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My bright idea of the day: Take the payroll tax cut and use it to fund personal retirement accounts

By James Pethokoukis

February 15, 2012, 10:21 am

It now looks like the 2-percentage-point payroll tax cut will be extended until the end of the year and not paid for. The $100 billion cost will simply be added to the already huge budget deficit. So what happens in 2013? Well, Washington could simply let the supposedly temporary tax cut expire—except that anyone supporting that idea this year will get slammed as a “tax hiker.” And on middle-income voters, no less! Now, at a Senate Finance Committee hearing on Tuesday, Senator Jeff Bingaman, a New Mexico Democrat, raised the idea of a permanent reduction in the payroll tax. But Treasury Secretary Tim Geithner put the kibosh on it. “I don’t think that’s realistic,” Geithner said.

But whatever the economics of a permanent payroll tax cut extension, the politics are favorable. Howard Gleckman of the Tax Policy Center says he “can imagine the payroll tax extension becoming another version of the Alternative Minimum Tax patch–extended year after year with borrowed money.”

I have a better idea. Why not take the payroll tax cut and use the dough to create new personal retirement accounts? If we are going to be shifting more than $100 billion every year from Social Security anyway, why do it just to boost consumer spending? What this country needs is more investment, less consumption. Personal retirement accounts would help supply that investment. Social Security is not real wealth. It’s just a claim on taxpayers, both now and in the future. Why not create real wealth for Americans by giving them this new opportunity to save and invest? And that would boost economic growth. Back in 1997, economist Martin Feldstein calculated that completely privatizing Social Security would “increase the economic well-being of future generations by an amount equal to 5 percent of GDP each year … [with a] net present value of the gain of as much as $10-20 trillion.”

Now, what I’m talking about wouldn’t be nearly so bold. But it would be a solid start to reorienting the economy toward one that is built on investment-led growth, not just debt-fueled consumption. Of course, personal accounts wouldn’t obviate the need to fix Social Security’s long-term financing by raising the retirement age, altering how benefits are calculated vs. inflation, and instituting other modifications. Here’s AEI’s Andrew Biggs:

If workers invest part of their Social Security taxes in personal accounts, they could indeed earn higher returns and generate higher benefits without taking more risk. But diverting taxes to accounts leaves the program short of what is needed to pay benefits to today’s retirees. To cover these “transition costs,” we would need to generate new revenues for the program, either by raising taxes, cutting other programs, or borrowing.

So it’s no magic bullet. I don’t believe in those anyway, though. But my idea would a) create another option to boost economic growth, and b) reinvigorate the Social Security debate. And for Republicans, the natural base of support for this idea, it would give them another way to talk about the payroll tax issue.

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Categories: Economic Policy, Retirement and Social Security | Tags: payroll taxes, Social Security, taxes

When Medicare wipes out Social Security: Healthcare fact of the week

By Christopher J. Conover

February 3, 2012, 2:30 pm

Attention, children and grandchildren of Baby Boomers: save early and save often. Within 75 years, the average monthly premiums required for Medicare and out-of-pocket spending for Medicare-covered services (i.e., deductibles and coinsurance) will equal the average monthly Social Security check (figure 20.7b).

You heard that right. A typical senior counting on Social Security to pay for food, clothing, and shelter will be out of luck. That is, even assuming that Uncle Sam honors the promise to keep sending out Social Security checks, virtually every penny of the average check will be wiped out by the amount seniors will need to pay their premiums for Medicare Part B (outpatient services) and Part D (prescription drugs) and the average amount of cost-sharing paid by a typical senior for deductibles and the 20 percent coinsurance required on Part B services.

Currently, such typical Medicare costs (which do not even include elderly spending on private Medicare supplemental policies or spending on services not covered by Medicare) absorb 30 percent of the typical Social Security check. This is a sea change in the fiscal plight of seniors, and one more reason it is regrettable that the president elected to duck America’s “humongous healthcare problem” in his most recent State of the Union address.

Admittedly, under “current law” the Medicare cost burden facing seniors will grow “only” by about three-fifths between now and 2085. But few people believe current law will stick. According to the Medicare Trustees, “current-law costs are almost certainly understated as a result of the substantial physician payment reductions required under current law and are further understated if the productivity adjustments to other Medicare price updates under the Affordable Care Act cannot be continued in the long range.” This is why the Medicare actuary developed an “alternative fiscal scenario” whose results also are reported in the latest Medicare Trustees report. The most recent report issued by the Congressional Budget Office confirms the credibility of those alternative projections. CBO systematically reviewed all the evidence from Medicare’s past demonstration projects on disease management, care coordination, and value-based payment. This is the same laundry list of ideas that was stuffed into the Affordable Care Act in the expectation that surely one of these might actually bend the cost curve. This expectation appears to have been a triumph of hope over experience, as the CBO analysis concluded “In nearly every program involving disease management and care coordination, spending was either unchanged or increased relative to the spending that would have occurred in the absence of the program.” There was exactly one value-based purchasing program (out of four) that saved money.

Also, the 20 percent of seniors who rely exclusively on Social Security income in retirement are subject to lower premiums and cost sharing than others, so the picture for them will not be quite as bleak as shown. Nevertheless, future seniors with supplemental retirement savings who rely on Social Security to help pay at least some bills will be in for a rude awakening.

In short, there are two reasons policymakers need to take seriously the Wyden-Ryan bipartisan proposal to address Medicare’s long-term fiscal unsustainability. Financing the projected growth in Medicare over the next 75 years (which will rise from 3.6 percent of GDP in 2010 to 10.6 percent of GDP by 2085 under the alternative fiscal scenario) will require levels of federal taxation that are unprecedented in this country. There is no public opinion evidence I’ve seen that a majority of Americans (or even close to a majority) wish to be taxed at such levels. Moreover, the Affordable Care Act actually made the challenge of solving the Medicare entitlements crisis much greater by diverting a half trillion in potential savings and using these to expand coverage rather than shore up Medicare. But even if Congress magically could find a way to obtain the revenues to pay for Uncle Sam’s share, there is the inconvenient truth that a substantial fraction of seniors will simply be unable to afford their share of the massive increases in Medicare spending they will face.

The claim that 20-somethings are more likely to believe they will see flying saucers than collect from Social Security is exaggerated. Nevertheless, until and unless policymakers step up to the plate on this issue, those in their twenties (and especially their children) might do well to save as if Social Security will not be around. Should the Supreme Court strike down the Affordable Care Act this June, it might give policymakers a serendipitous opportunity for a do-over.

Christopher J. Conover is a research scholar at Duke University’s Center for Health Policy and Inequalities Research, an adjunct scholar at AEI, and an affiliated senior scholar at the Mercatus Center at George Mason University. The charts shown are from his new book American Health Economy Illustrated, to be released in February 2012 by AEI Press. See PowerPoint version of Figure 20.7b and Excel spreadsheet containing estimated Medicare cost sharing obligations as a percentage of average Social Security benefit, 2010 and 2085 for data, sources, and methods.

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Categories: Health Policy, Retirement and Social Security | Tags: entitlements, health reform, health spending

Who’s enriching the 1 percent?

By Andrew Biggs

January 13, 2012, 10:45 am

Over at the Huffington Post, the AFL-CIO’s Secretary-Treasurer Lee Saunders takes a shot at me in an article subtly titled “Killing Pensions to Benefit the 1 Percent.”

Andrew Biggs and Jason Richwine—representing two right-wing, corporate-funded propaganda outfits, the American Enterprise Institute and the Heritage Foundation—were given prime space on the Journal’s op-ed page last week to make an argument for radically transforming the retirement savings of working Americans. They laid out a reckless plan to end guaranteed retirement accounts, and in some cases require workers to forfeit their life savings, and force public workers to enrich Wall Street firms that have already demonstrated their inability to produce adequate resources to meet the needs of retirees.

Leaving aside the total bull about requiring workers to forfeit their life savings, who does the AFL-CIO think manages public pension investments, the tooth fairy? The “1 percent” is all over public pensions, which are the largest single investor in hedge funds and are shifting heavily into private equity. That’s a lot of corporate jets and Cristal for the top 1 percent, courtesy of public sector pensions and the unions that back them.

The typical 401(k), by contrast, has nothing to do with hedge funds and private equity, and certainly doesn’t pay anything like that 2 percent of assets and 20 percent of profits that public pensions pay to hedge fund managers. A well-run defined-contribution pension like the Thrift Savings Plan for federal government workers—which is the more likely model if state/local workers shifted to DC plans—pays almost nothing to Wall Street managers of any kind.

In truth, the “1-percenters” make far, far more money off public sector pensions than they ever would from 401(k) plans.

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Categories: Economic Policy, Retirement and Social Security | Tags: pensions

Response to Randi Weingarten, president of the American Federation of Teachers

By Andrew Biggs

January 13, 2012, 9:00 am

Over at Education Week, Jason Richwine and I have an article responding to criticisms of our work on teacher pay. We found that, contrary to conventional wisdom, public school teachers receive higher pay than similar private sector workers. Their salaries are about on par but their benefits are a lot more generous. We think the Ed Week article resolves many of the obvious objections to our paper.

Not surprisingly, though, the comments sections is crammed with entries (some reasonable, others kind of nutty). One comment was from Randi Weingarten, president of the American Federation of Teachers, one of the largest and most influential teachers’ unions. Here are her comments, followed by my responses.

Weingarten: “If we had a society where thousands of people wanted to become teachers and stay teachers, saying teachers are overpaid would have a scintilla of credibility. However, in the teaching profession, attrition nationwide is through the roof. In New York City, for example, 66,000 teachers have left their jobs since Mayor Michael Bloomberg took office. With these losses, our children lose experienced, high-quality teachers.”

Biggs: As we point out in the article, teacher colleges regularly graduate thousands more prospective teachers than can find jobs. Most teaching openings, even prior to the recession, received multiple applicants; in Connecticut in 2007-8, for instance, schools received an average of 15 qualified applicants per opening. Finally, teacher turnover is not appreciably higher than other professions. None of these facts point toward a profession that is deemed undesirable or underpaid.

Weingarten: “The authors believe teacher salaries should be market-based, while we believe teacher salaries should be based on the value our society places on children and their education, and our need to recruit and retain excellent teachers.”

Biggs: It is silly to argue that teacher pay should be set without reference to the market. There are many, many important jobs in society; doctors who cure your illnesses, lawyers who defend you in court, and so on. Pay for practically all of them relies on market pricing. As Ms. Weingarten seems to acknowledge, if we wish to attract and retain teachers, we have to know what the market would pay them in alternate employment. Our paper shows that we’re already paying above-market compensation, meaning that it’s factors other than pay that are preventing school from getting the best teachers.

Weingarten: “Indeed, the 2010 report on closing the talent gap by McKinsey & Co. found that improving compensation and working conditions could dramatically increase the recruitment and retention of top college students in high-needs schools and school districts.”

Biggs: The McKinsey report actually supports our basic finding: it shows that public school teachers are generally recruited from the bottom third of their college graduating class, meaning they’re less qualified than the typical college graduate. So it shouldn’t be surprising if they receive salaries that are somewhat lower than the typical college graduate. That said, it’s not illogical to assume, as McKinsey does, that higher pay would automatically attract better qualified teachers. In most other professions, it would. But our own work shows that we’re already paying for better teachers than we’re getting. The question is, why? Vanderbilt University economist Dale Ballou has shown that public schools often don’t hire the best applicants even when offered. Prospective teachers who graduated from better colleges, had higher GPAs and majored in subjects like math and science rather than education, actually have lower chances of being hired than applicants who took the traditional teacher training route. Ballou and University of Missouri economist Mike Podgursky show that, when schools are indifferent to applicants’ qualifications, raising pay without reforms will do little for teacher quality. A 20 percent salary increase would raise the average SAT score of teachers by only around 2 points. There’s something really screwy with how public schools are managing their workforces and simply raising pay isn’t going to fix it.

Weingarten: “The debate over whether teachers are overpaid is another example of blaming and demeaning teachers, which doesn’t help move us toward improving teaching and learning for all students.”

Biggs: Nowhere have we blamed or belittled teachers; such claims are made to generate emotional responses that distract from the factual arguments we have presented. We have merely shown that today’s teachers are not underpaid relative to what they would earn in the private sector. If we are correct, and to date no one has shown that we are not, this has significant implications for education policy and state/local government budgets.

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Categories: Education, Retirement and Social Security | Tags: pensions, teachers

One step closer to a Medicare reform that can work

By Joseph Antos

December 15, 2011, 3:46 pm

The Medicare reform proposal released today by Representative Paul Ryan (R-Wisconsin) and Senator Ron Wyden (D-Oregon) recognizes that even the federal government cannot guarantee to pay for health services, or anything else, without limit. The new proposal is more realistic in some respects than the Medicare reform advanced by Ryan in the House budget resolution, but it leaves many questions unanswered. Those details, and the public’s reaction to them, will determine whether the premium support concept that caps the federal subsidy will be adopted.

Under the new proposal, traditional fee-for-service Medicare would continue to be available to future generations of seniors, but it must now compete head-to-head with private plans. That is very similar to the competitive bidding model advanced by AEI experts Robert Coulam, Roger Feldman, and Bryan Dowd. In contrast, the House plan would have made traditional Medicare unavailable to new beneficiaries as of 2022—clearly unpopular with seniors, who view this as undermining their program and are likely to express their displeasure at the polls.

Some conservatives will criticize this change as backsliding. They correctly see the traditional Medicare program in its current form as inefficient and anti-competitive. But pretending that the program will disappear in ten years feeds the worst tendencies of politicians, who would avoid making important but difficult decisions needed to set traditional Medicare on a fiscally sustainable path.

The reality is that traditional fee-for-service Medicare likely will have some 50 million enrollees in 2022, and will remain a dominant force in the health sector for decades. Ryan and Wyden hint at the need for common-sense reforms to traditional Medicare, including a new structure of deductibles and copayments, a cap on catastrophic costs, and a new physician payment system. They skirt the central problem: disorganized fee-for-service and top-down limits on prices paid for services drive up the use of more, and more complicated, services. The program’s survival depends on our willingness to make substantial changes over the next few years so that traditional Medicare can provide cost-effective care without draining the Treasury.

With the massive baby boom generation beginning to turn 65, we have almost run out of time to put Medicare on a sustainable basis. Fortunately, the influx of baby boomers slows the growth of Medicare spending for a few years because younger beneficiaries need less healthcare. That buys Congress a little more time to face financial reality and reform the program.

Between 2005 and 2010, Medicare spending per beneficiary increased 39 percent, but between 2010 and 2015 the increase is projected to be about 7.5 percent. However, that assumes Congress will allow a 27.4 percent cut in physician fees to take effect in January. Under the more reasonable assumption that a doc fix is enacted, I estimate that Medicare spending between 2010 and 2015 is likely to increase by about 16 percent—still much lower than the preceding five-year period. Soon after that, costs begin to rise steeply as the boomers begin to reach their 70s.

That leaves Congress with barely enough time to truly reform Medicare. The Ryan-Wyden plan hints at that, and backs it up with a cap on Medicare spending limited to the growth in GDP plus 1 percent after 2022. That is a weaker constraint on spending than under the House proposal, but more likely to garner political support.

Waiting another decade to bend Medicare’s cost curve is not an option. If the president and the new Congress fail to take decisive action early in the new term, the corrective fiscal surgery will be far more severe. Paul Ryan and Ron Wyden have set out a useful marker that could be the basis for real Medicare reform in 2013.

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Categories: Economic Policy, Health Policy, Retirement and Social Security | Tags: Medicare, paul ryan, Ron Wyden

Let’s get real on entitlements

By Peter J. Wallison

November 21, 2011, 3:59 pm

Lost in the media babble about the SuperCommittee’s failure is any sensible assessment of the real issue. As the Congressional Budget Office (CBO) numbers show, the entitlements—Social Security, Medicare, and Medicaid—are too large to be attacked with increased taxes. If we tried, we would crush any hope for economic growth and thus the continuation of entitlements in any form.

The Democrats on the SuperCommittee apparently wanted additional revenue from the “wealthy,” but were unwilling—as were the Republicans—to increase the taxes of anyone under $200,000 by eliminating all of the Bush tax cuts. Let’s leave aside the sterile debate over the Bush tax cuts and look at the numbers from the perspective of what’s actually possible.

According to CBO, the cost of entitlements alone rises from $1.5 trillion in 2011 to $2.5 trillion in 2021. The Wall Street Journal, using the boom year of 2005 and IRS numbers, reported that if all income over $200,000 that year were simply confiscated the total additional government revenue would be about $1.9 trillion. In other words, that would pay for the average cost of the entitlements for one year between now and 2021. No matter where you are in the tax- versus entitlement-cuts debate, you probably recognize that confiscation would not work as a tax or economic policy, at least for more than one year.

Accordingly, those who are seeking to balance entitlement reductions with tax increases either cannot do the math or are playing a political game, perhaps buying time at the expense of the national welfare. Unfortunately for the Democrats, they have created an entitlement system that has simply outrun the ability to pay for it. The beginning of a solution will be at hand when the Democrats admit that whether and how much taxes are increased is not the issue. The entitlements problem can only be addressed by thoroughgoing reform.

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Categories: Economic Policy, Retirement and Social Security, U.S. Economy | Tags: entitlement reform, super committee

The Lincoln-Douglas standard

By Andrew Rugg

November 1, 2011, 3:56 pm

Today’s modern presidential debates are not exactly intellectual affairs. They emphasize sound bites, quick jabs, and not making mistakes. But Herman Cain and Newt Gingrich want to change that. They plan to debate the future of Social Security and Medicare in the Lincoln-Douglas format at a Houston fundraiser on November 5. As a former high school Lincoln-Douglas debater, this understandably excites me. But is it the right decision for the Republicans?

The Lincoln-Douglas debate format grew out of the 1858 debates between the Illinois Senate contestants. It emphasizes long argumentation and direct responses to your opponents. It’s also what debaters call a values debate, forcing participants to relate their individual points to overarching values. The original debates in 1858 were over slavery and the role popular sovereignty should play in expanding the practice. The proposed debate will be over Social Security and Medicare—issues where Cain and Gingrich share almost identical positions and values. The lack of disagreements to debate over won’t do the format justice. While everyone would like to see more substance in modern campaigns, one has to wonder if a 3-hour debate between candidates who agree with each other is the most prudent way to go about it.

It’s especially surprising that Gingrich wants to go toe to toe with another Republican. He’s consistently argued that the Republican candidates shouldn’t argue among themselves and should save their efforts for defeating Obama. Fueled by his own strong debate performances, Gingrich seems intent on brandishing his intellectual credentials to make his case. But do Americans, and most specifically Republicans, want the best debater to be president? Leadership is not synonymous with eloquence or even intelligence. And most Republicans seem to agree with that assessment. In an August CBS/Vanity Fair poll, a plurality of Republicans held character (43 percent) over intelligence (31 percent) as the most important characteristic for a president to have. Democrats, on the other hand, prefer intelligence (49 percent) over character (27 percent) by a wide margin.

Republicans want a president with the character and strength to lead. They don’t necessarily want the smartest wonk. Debates are great venues for assessing policy differences, but they fail as tests of leadership. They bias certain personal qualities—qualities that may not make the best occupant of the White House. Republican voters should therefore be cautious in how they weigh debate skills in choosing a nominee.

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Categories: Politics and Public Opinion, Retirement and Social Security | Tags: herman cain, Medicare, newt gingrich, social security reform

The chained CPI is a stealth tax increase

By Andrew Biggs

October 28, 2011, 10:28 am

Various news sources are reporting that congressional Democrats on the deficit Super Committee have floated the idea of changing the measure of inflation used for most federal policies. The shift would move from the conventional Consumer Price Index to the so-called “chain weighted” CPI, which better accounts for how buyers change their purchasing habits as relative prices between goods change. The chain weighted CPI generally shows lower inflation by around 0.3 percentage points.

The chained CPI would affect both spending and revenues. On the spending side, Social Security, federal pensions, and certain other payments are indexed to the CPI, so using a lower measure of inflation would reduce Cost of Living Adjustments (COLAs). Likewise, the CPI is also used to index income tax brackets and certain other aspects of the tax code. A lower measure of inflation would push a greater share of individuals’ incomes into higher tax brackets, thereby raising average tax rates and total revenues.

As I’ve argued here, I don’t think the chained CPI is the best measure for Social Security COLAs because it is based on the buying habits of working age Americans, not seniors. A new measure—a chain-weighted CPI specifically geared toward the elderly—would likely show somewhat lower inflation than the current CPI, but not as low as the standard chained CPI.

Likewise, it doesn’t make sense for the tax code to automatically raise revenues over time without Congress having to weigh in. Using the current CPI, income tax revenues would rise to record levels relative to GDP even if we made the Bush tax cuts permanent. Accelerating that increase in taxes—and it is a tax increase—by stealth bypasses the choices we need to make regarding the size of government going into the future.

It would be nice to think that Congress could walk and chew gum at the same time—that is, that they could both balance the books and create good public policy. But it looks like we may have to choose.

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Categories: Economic Policy, Fiscal Policy and Taxes, Retirement and Social Security | Tags: consumer price index, inflation, super committee

Adult baby is a symptom of a broken Social Security system

By Matthew McKillip

October 21, 2011, 12:37 pm

Perhaps Stanley Thornton will be the giant straw that causes a policy breakthrough in our failing disability system. Thornton, as The Atlantic reported, is a 350 pound “adult baby” who receives disability benefits. Earlier this week it was decided that he was not fraudulently on the Social Security rolls.

Senator Tom Coburn asked for an investigation into Thornton’s case on the seemingly sound logic that anyone who can “custom-make baby furniture to support a 350-pound adult” should not receive Social Security Disability Insurance (SSDI) disability benefits.

While Thornton’s unique case is sure to stir outrage, of greater consequence is the SSDI system that he is drawing benefits from. The SSDI is both a fiscal and functional disaster: it is on pace for insolvency in 2017 and it discourages workers from returning to work through an ill-conceived incentive system. Austerity measures that aim to trim “adult babies” and others who can work off the disability rolls is at best a short-term fix. President Reagan attempted it in the early eighties but, as AEI Adjunct Scholar Richard Burkhauser explains, his efforts “were extremely controversial and resulted in a backlash that ended up making both SSDI eligibility criteria less strict and removing someone already on the rolls nearly impossible.” Cuts alone will only delay the reality that policy, not fraud or health conditions, is the root cause of the disability system’s failure.

Burkhauser, author of The Declining Work and Welfare of People with Disabilities, told McClatchy:

This is not a disability crisis in the sense that suddenly our workers are becoming less healthy. This is a fundamental flaw in the system that leads us to increasingly use SSDI as a long-term unemployment program for people who could be in the workforce if they had the appropriate (workplace) accommodations and rehabilitation.

The way forward is a serious conversation about what should be happening at the onset of a worker’s disability. Currently, there is little to nothing in the system that signals the costs to both workers and employers—both are inclined to increase the SSDI rolls on the federal dollar. Drawing on the experience of the Dutch, who have managed to stabilize a disability system which at one point had ballooned to 12 percent of their workforce, we should consider reforms such as making firms responsible for employees’ first year of sick pay or experience rating SSDI taxes. Experience rating allows those employers who do an above average job of getting workers back to work pay fewer taxes, while those who are poor at it pay more. Both of these adjustments provide an incentive for a company to accommodate workers, get them back on their feet, and help them lead a happier and more productive life.

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Categories: Economic Policy, Retirement and Social Security | Tags: disability, Social Security

Uncapping Social Security payroll tax is hardly a panacea

By Andrew Biggs

October 19, 2011, 11:11 am

In a blog item on the Social Security/Ponzi Scheme nexus (which I touched on here), Ezra Klein makes a characteristic pitch for eliminating the cap on earnings subject to payroll taxes:

…Social Security has a funding gap equal to 0.7 percent of GDP over the next 75 years. We could wipe that gap out by lifting the payroll tax cap (right now, payroll taxes only apply to the first $107,000 of income) or by adjusting benefits downwards. Once it’s done, however, it’s done. Stable.

Um, maybe not so done. The chart below shows Social Security’s annual net cash flows – meaning, taxes collected minus benefits paid out – for current law (red line) and if we eliminated the payroll tax ceiling (blue line). Under current law, the system is running small deficits today, will (supposedly) improve over the next few years as the economy recovers, and then head deeper into deficit around 2016 or so. If we eliminate the payroll tax ceiling we get a big inflow of money in the near term, so we shoot up to a surplus of over 2 percent of payroll – that’s around $110 billion. But these new surpluses peak in 2014 and then start heading south. By 2025 the program is once again in deficit.

Now, if you think that those near-term surpluses generated by eliminating the tax max will be saved, then Social Security’s trust fund balance – shown in the green line plotted against the right axis – will be meaningful to you. But even then, it’s pretty clear that this isn’t what you’d call “done.” The new trust fund ratio – that is, the ratio of the trust fund balance to annual benefit payments – would peak in 2024 and decline after that.

If you don’t think the trust fund is meaningful – and there are plenty of reasons not to – then eliminating the tax max creates a short-term glut of cash to be spent on other things and thereafter cuts Social Security’s annual deficits only about in half. That’s not much considering that lifting the cap would raise the total top marginal tax rate – federal income and payroll taxes and state income taxes – to over 60 percent, without having done anything to fix the larger problems in Medicare and Medicaid.

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Categories: Economic Policy, Retirement and Social Security | Tags: Social Security

‘What a Piece of Junk’: Responding to the Economic Policy Institute on Public Employee Pay

By Andrew Biggs

October 6, 2011, 5:30 pm

In the original”Star Wars” trilogy (not those crappy prequels), Luke Skywalker uttered these words when he first saw Han Solo’s ship, the Millennium Falcon: “What a piece of junk.” I had the same reaction to a new policy brief from the Economic Policy Institute (EPI), which attacks my work with Jason Richwine on public sector pay, in particular a recent study for the Ohio Business Roundtable. (I should note that these comments are my own and that Jason is far more polite than I am).

In previous work for EPI, Rutgers University’s Jeffrey Keefe concluded that Ohio state and local government workers receive slightly lower total pay and benefits than similar workers in the private sector. We find, by contrast, that the combined value of public sector salaries, benefits, and job security exceeds private sector levels by roughly 43 percent.

Keefe questions practically every part of our Ohio paper and, trust me, we have answers to almost all of his points. If you read EPI’s paper and are tempted to believe its claims, post a comment and I’ll address it.

But pensions are where the real action is. Once you accept our view of pensions, you could buy pretty much everything else EPI says and still conclude that public employees are overpaid. EPI thinks pay studies should focus on what employers contribute toward pensions while we look at the benefits employees actually receive.

Put simply, EPI believes that government pensions can generate a given dollar of future retirement benefits at roughly one-third the cost of a private sector employer. And it’s true that, for each dollar of guaranteed future benefits, governments actually do contribute about one-third as much as private pensions. These lower contributions are based on aggressive accounting rules that let public plans “discount” their future benefit liabilities using high interest rates of around 8 percent, versus about 5.5 percent for private defined benefit (DB) plans and, implicitly, around 4 percent for 401(k)-type pensions. Based on low employer contributions, EPI concludes that public sector pensions aren’t actually all that generous. We counter that if you look at the benefits employees actually receive, most public employees’ total compensation package is well above private sector levels.

In effect, EPI’s argument rests on you believing that “Public employees are overpaid, but we aren’t overpaying them.” That is, government possesses some magic by which it can pay far higher pensions at far lower costs than the private sector. This claim is doubly wrong.

1) The vast, vast majority of professional economists don’t believe that government possesses such magic. As Keefe himself admits, most economists argue that accounting rules that let public plans contribute so much less than private pensions are simply wrong. Don’t take my word for it, though: Nobel Prize-winning economists, the Federal Reserve, and the Congressional Budget Office all say the same thing. If public pensions followed economically-sound accounting rules, their contribution rates would rise and it would be obvious that public employees receive higher total compensation.

2) Moreover, even if government can magically generate pension benefits at one third the cost, that does not imply that employees should be the beneficiaries of that little miracle. According to the theory of “equalizing differences”—which the Handbook of Labor Economics calls “the fundamental (long-run) market equilibrium construct in labor economics”—government just as well could pay lower wages and use the savings to reduce taxes or increase other government programs.

For a public/private pay comparison, what we want to know is whether that offset has taken place. By measuring the pensions people will actually receive, along with their salaries and other benefits, we can accurately compare total compensation packages between the public and private sectors. And, based on these actual benefits, it is unequivocal that public employees in Ohio, and in most other states for that matter, receive higher total pay than private sector workers.

Other public sector pay studies—such as from the (hardly conservative-leaning) Center for State and Local Government Excellence, which EPI cited in its highly-misleading blog post on our paper—note that, “the public sector contribution under-states public sector compensation,” for exactly the reasons we describe. (We have other issues with the CSLGE study, but on this point they’re correct).

So to accept EPI’s arguments regarding pensions and overall public sector compensation, you have to reject the views of both the vast majority of financial economists and the vast majority of labor economists. Nice going, EPI.

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Categories: Economic Policy, Retirement and Social Security | Tags: Federal Employee Pensions

How Generous Are Federal Employee Pensions?

By Andrew Biggs

September 30, 2011, 10:27 am

USA Today reports that “retirement programs for former federal workers—civilian and military—are growing so fast they now face a multitrillion-dollar shortfall nearly as big as Social Security’s.” USA Today’s figures include both pension and retiree health costs and are inclusive of military programs, so it is a broad figure. Nevertheless, it raises an interesting question: how did retirement costs for a small segment of the population grow to rival Social Security, a program designed to cover nearly all Americans? One big reason is that federal pension benefits are simply very generous relative to typical private sector plans.

How generous? To check, I took a stylized worker and ran his annual salary through both the federal pension programs and a typical plan offered to private sector employees to see the difference in how much they would end up with at retirement. Since federal workers receive higher salaries than the average private sector worker (more on that here) I assumed the employee earned 150 percent of the average wage each year; that would put his earnings this year at a bit over $60,000. I assumed he entered the workforce at age 21 and worked until age 65; in reality, most people take some time out of the workforce and most federal employees have held other jobs, but for these purposes that doesn’t matter too much.

Most current federal employees are covered by two pension plans: a defined benefit (DB) program known as the Federal Employees Retirement System (FERS) and a defined contribution (DC) program called the Thrift Savings Plan (TSP). For a federal employee who retires at age 62 or older and has 20 or more years of service, his basic FERS benefit will equal 1.1 percent of his highest 3 years of average earnings, multiplied by his years of service. For FERS, most federal employees contribute 0.85 percent of pay, with the remaining costs covered by the government. The Thrift Savings Plan functions similarly to a private sector 401(k) plan. Federal employers contribute 1 percent of worker wages to the TSP regardless of whether individuals participate. In addition, the federal government matches employee contributions $1.00 per $1.00 for the first 3 percent of earnings contributed and $.50 per $1.00 for the next 2 percent of earnings. A federal employee contributing 5 percent of earnings to the TSP would receive a total employer contribution of 5 percent of earnings. Most current federal employees also participate in the Social Security program.

In the private sector, a typical pension plan today is a defined contribution 401(k) program, which is generally funded with a combination of worker contributions and employer matches. The most common matching formula is $.50 per $1.00 of contributions, up to the first 6 percent of pay. Around one-third of employers offering matching 401(k) plans use this approach, so we’ll follow it here. DB plans still exist in the private sector, but they’re shrinking fast: only 13 of the Fortune 100 companies now offer a traditional DB plan to newly hired employees. Some offer so-called “hybrid plans”—which are themselves shrinking—while the remainder offer 401(k) plans.

For both 401(k)s and the TSP, we need to make the risk of the benefits they offer comparable to the guaranteed benefits from a defined benefit plan; otherwise, investments in riskier assets like stocks will seem like “free money.” To do that, I follow the Congressional Budget Office’s approach of assuming that DC plans invest in government bonds, which I assume to have a 4 percent yield. That’s higher than the roughly 2.5 percent Treasury securities are currently paying but lower than the historical average, so you can adjust up or down as you see fit. Once people retire, I convert their DC accounts to a joint and survivor annuity using rates published by the TSP. For both workers, I assume they contribute enough to receive the maximum employer match to their DC account; but in comparing benefits I use only those generated by the employer match, not from the worker’s own contributions.

In both federal and private sector employment the worker would receive the same annual Social Security benefit of around $21,656. At retirement, the worker’s highest three years of earnings average at $60,368; with an assumed 44 years of service and a 1.1 percent replacement factor, that generates an annual FERS pension of $29,218. In addition, the annuitized value of the employer match to the TSP generates another $6,960 in annual benefits, for a total retirement income of $57,834. In addition, the federal employee would have whatever income his own TSP contributions generated.

The private sector worker would have a Social Security benefit of around $21,656, plus an annuity payment drawn from his employer’s 401(k) contributions of around $4,175 per year. The total retirement income would be around $25,832, plus whatever he received through his own 401(k) contributions. To make things simple, $25,832/$57,834 = around 45 percent, so the private sector worker clearly is receiving far less.

Now, we can haggle about some of these assumptions. Maybe private sector workers who are comparable to federal workers in terms of education or other skills receive more generous pensions. But even if we assume that the employer matches 6 percent of pay rather than the more typical 3 percent, that brings the private pension benefit up to only 51 percent of the federal level. And bear in mind that these percentage differences are reduced by the inclusion of Social Security; if I looked only at employer-provided pension benefits, the private benefit would be only around one-tenth the federal level.

Put it this way: federal employees have a more generous defined contribution pension than most private sector workers, and on top of this they have a defined benefit plan for which they pay less than 1 percent of salaries. State and local workers who participate in Social Security usually have more generous DB plans (a replacement factor of around 1.9 percent of final earnings versus 1 or 1.1 percent for federal employees, according to the Public Plans Database), but they pay far more for their benefits: almost 5 percent of pay versus less than 1 percent for federal employees.

In addition, federal employees are also eligible for retiree health coverage, which is very valuable for early retirees but which in the private sector is shrinking even faster than DB pensions. Based on CBO figures, Jason Richwine and I estimated that eligibility for retiree health coverage is worth around an extra 6 percent of pay for federal workers.

In simple terms, the federal employment package is a great deal for federal employees, and as a former federal employee I was happy to get it. But if you wonder why costs are so high, now you know.

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Categories: Retirement and Social Security | Tags: Federal Employee Pensions, Social Security

How Much Do D.C. Teachers Value Job Security?

By Andrew Biggs

September 20, 2011, 5:47 pm

In my work on public sector pay with Jason Richwine, we’ve attempted to place a monetary value on the extra job security that government employees receive. Job security is like an insurance policy against unemployment. Also, it can protect a position that pays a salary or benefits premium relative to the private sector. We find that the baseline value of protection against unemployment is worth an extra 2 to 3 percent of pay.

Job security is an area where our critics have taken our work the least seriously. Other studies on public employee pay, such as those from Jeffrey Keefe and the Center for State and Local Government Excellence, make no real attempt to value job security. Others have simply scoffed, such as the Ohio Public Employees Retirement System, which placed the phrase “job security” in quotes, as if to deny that public employees actually do have greater job security.

This morning’s Washington Examiner reports that growing numbers of elite teachers in Washington, D.C., are willing to trade higher salaries for lower job security. Looking at who was eligible for the raises, how much job security they would give up, and how many took the deal can give us an idea of how public employees value job security.

Under D.C.’s Impact Plus program, teachers who are rated “highly effective” two years running are eligible for annual raises of up to $20,000, in exchange for which they give up the right to stay on the rolls and seek retraining and other options if their teaching position is eliminated. Importantly, under the teaching contract signed under former Chancellor Michelle Rhee, layoffs are now at least partially performance based. As Washington Teachers Union head Nathan Saunders has said, “Excessing is the new teacher firing.” If so, elite teachers presumably have much less to fear compared to layoffs based solely on staffing needs and seniority.

Two-hundred and ninety teachers were eligible for the raise, the top 7 percent of the district’s teaching force. The district illustrates the scale of the salary increases using a teacher who holds only a bachelor’s degree and has a salary level of $51,716. That teacher’s salary would immediately rise to $69,132, a 34 percent increase that puts the teacher at the level ordinarily granted to a teacher on Step 7 of the master’s degree scale.

Of the eligible teachers, 80 percent accepted the raise. This has been interpreted as a positive sign for the program (and it probably is). But look at it this way: one-fifth of the very highest rated teachers turned down a one-third increase in pay to avoid reducing their job security. Presumably, the average teacher would have given up an even larger raise, since he’d have more to fear from a loss of job security. And all teachers would likely give up larger raises if the trade-off had taken job security fully down to private sector levels, where there is employment “at will.”

Now, public employees are more risk averse, and therefore may value security more, than the typical private sector employee. And there’s also the chance that some of the teachers turned the raise down for philosophical reasons; if we can obtain better data on which teachers accepted and which refused, we can get a better handle on that aspect of things.

But all of this tells me it’s worth our while to put a dollar value on job security.

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Categories: Education, Retirement and Social Security | Tags: Job Security

How Private Health Insurance Slashed the Uninsured Rate for Americans: Health Fact of the Week

By Christopher J. Conover

September 16, 2011, 10:55 am

The latest Census figures show the United States now has 49.9 million uninsured, an increase of nearly 1 million over the preceding year. Both in terms of absolute numbers and the percentage of Americans without coverage, this is the highest figure recorded since the Bureau began asking questions about health insurance in its annual survey three decades ago. If fully implemented, the Affordable Care Act is expected to cut this number by more than half. But this is a pittance compared to the dramatic decline in the number of uninsured that occurred before the introduction of Medicare and Medicaid in 1966. This is not unlike the dramatic decline in the poverty rate that occurred before the nation officially declared a war on poverty in the 1960s.

Over 70 years, the uninsured rate has declined by more than 80 percent (figure 6.6). It is noteworthy to see just how much of this decline occurred before the government got heavily involved in providing coverage during the 1960s. In 1940, approximately nine of ten Americans lacked health insurance coverage. By 1960, this had fallen to 25 percent. There were at least 60 million fewer Americans without health insurance in 1960 compared to 1940 despite a population increase of nearly 50 million over that same period. This dramatic decline reflected the enormous expansion of employer-based health coverage fueled by the tax subsidy that began in 1943.

These numbers are approximations for the earliest decades. The nation did not start to seriously measure the extent of lack of coverage until the mid-1970s. Before that time, the only consistent annual data on coverage came from health insurance industry surveys that counted the number of individuals with various types of medical insurance policies (for example, hospital insurance). Thus, one could obtain an approximate count of the uninsured using assumptions about how much duplication there was between policies of various types and then subtracting this insured number from the total population. Today, the most widely quoted current numbers about the uninsured (such as this week’s report) come from the Current Population Survey (CPS), which did not start collecting a consistent measure of coverage until 1988. There are multiple surveys, each with various shortcomings, but the CPS has gradually improved over time so that it is less likely to over-count the number of uninsured than it was in the past. The point is that the numbers for 1990 forward are a more precise approximation of the truth than the numbers that precede it, although every effort has been made to convert these earlier figures into estimates of how many uninsured would have been counted had a CPS-like survey been conducted in those earlier years.

By 1970, the uninsured rate had fallen to less than 15 percent, reflecting continued expansion of employer-provided coverage and the introduction of Medicare and Medicaid. There is substantial evidence of “crowd-out” of private health coverage by both programs: that is, the programs cover individuals who otherwise would have had private insurance. For example, one-quarter of seniors had comprehensive health insurance even before Medicare was introduced. When Medicaid expanded coverage to children and pregnant women between 1987 and 1992, crowd-out accounted for nearly half of those who were newly enrolled through these eligibility expansions. Consequently, there is much less than a one-for-one reduction in the number of uninsured for each new beneficiary who is enrolled. Conversely, the entire decline in the uninsured rate through 1970 cannot be attributed to public coverage since private coverage also was expanding during this same period.

After 1970, the uninsured rate remained quite stable for decades. Thus, the slight increase between 1990 and 2010 is barely a blip from this much longer-term view. Official government projections of what is supposed to happen to the uninsured rate if health reform is fully implemented are included in the figure shown. There still is substantial uncertainty about how much of the Affordable Care Act (ACA) will ultimately be implemented. But the 2020 number is a useful reminder that the ACA did not intend, nor will it possibly achieve, universal coverage. Some 23 million uninsured Americans would still be uninsured that year, according to the latest projections by the Congressional Budget Office. By 2021, assuming ACA is fully in place, half of the decline in the number of uninsured would be attributable to expansions of Medicaid and the Children’s Health Insurance Program (CHIP). This is a marked contrast to prevailing patterns of coverage: that is, in 2010, there were four people covered by private insurance for every person covered through Medicaid/CHIP. In short, notwithstanding the many severe limitations of Medicaid, the ACA would move the system in the direction of much heavier reliance on that program to cover those who cannot afford their own health insurance coverage. Moreover, the decline in the rate of being uninsured will be much more modest over the next decade than during the remarkable expansion of private coverage in the 1940s and 1950s. We can only imagine what might have happened had the designers of ACA been more willing to contemplate greater reliance on the expansion of private, rather than public health insurance.

Christopher J. Conover is a research scholar at Duke University’s Center for Health Policy and Inequalities Research and an adjunct scholar at AEI. The charts shown are from his new book American Health Economy Illustrated, to be released in January 2012 by AEI Press. See PowerPoint version of Figure 6.6 and Excel spreadsheet on health insurance coverage from 1940-2020 for data, sources, and methods.

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Categories: Health Policy, Retirement and Social Security | Tags:

Social Security as a ‘Monstrous Lie,’ Obama’s Jobs Plan, and More: What You May Have Missed in the Polls

By Karlyn Bowman and Andrew Rugg

September 16, 2011, 10:20 am

Social Security: A Monstrous Lie?: CNN and the Opinion Research Corporation did not mention Rick Perry in their question about whether the Social Security system was a “monstrous lie and a failure.” Twenty-seven percent said this was an accurate description, but 72 percent disagreed. Forty-two percent of young people thought the description was accurate; 58 percent disagreed.

In another question in the poll, only 4 percent said the system “has no serious problems, certainly none that require changing the current system.” Twenty-eight percent said it has minor problems that can be fixed with minor changes, 55 percent said it has serious problems that can be fixed with major changes, and 12 percent said the problems are so bad that the system should be scrapped. More 18-24 years olds (21 percent) than people in any other age group thought it was irredeemable.

Obama’s Plan: Early Reviews: When asked about approaches that would be more likely to be successful in growing the economy, 57 percent in the new Selzer/Bloomberg poll said spending cuts and tax cuts will give business more confidence to hire, while 23 percent said the government needs to spend more to stimulate the economy. Thirteen percent wanted government spending kept at the same level. When the Bloomberg pollsters described the Obama plan as “a package of tax cuts, spending on public works, and aid to local governments that will cost an estimated $447 billion,” 40 percent said it would help lower the unemployment rate, while 51 percent said it would not.

In a new Gallup poll, 45 percent wanted their member of Congress to vote for a jobs plan like the one Obama proposed, while 32 percent were opposed.

In the Bloomberg poll, 43 percent said President Obama had laid out the better vision for a successful economic future, and 41 percent said the Republicans had.

Handling the Country’s Top Problem: For decades, Gallup has asked Americans to tell them in their own words what the most important problem facing the country is. Sometimes Gallup follows up by asking people which party would do a better job handling the problem they have just mentioned. In their latest poll, 44 percent said the Republican Party and 37 percent the Democratic Party. The GOP had an edge in September 2010, the last time the question was asked, but not in 2009 or 2008.

Constitution Day: On September 20, in celebration of Constitution Day, AEI will honor its great constitutional scholar Walter Berns. Supreme Court Justice Antonin Scalia and a distinguished panel will discuss Berns’s contributions. In a 2002 essay, Berns discussed the Constitution’s enduring popularity, noting that Americans esteem it and the men who framed it.

To the extent that Americans know much about the document, it is because of the work of people such as Walter Berns. In a poll conducted this summer for Time, 85 percent said they knew a “great deal” or “some” about the document. In a new poll conducted by the National Constitution Center, 74 percent said the document is an enduring one that remains relevant today. Twenty-four percent said it was outdated and needs to be modernized.

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Categories: Economic Policy, Law and the Constitution, Politics and Public Opinion, Retirement and Social Security | Tags:

CalPERS Admits that Market Valuation Makes Sense

By Andrew Biggs

August 29, 2011, 3:06 pm

The California Public Employees Retirement System (CalPERS), and public pensions across the country, have been pushing back on the idea that they should value their liabilities more conservatively, using methods that economists, financial markets and, more recently, the Congressional Budget Office, have deemed more accurate. Currently, public pensions “discount” their future benefit liabilities using the high 8 percent return they project they’ll receive on their plans’ investments. Financial economists counter that this is wrong, because this 8 percent return is based on a risky investment portfolio while public pension benefits are effectively guaranteed. Financial markets value a liability based on the risk of the liability itself, not of any assets used to fund the liability. Most studies have argued for discount pension liabilities using the risk-free Treasury security rate (currently around 3.1 percent over 20 years, although the studies tend to use older values of around 4 percent). Using the Treasury rate, economists such as Josh Rauh and Robert Novy-Marx have estimated that public pensions face unfunded liabilities not of the $600 billion or so that the pensions acknowledge, but more like $3 trillion. Ouch.

I took a somewhat similar tack in an AEI working paper (forthcoming in Public Budgeting and Finance). Public pensions argue that using the Treasury rate ignores the actual investments they make and the returns they can expect to receive. (It doesn’t, but I’m indulging them.) So I took a different approach, which was based on actual pension investment portfolios but also included the price of the taxpayer guarantee to back up the pension if the investments fell short. The cost of this implicit “put option” is ignored in pension accounting, but when you do calculate it, total unfunded liabilities sum to—lo and behold—around $3 trillion. Maybe Rauh and Novy-Marx were right after all. Pensions continue to squabble over these points, but substantively the argument has pretty much been won (with the important exception of the Government Accounting Standards Board, which can’t seem to make heads or tails of the whole thing).

Recently, though, CalPERS essentially acknowledged my main point: that the ability to turn to taxpayers for additional funds when needed is actually worth something. And that something turns out to be a lot. Steven Greenhut of the Orange County Register reports that some local governments are looking to terminate their pension plans to reduce costs, and CalPERS recently issued new rules on how to handle the liabilities of such plans.

Under those rules, liabilities would no longer be discounted at the 7.75 percent interest rate that CalPERS currently uses. Instead, CalPERS would value them using a lower 3.8 percent discount rate. Why? Because when a plan is terminated, CalPERS would no longer have recourse to the sponsoring government—that is, the taxpayers—to bail out the plan should it need additional funds. This is exactly the argument I made—that the difference between the expected return on risky assets and the riskless return is captured by the taxpayer guarantee in case the investments go south.

CalPERS, of course, claims that this is a special case—but it’s not. CalPERS says that in the case of terminated plans, they must invest more conservatively to be sure that assets and liabilities are more closely matched. This is the investment approach you would take if you wished to “immunize” taxpayers from future benefit liabilities—that is, to ensure that you won’t need to go back to them for more cash. CalPERS follows this approach simply because, in the specific case of terminating plans, they have to. But in terms of the value of public pension liabilities, this approach follows across the board. Guaranteed public pension benefits include the implicit right to go back to the taxpayer for more money when needed. This guarantee is valuable to the pension and expensive to the taxpayer since, as recent history shows, it’s most likely to be accessed in an economic downturn, when the taxpayer is least able to come up with additional funds.

So thank you, CalPERS—you’ve gotten it right at last.

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Categories: Economic Policy, Retirement and Social Security | Tags:

Are Military Pensions too Generous?

By Andrew Biggs

August 23, 2011, 1:25 pm

The Associated Press asks “Are military pensions too generous,” which in terms of precision is a little like asking “How’s your wife?” (In both cases, “compared to what” comes into play.) The AP reports that the Obama administration is thinking of shifting both the form and the generosity of military pensions. A report from the Defense Business Board points out that military pensions are generous relative to the private sector, but that benefits are concentrated in the small percentage of servicemen who stay for 20 years. The Board recommended a shift to the defined contribution Thrift Savings Plan, which the military participates in but does not match employee contributions.

Military pensions require that an individual have 20 years of service before becoming eligible. And, unlike other areas of public service, in the military you need to be promoted to retain your job, meaning that a lot of folks who would be willing to stay 20 years don’t get to do so. This makes military pensions a winners vs. losers game: the 83 percent who leave before 20 years get little or nothing, while those who make it to 20 years receive half pay for life. (Full disclosure: my brother is a career Navy officer with more than 20 years of service, who presumably is looking forward to a life of half-pay leisure…)

The generosity is more difficult to measure due to the differing accounting conventions of defined benefit pensions. What we want to know is the value of what’s called the “normal cost” of the pension, which represents the value of benefits accruing in a given year. If the normal cost is 10 percent of pay, then you would be roughly indifferent between receiving your pension and getting a 10 percent salary increase each year.

The Department of Defense reports a “normal cost” of pensions for full-time workers of 32.7 percent of pay. That’s pretty generous; for ordinary federal employees, the normal cost, including both defined benefit pensions and employer matches to the Thrift Savings Plan, is around 17 percent of pay. So military pensions are more generous than federal civilian pensions, which are themselves far more generous than pensions in the private sector, where the typical employer contribution toward pensions is around 6 percent of salaries.

Moreover, to make defined benefit pensions comparable to defined contribution plans you need to adjust for different accounting conventions. Federal DB pensions assume an interest rate of 5.75 percent, versus the current Treasury yield of around 4 percent. Put another way, federal employees receive a guaranteed return of 5.75 percent on their and their employers’ contributions while a worker with a 401(k) plan could receive a guaranteed return of only around 4 percent. Adjusting for those differences, military pensions are worth around 1.6 times more, or about 52 percent of salaries. Pretty sweet, so long as you make it to 20 years to receive the pension.

How do military pensions compare to those of other high-risk government jobs, such as police and firefighters? For instance, the Florida Retirement System’s Special Risk plan reports a normal cost of 22 percent of pay, but this is based on an assumed 7.75 percent discount rate. Again adjusting to a 4 percent Treasury rate for consistency, that would rise to close to 58 percent of pay. So Florida police and firefighters receive more generous pensions than do members of the military. My guess is that being in the military is a bit tougher — more time away from your family, plus a fair amount of getting shot at — but that demands more analysis.

My gut is that both military pensions and public safety pensions are too generous; that is, the military allocates a greater share of total compensation to retirement benefits than a rational individual would if you simply gave him a single pot of money and let him split it between wages and benefits. My gut also tells me that part of the reason public sector pensions are so generous is that — because no one can figure out exactly what they cost (see my calculations above) — generous pensions and other fringe benefits allow total compensation to rise higher than would be politically sustainable if pay increases came through salaries, the generosity of which are easy for the public to gauge.

Would it make sense for the military (and, for that matter, police and fire) to shift to a DC pension structure? Probably so. It’s fairer to different employees, doesn’t penalize people who want to leave for a different career, and has far more transparent accounting so the risk to government finances and the taxpayer is lower.

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Categories: General, Retirement and Social Security | Tags:

Entitlement Spending Can be Constrained

By Alan Viard

August 16, 2011, 11:13 am

Charles and Nick, I can’t subscribe to your view of the Republican candidates’ uncompromising stand against tax increases at last week’s Iowa debate. Like Peter Wehner and Norm, I am deeply disturbed that all of the candidates said they would reject a hypothetical deficit reduction agreement featuring $10 of spending cuts for each dollar of tax increases. I stand by my position (see here and here) that Republicans should be willing to compromise on tax increases in order to reduce entitlement spending.

As I pointed out, the additional government debt that will be issued if we fail to reach a deficit reduction agreement today must be serviced with tax increases or spending cuts in the future. Is there any real doubt that future presidents and Congresses will turn to tax increases for more than 10 percent of the financing? If so, then rejecting a 90-percent-spending-cut deal today actually increases the long-run tax burden.

Despite Charles’s claim to the contrary, there is such a thing as a real spending cut deal. To be sure, agreements to cut discretionary spending are hard to sustain over extended periods, because discretionary spending levels must be voted on each year and frequently change in response to unexpected developments. Even in this area, though, it’s possible to achieve some savings. The two Gramm-Rudman-Hollings laws and the Budget Enforcement Act restrained discretionary spending growth in the late 1980s and early 1990s.

In any case, it’s entitlement spending that really need to be restrained. Fortunately, agreements to cut entitlement benefits are more durable than agreements to cut discretionary spending. Because entitlement spending is not voted on each year, spending reductions remain in effect unless and until the president and Congress affirmatively pass legislation to overturn them. The historical record shows that real benefit cuts adopted in a bipartisan agreement can remain in place.

In 1983, Ronald Reagan signed a Social Security compromise that included both payroll tax increases and benefit cuts. One of the benefit cuts, a six-month delay in the cost-of-living adjustment, took effect as scheduled in the year of enactment. The largest benefit cut, an increase in the normal retirement age, may have initially seemed more vulnerable to backsliding because it wasn’t slated to take effect until decades down the road. Yet, the first stage of that increase, with the age rising from 65 to 66, has now taken effect. The second stage, with the age rising from 66 to 67, is still on track to take effect in upcoming years, with nary a proposal from either party to block it.

Besides, if there were no real spending cut deals, what would be the policy implication? That entitlements will be unilaterally cut by Republicans when they control all branches of government? Republicans’ track record offers no support for such a prediction. Or, that entitlements will never be cut? In that case, tax increases are unavoidable; blocking tax hikes today merely puts them off to the future and needlessly allows deficits to crowd out investment in the meantime.

In reality, entitlement spending can be restrained. But doing so almost always requires bipartisan agreement and therefore compromise. Of course, Republicans should insist on a good deal. But a 10-1 ratio is likely to meet that standard, at least if a significant portion of the spending cuts are to entitlement benefits.

A hard-line stance may offer some short-run political benefits, as evidenced by the resounding applause that the candidates received from the Republican audience last week. Unfortunately, an absolute refusal to accept tax increases today is likely to doom efforts to cut entitlement spending, guaranteeing onerous tax increases tomorrow.

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Categories: Economic Policy, Fiscal Policy and Taxes, Retirement and Social Security | Tags:

How Much Risk Do Public Sector Pensions Need to Take?

By Andrew Biggs

August 11, 2011, 12:37 pm

Public pensions report that over the 25-year period from 1985 through 2011 they have achieved a median investment return of 8.8 percent, exceeding the 8 percent returns they project for the future, and have earned these returns without taking undue risks. Given this, they say, why shouldn’t we assume they can keep on doing so into the future?

One reason is that over the last 25 years you didn’t need to take that much risk in order to generate a high return, simply because the riskless interest rate—that is, the rate of return generated by low-risk investments like U.S. Treasury securities—was a lot higher than it is today. Standing on this foundation, a plan could achieve decent returns without overloading on risk. When the riskless return falls, though, a plan needs to take more risk in order to achieve the same returns.

In 1985, the yield on 30-year U.S. Treasury securities was 10.8 percent. Even from 1986 through 1990, after interest rates had fallen, the average 30-year yield was 8.5 percent. So during that period you could get 8.5 percent with pretty much no risk other than inflation; getting it up to 8.8 percent didn’t demand a huge shift into risky assets. And in fact, as of 1986 public sector pensions held less than a third of their assets in stocks, according to the Fed’s Flow of Funds data. They didn’t really need to go beyond that.

Over time, though, interest rates have fallen—today, the yield on 30-year Treasury securities is about 3.5 percent. So if you want to keep on earning 8 percent—which is the most common assumption made by public pension plans today—you’ve got to jack up the risk to get there. Public pensions have doubled the share of their portfolios invested in equities, and increasingly are shifting to “alternative investments” such as hedge funds and private equity, which now make up almost a tenth of pensions target portfolios.

If you don’t care about market risk and the costs it imposes on the public—and public pension accounting, to be clear, does not care about those things—then all that matters is a plan’s expected return, not how much risk it has to take to get there. In the real world, though, a market downturn imposes costs on a whole range of government stakeholders, from taxpayers, to beneficiaries of government programs that might be cut to make room for rising pension costs, to bondholders, to public employees themselves, who today are paying higher pension contributions as a direct result of poor investment returns. Those costs somehow need to be tallied, yet both the pensions and their nominal regulator, the Governmental Accounting Standards Board, show no intention of doing so.

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Categories: Economic Policy, Retirement and Social Security | Tags:

Annual pension benefits at age 62
	Federal	Private
Defined benefit	$23,710	$ -
Defined contribution	$8,610	$7,044
Social Security	$18,264	$18,264
*Total*	*$50,583*	*$25,308*

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