greatly on the rate of increase in medical costs.  Pensions could be fixed but Illinois shows us why it doesn’t happen in many states.

The clock is ticking.  Social Security needs to be means tested yesterday.  Start now with a small changes and get it right by the end of the decade.

The only current good news is that the GOP is trying to fix Medicare while eliminating the ironically named Affordable Care Act.  Let’s hope they get their sums right.