Thursday, October 29, 2015

Why You Need to Pay Attention to the Retirement Crisis (even if your retirement is fully funded)

A recent survey in Forbes of attitudes toward retirement revealed 18% of Americans believe they are very prepared for the expenses of retirement. A report of the Employee Benefit Research Institute, however, estimates that 43% of Americans believe they are unprepared. The remaining 39% are uncertain about their ability to support themselves in retirement. Many of those who are unprepared believe the government will find a way to support them in their golden years. While those comfortable in their own plans believe the retirement crisis is simply "not their problem". Both groups are wrong. Here's why.

Currently in America, half of pre-retirees (age 55-64) have no retirement savings, while the half that do show median savings of $111,000. The median retirement savings of this age cohort as a whole (including both those with and those without funded accounts) is only $14,000. By 2030, just fifteen years from now, Americans age 65 and over will total 70 million. Half, or 35 million people, will have no retirement savings. The median balance of those with savings will support retirement income of about $370 per month. So, another 17.5 million will be grossly underfunded in their retirement savings. Roughly 9% of this group, or 6.3 million work for public sector agencies, often with good retirement plans and benefits. This means roughly 46 million people will neither have the benefit of public employee pension plans, nor adequate personal retirement savings. By 2030, US total population is projected to be on the order of 375 million people, so this group of economically distressed seniors will represent an estimated 12.3% of the nation's population.

First, as to why the government can't make this problem go away. The 2015 Trustees Report of the Social Security Administration shows a projected date of insolvency of the Social Security Trust fund of 2034. By that date, the Trustees predict, Social Security will only be able to pay roughly 75% of annual benefits. Now, median annual benefits of Social Security last year were just $15,000, so (in current dollars) median benefits would be reduced down to $10,000 per year (75% of $15,000), substantially below the poverty line. For the fund as a whole, the present value deficit of Social Security today, again per the Trustees report, is a staggering $10.7 trillion.

Now, why this is your problem, even if you believe it is not. If you've been reading along, you have a sense of the magnitude of the retirement crisis and can begin to imagine the consequences to the economy of a burden of 46 million seniors living in poverty. But consider this. In addition to the under-funding of personal retirement accounts and Social Security mentioned above, US state and local government pension plans are underfunded by an estimated $4 trillion. These are funds that governments are legally responsible to pay retirees. To raise the funds necessary to pay their pension obligations, governments will turn to...taxpayers. There is no one else. Now, don't shoot the messenger, as bad as the problem is, it's still better to be aware of the issue now, while some solutions still exist. 

If you'd like to read more about the retirement crisis and what can be done about it, please check out my new book, Up In Smoke: How the Retirement Crisis Shattered the American Dream, available now on Amazon.com. 

Wednesday, October 21, 2015

There's Still a Jobs Problem in America

Once a month the Bureau of Labor Statistics (BLS) reports on jobs. From it's peak in 2009, the BLS has reported a falling unemployment rate, from 10% to the current 5.1%. Despite these impressive gains, there's still a jobs problem in America. Here's why.

Many Americans are aware of the falling unemployment rate. They hear about it on the nightly news. They read about it in the newspaper. But behind the headlines, economists have quietly been warning about the quality of jobs being created and the falling labor participation rate. Low paying jobs in the services sector and a record number of Americans mysteriously dropping out of the labor force, both serve to artificially reduce the unemployment rate, making the jobs economy appear much stronger than it actually is. 
                                                     
The counterargument is that retiring baby boomers are the reason for the falling labor participation rate. It's to be expected, with an aging population. But is that really true? First, let's explain the labor participation rate. It's the share of Americans, age 16 and over, who are employed or actively looking for work. If fewer Americans are in the labor force, then those holding jobs represent a greater percentage of this total. Hence, a lower unemployment rate.

Thus, the unemployment rate has been biased by the steeply falling labor participation rate since 2008. For this reason, the more compelling chart to look at may be the employment to population ratio, also maintained by the BLS.
               
With no bias in the data due to a falling labor participation rate, this chart simply shows the proportion of the population, age 16 and over, that is employed. Now it's true that this chart would be influenced by retiring boomers, but it's hard to believe that 5% of the working population, or 7.7 million people, would have all decided to retire in the two years from 2008-2010. In fact, the first of the baby boomers to turn 65 did not occur until 2011. So something else is clearly responsible for the steep decline in the employment to population ratio in the first two years of the great recession. 

The problem is weak job creation, not retiring baby boomers. Not only are fewer high paying, full-time jobs being created, but the employment that is being generated is seasonal, part-time or in lower paying jobs in the services sector. 

To understand why this is occurring, we first have to step back and understand how new jobs are actually created in the private sector. Since there are few, if any, economic incentives for hiring new employees, businesses hire new people when they forecast they will see the sales and revenue opportunities to pay these salaries. Think about it. If you run a small factory that makes running shoes, the only way you would expand and hire more staff is if you believed that demand for your shoes would support the investment in increasing production. And that, right there, is the problem.

Let's take a look at new business investment in America since the beginning of the recession. After recovering somewhat dramatically in the year following the 2009 recession, the rate of growth of new business investment has leveled off and in fact fallen in recent years. Why? Because companies are not seeing the demand for their products in the US or, increasingly, abroad. Weak demand, weak investment, weak hiring.

Unfortunately, the public sector isn't helping. Faced with a slowly recovering, but now flat tax revenue outlook, state and local governments are desperately struggling to pay rising salaries, retirement benefits, energy and health care costs. As a consequence, new capital investment fell off a cliff in 2009 and continues to decline today.
                  
                        U.S. Investment in Public Infrastructure
With business and local government investment this lackluster, the prospects for meaningful new job creation looks highly doubtful. Until businesses see new demand they will be unlikely to expand current production. Entrepreneurs will shy away from starting new businesses and investing in new ventures. 

Unfortunately, igniting demand is something that America and other developed economies have very little experience addressing. And so, we have a bit of a chicken and egg problem. If consumers had more job certainty, higher wages and more disposable income, they'd be willing to spend more freely, thereby generating demand for products and services. However, businesses are unwilling to increase hiring or pay greater salaries, without seeing greater business opportunities. So which comes first, jobs or consumer demand? For this very reason, we've remained mired in the same stalled economy for the past seven years, with uncertain prospects for new job creation.


Wednesday, October 7, 2015

Connecticut: #1 in Per Capita Income, #48th in Pension Funding

This past week, the Wall Street Journal ran an article about the dire state of public pension funding in the very wealthy state of Connecticut. The Journal drew appropriate irony to the fact that America's #1 state in per capita income also ranked a disturbing 48th in the funding of its public employee pension liabilities. Home to hedge fund managers, corporate executives and Wall Street elite, Connecticut has approximately half of what it needs to fund its employee pensions. The state has an unfunded liability of $26 billion, with pension liabilities doubling over the past decade.

As readers are becoming increasingly aware, the unfunded pension liabilities of US states, cities, counties and local districts have become an issue of urgent concern. The pension deficit, nationally, has been estimated as high as $4 trillion. Let's stop and think about that number for a moment. If US state and local governments contributed $275 million per day to pay off this deficit (which is considerably more than what is currently being paid) it would take 40 years to right the ship. And that's just the liability for current retirees and employees. Any new hire would add to the funding burden. Further, as the Journal article points out, even these projections are based upon an assumed earnings rate going forward of 8%. If markets correct and deliver returns to pensions of, let's say, 4% or heaven's forbid, negative returns the deficits will increase disproportionately. 

Now, I understand that some people read about the magnitude of government pension deficits and roll their eyes, already convinced that government in most localities is something of a mess. So what's new? The problem is that this issue will not and cannot go away on its own. Governments will need to turn to taxpayers to raise revenue to pay these deficits.

What should be obvious to all, but what many people simply do not realize, is that state and local governments rely upon taxes from individuals for the vast majority of the revenue that they raise. Be they personal income taxes, sales taxes, property taxes, motor vehicle license or fuel taxes, or taxes on services like utilities, telephone, or otherwise, the individual taxpayer provides an estimated 91% of state and local tax revenue, nationally. 

While 70% of those polled in a recent survey by the Reason Foundation indicated that they would oppose reducing benefits to public sector retirees, this same group also opposed raising taxes to pay for benefits. Those polled were against raising taxes, against reducing government services, and against reducing pensions for retired workers. This failure to appreciate the linkage between local government liabilities and the tools by which governments fund these liabilities, is a primary obstacle in addressing the growing and unsustainable public sector pension crisis.


Thursday, October 1, 2015

Teacher Pensions are Well Earned, But...

An article with this title, written by Michael Hiltzik, recently appeared in the Los Angeles Times. In LA Times fashion the article, more an editorial than newsworthy, nonetheless appeared on the front page of the Sunday Business Times. The article caught our attention, not just because of an interest in public pensions, but also for the indispensable work of public school teachers.

In the piece, the writer singles out a teacher with 30 years' experience in the Los Alamitos School District, a small district outside of Los Angeles. The teacher is mentioned by name in the article (presumably to lend credibility) which we won't do here. Our argument is not with the retirement pension of this teacher, or of any teacher in particular. This educator spent 30 years in front of a classroom, made payroll contributions to her retirement plan and is entitled to rely upon that pension income in her retirement.

This case, however, illustrates a point about public employee pensions and those calling for reform. The reform effort, proposed in California for the 2016 electoral ballot, along with local measures passed several years ago in the cities of San Jose and San Diego, do nothing to touch existing retiree or current employee pensions. Rather, the reforms, are effective only for prospective employees, yet to be hired. This simple fact, is what makes the anti-reform efforts of the public unions and editorials like this one in the Los Angeles Times, so peculiar.

But let's go to the core of Mr. Hiltzik's argument. The teacher in question, now 61, will soon enjoy a lifetime annual pension "in the range of $100,000", representing approximately 90% of her highest year annual salary. Mr. Hiltzik goes on to characterize that pension as "decent". Now, if a pension of 90% of salary is considered "decent" in the world of state and local government, then literally millions of private sector workers are living indecently. Saving an account balance through an IRA or 401k that will generate lifetime retirement income of 90% of highest year salary is virtually unheard of in the private sector. 

Mr. Hiltzik, however, continues to justify this level of retirement income by pointing out that the teacher "funded much of her pension from her own paycheck, a contribution that comes to 9.2% of her pay this year". This now reaches to the point of this post. While no one would like to see this teacher's retirement income, so well earned, so well funded and, well so decent, to now be changed. But what we must also consider, is that this lifetime pension of $100,000 per year (adjusted for cost of living increases) must actually be paid by someone, in this case, the school district and the CalSTRS public employee pension system.

But then again, if Mr. Hiltzick's representation that the teacher has funded much of her pension is true, then what's the concern?  Now, this is where we need to drag some math into the conversation. If the teacher's pension is $100,000 and it represents 90% of her highest year salary, then her salary, by simple mathematics would have been roughly $111,000. That would mean her payroll contribution in her highest year, at 9.5%, was $10,555. This would be her contribution, though, for just her highest (presumably last) year of employment. Her average salary over her total employment, we can assume was approximately $60,000. That would imply total pension contributions over 30 years were on the order of $170,000. Investment earnings, to a varying degree, would have been earned on those contributions, so for arguments sake let's say the current value of this teacher's contributions, plus interest are approximately $350,000.

Let's now consider the value of the pension to the teacher and, most importantly for this discussion, the cost of the pension to the public agencies that must provide it. Investment professionals use a rule of thumb for spending in retirement from a 401k or IRA of 4%. Using this metric, a portfolio that produces $100,000 in annual income, would need to be precisely $2,500,000 in size. So, in effect, our teacher is indifferent to an annual lifetime pension of $100,000 or to having been given a lump sum of $2.5 million, from which she can draw 4% per year.

But let's also consider the impact of this one pension on the public agencies that are required to provide it. These public agencies are holding roughly $350,000 from our teacher's lifelong payroll contributions, plus investment income. With a pension liability for the agencies that amounts to $2.5 million, our teacher's pension is underfunded by $2,150,000. Magnify this case, by literally millions of public employee pensions and you can begin to appreciate the enormity of the public employee pension crisis and its impact on local governments and their taxpayers.





Wednesday, September 23, 2015

Chicago Hikes Taxes to Pay Public Employee Pensions

Mayor Rahm Emanuel at City Council Meeting on 2016 Budget
Chicago Tribune
News broke this week of a proposal by Chicago Mayor Rahm Emanuel to hike property taxes for city residents by $588 million over the next four years. Tax increases are certainly not uncommon, but what caught median attention was the direct link between the need to raise taxes and the fact that the tax revenue would be directed to shore up underfunded public employee pensions. Community residents suddenly find themselves faced with the stark reality that their ability to fund their own retirement savings will be compromised by the city's need to fund the retirement of its employees.

The news followed recent downgrades of the City of Chicago in May 2015 to junk bond ratings. In lowering the city’s rating, Moody’s Investors Services cited “the city’s highly elevated unfunded pension liabilities” continuing, “we believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably.”  This thus points to the most troubling concern about public employee pension liabilities: that even well-intentioned efforts at pension reform may take years to slow the growth of unfunded liabilities.

For taxpayers of the City of Chicago, the pension deficits of the city are additive to those of the State of Illinois.  In a working paper of the Harvard Kennedy School of Government in 2012, the authors estimated that the household public employee pension burden of taxpayers in the City of Chicago – that is, each individual family’s share of unfunded public employee pension liability - totaled $81,118, comprised of $41,966 for their share of City of Chicago liabilities and an additional $46,152 for the share of State of Illinois underfunding.  If you happen to live in the City of Chicago, you might want to start planning for how you will pay this obligation.  Failing an economic miracle or a Federal bailout, the taxpayer is the only resource for paying this deficit.

Pension liabilities have now been cited as the reason for credit downgrades in Connecticut, New Jersey, Pennsylvania and Puerto Rico, as well as for the cities of Cincinnati, Philadelphia, Detroit, Chicago, Evanston, Omaha, Jacksonville, Des Moines and Minneapolis, among others.  These credit downgrades stand apart from the local governments that have suddenly and dramatically been plunged into bankruptcy like the cities of Stockton, Detroit, San Bernardino, Vallejo, Harrisburg and Central Falls.

For states, like the State of Illinois, the problem is even more complex. While cities, individuals and private businesses can reorganize their liabilities in bankruptcy, no such provision exists for the states, at lease under current law. Without the legal ability to restructure their pension obligations in bankruptcy court, states faced with pension deficits similar to those of Illinois must opt for one of two unenviable choices. They can raise taxes, where possible to fund the replenishment of their pension fund, or they can reduce general services to residents to provide budget relief for funding the shortfall.  But in many instance the tax route isn’t just unpopular, it’s simply not practical. According to Moody’s, to fully fund the City of Chicago’s annual required pension contribution would necessitate raising its property taxes by 95%.

A recent report of Alliance Bernstein quantified the annual pension costs, debt service and fixed charges of the City of Chicago at 40% of its general fund budget. That would mean paying just these items, would require that all the other vital services of the city, including police, fire, sanitation, public works, etc., must all get crammed into an ever shrinking portion of the pie, now just 60% of the total budget.

So just what happened to turn these pension funds so horribly upside down?  First, in the case of the Chicago Police Benefit Fund, average salaries grew by 55% over the past fifteen years, or roughly 4% per annum – not unreasonable.  Average pension benefits, however, grew by 79% over this same period, while the number of former employees receiving retirement benefits increased by 45%.

Modest annual salary increases, coupled with rising benefits and an accelerated population of retirees, spelled soaring benefit payouts for the fund, with total retirement benefits growing by 160% over the same period. Plan contributions simply failed to keep pace. The solution, it now appears, falls squarely on the shoulders of its taxpayers.


You can read more about the US state and local government pension crisis in my new book: Up In Smoke: How the Retirement Crisis Shattered the American Dream, available on Amazon, iTunes and Barnes and Noble bookstores. 

Wednesday, September 16, 2015

Election Year Spin on Social Security

Bernie Sanders' campaign for the White House has triggered a firestorm of rants, tweets and accusations about Social Security, thrusting the now seventy year old program to center stage in a forum of election year theatre. Sanders' charges, often wrapped in outright inaccuracies, are carefully aimed at a demographic the candidate knows to be voter-ific: aging Baby Boomers. Most, or at least half, of this generation are wholly unprepared for the expenses of retirement, while the other half is, well, just modestly underfunded. Both will be dependent on Social Security in varying degrees, a program that is suffering a mid-life crisis of its own.

The purpose of this post is not to offer my opinions on Social Security, but rather to simply state the facts, as more officially presented to Congress by the Trustees of the Social Security Administration in their 2015 Annual Summary on the Social Security and Medicare Programs. Both the summary and the full report of the Trustees can be easily accessed on the internet or through the link provided in this post.

Sanders' claim of the "myth of Social Security insolvency" is quickly followed by accusations that Republicans plan to "cut benefits" to retirees. Boy, I tell you, it's enough to get a retirees' blood to boil. Then again, maybe that's the point. But in Sanders' attempts to sway public opinion for his electoral purposes, the blatant misstatement of the facts surrounding Social Security actually does far more harm than good for the program and to the millions that depend upon it. 

In an article from earlier this year in the Des Moines Register, entitled "Social Security; Expand it don’t Cut it", the Senator was quoted, 

"Republicans are trying to convince voters that Social Security is in crisis. Let's not kid ourselves: We do have an urgent problem on our hands, but it's not Social Security. Millions of middle-class Americans are facing a retirement crisis as a result of inadequate income and growing wealth inequality. Social Security isn't the problem. It's an essential part of the solution."

While the Senator is correct about the latter part of his comments, he's dead wrong about the former. Social Security is most definitely in crisis, at least according to the Trustees of the Social Security Administration. Perhaps before moving on, we should spend a moment and define who the Trustees actually are and what their role is in all of this. 

By law, there are six Trustees of the Social Security Administration or Trust Fund. These are, the Secretaries of the Treasury, Departments of Labor, Health and Human Services and the Commissioner of Social Security. The two remaining Trustees are public representatives who, along with the aforementioned cabinet members and Commissioner, are all appointed by the President, or in this instance, specifically by President Obama, a Democrat. That being said, it's really not rational to dismiss the comments in the report, or at least not to 
discount them as a Republican ploy.

Here, then, are direct quotes from the 2015 Trustee report to Congress. Decide for yourself if Social Security insolvency is a myth, as Senator Sanders argues:

“Social Security and Medicare together accounted for 42% of total Federal program expenditures in 2014”

“Both Social Security and Medicare will experience cost growth substantially in excess of GDP through the mid-2030s”

“Social Security’s Disability Insurance Trust Fund now faces an urgent threat of reserve depletion by 2016”

“Beyond DI, Social Security as a whole as well as Medicare cannot sustain projected long-run program costs under currently scheduled financing”

“The Trustees project that the Medicare Trust Fund will be depleted in 2030”

“After 2019, Treasury will redeem trust fund asset reserves until depletion of Social Security Trust Fund reserves in 2034”

Seems fairly straightforward to me that there's an urgent problem with not just Social Security, but Disability Insurance and Medicare. Now why would Bernie Sanders be arguing something altogether different?

For more detail on Social Security and the broader retirement crisis in America, please see my new book: Up In Smoke: How the Retirement Crisis Shattered the American Dream, available on Amazon, iTunes and Barnes and Noble bookstores. 

Thursday, September 10, 2015

Are Stocks Headed Lower?

This is, of course, the question foremost on investors' minds. After all, it's been several years since we've seen a correction to the major averages that stocks have experienced since mid-July. True to form, market swoons of this sort seem to come out of nowhere. Yet as one market sage was quoted, "no one rings a bell at the top". But did we see the market top on July 20, or are we poised to consolidate and move higher?

Visit any financial news website and there are plenty of commentators quick to provide an expert opinion. But of course, no one really knows where markets are headed. We simply try, as best we can, to make informed judgements (or as some have called them, "bets"). 

If you look closely, though, the data have been quietly sending indications of direction. The plunge in oil prices earlier this year seemed to have caught investors (and oil company executives) completely off guard. Oil prices that had hovered in the range of $80-100 per barrel for five years, began a move in the latter part of 2014 that can only be described as a plunge. Now settling in the low 40s, equity investors are considering the implications of these new levels for global industrial demand and GDP.

But there were warning signs of oil's imminent decline that now appear more clearly in hindsight. A robust and vibrant US oil sector, with highflying fracking stocks like Pioneer Natural Resources, EOG and Oasis began to wobble in 2014, but only after their drilling and exploration counterparts that lead production, like Halliburton and Schlumberger, faltered. Prior to this, warning shots were fired by HiCrush and US Silica that make the key raw materials integral to the fracking process. But the real leading indicators we now see were in specialty energy companies like Geospace Technologies that make seismic data analysis tools and provide critical research for drillers and oil exploration companies. Their stock began crashing in late 2013 and should have signaled the "canary in the coal mine" for anyone interested in the direction of oil demand, supply and price.

Oil aside, however, the abysmal levels of a broad range of commodity prices, from copper to steel, has investors questioning global industrial demand. With prices for many of those commodities now believed to have been artificially inflated by China government investment (i.e., building empty cities and bridges to nowhere) everyone is a bit concerned about the veracity of sustainable global demand. Commodity dependent economies like Brazil, South Africa and Australia are unquestionably suffering ill effects, as a result of the reduced demand. These effects are echoing throughout the emerging markets. They are also being felt in the US high yield bond market, where many small energy companies financed their growth and development and now struggle to meet debt service.

With the US and EU economies piddling along, all eyes for now will remain on China. As government mal-investment there subsides, investors are questioning whether there is really internal demand to support consumption or growing global demand to boost exports? The answer, from the most recent data, appears to be a resounding no.

Thursday, September 3, 2015

Will China Selling put Upward Pressure on US Treasury Yields?

There's been more than a little attention devoted to this question lately. The concern follows reports that China has been selling portions of its massive US Treasury holdings to support a destabilized Yuan. 

Marketwatch had a nice piece this morning that should dispel much of investors' concerns. This chart from Marketwatch shows net flows of foreign private and official sector purchases of Treasuries. Despite recent selling pressure, private sector purchases appear to be more than offsetting the selling of foreign governments.

Here are some other factors to consider that should equally support US Treasury prices, if not exert downward pressure on bond yields. First, as reported elsewhere, China cannot dump its holdings of UST for fear of price instability and also the question of where to go to reinvest some $1.2 trillion of proceeds. Second, if the world is really trending towards deflation, as is being reported, US Treasury bonds will climb in value. As inflation erodes the value of fixed income securities, deflation produces just the opposite effect. Third, lower US budget deficits (for however long that lasts) will decrease UST new issuance. Fourth, US pension funds are increasingly talking about "de-risking" their investment portfolios, by selling equities and corporate bonds to move into US Treasuries and other safer investments. 

Given these considerations, don't be surprised if near-term the 10-year heads back towards its January 2015 low of 1.68%, particularly if there's a flight to safety trade following a stock decline.

Wednesday, August 26, 2015

The Public Pension Crisis: Illinois, New Jersey and Puerto Rico

The US protectorate of Puerto Rico has captured headlines for several weeks now following its default on US dollar tax-exempt bonds. The default occurred on August 1, when the Commonwealth paid only $628,000 of a required $58 million payment due bondholders of its Public Facilities Corporation. The consequences of default for the island are severe, as seen most recently when a proposed new $750 million bond issue to fund needed improvements to its water system failed to attract buyers, causing underwriters to pull the sale.

For some time prior to the bond default, concerns with Puerto Rico's credit began to surface with high levels of debt and mounting unfunded liabilities of its employee pensions systems. These unfunded pension liabilities served to magnify the Commonwealth's already hefty public indebtedness. Puerto Rico is now faced with $72 billion of unpaid bonds, plus $33 billion of unfunded pension liability, or $105 billion in total obligations.  For an island with only 3.5 million people, that's $30,000 per capita.

What bond investors are now beginning to realize is that pension liabilities are tantamount to debt. They must be weighed equally in evaluating the level of government debt burden and its capacity to repay its obligations. This concern was highlighted by the outcomes of recent U.S. municipal bankruptcy cases, where public bondholders were paid as little as 12 cents on the dollar, only to see retirement obligations of the local government paid in full. This turn of events has the effect of investors not only recognizing that pension obligations are debt, but debt that may also be a superior obligation, to be paid first in a time of financial crisis.

This has us thinking about some more highly rated municipal credits, like New Jersey and the State of Illinois, and what their true debt burdens might be, considering unfunded pension liabilities. New Jersey, fortunately, fairs a little better than Puerto Rico, with $84 billion of State public debt and $87.6 billion of unfunded pension liabilities, or $171 billion in combined debt overall. Spread over 8.9 million residents, New Jersey total debt per capita is on the order of $19,000.

For Illinois, with $127 billion of bonds outstanding, debt burden is considered "moderate" by the bond rating agencies. But adding $167 billion of unfunded pension liabilities, brings their total amount due to creditors to a whopping $294 billion.  Measured on a per capita basis, this ranks Illinois with 12.8 million people and total debt per capita of $23,000 just behind Puerto Rico. Unlike Puerto Rico, however, residents of many cities (and counties) in Illinois have the added debt and pension burdens of their local governments to contend with, as well. In the case of the City of Chicago, this would add debt per resident of $23,000 to the Illinois state total, or a total debt per capita of $46,000, far greater than that of Puerto Rico.


Friday, August 21, 2015

Means Testing Social Security

Chris Christie's recent comments about means testing Social Security benefits set off a torrid of accusations of Republican cuts to Social Security. Leaving aside the obvious fact that Governor Christie is only one of more than a dozen candidates running for the Republican nomination, critics nonetheless seized the opportunity to indict the entire party for mistreating senior citizens. Social Security reform has been called the third-rail of American politics, and Christie received quite a jolt.

But what is means testing about and can it help restore the solvency of the Social Security Trust? As discussed in previous blog posts, the 2015 report of the Trustees of the Social Security Administration clearly spells out the trouble ahead for Social Security. By their estimates, Social Security will be insolvent by 2034, with the Disability Insurance component becoming insolvent next year. The Trustees point to the present value deficit of the Trust Fund, now running $10.7 trillion. Argue all you will about what to do, but clearly something must be done, unless our intent is to bury our heads in the sand and simply leave the mess to future generations.

With a deficit that large, there are only two possible avenues to cure the problem: increase payroll taxes to boost the income side of the equation, or reduce outflows. Those leaning left advocate the former, those leaning right, the latter. We've pointed out in other blog posts, though, the limitations and consideration with raising the payroll tax rate. So let's spend a few moments examining other options.

Means testing, as discussed by Governor Christie is an attempt to gradually reduce outflows of Social Security by reducing benefits for those who need them least: the wealthy. The idea is test the means of financial support of retirees, before providing scarce resources from an impoverished and soon insolvent Social Security Trust Fund. Left leaning opponents of this plan are quick to characterize means testing as a Republican attempt to cut benefits, when in reality, it is simply attempt to limit benefits to the wealthy. 

Paul Krugman blogged about this earlier this week from his platform as acting-editor of the New York Times in a sensational piece entitled, "Republicans Against Retirement". Catchy, no?  In bolstering his argument that means testing is impractical, he and other Democrats with political aspirations, point to just one study on the topic, a sloppy bit of economic research by Dean Baker of the Center for Economic and Policy Research. That study based upon 2009 data, concluded that means testing would save very little, as "more than 75% of Social Security benefits go to individuals with non-Social Security incomes of less than $50,000 per year". Sounds reasonable.

But let's stop and think about this. First, this is 2009 data, that comes at the depth of the greatest recession since the Great Depression. Second, Baker is not referring to those individuals with pre-retirement annual incomes of less than $50,000, but rather those in retirement claiming income for tax purposes of less than $50,000. So he is measuring retirement income from a combination of pension income, private investment income and capital gains, and taxable distributions from 401(k) and IRA accounts.

As you might imagine, retirees, like everyone else in America, are doing their best to manage their tax liability. Thus, retirees are only reporting investment income to the extent they must, often choosing tax-exempt investments like municipal bonds, and avoiding capital gains on stock investments. Thus, someone who has $10 million invested in tax-exempt bonds, and earned $500,000 in annual investment income, would record non-Social Security income of $0.00 (assuming they had no pension or other income). Similarly someone with an IRA of this same amount may choose to take distributions of $50,000, as a prudent way of managing income and tax liability.

But let's leave these obvious considerations aside (as does Mr. Baker in his analysis). Let's also ignore the fact that we're working with income data that is six years old. The point is, Baker's study still reports that 3.4% of Social Security benefits are provided to retirees with greater than $80,000 per year in non-Social Security income. With total benefit outflows of Social Security last year of just over $706 billion, were these benefits means tested and reduced, the annual savings to Social Security would thus be in the range of $24 billion per year. It may not fix the entire problem, but that ain't chump change to a system with a $10.7 trillion deficit.