Three key members of the new GOP majority in the House of Representatives have introduced legislation to require States and local government sponsors of public pension plans to provide specific funding information to Treasury based on the market value of assets and liabilities (calculated with U.S. Treasury obligation yield curve rates), as well as other assumptions and methods proscribed by Treasury to achieve comparability across plans. Failure to do so would cause the offending State or political subdivision to lose all Federal tax benefits with respect to any State or local bond issues. The sponsors say the legislation is needed because the debt reported by public pensions fails to convey the true size of the debt confronting taxpayers because public pensions are able to calculate their liabilities using “unreasonably high discount rates” and to “distort fair market value of assets in order to hide debt.” Grover Norquist and his Americans for Tax Reform are among the initial and vocal supporters of the bill. While nothing will happen to the legislation before the current “lame duck” session of Congress adjourns later this month, the sponsors have said it will be quickly re-introduced in the new 112th Congress. The legislation can be expected to be one of the focal points for Congressional hearings and possible legislative action in the House in 2011 – and a major priority for NCTR.
On December 2, 2010, Congressmen Devin Nunes (R-CA), Paul Ryan (R-WI) and Darrell Issa (R-CA) introduced HR 6484, the Public Employee Pension Transparency Act, which would amend the Internal Revenue Code. It would condition the continuation of certain specified Federal tax benefits --namely the ability to issue federally tax-exempt bonds, as well as receive direct subsidies under the Build America Bonds program and other direct subsidy bond programs -- upon State or local government pension plan sponsors’ filing certain reports with the Secretary of the Treasury. These reports would set forth each plan’s financial data using Federally-proscribed methodologies and valuations, including, among other things, a “market value of liabilities.” The legislation would also mandate the creation of a public website, with searchable capabilities, for purposes of posting the information received by the Federal government in these reports.
Mr. Nunes is a member of the House Ways and Means Committee, to which the legislation will be referred for further action. Mr. Ryan is the incoming Chairman of the House Budget Committee, which will play an increasingly important role in the 112th Congress given the GOP's focus on deficit reduction. He is very well-respected by his colleagues and will be a key member of the House leadership.
Finally, Mr. Issa will be the new Chairman of the House Oversight and Government Reform Committee, where he intends to hold what could prove to be a record number of oversight hearings on any number of subjects. (See story below.) These three gentlemen are therefore very well-positioned to advance such legislation.
The bill is seen as necessary because “lucrative pension promises are being made to public employees that taxpayers simply cannot afford” and the “true level of unfunded liabilities associated with these plans – perhaps more than $3 trillion – is being hidden thanks to unrealistic accounting standards,” according to Congressman Nunes.
Congressman Ryan claims that “We need to ensure that state and local governments are accurate and honest in detailing their financial liabilities, including the cost of pension plans for public employees,” apparently suggesting that currently, accuracy and honesty may be absent. Finally, Congressman Issa asserts that the American people have a right to “know the truth about the unfunded liabilities being run-up by state and local pensions.” “Quite frankly,” Mr. Issa notes, “if they [public pensions] have nothing to hide, there’s no reason why the states and local governments who control public employee pensions should not embrace this effort to ensure that the taxpayers have a more transparent accounting of the true nature of pension liabilities.”
The legislation is very tightly and carefully crafted. It begins with a number of findings setting forth both the constitutional basis for Federal involvement as well as the policy rationale. For example, it notes that:
• State and local government employee pension plans are substantially facilitated by the favorable Federal tax treatment of participants and beneficiaries, investment earnings, and employee contributions;
• The investment of public pension plan assets, the distribution of benefits, and other financial activities are facilitated through the use of instrumentalities of, and substantially affect, interstate commerce, and these interstate activities have “a substantial impact on the national economy, affect capital formation, regional growth and decline, the national markets for insurance, and the markets for securities and the trading of securities of State and local governments;”
• State and local government employee pension plans have a substantial impact on interstate commerce as a consequence of the interstate movement of participants;
• Public pension plans are “affected with a national public interest” and meaningful disclosure of the value of their assets and liabilities is necessary and desirable in order to adequately protect plan participants and their beneficiaries and the general public;
• “Meaningful disclosure” would also further efforts to provide for the general welfare and the free flow of commerce.
The legislation states that its policy is:
(1) to protect the interests of participants and beneficiaries in State or local government employee pension benefit plans and the interests of the Federal government and the general public in the fiscal soundness of such plans;
(2) to minimize the threat of a possible adverse impact of the operations of such plans on Federal revenues and expenditures and the national securities markets; and
(3) to encourage sponsors of such plans to examine the problems which may be experienced by their plans and to “expeditiously implement those remedial measures which may be necessary to guarantee meaningful disclosure of the assets and liabilities of such plans as well as their fiscal soundness, by providing for meaningful disclosure of the value of State or local government employee pension benefit plan assets and liabilities.”
There would be an Annual Report as well as Supplementary Reports required by a plan sponsor for each plan. The Annual Report would have to include the following:
• A schedule of funding status, to include a statement as to the current liability of the plan, the amount of plan assets available to meet that liability, the amount of the net unfunded liability (if any), and the funding percentage of the plan;
• A schedule of contributions by the plan sponsor for the plan year;
• Alternative projections for each of the next 20 plan years relating to the amount of annual contributions, the fair market value of plan assets, current liability, the funding percentage, together with a statement of the assumptions and methods used in connection with such projections, including assumptions related to funding policy, plan changes, future workforce projections, and future investment returns (To “achieve comparability across plans,” the Treasury Secretary is to specify the projection assumptions and methods to be used.);
• A statement of the actuarial assumptions used for the plan year, including the rate of return on investment of plan assets;
• A statement of the number of participants who are retired or separated from service and are receiving benefits, those who are retired or separated and entitled to future benefits, and those who are active under the plan;
• A statement of the plan’s investment returns, including the rate of return, for the plan year and the 5 preceding plan years;
• A statement of the degree to which, and manner in which, the plan sponsor expects to eliminate any unfunded current liability that may exist for the plan year and the extent to which the plan sponsor has followed the plan’s funding policy for each of the preceding 5 plan years; and
• A statement of the amount of pension obligation bonds outstanding.
In any case in which either the value of plan assets in the Annual Report is determined using a standard other than fair market value, or the interest rate or rates used to determine the value of liabilities or as the discount value for liabilities are not interest rates based on US Treasury obligation yield curve rates, then the plan sponsor would have to file Supplementary Reports.
The Supplementary Report would be required to include the information specified in the Annual Report, but determined by valuing plan assets at fair market value and by using certain Treasury yield curves based on the following three periods: benefits reasonably determined to be payable during the 5-year period beginning on the first day of the plan year; benefits reasonably determined to be payable during the following 15-year period; and benefits reasonably determined to be payable thereafter.
As is obvious, this would appear to be essentially a Federally-mandated “market value of liabilities” (MVL) restatement of a pension plan’s liabilities and an unsmoothed assessment of the value of its assets. It would also impose a standardized Federal set of methods and assumptions for valuation purposes. Due to the use of MVL and an unsmoothed asset valuation, the reports would present highly inflated and volatile numbers compared to those used by plans and employers currently for valuation and funding purposes. It would likely create tremendous confusion among decision-makers as well as the public.
Furthermore, to the extent that it places in question to any degree the status of any Federal exemption from gross income relating to interest on State and local bonds, or any credit allowed to holders of qualified tax credit bonds, or any credit allowed under build America bonds, it could threaten investor confidence in the municipal bond markets at a time when State and local government can ill afford any restrictions on their financing capabilities.
Unfortunately, the legislation will likely have a certain appeal to some lawmakers, who will be told that it is all about transparency – and after all, if public pension plans thought that increased transparency was good for corporate America and the financial sector in the Dodd-Frank financial reform legislation, how could they reasonably oppose it being applied to them?
Also, the fact that the legislation will represent a case of “reform” that will not cost the Federal government a cent will also have its fans. This is bolstered by the proponents’ claim that the bill also “establishes a clear federal prohibition on any future public pension bailouts by the federal government.” Indeed, the legislation does have a provision that provides that “the United States shall not be liable for any obligation related to any current or future shortfall in any State or local government employee pension plan.”
However, public pension plans have not been requesting any such Federal bailout. Nevertheless, this did not stop Thomas Schatz, President of Citizens Against Government Waste, from declaring that “State and local governments’ empty coffers should not be ignored, nor should they become dependent on federal bailouts to ensure the fiscal soundness of their pension plans” in a statement supporting the bill.
The Chamber of Commerce, another showcased supporter of the legislation, also indirectly raised the bailout issue. “The unfunded liabilities of state and local government pension plans has [sic]reached crisis proportions with no solution in sight,” said Randel K. Johnson, senior vice president of Labor, Immigration, and Employee Benefits for the U.S. Chamber. “Unfortunately, the one solution governments may turn to as a source of funding is further taxation on private sector employers and workers.”
Mr. Johnson also argued that private sector pension standards should be applied to the public sector, saying that “it is hardly fair that the private sector is held to stringent funding requirements under the Employee Retirement Income Security Act, which can adversely affect wages and benefits for workers as funding shortages are addressed,” Johnson stressed, “while the public sector often remains free to promise increasing levels of benefits without properly funding those benefits for the future.”
Ironically, Mr. Johnson failed to note that the Chamber worked aggressively on Capitol Hill to obtain relief from the very Pension Protection Act funding rules that it believes should now be applied to the public sector. Specifically, the Chamber helped make sure that the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010 included provisions which ensured that pension contributions “are not out of proportion to those required before the market downturn.” The Chamber website calls “Defined Benefit Plan Funding Relief” one of its policy accomplishments for 2010.
While it is extremely unlikely that the legislation will see any action before Congress adjourns later in the month, its supporters have promised to reintroduce it next year. Such reintroduction will likely serve as the focal point of a hearing before Mr. Issa’s Committee on Oversight and Government Reform. It is probably a safe bet to assume that critics of current pension accounting, such as Joshua Rauh, will be among the witnesses.
Finally, it is important to note that in addition to Grover Norquist and the Americans for Tax Reform, other supporters include Americans for Prosperity, the American Conservative Union, National Taxpayers Union, Americans for Limited Government, and, as also previously noted, the U.S. Chamber of Commerce. Not only is the list impressive, but the fact that these supporters were already lined up for the introduction of the legislation is another indication of the careful planning behind this overall effort.
(For those who may not be familiar with Mr. Norquist , he has famously said that “My goal is to cut government in half in twenty-five years, to get it down to the size where we can drown it in the bathtub.” He is also well known among public employee pension plans because of his campaign to dismantle and privatize state pension plans and the trillions of dollars of public funds held as investments for retirees. He has said, “Just 115 people control $1 trillion in these funds. We want to take that power and destroy it.”)
In summary, this legislation must be taken very seriously. It has been carefully crafted and its introduction well-orchestrated. Its supporters are in positions to advance it while also using it as a means to continue to inflame public opinion against public pensions, and their resources with which to do so are formidable. It obviously implicates the entire GASB debate involving pension accounting and MVL. Finally, by connecting the legislation to municipal bonds, it links up with the SEC and its actions in this area (see story below).
This legislation will therefore be a major priority of NCTR in 2011. We are already reaching out to public employer organizations to make sure that they understand all of its implications, and we will also be working closely with other public sector groups to ensure that the Congress is made aware of the negative implications of this legislation. A key message will be that doomsday predictions and draconian legislative proposals distract attention from the real pension crisis that Congress should address, namely the vast majority of Americans who have no pension and little to nothing set aside for future retirement needs.
One last point to note: even though its provisions are clearly crafted to apply to defined benefit plans, the legislation’s drafters were careful to explicitly note that it does not apply to DC plans. Hmmmm.
• Nunes Press Release on Public Employee Pension Transparency Act
• Copy of HR 6484
• Chamber of Commerce Press Release
Wednesday, December 8, 2010
The Mid-Term Elections and You: A Public Pension Perspective
As many political forecasters had predicted, Democrats suffered widespread losses in the November, 2010 mid-term elections. As of this writing -- with one seat still undecided (New York’s 1st District) -- Republicans will have a 242 to 192 majority in the House of Representatives in 2011. The GOP’s gain of 63 seats provides them with the most seats they have held in more than 60 years. In the Senate, Democrats will still retain control, but their majority has been reduced to 53, assuming that Independents Bernie Sanders (VT) and Joe Lieberman (CT) continue to caucus with the Democrats, as they have in the past. Public employees are likely to face increasing criticism, and an incoming House Committee Chairman, worried that public pensions are the next financial disaster time-bomb waiting to explode, apparently has a new report in the works that will examine State and local government pension plan underfunding and has cosponsored legislation that would impose new Federal reporting requirements on public pensions and force all plans to develop and disclose valuations based on so-called market values. What are the implications for retirement security in general and public pensions in particular?
While the “big picture” impact of the Republican victory, particularly in the House, will be significant, the individual policy implications are still being closely analyzed. Therefore, it is difficult to predict specifics at this point. Clearly, however, there is much support among many House Republicans for a concerted effort to repeal the Affordable Care Act, the historic (and controversial) healthcare reform legislation approved in March of this year. The more recent Dodd-Frank financial services reform legislation is also a likely target for some degree of dismantling.
Nevertheless, even if the House of Representatives were to pass healthcare repeal, it is very unlikely that it would clear the Senate, let alone do so with a veto-proof majority. Piecemeal repeal of sections of Dodd-Frank might be more likely, but what is more probable is a very strong effort to delay implementation of both massive pieces of legislation by means of the appropriations process. This could bring the huge regulatory efforts that both new laws set in motion – and which are so vital to their effectiveness -- to a screeching halt.
Another likely delaying tactic is for the House to hold numerous oversight hearings, which will serve to further slow down the Federal bureaucracy through requests to testify. The incoming Chairman of the House Committee on Oversight and Government Reform, Congressman Darrell Issa (R-CA), is already talking about a huge increase in oversight by his committee in 2011, including new investigations into the bank bailout, the financial stimulus legislation, and health care reform. He has been quoted as saying that he wants each of his seven subcommittees to hold one or two hearings each week. ”I want seven hearings a week, times 40 weeks,” Issa said. (By comparison, Congressman Henry Waxman (D-CA), the Committee’s current chair, held a total of 203 oversight hearings in the two years of the 110th Congress when George W. Bush was President.)
Therefore, to the extent that healthcare implementation was of interest to some in the public pension community, the GOP win in November could signal major delays ahead in its implementation – and possibly even interruptions in the funding of some of its assistance programs. Also, it is very likely that the activist role of the Securities and Exchange Commission (SEC) in the area of corporate governance, and in the implementation of other features of the Dodd-Frank reforms of concern to the business community, will be another focus of the House Republican leadership.
There are also a number of other indications that the going may be a little rougher, specifically for public pensions, in the 112th Congress that will convene on January 3, 2011.
In the House, a significant factor will be an increasingly anti-public employee tone of the Republican leadership and many of its newer “Tea Party” members. While this is focused primarily on Federal employees at this point, its negative implications for government at all levels will be difficult to contain.
For example, as the election campaign began to heat up over the summer, the incoming Speaker of the House, John Boehner (R-OH), complained about what he characterized as the increasing gap in pay between Federal employees and the private workforce, blaming the Democrats for exacerbating the problem at a time when many Americans had no jobs at all.
In a speech to the City Club of Cleveland on August 24th, Mr. Boehner said that “Since February 2009, the private sector has lost millions of jobs while the federal government has grown by hundreds of thousands of workers.” Furthermore, he said that “We’ve seen not just more government jobs, but better-paying ones too,” arguing that “Federal employees now make on average more than double what private sector workers take in.” (This clearly echoes similar criticisms of State and local government salaries.) Congressman Boehner argued that “It’s just nonsense to think that taxpayers are subsidizing the fattened salaries and pensions of federal bureaucrats who are out there right now making it harder to create private sector jobs.”
Furthermore, as an indication of the spread of this anti-government employee mood to the State and local government workforce, Mr. Boehner was also critical of the $26 billion in stimulus monies approved over GOP objections earlier that same month. The legislation included $10 billion in funding aimed at saving 161,000 teacher jobs and $16.1 billion in Medicaid assistance to the states that was intended to preserve police and firefighter jobs by reducing state shortfalls.
However, it should also be remembered that in 2005, before he was elected as the GOP Leader in the House in early 2006, Mr. Boehner was Chairman of the House Education and the Workforce Committee, and was one of the major proponents of H.R. 2830, the House's version of pension reform legislation at the time. He was instrumental in getting this legislation through the House with a provision making permanent the pension provisions of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, which was a major goal of NCTR.
(This legislation, which ultimately cleared Congress in 2006, included a number of other very important provisions strongly supported by NCTR, including revisions to IRC Section 415(n) dealing with the purchase of service credits, specifically permitting their purchase for periods for which there is no performance of service (e.g. airtime), and in order to qualify for an increased benefit (e.g. a higher tier/formula in the same plan). In addition, the legislation clarified that (1)trustee-to-trustee transfers of 403(b) and 457 funds into a governmental defined benefit plan to purchase service credit does not need to be tested under the 415(n)limits on after-tax contributions to the plan. )
The incoming House leadership’s focus on public employees includes their pensions. Congressman Eric Cantor (R-VA), who will be the new House Majority Leader, has proposed that Federal employee pensions should be “updated” to “reflect private sector practices,” including basing pensions on the average of an employee's highest earnings over five years, not three, and by eliminating the current early retirement benefit for those who retire voluntarily. (Currently, Federal employees who retire at age 55 or older with at least 30 years of service or at age 60 with at least 20 years of service can receive an early benefit equivalent to Social Security until they reach age 62.)
However, perhaps the most disturbing indication of a new focus on public sector pensions, including those of State and local governments, comes from the incoming Chairman of the House Oversight and Government Reform Committee, Darrell Issa (R-CA), mentioned above. For example, Congressman Issa has indicated that the Federal DB plan has a “structural flaw” which, in his words, “incentivizes our most qualified employees to take … retirement rather than stay around.”
In a Q&A with the Washington Post’s “Federal Diary” in March of 2009, Mr. Issa was asked what problems he saw with a defined-benefit plan. He answered as follows: “Simply stated, defined-benefit plans lack portability, and there is no incentive to say, ‘I have my retirement already, but every day I stay, I am better off.’ Currently, our defined-benefit plans almost mandate retirement for our federal workers. This is a problem which has existed for decades. This system encourages our federal workers to retire, and to take their knowledge and experience to the private sector. We have got to come up with a plan where it is in the best interest of the federal employee to remain in the workforce, either directly or in a post-retirement role, for as long as possible, because the skills these experienced federal workers have are essential.”
Most alarming, however, is a report that Mr. Issa’s staff has recently indicated he is concerned "that calls for a federal bailout to avert a fiscal disaster for state and local governments may be just over the horizon." According to “Business Week” (October 13, 2010), Issa is currently drafting a report about underfunded state and local pension plans in connection with this impending failure. While his Committee would have no authority to actually consider new Federal laws to address whatever problems are identified, Congressional oversight hearings on such a report would be very problematic.
Based on Congressman Issa’s sponsorship of the new “‘Public Employee Pension Transparency Act’’ (see story above), it seems likely that he is preparing just such a hearing for next year when this very troubling legislation will be re-introduced. Such a hearing would create pressure for a legislative response by the committees with appropriate jurisdiction.
One such committee is Ways and Means, to which the new Public Employee Pension Transparency Act has been referred. Its incoming Chairman, Congressman Dave Camp (R-WI), has recently said that he plans to push for comprehensive tax reform during the 112th Congress. While this is not exactly a revolutionary notion for a new Ways and Means Chairman, it does signal that he may well be more interested than others have been in recent years to tackle tax reform as part of a more comprehensive budget deficit reform effort, particularly since he serves on the President’s Commission on Fiscal Responsibility and Reform.
This, in turn, could mean that recommendations affecting retirement security (see the following story on the deficit commission’s proposals) could be more in play that some might otherwise think. And if so, this should be of major interest to pension plans, both public as well as private.
Otherwise, Congressman Camp has been involved in a number of pension issues over the years in his leadership capacity on the Ways and Means Committee, and is clearly interested in the overall issue of retirement security. It is therefore possible that some legislative proposals in this general area could be on the Committee’s agenda in the next two years, but they would clearly have to have bipartisan support, which will be all the more difficult to obtain in a divided Congress with one party controlling the House and the other the Senate.
One such proposal that has been mentioned as a possible candidate is automatic workplace individual retirement accounts, an idea that was developed by Mark Iwry, formerly Treasury Benefits Tax Counsel under President Clinton and currently senior adviser to Treasury Secretary Geithner and deputy assistant Treasury secretary for retirement and health policy. Mr. Iwry, while working at the Brookings Foundation, was joined in the development of this idea by David Johns at the Heritage Foundation. The proposal builds on payroll-deposit saving; automatic enrollment; low-cost, diversified default investments; and individual retirement accounts (IRAs).
Finally, what about legislation to address Social Security? Again, given its partisan nature, a consensus decision on what the best reform approach to follow looks like may be very difficult to achieve. However, as discussed below, it is well to note that the proposals coming out of the several “deficit reduction” panels do not include private investment accounts, which have been the focus of this partisan dispute over the last decade. Since the incoming Chairman of the House Budget Committee, Congressman Paul Ryan (R-WI), continues to support providing workers with the voluntary option of investing a portion of their FICA payroll taxes into personal savings accounts, some think that Democrats may consider more seriously trying to get a compromise proposal on the table that has the possible support of other key Republicans working on President Obama’s Commission on Fiscal Responsibility and Reform than they might otherwise have been had Democrats remained in charge in the House.
Also, mandatory Social Security for public employees would definitely be in play should reform be considered, and such a proposal seems to be gaining some traction in deficit reduction discussions. This could not be coming at a more potentially dangerous time, given the increasing anti-government employee mood of the Congress and the country. Furthermore, as discussed below, mandatory coverage is now being discussed outside the scope of Social Security reform. If the Ways and Means Committee takes up the new Public Employee Pension Transparency Act in the next Congress, mandatory coverage could be considered in the context of ”reform” of public pensions.
Before turning to look at the changes in the Senate, one of the most disappointing results of the November 2nd election for the public pension community in the House was the loss of Earl Pomeroy (D), who has represented North Dakota in the that body since 1992. Mr. Pomeroy is a member of the House Ways and Means Committee, with more direct control over legislation of interest to public pensions than probably any other committee in the House. His Congressional career has been distinguished by his interest in retirement policy, especially the revitalization of the defined benefit plan, and Pomeroy has been called a "champion of pensions on Capitol Hill" by Institutional Investor.
Mr. Pomeroy and his staff have been of tremendous help to public plans in ensuring that our unique nature was taken into account whenever Federal tax laws, rules and regulations were being drafted and implemented. For example, in 1998, Mr. Pomeroy agreed to sponsor important portability legislation that would permit amounts in 403(b) and 457 plans to be used to purchase service credit in defined benefit plans, and to allow the rollover of distributions between defined benefit plans and 403(b) or 457 plans. These provisions were added to his Retirement Account Portability Act that subsequently was included in the Portman-Cardin legislation that became law as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)in 2001.
A recent example of his attention to public pension concerns was the Congressional roundtable in September of 2008 on the Internal Revenue Service’s Governmental Plans Compliance Initiative. Congressman Pomeroy chaired the two-hour meeting, which included representative of the public pension community, to discuss the IRS’ initiative to gather information on and significantly increase its audits of governmental pension plans. As a direct consequence of this meeting, the draft IRS survey of public plans was opened up to further review and comment by governmental plan representatives, and Congressman Pomeroy has continued to stress the importance of a more collaborative focus for the IRS in this area. His efforts truly helped to reshape this overall initiative.
Congressman Pomeroy was the first recipient of the "National Council on Teacher Retirement Award for Outstanding Service to Public Pensions" in 2006. There is currently probably no other member of Congress who understands public pension plans better, and who is more committed to the defined benefit plan as a model for true retirement security. He and his staff will be truly missed.
With regard to the Senate, thanks to the arcane rules of that body, partisan gridlock is likely to continue, even with the gains the GOP made in the mid-term elections. Perhaps the most significant change of interest to public pensions is the move of Senator Charles Grassley (R-IA) from his Ranking position on the Senate Finance Committee to a similar spot on the Senate Judiciary Committee. Senator Grassley was required to leave his post on Finance due to a 6-year term limit for such positions imposed by Senate Republicans.
Senator Grassley has repeatedly expressed concerns with the state of public pensions over the years. For example, in 2006, when he was chairman of the Finance Committee, Senator Grassley asked the GAO to study the funding status of public pension plans, citing concern that many such plans are “poorly funded and have no back-up source for guaranteed benefit payments, as private pension plans have.”
More recently, Grassley has focused on public pension investments, particularly in alternatives such as hedge funds, and requested the GAO to examine investment practices and governance structures of public defined benefit plans. This GAO report, which was released in late summer of this year, found that State and local plans “appear to have moved toward investing in higher-risk assets with the goal of achieving a balanced, diversified portfolio that seeks higher returns and manages risk over the long term,” and did not make any recommendations. However, the study also noted that, as plans look to diversify their investment risk through the increasing use of alternative investments, “they could expose plan assets to new types of risk,” and if state and local pension plans and their sponsors are unable to properly monitor and manage these new risks, then “they may exacerbate recent market losses, which could result in increased employer contributions—costs that many governments are unable to afford.”
Senator Orrin Hatch (R-UT), who will take Grassley’s place as the Ranking Republican on Senate Finance, has a history of support on public pension issues. For example, in the late 1990’s, Senator Hatch was the primary Senate sponsor, along with Senator Kent Conrad (D-ND) , of legislation to provide a permanent moratorium on the application of the IRS non-discrimination rules to public pensions. In support of the legislation, Senator Hatch stressed that State and local government pension plans face a high level of scrutiny: “State law generally requires publicly elected legislators to amend the provisions of a public plan. Electoral accountability to the voters and media scrutiny serve as protections against abusive and discriminatory benefits.” One can only hope that, moving forward, Senator Hatch will remember those reassurances he offered to his fellow Senators at the time.
However, it is widely believed that the experience of his colleague, Senator Bob Bennett (R-UT), will have a major influence on Senator Hatch. Conservative activists were successful in ousting fellow Senator Bennett earlier this year at the Utah Republican state convention for not being conservative enough, and Senator Hatch will likely face a similar primary challenge in 2012 according to press reports. Therefore, it is expected that Hatch, who has a reputation as a deal-maker willing to work with Democrats, is going to have much less room to maneuver in the coming Congress. If entitlement reforms are undertaken, Senator Hatch will play a key role, and this pressure from his right flank could mean that a bipartisan compromise will be a much more difficult goal to achieve.
In another Senate development, some observers think that the election of former Ohio Republican Congressman Rob Portman to the Senate could provide a possible replacement for the leadership role on pensions that Congressman Pomeroy has played. Mr. Portman was very involved in pension reform legislation during his years in the House, and his return to Congress has raised some hope that a rekindling of the Portman-Cardin partnership that helped focus attention on pension reform in the House could be in the making in the Senate. (Former Congressman Ben Cardin (D-MD) has been a Maryland Senator since 2006.)
However, both Portman and Cardin were members of the House Ways and Means Committee when pension reform legislation advanced under their names. Senator Cardin is not on the Finance Committee and it does not appear likely that Senator-elect Portman will be named to that panel either. Therefore, reports of a possible Portman-Cardin pension “reunion” may be premature at best.
So the overall forecast for public pensions in the upcoming 112th Congress is probably cloudy with an increasing chance of rain. However, none of this is to suggest that Congressional Republicans are, across the board, somehow uniquely anti-public pension – or any more so than Democrats are. Nonetheless, it is clear that there is a growing concern within the Republican leadership that public salaries are too high, public retirement benefits may need to be adjusted and that state and local government pension plans are in financial trouble. It would be irresponsible not to be alert to the possible implications for our community as a result. Already, other members of Congress – including some Democrats -- have warned of a growing danger that public pensions are the next Federal bailout waiting to happen, and that there is therefore a need for Washington to become involved. Once again, the legislation introduced by Congressmen Nunes, Ryan and Issa is a perfect example of this attitude.
Complicating the issue are the funding problems of multiemployer plans in certain industries. Hearings were held in the Senate this year and more are likely in 2011, but finding a workable, bipartisan solution will be difficult, according to some. The problems of these plans are often confused with press reports of funding problems for public pensions, and some Hill staffers are equating the two, only intensifying the fear that a disaster is imminent for public plans.
In short, the tinder is very dry, and a small spark has the potential to set off a firestorm of Federal interest and involvement in public pensions not seen since the proposals in the late 1970’s for a Public Employee Retirement Income Security Act (PERISA) to create Federal rules, similar to those imposed by ERISA on private sector plans, for the public sector. Congress may well be very leery of extending any Federal protections to public employees, which could raise the question of participation in some form of a Pension Benefit Guarantee Corporation (PBGC). However, the idea of linking any further Federal benefits with the requirement for a “reform” of State and local pension systems may be a frightening idea whose time – at least in the view of some members of Congress – is fast approaching.
The introduction of the Public Employee Pension Transparency Act is a clear sign that the time has arrived for at least three key GOP members.
Let us hope, should Congress entertain the idea of an increased Federal role in public pensions, that it recalls the admonition of the Advisory Commission on Intergovernmental Relations (ACIR) in its December, 1980 Report on State and Local Pension Systems. In that report’s preface, the then-ACIR Chairman, Abraham D. Beame, former mayor of New York City, cautioned that “At a time when rising pension costs have prompted growing public support for increased state regulation and reform, imposing federal controls on state and local policymakers would be ill-timed as well as deleterious to our federal system.”
Those words are as true today as they were thirty years ago!
(The ACIR was an independent, bipartisan intergovernmental agency established by Public Law 86-380 in 1959 and subsequently disbanded in September of 1996. As it was established, ACIR's mission was to strengthen the American federal system and improve the ability of federal, state, and local governments to work together cooperatively, efficiently, and effectively.)
• 1980 ACIR Report on State and Local Pension Systems
While the “big picture” impact of the Republican victory, particularly in the House, will be significant, the individual policy implications are still being closely analyzed. Therefore, it is difficult to predict specifics at this point. Clearly, however, there is much support among many House Republicans for a concerted effort to repeal the Affordable Care Act, the historic (and controversial) healthcare reform legislation approved in March of this year. The more recent Dodd-Frank financial services reform legislation is also a likely target for some degree of dismantling.
Nevertheless, even if the House of Representatives were to pass healthcare repeal, it is very unlikely that it would clear the Senate, let alone do so with a veto-proof majority. Piecemeal repeal of sections of Dodd-Frank might be more likely, but what is more probable is a very strong effort to delay implementation of both massive pieces of legislation by means of the appropriations process. This could bring the huge regulatory efforts that both new laws set in motion – and which are so vital to their effectiveness -- to a screeching halt.
Another likely delaying tactic is for the House to hold numerous oversight hearings, which will serve to further slow down the Federal bureaucracy through requests to testify. The incoming Chairman of the House Committee on Oversight and Government Reform, Congressman Darrell Issa (R-CA), is already talking about a huge increase in oversight by his committee in 2011, including new investigations into the bank bailout, the financial stimulus legislation, and health care reform. He has been quoted as saying that he wants each of his seven subcommittees to hold one or two hearings each week. ”I want seven hearings a week, times 40 weeks,” Issa said. (By comparison, Congressman Henry Waxman (D-CA), the Committee’s current chair, held a total of 203 oversight hearings in the two years of the 110th Congress when George W. Bush was President.)
Therefore, to the extent that healthcare implementation was of interest to some in the public pension community, the GOP win in November could signal major delays ahead in its implementation – and possibly even interruptions in the funding of some of its assistance programs. Also, it is very likely that the activist role of the Securities and Exchange Commission (SEC) in the area of corporate governance, and in the implementation of other features of the Dodd-Frank reforms of concern to the business community, will be another focus of the House Republican leadership.
There are also a number of other indications that the going may be a little rougher, specifically for public pensions, in the 112th Congress that will convene on January 3, 2011.
The House of Representatives
In the House, a significant factor will be an increasingly anti-public employee tone of the Republican leadership and many of its newer “Tea Party” members. While this is focused primarily on Federal employees at this point, its negative implications for government at all levels will be difficult to contain.
For example, as the election campaign began to heat up over the summer, the incoming Speaker of the House, John Boehner (R-OH), complained about what he characterized as the increasing gap in pay between Federal employees and the private workforce, blaming the Democrats for exacerbating the problem at a time when many Americans had no jobs at all.
In a speech to the City Club of Cleveland on August 24th, Mr. Boehner said that “Since February 2009, the private sector has lost millions of jobs while the federal government has grown by hundreds of thousands of workers.” Furthermore, he said that “We’ve seen not just more government jobs, but better-paying ones too,” arguing that “Federal employees now make on average more than double what private sector workers take in.” (This clearly echoes similar criticisms of State and local government salaries.) Congressman Boehner argued that “It’s just nonsense to think that taxpayers are subsidizing the fattened salaries and pensions of federal bureaucrats who are out there right now making it harder to create private sector jobs.”
Furthermore, as an indication of the spread of this anti-government employee mood to the State and local government workforce, Mr. Boehner was also critical of the $26 billion in stimulus monies approved over GOP objections earlier that same month. The legislation included $10 billion in funding aimed at saving 161,000 teacher jobs and $16.1 billion in Medicaid assistance to the states that was intended to preserve police and firefighter jobs by reducing state shortfalls.
However, it should also be remembered that in 2005, before he was elected as the GOP Leader in the House in early 2006, Mr. Boehner was Chairman of the House Education and the Workforce Committee, and was one of the major proponents of H.R. 2830, the House's version of pension reform legislation at the time. He was instrumental in getting this legislation through the House with a provision making permanent the pension provisions of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, which was a major goal of NCTR.
(This legislation, which ultimately cleared Congress in 2006, included a number of other very important provisions strongly supported by NCTR, including revisions to IRC Section 415(n) dealing with the purchase of service credits, specifically permitting their purchase for periods for which there is no performance of service (e.g. airtime), and in order to qualify for an increased benefit (e.g. a higher tier/formula in the same plan). In addition, the legislation clarified that (1)trustee-to-trustee transfers of 403(b) and 457 funds into a governmental defined benefit plan to purchase service credit does not need to be tested under the 415(n)limits on after-tax contributions to the plan. )
The incoming House leadership’s focus on public employees includes their pensions. Congressman Eric Cantor (R-VA), who will be the new House Majority Leader, has proposed that Federal employee pensions should be “updated” to “reflect private sector practices,” including basing pensions on the average of an employee's highest earnings over five years, not three, and by eliminating the current early retirement benefit for those who retire voluntarily. (Currently, Federal employees who retire at age 55 or older with at least 30 years of service or at age 60 with at least 20 years of service can receive an early benefit equivalent to Social Security until they reach age 62.)
However, perhaps the most disturbing indication of a new focus on public sector pensions, including those of State and local governments, comes from the incoming Chairman of the House Oversight and Government Reform Committee, Darrell Issa (R-CA), mentioned above. For example, Congressman Issa has indicated that the Federal DB plan has a “structural flaw” which, in his words, “incentivizes our most qualified employees to take … retirement rather than stay around.”
In a Q&A with the Washington Post’s “Federal Diary” in March of 2009, Mr. Issa was asked what problems he saw with a defined-benefit plan. He answered as follows: “Simply stated, defined-benefit plans lack portability, and there is no incentive to say, ‘I have my retirement already, but every day I stay, I am better off.’ Currently, our defined-benefit plans almost mandate retirement for our federal workers. This is a problem which has existed for decades. This system encourages our federal workers to retire, and to take their knowledge and experience to the private sector. We have got to come up with a plan where it is in the best interest of the federal employee to remain in the workforce, either directly or in a post-retirement role, for as long as possible, because the skills these experienced federal workers have are essential.”
Most alarming, however, is a report that Mr. Issa’s staff has recently indicated he is concerned "that calls for a federal bailout to avert a fiscal disaster for state and local governments may be just over the horizon." According to “Business Week” (October 13, 2010), Issa is currently drafting a report about underfunded state and local pension plans in connection with this impending failure. While his Committee would have no authority to actually consider new Federal laws to address whatever problems are identified, Congressional oversight hearings on such a report would be very problematic.
Based on Congressman Issa’s sponsorship of the new “‘Public Employee Pension Transparency Act’’ (see story above), it seems likely that he is preparing just such a hearing for next year when this very troubling legislation will be re-introduced. Such a hearing would create pressure for a legislative response by the committees with appropriate jurisdiction.
One such committee is Ways and Means, to which the new Public Employee Pension Transparency Act has been referred. Its incoming Chairman, Congressman Dave Camp (R-WI), has recently said that he plans to push for comprehensive tax reform during the 112th Congress. While this is not exactly a revolutionary notion for a new Ways and Means Chairman, it does signal that he may well be more interested than others have been in recent years to tackle tax reform as part of a more comprehensive budget deficit reform effort, particularly since he serves on the President’s Commission on Fiscal Responsibility and Reform.
This, in turn, could mean that recommendations affecting retirement security (see the following story on the deficit commission’s proposals) could be more in play that some might otherwise think. And if so, this should be of major interest to pension plans, both public as well as private.
Otherwise, Congressman Camp has been involved in a number of pension issues over the years in his leadership capacity on the Ways and Means Committee, and is clearly interested in the overall issue of retirement security. It is therefore possible that some legislative proposals in this general area could be on the Committee’s agenda in the next two years, but they would clearly have to have bipartisan support, which will be all the more difficult to obtain in a divided Congress with one party controlling the House and the other the Senate.
One such proposal that has been mentioned as a possible candidate is automatic workplace individual retirement accounts, an idea that was developed by Mark Iwry, formerly Treasury Benefits Tax Counsel under President Clinton and currently senior adviser to Treasury Secretary Geithner and deputy assistant Treasury secretary for retirement and health policy. Mr. Iwry, while working at the Brookings Foundation, was joined in the development of this idea by David Johns at the Heritage Foundation. The proposal builds on payroll-deposit saving; automatic enrollment; low-cost, diversified default investments; and individual retirement accounts (IRAs).
Finally, what about legislation to address Social Security? Again, given its partisan nature, a consensus decision on what the best reform approach to follow looks like may be very difficult to achieve. However, as discussed below, it is well to note that the proposals coming out of the several “deficit reduction” panels do not include private investment accounts, which have been the focus of this partisan dispute over the last decade. Since the incoming Chairman of the House Budget Committee, Congressman Paul Ryan (R-WI), continues to support providing workers with the voluntary option of investing a portion of their FICA payroll taxes into personal savings accounts, some think that Democrats may consider more seriously trying to get a compromise proposal on the table that has the possible support of other key Republicans working on President Obama’s Commission on Fiscal Responsibility and Reform than they might otherwise have been had Democrats remained in charge in the House.
Also, mandatory Social Security for public employees would definitely be in play should reform be considered, and such a proposal seems to be gaining some traction in deficit reduction discussions. This could not be coming at a more potentially dangerous time, given the increasing anti-government employee mood of the Congress and the country. Furthermore, as discussed below, mandatory coverage is now being discussed outside the scope of Social Security reform. If the Ways and Means Committee takes up the new Public Employee Pension Transparency Act in the next Congress, mandatory coverage could be considered in the context of ”reform” of public pensions.
Congressman Earl Pomeroy (D-ND)
Before turning to look at the changes in the Senate, one of the most disappointing results of the November 2nd election for the public pension community in the House was the loss of Earl Pomeroy (D), who has represented North Dakota in the that body since 1992. Mr. Pomeroy is a member of the House Ways and Means Committee, with more direct control over legislation of interest to public pensions than probably any other committee in the House. His Congressional career has been distinguished by his interest in retirement policy, especially the revitalization of the defined benefit plan, and Pomeroy has been called a "champion of pensions on Capitol Hill" by Institutional Investor.
Mr. Pomeroy and his staff have been of tremendous help to public plans in ensuring that our unique nature was taken into account whenever Federal tax laws, rules and regulations were being drafted and implemented. For example, in 1998, Mr. Pomeroy agreed to sponsor important portability legislation that would permit amounts in 403(b) and 457 plans to be used to purchase service credit in defined benefit plans, and to allow the rollover of distributions between defined benefit plans and 403(b) or 457 plans. These provisions were added to his Retirement Account Portability Act that subsequently was included in the Portman-Cardin legislation that became law as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)in 2001.
A recent example of his attention to public pension concerns was the Congressional roundtable in September of 2008 on the Internal Revenue Service’s Governmental Plans Compliance Initiative. Congressman Pomeroy chaired the two-hour meeting, which included representative of the public pension community, to discuss the IRS’ initiative to gather information on and significantly increase its audits of governmental pension plans. As a direct consequence of this meeting, the draft IRS survey of public plans was opened up to further review and comment by governmental plan representatives, and Congressman Pomeroy has continued to stress the importance of a more collaborative focus for the IRS in this area. His efforts truly helped to reshape this overall initiative.
Congressman Pomeroy was the first recipient of the "National Council on Teacher Retirement Award for Outstanding Service to Public Pensions" in 2006. There is currently probably no other member of Congress who understands public pension plans better, and who is more committed to the defined benefit plan as a model for true retirement security. He and his staff will be truly missed.
The Senate
With regard to the Senate, thanks to the arcane rules of that body, partisan gridlock is likely to continue, even with the gains the GOP made in the mid-term elections. Perhaps the most significant change of interest to public pensions is the move of Senator Charles Grassley (R-IA) from his Ranking position on the Senate Finance Committee to a similar spot on the Senate Judiciary Committee. Senator Grassley was required to leave his post on Finance due to a 6-year term limit for such positions imposed by Senate Republicans.
Senator Grassley has repeatedly expressed concerns with the state of public pensions over the years. For example, in 2006, when he was chairman of the Finance Committee, Senator Grassley asked the GAO to study the funding status of public pension plans, citing concern that many such plans are “poorly funded and have no back-up source for guaranteed benefit payments, as private pension plans have.”
More recently, Grassley has focused on public pension investments, particularly in alternatives such as hedge funds, and requested the GAO to examine investment practices and governance structures of public defined benefit plans. This GAO report, which was released in late summer of this year, found that State and local plans “appear to have moved toward investing in higher-risk assets with the goal of achieving a balanced, diversified portfolio that seeks higher returns and manages risk over the long term,” and did not make any recommendations. However, the study also noted that, as plans look to diversify their investment risk through the increasing use of alternative investments, “they could expose plan assets to new types of risk,” and if state and local pension plans and their sponsors are unable to properly monitor and manage these new risks, then “they may exacerbate recent market losses, which could result in increased employer contributions—costs that many governments are unable to afford.”
Senator Orrin Hatch (R-UT), who will take Grassley’s place as the Ranking Republican on Senate Finance, has a history of support on public pension issues. For example, in the late 1990’s, Senator Hatch was the primary Senate sponsor, along with Senator Kent Conrad (D-ND) , of legislation to provide a permanent moratorium on the application of the IRS non-discrimination rules to public pensions. In support of the legislation, Senator Hatch stressed that State and local government pension plans face a high level of scrutiny: “State law generally requires publicly elected legislators to amend the provisions of a public plan. Electoral accountability to the voters and media scrutiny serve as protections against abusive and discriminatory benefits.” One can only hope that, moving forward, Senator Hatch will remember those reassurances he offered to his fellow Senators at the time.
However, it is widely believed that the experience of his colleague, Senator Bob Bennett (R-UT), will have a major influence on Senator Hatch. Conservative activists were successful in ousting fellow Senator Bennett earlier this year at the Utah Republican state convention for not being conservative enough, and Senator Hatch will likely face a similar primary challenge in 2012 according to press reports. Therefore, it is expected that Hatch, who has a reputation as a deal-maker willing to work with Democrats, is going to have much less room to maneuver in the coming Congress. If entitlement reforms are undertaken, Senator Hatch will play a key role, and this pressure from his right flank could mean that a bipartisan compromise will be a much more difficult goal to achieve.
In another Senate development, some observers think that the election of former Ohio Republican Congressman Rob Portman to the Senate could provide a possible replacement for the leadership role on pensions that Congressman Pomeroy has played. Mr. Portman was very involved in pension reform legislation during his years in the House, and his return to Congress has raised some hope that a rekindling of the Portman-Cardin partnership that helped focus attention on pension reform in the House could be in the making in the Senate. (Former Congressman Ben Cardin (D-MD) has been a Maryland Senator since 2006.)
However, both Portman and Cardin were members of the House Ways and Means Committee when pension reform legislation advanced under their names. Senator Cardin is not on the Finance Committee and it does not appear likely that Senator-elect Portman will be named to that panel either. Therefore, reports of a possible Portman-Cardin pension “reunion” may be premature at best.
The 112th Congress
So the overall forecast for public pensions in the upcoming 112th Congress is probably cloudy with an increasing chance of rain. However, none of this is to suggest that Congressional Republicans are, across the board, somehow uniquely anti-public pension – or any more so than Democrats are. Nonetheless, it is clear that there is a growing concern within the Republican leadership that public salaries are too high, public retirement benefits may need to be adjusted and that state and local government pension plans are in financial trouble. It would be irresponsible not to be alert to the possible implications for our community as a result. Already, other members of Congress – including some Democrats -- have warned of a growing danger that public pensions are the next Federal bailout waiting to happen, and that there is therefore a need for Washington to become involved. Once again, the legislation introduced by Congressmen Nunes, Ryan and Issa is a perfect example of this attitude.
Complicating the issue are the funding problems of multiemployer plans in certain industries. Hearings were held in the Senate this year and more are likely in 2011, but finding a workable, bipartisan solution will be difficult, according to some. The problems of these plans are often confused with press reports of funding problems for public pensions, and some Hill staffers are equating the two, only intensifying the fear that a disaster is imminent for public plans.
In short, the tinder is very dry, and a small spark has the potential to set off a firestorm of Federal interest and involvement in public pensions not seen since the proposals in the late 1970’s for a Public Employee Retirement Income Security Act (PERISA) to create Federal rules, similar to those imposed by ERISA on private sector plans, for the public sector. Congress may well be very leery of extending any Federal protections to public employees, which could raise the question of participation in some form of a Pension Benefit Guarantee Corporation (PBGC). However, the idea of linking any further Federal benefits with the requirement for a “reform” of State and local pension systems may be a frightening idea whose time – at least in the view of some members of Congress – is fast approaching.
The introduction of the Public Employee Pension Transparency Act is a clear sign that the time has arrived for at least three key GOP members.
Let us hope, should Congress entertain the idea of an increased Federal role in public pensions, that it recalls the admonition of the Advisory Commission on Intergovernmental Relations (ACIR) in its December, 1980 Report on State and Local Pension Systems. In that report’s preface, the then-ACIR Chairman, Abraham D. Beame, former mayor of New York City, cautioned that “At a time when rising pension costs have prompted growing public support for increased state regulation and reform, imposing federal controls on state and local policymakers would be ill-timed as well as deleterious to our federal system.”
Those words are as true today as they were thirty years ago!
(The ACIR was an independent, bipartisan intergovernmental agency established by Public Law 86-380 in 1959 and subsequently disbanded in September of 1996. As it was established, ACIR's mission was to strengthen the American federal system and improve the ability of federal, state, and local governments to work together cooperatively, efficiently, and effectively.)
• 1980 ACIR Report on State and Local Pension Systems
Deficit Panels Considering Major Changes to Tax Treatment of Pensions; Mandatory Social Security Also in Play
The draft recommendations on how to reduce the nation’s budget deficit, released November 10th by the two CoChairs of President Obama’s National Commission on Fiscal Responsibility and Reform – the so-called “Deficit Commission” -- certainly produced strong reactions from across the political spectrum. Then, one week later, the Debt Reduction Task Force -- a bipartisan group of budget experts, launched by the Bipartisan Policy Center founded by former Senate Majority Leaders Howard Baker (R-TN), Tom Daschle (D-SD), Bob Dole (R-KS), and George Mitchell (D-ME), and led by former Senate Budget Committee Chairman Pete Domenici (R-NM) and former White House budget director Alice Rivlin --revealed its own plan to curb the Federal deficit. It received an equally strong response from many groups. Now the President’s Deficit Commission has released its more detailed draft report, and the full Commission is currently debating it. While different in some major respects, there are several areas where the various drafts seem to be heading in the same direction, including proposals dealing with the treatment of so-called “tax expenditures” related to retirement savings, and a recommendation to include future public employees in Social Security. Even if nothing more happens with these large “hot-button” packages of recommendations, will the specific proposals on which there appear to be some consensus forming take on a separate life of their own? If so, then major changes could lie ahead for public pensions.
Following a Congressional stalemate over its creation, the bipartisan Deficit Commission was created through Executive Order by President Obama in February of this year to address the nation's fiscal challenges. The Commission is charged with identifying policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run. Specifically, it is to propose recommendations designed to balance the budget, excluding interest payments on the debt, by 2015.
The Deficit Commission consists of 18 members: six members appointed by the President, not more than four of whom shall be from the same political party; three members selected by the Majority Leader of the Senate, all of whom shall be current Members of the Senate; three members selected by the Speaker of the House of Representatives, all of whom shall be current Members of the House of Representatives; three members selected by the Minority Leader of the Senate, all of whom shall be current Members of the Senate; and three members selected by the Minority Leader of the House of Representatives, all of whom shall be current Members of the House of Representatives.
In short, it consists of the very politicians who will have to overcome their entrenched opposition to the other side’s views if the Congress is ever to be able to ultimately reach a compromise and pass a true bipartisan deficit reform proposal.
A guaranteed recipe for failure, or the only hope for obtaining a real deal? The Commission was to vote on a final report containing a set of recommendations to achieve its mission no later than December 1st, but this has now been deferred to December 3rd. In order for there to be any such final report, it will require the approval of at least 14 of the Commission's 18 members.
If such a “super-majority” report is issued, Senate Majority Leader Harry Reid (D-NV) and current House Speaker Nancy Pelosi (D-CA) have promised to hold a vote on it before the current “lame duck” session of Congress adjourns sometime in December. However, according to recent press reports, there have been new assurances from Senator Reid and House Speaker-elect John Boehner (R-OH) that they would also agree to hold a vote in the next Congress as well.
Generally, the CoChair’s advance recommendations would provide for $4 trillion in cuts through 2020, with about 75 percent obtained from spending cuts and the other 25 percent from tax increases. The final draft report, released December 1st and, entitled “The Moment of Truth,” provides much more detail.
The plan has six major components:
(1) Discretionary spending cuts: hold spending in 2012 equal to or lower than spending in 2011, and return spending to pre-crisis 2008 levels in real terms in 2013. Limit future spending growth to half the projected inflation rate through 2020. Security as well as non-Security spending would be cut, but there would be a “firewall” between the two categories through 2015, with equal percentage cuts required from both broad categories.
(2) Tax reform: eliminate all “tax expenditures,” dedicate a portion of the additional revenue to deficit reduction, and use the remaining revenue to lower rates and add back necessary expenditures and credits.
(3) Health care savings: reform the Medicare Sustainable Growth Rate for physician payment and require the fix to be offset; reform or repeal the Community Living Assistance Services and Supports (CLASS) Act, the voluntary long-term care insurance program enacted as part of healthcare reform (the Affordable Care Act); reform Medicare cost-sharing rules by replacing the current structure with a single combined annual deductible of $550 for Part A (hospital) and Part B (medical care), along with 20 percent uniform coinsurance on health spending above the deductible; prohibit Medigap plans from covering the first $500 of an enrollee’s cost-sharing liabilities and limit coverage to 50 percent of the next $5,000 in Medicare cost-sharing; extend the Medicaid drug rebate to dual eligibles in Part D; transform the Federal Employees Health Benefits (FEHB) program into a defined contribution premium support plan that offers federal employees a fixed subsidy that grows by no more than GDP plus 1 percent each year, and, based on the experience with that change, consider transforming Medicare into a similar “premium support” system that offers seniors a fixed subsidy (adjusted by geographic area and by individual health risk) to purchase health coverage from competing insurers; and establish a global budget for total federal health care costs and limit the growth to GDP plus 1 percent.
(4) Reform other mandatory programs (i.e., civilian and military retirement, income support programs, veterans’ benefits, agricultural subsidies, student loans, and others): create a federal workforce entitlement task force to re-evaluate civil service and military health and retirement programs to “bring both systems more in line with standard practices from the private sector,” including using highest five years of salary vs. three in calculating benefits, deferring COLAs until age 62, and equalizing employer/employee contributions; eliminate income-based subsidies for federal student loan borrowers; and provide the PBGC authority to increase premiums.
(5) Social Security reform: modify the current three-bracket formula to a more progressive four-bracket formula; gradually increase early and full retirement ages, based on increases in life expectancy (i.e. increase the SS Normal Retirement Age to 68 by about 2050 and 69 by about 2075, and the Early Eligibility Age to 63 and 64 in lock step); gradually increase the taxable maximum to cover 90 percent of wages by 2050; use the chained CPI to calculate the Cost of Living Adjustment for Social Security beneficiaries; and require mandatory coverage of newly hired state and local workers after 2020.
(6) Reforms in Processes: adopt the “chain-weighted” Consumer Price Index for Urban Consumers (C-CPI-U) for all federal programs and tax provisions that currently rely on the CPI-U and CPI-W; establish a debt stabilization process to enforce deficit reduction targets; and conduct a complete review of all budget scoring practices (“budget concepts”) by the budget committees, the Congressional Budget Office, and the Office of Management and Budget.
The Domenici-Rivlin Task Force plan would be divided about 60-40 between spending cuts and tax increases, with a new 6.5 percent national sales tax. Other proposals include a gradual increase in Medicare Part B premiums from 25 to 35 percent of total program costs and a transition of Medicare, starting in 2018, to a “premium support” program that limits growth in per-beneficiary Federal support; an increase in the amount of wages subject to Social Security payroll taxes to eventually cover 90 percent of all wages; and a reduction in the growth in benefits compared to current law for approximately the top 25 percent of Social Security beneficiaries.
While the “smart money” is currently betting that there will not be the required 14 votes for the Deficit Commission to issue a formal report, the release of the CoChairs’ recommendations has served to spark a debate in earnest over deficit reduction nonetheless. The more detailed report on which a vote will be held will advance that discussion. Finally, the Domenici-Rivlin Task Force plan has presented another serious set of alternatives for consideration, and likely bolstered support for areas where it and the Presidential Commission’s report are in agreement. Given the interest in and commitment to addressing the Federal deficit on the part of many GOP freshmen, it is not outside the realm of possibility that the 112th Congress could make a real stab at taking on the gargantuan challenge that serious reform efforts must entail.
Then again, pigs might fly, but it’s not very likely.
Sadly, the partisan rancor in Congress has not been diminished by the mid-term elections, and activist victories on both sides of the aisle have only served to make bipartisan cooperation even less likely. However, there is also a growing sense that “something must be done.” So although comprehensive deficit reduction efforts may not be possible, certain aspects of reform could be addressed piecemeal in an effort to at least get the ball rolling.
Which suggests it would be prudent to give closer consideration to certain proposals that seem to be garnering increased attention and consensus, several of which could have serious implications for public pensions. One such area is reform of the current tax treatment of retirement savings.
The Deficit Commission report recommends the House Committee on Ways and Means and the Senate Committee on Finance, in cooperation with the Department of the Treasury, be required to report out comprehensive tax reform legislation through a fast track process by 2012. This reform should rely on “zero-base budgeting” by eliminating all existing income tax expenditures, and then using the revenue to lower rates and reduce deficits. A small number of “simpler, more targeted provisions that promote work, home ownership, health care, charity, and savings” would replace the current tax structures.
Tax expenditures are losses to the U.S. treasury (i.e. tax revenues that the Federal government would otherwise collect) that result from granting certain deductions, exemptions, deferrals or credits to specific categories of taxpayers in order to encourage or promote certain policy objectives, such as home ownership in the case of the home mortgage interest deduction. In effect, tax expenditures are an indirect form of government spending on policy programs.
The largest of these expenditures in FY 2009, according to the Congressional Joint Committee on Taxation, were the exclusion of health benefits from income taxation ($94.4 billion), the home mortgage deduction ($86.4 billion), and the net exclusion of pension contributions and earnings associated with defined benefit and defined contribution retirement plans ($73 billion). For defined benefit plans alone, the five year total (FY 2009 through FY 2013) is estimated to be $275.7 billion.
The Deficit Commission’s so-called “Zero Plan” elimination of these and all other tax expenditures would produce a bottom tax rate of 8 percent, a middle tax rate of 14 percent and a top individual tax rate of 23 percent. The corporate tax rate would be 26 percent. Then, by adding back a number of ”reformed” tax expenditures, the rates would rise to 12 percent, 22 percent and 28 percent, respectively. The corporate rate would be 28 percent.
These new tax expenditures would be smaller and more targeted than under current law. The Commission report recommends that the new tax code must include provisions (in some cases permanent, in others temporary) for the following:
• Support for low-income workers and families (e.g., the child credit and EITC);
• Mortgage interest only for principal residences;
• Employer-provided health insurance;
• Charitable giving;
• Retirement savings and pensions.
Let’s be clear: completely eliminating the current tax expenditures for retirement savings would no longer permit employee contributions to their pensions – a DB plan or DC plan -- to be made in pre-tax dollars. Thus, in cases where the public employee contribution was being picked up, employees’ take home compensation would no longer be reduced by the contribution amount for Federal tax purposes. Furthermore, investment returns would no longer be treated as tax-deferred. DB pension plan trust funds would become taxpayers and the impact on the compounding effect of permitting the inside build-up to be tax-deferred until paid out in the form of a pension would be devastating.
Therefore, whatever replaces the retirement savings tax expenditures will be critical to the future survival of pension plans. As an “illustration” of what the Deficit Commission believes would be an appropriate reform in this area, it would “consolidate retirement accounts; cap tax-preferred contributions to lower of $20,000 or 20% of income, expand saver’s credit.” This appears to be primarily focused on defined contribution plans, and it is unclear if the tax expenditure structures related to defined benefit plans would be left untouched.
However, this would in fact be the case under the Domenici-Rivlin Task Force. It would also restructure itemized deductions and eliminate “almost all” tax expenditures. However, the Task Force proposes that tax expenditure related to employer defined benefit retirement plans be retained, while those associated with 401(k) plans, Individual Retirement Accounts, and Keogh plans would be modified.
In the Task Force’s own words, most individuals would “retain the ability to contribute enough to qualified retirement plans to accumulate enough tax-free assets to purchase an annuity that replaces a substantial share of their earnings in retirement.” Specifically, individuals and employers combined “will be able to contribute up to 20 percent of annual earnings to such qualified plans, up to a maximum of $20,000 per year, indexed to inflation.” The goal is to ensure that “qualified plans will no longer be a vehicle for wealthy individuals to convert a substantial share of their assets into tax-free retirement assets.”
While the suggestions for changes in the Federal tax code vary in a number of significant ways between the Bowles-Simpson Deficit Commission recommendations and the Domenici -Rivlin Task Force plan, there is one striking similarity involving Social Security coverage for public employees.
Specifically, both the Deficit Commission recommendations and the Domenici-Rivlin Task Force plan propose to require that all newly-hired employees of state and local governments after 2020 be covered under Social Security. In addition, state and local pension plans would be required to share data with the Social Security Administration until the transition is complete.
The Deficit Commission believes that excluding some public employees from Social Security and instead maintaining separate retirement systems “has become riskier for both government sponsors and for program participants and a potential future bailout risk for the federal government” due to prolonged fiscal challenges and an aging workforce. Their argument is that mandatory coverage is necessary to mitigate these risks. “Full coverage will simplify retirement planning and benefit coordination for workers who spend part of their career working in state and local governments,” the deficit Commission argues, “ and will ensure that all workers, regardless of employer, will retire with a secure and predictable benefit check.”
The Domenici-Rivlin Task Force takes a somewhat similar tack, explaining that not only will “[i]ncorporating these new government employees reflects the goal of increasing the universality of Social Security, which was pursued throughout the second half of the 20th century,” but it will also “provide better disability and survivor insurance protection for many workers who move between government employment and other jobs.”
The Task Force explains the delayed effective date as an acknowledgement of the “poor fiscal condition of state and local governments” as well as what they refer to as “the significant underfunding of public employee pensions.” According to the Task Force, this “grace period” is intended to provide governments the time to “shore up and reform their pension systems.” The Task Force concludes that “Over the long run, covering all of their employees under Social Security could help states and localities get their fiscal houses in order through transitioning to more sustainable pension programs.”
What is the likelihood that either of these kinds of proposals – changes in the tax incentives for retirement savings or mandatory Social Security for public sector new hires – could gain momentum in the upcoming Congress?
First, the impact of tax expenditures – both on the Federal budget as well as on the goals they were designed to achieve – has come under increasing scrutiny. As has been pointed out recently by the Committee for a Responsible Federal Budget – a bipartisan, non-profit organization made up of some of the nation's leading budget experts including many of the past Directors of the Budget Committees, the Congressional Budget Office, the Office of Management and Budget and the Federal Reserve Board –“the great political appeal-of tax expenditures is that they are not subject to annual budget review: they are created without the same level of scrutiny received by other areas of the budget, and then run open-ended with little review. Because they escape the normal budget process, policymakers have found them particularly attractive, and the tax expenditure budget has grown tremendously.”
Currently, the tax code contains around 250 tax expenditures. Most recently, the largest of them, the exclusion for employer-provided healthcare, was a major focus during the healthcare reform debate, particularly in the Senate Finance Committee. It estimated that the exclusion of employer-sponsored health care from income, when added to the other healthcare subsidies in the Internal Revenue Code, such as the exclusion of Medicare benefits from income, and factoring in the reduction in payroll taxes, produced a total tax “spending” on health care of $287.7 billion in 2008.
With 46 million Americans lacking healthcare coverage at the time, the question became whether this Federal tax expenditure was a fair one, or if it resulted in discriminatory treatment of those who do not have employer-provided coverage, many of whom are also low-income workers. Although the Finance Committee toyed with the idea of capping the health tax expenditures – such as limiting the value of employer-provided health coverage that is excludible from gross income to some specific dollar amount or applying such a limit only to taxpayers whose incomes exceed a threshold – the end result was the excise tax on so-called “Cadillac” health plans, currently set to take effect in 2018. This tax has the same effect of limiting the tax expenditure.
The same kind of concerns can be raised with the tax expenditures related to retirement savings. After all, since most low-wage workers do not participate in IRAs and have limited access to 401(k)s or other employer-provided pensions, it is effectively a tax subsidy primarily skewed to middle- and high-income wage earners.
There are those who have argued that taxing pensions on a deferred basis can be justified only if pension plans provide rank and file employees with retirement benefits that they would not have accumulated on their own, or, failing that test, if they increase the saving of those who are covered so that national saving and capital accumulation are greater than they would have been otherwise. However, that does not appear to have been the case with the retirement savings tax expenditure, and some experts therefore have concluded that pensions benefit a relatively privileged minority of the population, while all taxpayers face higher rates to cover the preferences accorded qualified plans.
Therefore, the idea that tax expenditures related to retirement savings are somehow sacrosanct is a dangerous assumption to make. Also, the idea that eliminating such tax expenditures would result in taxation of pensions is no reason for Congress to automatically reject it. In fact, the Congressional Budget Office (CBO) has proposed a flat 5% tax on pension investment earnings in the past as a possible revenue raiser that Congress could consider.
Also, during the early years of the first Clinton Administration, no less an authority on pensions than Alicia Munnell, currently the director of the Center for Retirement Research at Boston College, argued that the time had come for the current taxation of qualified pension plans. Her 1992 proposal was for an annual 15% tax on pension contributions and pension fund earnings, paid at the fund level, with benefits then withdrawn tax free.
As for the problem of dealing with State and local governmental plans, Ms. Munnell recognized that ways would have to be devised to work around constitutional constraints against direct taxation, and she suggested, as one possibility, enactment of an alternative tax whereby contributions and earnings would be attributed to individual employees and taxed at a rate greater than the rate applied to the plan if the tax were not paid at the fund level.
However, she also realized that State and local governments, being exempt from ERISA, could respond by reducing their funding efforts to offset the impact of the tax, so she also recommended that any effort to tax pension accruals for State and local employees “would have to be accompanied by federal legislation to regulate funding of government plans.”
Therefore, eliminating or otherwise “reforming” the pension tax preferences can be done, even for public plans. Furthermore, to think that only DC plans will take a “haircut” under any reforms of the retirement savings tax expenditures is unrealistic, particularly given that they represent a greater portion of the overall “costs” when compared with DC plans. The fact that defined benefit plans are now primarily the retirement savings vehicle of choice for public employees also plays into the hands of those who think that public employees are already paid too much and are treated as a special class of employee compared to most private sector American workers. They will not be willing to leave DB plans unscathed.
Is the time therefore finally ripe to make major revisions to the tax structures supporting retirement savings? Having some specific reform proposals on the table, with an increasing consensus on how to accomplish this reform, definitely increases the likelihood that the answer may well be “yes.” This is particularly so if it is done in the overall context of necessary deficit reduction efforts, and other tax expenditures such as those associated with the home mortgage deduction and employer-provided healthcare are also being modified.
Turning to the question of mandatory Social Security coverage for all new hires of State and local government, this is an idea whose time has appeared to have arrived numerous times in the past. Yet it has always eventually been abandoned as too disruptive and costly for State and local governments, with too little benefit to overall Social Security reform. Indeed, it has always been assumed that such an effort would not be considered separate and apart from a discussion of Social Security solvency.
But that was then. This is now. And the rhetoric surrounding the proposal in both the Deficit Commission and the Domenici-Rivlin Task Force plan suggests a new approach for supporters of such an effort: it is necessary as a means of reforming State and local pension systems to make them “more sustainable” and to avoid the need for a Federal bailout If this idea takes root, it could well play beautifully into the hands of those who are anxious to appear to be helping address the “impending” financial threat that underfunded public plans pose to their sponsors, their participants, and eventually to the Federal government.
Therefore, the fact that both major deficit reduction plans include mandatory Social Security should not be taken lightly, and that their rhetoric to support the move has changed. If Congress becomes convinced that it must “do something” to address a perceived public pension crisis, mandatory coverage could surface as one piece of some larger, overall package designed to make State and local governments “reform” their pensions to become more sustainable. If mandatory coverage is effectively removed from the context of overall Social Security reform, where it has always been able to be argued as providing too little relief at too great a cost, it will change the entire tenor of the discussion. Public plans would do well to anticipate such a possibility and prepare themselves accordingly.
• Deficit Commission Final Report
• Bowles-Simpson Deficit Commission CoChair Recommendations
• Domenici-Rivlin Task Force Plan
Following a Congressional stalemate over its creation, the bipartisan Deficit Commission was created through Executive Order by President Obama in February of this year to address the nation's fiscal challenges. The Commission is charged with identifying policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run. Specifically, it is to propose recommendations designed to balance the budget, excluding interest payments on the debt, by 2015.
The President’s Deficit Commission (Bowles-Simpson)
The Deficit Commission consists of 18 members: six members appointed by the President, not more than four of whom shall be from the same political party; three members selected by the Majority Leader of the Senate, all of whom shall be current Members of the Senate; three members selected by the Speaker of the House of Representatives, all of whom shall be current Members of the House of Representatives; three members selected by the Minority Leader of the Senate, all of whom shall be current Members of the Senate; and three members selected by the Minority Leader of the House of Representatives, all of whom shall be current Members of the House of Representatives.
In short, it consists of the very politicians who will have to overcome their entrenched opposition to the other side’s views if the Congress is ever to be able to ultimately reach a compromise and pass a true bipartisan deficit reform proposal.
A guaranteed recipe for failure, or the only hope for obtaining a real deal? The Commission was to vote on a final report containing a set of recommendations to achieve its mission no later than December 1st, but this has now been deferred to December 3rd. In order for there to be any such final report, it will require the approval of at least 14 of the Commission's 18 members.
If such a “super-majority” report is issued, Senate Majority Leader Harry Reid (D-NV) and current House Speaker Nancy Pelosi (D-CA) have promised to hold a vote on it before the current “lame duck” session of Congress adjourns sometime in December. However, according to recent press reports, there have been new assurances from Senator Reid and House Speaker-elect John Boehner (R-OH) that they would also agree to hold a vote in the next Congress as well.
Generally, the CoChair’s advance recommendations would provide for $4 trillion in cuts through 2020, with about 75 percent obtained from spending cuts and the other 25 percent from tax increases. The final draft report, released December 1st and, entitled “The Moment of Truth,” provides much more detail.
The plan has six major components:
(1) Discretionary spending cuts: hold spending in 2012 equal to or lower than spending in 2011, and return spending to pre-crisis 2008 levels in real terms in 2013. Limit future spending growth to half the projected inflation rate through 2020. Security as well as non-Security spending would be cut, but there would be a “firewall” between the two categories through 2015, with equal percentage cuts required from both broad categories.
(2) Tax reform: eliminate all “tax expenditures,” dedicate a portion of the additional revenue to deficit reduction, and use the remaining revenue to lower rates and add back necessary expenditures and credits.
(3) Health care savings: reform the Medicare Sustainable Growth Rate for physician payment and require the fix to be offset; reform or repeal the Community Living Assistance Services and Supports (CLASS) Act, the voluntary long-term care insurance program enacted as part of healthcare reform (the Affordable Care Act); reform Medicare cost-sharing rules by replacing the current structure with a single combined annual deductible of $550 for Part A (hospital) and Part B (medical care), along with 20 percent uniform coinsurance on health spending above the deductible; prohibit Medigap plans from covering the first $500 of an enrollee’s cost-sharing liabilities and limit coverage to 50 percent of the next $5,000 in Medicare cost-sharing; extend the Medicaid drug rebate to dual eligibles in Part D; transform the Federal Employees Health Benefits (FEHB) program into a defined contribution premium support plan that offers federal employees a fixed subsidy that grows by no more than GDP plus 1 percent each year, and, based on the experience with that change, consider transforming Medicare into a similar “premium support” system that offers seniors a fixed subsidy (adjusted by geographic area and by individual health risk) to purchase health coverage from competing insurers; and establish a global budget for total federal health care costs and limit the growth to GDP plus 1 percent.
(4) Reform other mandatory programs (i.e., civilian and military retirement, income support programs, veterans’ benefits, agricultural subsidies, student loans, and others): create a federal workforce entitlement task force to re-evaluate civil service and military health and retirement programs to “bring both systems more in line with standard practices from the private sector,” including using highest five years of salary vs. three in calculating benefits, deferring COLAs until age 62, and equalizing employer/employee contributions; eliminate income-based subsidies for federal student loan borrowers; and provide the PBGC authority to increase premiums.
(5) Social Security reform: modify the current three-bracket formula to a more progressive four-bracket formula; gradually increase early and full retirement ages, based on increases in life expectancy (i.e. increase the SS Normal Retirement Age to 68 by about 2050 and 69 by about 2075, and the Early Eligibility Age to 63 and 64 in lock step); gradually increase the taxable maximum to cover 90 percent of wages by 2050; use the chained CPI to calculate the Cost of Living Adjustment for Social Security beneficiaries; and require mandatory coverage of newly hired state and local workers after 2020.
(6) Reforms in Processes: adopt the “chain-weighted” Consumer Price Index for Urban Consumers (C-CPI-U) for all federal programs and tax provisions that currently rely on the CPI-U and CPI-W; establish a debt stabilization process to enforce deficit reduction targets; and conduct a complete review of all budget scoring practices (“budget concepts”) by the budget committees, the Congressional Budget Office, and the Office of Management and Budget.
The Debt Reduction Task Force (Domenici-Rivlin)
The Domenici-Rivlin Task Force plan would be divided about 60-40 between spending cuts and tax increases, with a new 6.5 percent national sales tax. Other proposals include a gradual increase in Medicare Part B premiums from 25 to 35 percent of total program costs and a transition of Medicare, starting in 2018, to a “premium support” program that limits growth in per-beneficiary Federal support; an increase in the amount of wages subject to Social Security payroll taxes to eventually cover 90 percent of all wages; and a reduction in the growth in benefits compared to current law for approximately the top 25 percent of Social Security beneficiaries.
Overall Prognosis
While the “smart money” is currently betting that there will not be the required 14 votes for the Deficit Commission to issue a formal report, the release of the CoChairs’ recommendations has served to spark a debate in earnest over deficit reduction nonetheless. The more detailed report on which a vote will be held will advance that discussion. Finally, the Domenici-Rivlin Task Force plan has presented another serious set of alternatives for consideration, and likely bolstered support for areas where it and the Presidential Commission’s report are in agreement. Given the interest in and commitment to addressing the Federal deficit on the part of many GOP freshmen, it is not outside the realm of possibility that the 112th Congress could make a real stab at taking on the gargantuan challenge that serious reform efforts must entail.
Then again, pigs might fly, but it’s not very likely.
Sadly, the partisan rancor in Congress has not been diminished by the mid-term elections, and activist victories on both sides of the aisle have only served to make bipartisan cooperation even less likely. However, there is also a growing sense that “something must be done.” So although comprehensive deficit reduction efforts may not be possible, certain aspects of reform could be addressed piecemeal in an effort to at least get the ball rolling.
Which suggests it would be prudent to give closer consideration to certain proposals that seem to be garnering increased attention and consensus, several of which could have serious implications for public pensions. One such area is reform of the current tax treatment of retirement savings.
Tax Reform: Retirement Savings Tax Expenditures
The Deficit Commission report recommends the House Committee on Ways and Means and the Senate Committee on Finance, in cooperation with the Department of the Treasury, be required to report out comprehensive tax reform legislation through a fast track process by 2012. This reform should rely on “zero-base budgeting” by eliminating all existing income tax expenditures, and then using the revenue to lower rates and reduce deficits. A small number of “simpler, more targeted provisions that promote work, home ownership, health care, charity, and savings” would replace the current tax structures.
Tax expenditures are losses to the U.S. treasury (i.e. tax revenues that the Federal government would otherwise collect) that result from granting certain deductions, exemptions, deferrals or credits to specific categories of taxpayers in order to encourage or promote certain policy objectives, such as home ownership in the case of the home mortgage interest deduction. In effect, tax expenditures are an indirect form of government spending on policy programs.
The largest of these expenditures in FY 2009, according to the Congressional Joint Committee on Taxation, were the exclusion of health benefits from income taxation ($94.4 billion), the home mortgage deduction ($86.4 billion), and the net exclusion of pension contributions and earnings associated with defined benefit and defined contribution retirement plans ($73 billion). For defined benefit plans alone, the five year total (FY 2009 through FY 2013) is estimated to be $275.7 billion.
The Deficit Commission’s so-called “Zero Plan” elimination of these and all other tax expenditures would produce a bottom tax rate of 8 percent, a middle tax rate of 14 percent and a top individual tax rate of 23 percent. The corporate tax rate would be 26 percent. Then, by adding back a number of ”reformed” tax expenditures, the rates would rise to 12 percent, 22 percent and 28 percent, respectively. The corporate rate would be 28 percent.
These new tax expenditures would be smaller and more targeted than under current law. The Commission report recommends that the new tax code must include provisions (in some cases permanent, in others temporary) for the following:
• Support for low-income workers and families (e.g., the child credit and EITC);
• Mortgage interest only for principal residences;
• Employer-provided health insurance;
• Charitable giving;
• Retirement savings and pensions.
Let’s be clear: completely eliminating the current tax expenditures for retirement savings would no longer permit employee contributions to their pensions – a DB plan or DC plan -- to be made in pre-tax dollars. Thus, in cases where the public employee contribution was being picked up, employees’ take home compensation would no longer be reduced by the contribution amount for Federal tax purposes. Furthermore, investment returns would no longer be treated as tax-deferred. DB pension plan trust funds would become taxpayers and the impact on the compounding effect of permitting the inside build-up to be tax-deferred until paid out in the form of a pension would be devastating.
Therefore, whatever replaces the retirement savings tax expenditures will be critical to the future survival of pension plans. As an “illustration” of what the Deficit Commission believes would be an appropriate reform in this area, it would “consolidate retirement accounts; cap tax-preferred contributions to lower of $20,000 or 20% of income, expand saver’s credit.” This appears to be primarily focused on defined contribution plans, and it is unclear if the tax expenditure structures related to defined benefit plans would be left untouched.
However, this would in fact be the case under the Domenici-Rivlin Task Force. It would also restructure itemized deductions and eliminate “almost all” tax expenditures. However, the Task Force proposes that tax expenditure related to employer defined benefit retirement plans be retained, while those associated with 401(k) plans, Individual Retirement Accounts, and Keogh plans would be modified.
In the Task Force’s own words, most individuals would “retain the ability to contribute enough to qualified retirement plans to accumulate enough tax-free assets to purchase an annuity that replaces a substantial share of their earnings in retirement.” Specifically, individuals and employers combined “will be able to contribute up to 20 percent of annual earnings to such qualified plans, up to a maximum of $20,000 per year, indexed to inflation.” The goal is to ensure that “qualified plans will no longer be a vehicle for wealthy individuals to convert a substantial share of their assets into tax-free retirement assets.”
Mandatory Social Security Coverage
While the suggestions for changes in the Federal tax code vary in a number of significant ways between the Bowles-Simpson Deficit Commission recommendations and the Domenici -Rivlin Task Force plan, there is one striking similarity involving Social Security coverage for public employees.
Specifically, both the Deficit Commission recommendations and the Domenici-Rivlin Task Force plan propose to require that all newly-hired employees of state and local governments after 2020 be covered under Social Security. In addition, state and local pension plans would be required to share data with the Social Security Administration until the transition is complete.
The Deficit Commission believes that excluding some public employees from Social Security and instead maintaining separate retirement systems “has become riskier for both government sponsors and for program participants and a potential future bailout risk for the federal government” due to prolonged fiscal challenges and an aging workforce. Their argument is that mandatory coverage is necessary to mitigate these risks. “Full coverage will simplify retirement planning and benefit coordination for workers who spend part of their career working in state and local governments,” the deficit Commission argues, “ and will ensure that all workers, regardless of employer, will retire with a secure and predictable benefit check.”
The Domenici-Rivlin Task Force takes a somewhat similar tack, explaining that not only will “[i]ncorporating these new government employees reflects the goal of increasing the universality of Social Security, which was pursued throughout the second half of the 20th century,” but it will also “provide better disability and survivor insurance protection for many workers who move between government employment and other jobs.”
The Task Force explains the delayed effective date as an acknowledgement of the “poor fiscal condition of state and local governments” as well as what they refer to as “the significant underfunding of public employee pensions.” According to the Task Force, this “grace period” is intended to provide governments the time to “shore up and reform their pension systems.” The Task Force concludes that “Over the long run, covering all of their employees under Social Security could help states and localities get their fiscal houses in order through transitioning to more sustainable pension programs.”
What Are the Chances: Retirement Savings Reform?
What is the likelihood that either of these kinds of proposals – changes in the tax incentives for retirement savings or mandatory Social Security for public sector new hires – could gain momentum in the upcoming Congress?
First, the impact of tax expenditures – both on the Federal budget as well as on the goals they were designed to achieve – has come under increasing scrutiny. As has been pointed out recently by the Committee for a Responsible Federal Budget – a bipartisan, non-profit organization made up of some of the nation's leading budget experts including many of the past Directors of the Budget Committees, the Congressional Budget Office, the Office of Management and Budget and the Federal Reserve Board –“the great political appeal-of tax expenditures is that they are not subject to annual budget review: they are created without the same level of scrutiny received by other areas of the budget, and then run open-ended with little review. Because they escape the normal budget process, policymakers have found them particularly attractive, and the tax expenditure budget has grown tremendously.”
Currently, the tax code contains around 250 tax expenditures. Most recently, the largest of them, the exclusion for employer-provided healthcare, was a major focus during the healthcare reform debate, particularly in the Senate Finance Committee. It estimated that the exclusion of employer-sponsored health care from income, when added to the other healthcare subsidies in the Internal Revenue Code, such as the exclusion of Medicare benefits from income, and factoring in the reduction in payroll taxes, produced a total tax “spending” on health care of $287.7 billion in 2008.
With 46 million Americans lacking healthcare coverage at the time, the question became whether this Federal tax expenditure was a fair one, or if it resulted in discriminatory treatment of those who do not have employer-provided coverage, many of whom are also low-income workers. Although the Finance Committee toyed with the idea of capping the health tax expenditures – such as limiting the value of employer-provided health coverage that is excludible from gross income to some specific dollar amount or applying such a limit only to taxpayers whose incomes exceed a threshold – the end result was the excise tax on so-called “Cadillac” health plans, currently set to take effect in 2018. This tax has the same effect of limiting the tax expenditure.
The same kind of concerns can be raised with the tax expenditures related to retirement savings. After all, since most low-wage workers do not participate in IRAs and have limited access to 401(k)s or other employer-provided pensions, it is effectively a tax subsidy primarily skewed to middle- and high-income wage earners.
There are those who have argued that taxing pensions on a deferred basis can be justified only if pension plans provide rank and file employees with retirement benefits that they would not have accumulated on their own, or, failing that test, if they increase the saving of those who are covered so that national saving and capital accumulation are greater than they would have been otherwise. However, that does not appear to have been the case with the retirement savings tax expenditure, and some experts therefore have concluded that pensions benefit a relatively privileged minority of the population, while all taxpayers face higher rates to cover the preferences accorded qualified plans.
Therefore, the idea that tax expenditures related to retirement savings are somehow sacrosanct is a dangerous assumption to make. Also, the idea that eliminating such tax expenditures would result in taxation of pensions is no reason for Congress to automatically reject it. In fact, the Congressional Budget Office (CBO) has proposed a flat 5% tax on pension investment earnings in the past as a possible revenue raiser that Congress could consider.
Also, during the early years of the first Clinton Administration, no less an authority on pensions than Alicia Munnell, currently the director of the Center for Retirement Research at Boston College, argued that the time had come for the current taxation of qualified pension plans. Her 1992 proposal was for an annual 15% tax on pension contributions and pension fund earnings, paid at the fund level, with benefits then withdrawn tax free.
As for the problem of dealing with State and local governmental plans, Ms. Munnell recognized that ways would have to be devised to work around constitutional constraints against direct taxation, and she suggested, as one possibility, enactment of an alternative tax whereby contributions and earnings would be attributed to individual employees and taxed at a rate greater than the rate applied to the plan if the tax were not paid at the fund level.
However, she also realized that State and local governments, being exempt from ERISA, could respond by reducing their funding efforts to offset the impact of the tax, so she also recommended that any effort to tax pension accruals for State and local employees “would have to be accompanied by federal legislation to regulate funding of government plans.”
Therefore, eliminating or otherwise “reforming” the pension tax preferences can be done, even for public plans. Furthermore, to think that only DC plans will take a “haircut” under any reforms of the retirement savings tax expenditures is unrealistic, particularly given that they represent a greater portion of the overall “costs” when compared with DC plans. The fact that defined benefit plans are now primarily the retirement savings vehicle of choice for public employees also plays into the hands of those who think that public employees are already paid too much and are treated as a special class of employee compared to most private sector American workers. They will not be willing to leave DB plans unscathed.
Is the time therefore finally ripe to make major revisions to the tax structures supporting retirement savings? Having some specific reform proposals on the table, with an increasing consensus on how to accomplish this reform, definitely increases the likelihood that the answer may well be “yes.” This is particularly so if it is done in the overall context of necessary deficit reduction efforts, and other tax expenditures such as those associated with the home mortgage deduction and employer-provided healthcare are also being modified.
What Are the Chances: Mandatory Social Security?
Turning to the question of mandatory Social Security coverage for all new hires of State and local government, this is an idea whose time has appeared to have arrived numerous times in the past. Yet it has always eventually been abandoned as too disruptive and costly for State and local governments, with too little benefit to overall Social Security reform. Indeed, it has always been assumed that such an effort would not be considered separate and apart from a discussion of Social Security solvency.
But that was then. This is now. And the rhetoric surrounding the proposal in both the Deficit Commission and the Domenici-Rivlin Task Force plan suggests a new approach for supporters of such an effort: it is necessary as a means of reforming State and local pension systems to make them “more sustainable” and to avoid the need for a Federal bailout If this idea takes root, it could well play beautifully into the hands of those who are anxious to appear to be helping address the “impending” financial threat that underfunded public plans pose to their sponsors, their participants, and eventually to the Federal government.
Therefore, the fact that both major deficit reduction plans include mandatory Social Security should not be taken lightly, and that their rhetoric to support the move has changed. If Congress becomes convinced that it must “do something” to address a perceived public pension crisis, mandatory coverage could surface as one piece of some larger, overall package designed to make State and local governments “reform” their pensions to become more sustainable. If mandatory coverage is effectively removed from the context of overall Social Security reform, where it has always been able to be argued as providing too little relief at too great a cost, it will change the entire tenor of the discussion. Public plans would do well to anticipate such a possibility and prepare themselves accordingly.
• Deficit Commission Final Report
• Bowles-Simpson Deficit Commission CoChair Recommendations
• Domenici-Rivlin Task Force Plan
GAO Looks at GASB's Role in Municipal Securities Markets: Increased Scrutiny of Public Pension Accounting, Disclosure Practices Likely
The Government Accountability Office (GAO) has been tasked with a number of new studies as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into law on July 21, 2010. One of the mandates in the Act specifically requires GAO to study the role and importance of the Governmental Accounting Standards Board (GASB) in the municipal securities markets. Based on the Securities and Exchange Commission (SEC) settlement with the state of New Jersey over disclosures in its bond offerings related to its pension funds, it appears increasingly likely that public plan accounting and disclosures are going to be the subject of increased Federal attention and scrutiny
The new financial markets reform law, commonly referred to as “Dodd-Frank” in honor of the two Committee Chairmen who shepherded it through the Congress – Senate Banking Committee Chairman Christopher Dodd (D-CT) and House Financial Services Committee Chairman Barney Frank (D-MA) ---requires a number of studies to be conducted by the GAO dealing with municipal securities.
For example, one study, due within two years, is to review the disclosures made by municipal issuers, describing them and comparing their amount, frequency, and quality to those disclosures provided by corporate issuers. The GAO is also to evaluate and make recommendations regarding additional municipal disclosure requirements. Finally, the study is required to address “the advisability of the repeal or retention” of the so-called “Tower Amendment.” The Tower Amendment, named after former Senator John Tower (R-TX), prohibits the SEC and the Municipal Securities Rulemaking Board (MSRB) from requiring (directly or indirectly) municipal issuers to file municipal securities documents with the SEC or MSRB before the securities are sold.
Another study, due within 18 months, requires the GAO to provide an analysis of the mechanisms for trading, quality of trade executions, market transparency, trade reporting, price discovery, settlement clearing, and credit enhancements in the municipal bond market. The GAO is also to assess the needs of the markets and investors and the impact of recent innovations, and make recommendations on possible improvements in the transparency, efficiency, fairness, and liquidity of trading in the municipal securities markets. Finally, the study asks for information about the potential uses of derivatives in the municipal securities markets.
A third GAO study requires the agency to examine the role and importance of GASB in the municipal securities markets and to study the manner and the level at which GASB has been funded. This study must be completed by January 17, 2011, and the GAO must “consult with the principal organizations representing State governors, legislators, local elected officials, and State and local finance officers” in developing its report.
This GAO study of GASB should be of particular interest and concern to public pensions for a number of reasons. First, by way of background, GASB is recognized by the American Institute of Certified Public Accountants (AICPA) as the body that sets generally accepted accounting principles (GAAP) for State and local governments. Its funding currently comes “in part from sales of its own publications and in part from state and local governments and the municipal bond community,” according to GASB.
Even though compliance with GASB standards is often required by the laws of some States and through the audit process (whereby auditors render opinions on the fairness of financial statement presentations in conformity with GASB’s GAAP), there are no Federal statutory or regulatory requirements that State or local governments -- even those with public securities outstanding -- must comply with GASB standards. Finally, unlike the generally accepted accounting principles produced for private-sector entities by the Financial Accounting Standards Board (FASB), neither the SEC nor any other regulator has oversight over GASB’s standards.
This drives the SEC nuts.
For years now, and on a bipartisan basis, the Commission has therefore been intent on gaining control of GASB. Most recently, SEC Commissioner Elisse Walter has urged that Congress should provide for an independent and more reliable funding mechanism for GASB as well as SEC oversight. Although Dodd-Frank did not authorize such oversight, it did provide that the SEC may, in consultation with the principal organizations representing State governors, legislators, local elected officials, and State and local finance officers, require the Financial Industry Regulatory Authority (FINRA) to impose “a reasonable annual accounting support fee to adequately fund the annual budget” of GASB. However, there is no requirement as to when or even whether the SEC must exercise this authority.
Nevertheless, Commissioner Walter sees this as an important move in the right direction. As she recently put it, “the first step of independent funding is crucial. It should help to ensure GASB’s independence as a standard setter that is able to develop high-quality governmental accounting standards without undue pressure.”
Is the SEC effectively suggesting that GASB lacks independence; that its current governmental accounting standards are not “high-quality;” and that these standards have been developed under undue pressure – presumably from the entities who fund GASB? Some would suggest that the recent SEC settlement with the State of New Jersey confirms just that very kind of reading of her statement.
While the SEC New Jersey settlement primarily deals with New Jersey’s failures to adequately disclose pension underfunding and its potential effects on the state’s financial health, some of the findings in the SEC’s cease and desist order suggest that certain accounting methodologies—such as the smoothing of asset values, currently permissible under existing GASB standards—are nevertheless problematic. For example, the SEC found that New Jersey’s bond offering documents did not provide asset and funded ratio information on a market value basis, although it noted they were available in the state plans’ actuarial reports. Due to the significant difference between the smoothed actuarial value and market value of plan assets, the SEC found “the actuarial value did not accurately present the current value of the pension plans.”
The SEC has nevertheless insisted that the problem in New Jersey with the use of smoothed asset valuations and other GASB-approved accounting practices was a lack of their disclosure in the bond offering documents, and not with the actual numbers themselves.
Commissioner Walter, in a speech on October 29th of this year before the 43rd Annual Securities Regulation Seminar, discussed the new SEC focus on expanding its enforcement presence in the municipal area, building a comprehensive program that will develop case law and legal precedent through “high-impact cases.”
According to her, the new Municipal Securities and Public Pensions Unit “is focusing its efforts on investigating and pursuing enforcement actions in specific categories of misconduct, including: (1) offering and disclosure fraud; (2) tax or arbitrage-driven fraud; (3) pay-to-play and public corruption violations; (4) public pension accounting and disclosure violations; and (5) valuation and pricing fraud.”
Clearly, Commissioner Walter has distinguished “offering and disclosure fraud” from “public pension accounting and disclosure violations.” This would suggest that the SEC’s interest in this area is not just about disclosures of pension information contained in the official statements accompanying bond offerings, but rather that the SEC also feels it has the authority to investigate public pension accounting practices to determine if they violate the SEC’s anti-fraud laws.
Therefore, the GAO study of GASB’s role in the municipal securities market takes on added importance, as it could serve as the basis to argue for further SEC involvement in pension accounting practices and be used to document the need for SEC oversight of GASB. Furthermore, a GAO report critical of GASB could also serve to bolster arguments of opponents of public plans who claim that the accounting practices are outdated , rarely enforced, and designed to primarily serve the interests of pension plans and not of the users of their financial information, such as muni bond investors.
In short, it would provide significant support for the ideas behind the Nunes/Ryan/Issa legislation, discussed above.
So what is the status of this GAO report? A meeting with the various required national organizations was held with the GAO in early November in Washington, DC. Participants included GASB; the SEC; NASRA; the Government Finance Officers Association (GFOA); the Association of Local Government Auditors; the Association of Government Accountants; the Securities Industry and Financial Markets Association (SIFMA); the National League of Cities (NLC); the American Institute of Certified Public Accountants; Standard & Poor's; the Maryland State Treasurer's Office; the Association of School Business Officials;, the National Association of College and University Business Officers; the Investment Company Institute; T. Rowe Price; the International City/County Management Association (ICMA); the National Association of State Budget Officers (NASBO); the Financial Accounting Foundation (FAF); the National Association of State Auditors, Comptrollers and Treasurers (NASACT); the National Governors Association (NGA); the National Federation of Municipal Analysts; Insurance Industry Investors; the American Association of Individual Investors; the Native American Finance Officers Association; Moody's Investors Service; Fitch Ratings; the National Association of Counties (NACo); the National Conference of State Legislatures (NCSL); and the Council of State Governments.
The agenda included a discussion of the following questions, which suggest the focus of the GAO’s investigation and a possible outline of its report:
1. What are your perspectives on the extent of GAAP use by municipal issuers?
2. What are the characteristics of governments that are most likely and least likely to use GAAP in preparing financial statements?
3. What are the incentives and disincentives for governments to use GAAP for financial statement reporting?
4. To what extent does GAAP-basis financial reporting meet the needs of market participants, such as securities analysts, rating agencies, and investors, in comparison with other bases of accounting?
5. Are there particular types of municipal securities or issuers for which GAAP basis financial statements provide the most benefit?
6. How does a municipal issuer's use of GAAP-basis financial statements impact its ability to issue debt or lower its borrowing costs in contrast to non-GAAP financial statements?
7. Are there current limitations in GAAP that affect the use of GAAP-basis financial statements for assessing the quality of a municipal security?
8. Are there differences in cost for municipal issuers preparing GAAP-basis financial statements compared to financial statements prepared on another basis?
9. Has market participants' perception of the usefulness of GAAP-basis financial statements changed as a result of the credit crisis or the subsequent increased demand for municipal securities?
10. How does the level of importance that recent investors in the taxable securities markets place on GAAP-basis financial statements compare to that of conventional investors in the tax-exempt securities markets?
11. How has the recent decrease in bond insurance for newly issued municipal securities affected the desirability of GAAP-basis financial statements?
12. How have recent changes made by GASB to GAAP affected the role and importance of GAAP?
13. How does GASB respond to the evolving needs of the municipal markets?
14. What is the role of municipal market participants in the development of new GASB standards?
15. Are there steps GASB could take to improve the usefulness and timeliness of financial reporting?
The SEC has also been holding field hearings to examine the municipal securities markets, with the second to be held at its Headquarters in Washington, D.C., on December 7th. Topics will include market stability and liquidity, investor impact, accounting and self-regulation; one of the scheduled witnesses will be David Bean, GASB’s Director of Research and Technical Activities. Following the hearings, the Commission will release a staff report addressing information learned, including their recommendations for further action the Commission should pursue, which may include rulemaking, recommendations for changes in industry “best practices,” or legislation.
Once again, the SEC appears concerned that there are public pension accounting and disclosure violations of the Securities anti-fraud laws and that, depending on what the GAO study finds, the SEC and Congress may need to take further action to ensure that investors in municipal bonds are being adequately protected from false and misleading actions involving pension plan funding.
And you thought we only had the IRS to worry about!
• Walter Speech Discussing SEC Municipal Securities Efforts
• SEC Field Hearing on Municipal Securities Markets Agenda
The new financial markets reform law, commonly referred to as “Dodd-Frank” in honor of the two Committee Chairmen who shepherded it through the Congress – Senate Banking Committee Chairman Christopher Dodd (D-CT) and House Financial Services Committee Chairman Barney Frank (D-MA) ---requires a number of studies to be conducted by the GAO dealing with municipal securities.
For example, one study, due within two years, is to review the disclosures made by municipal issuers, describing them and comparing their amount, frequency, and quality to those disclosures provided by corporate issuers. The GAO is also to evaluate and make recommendations regarding additional municipal disclosure requirements. Finally, the study is required to address “the advisability of the repeal or retention” of the so-called “Tower Amendment.” The Tower Amendment, named after former Senator John Tower (R-TX), prohibits the SEC and the Municipal Securities Rulemaking Board (MSRB) from requiring (directly or indirectly) municipal issuers to file municipal securities documents with the SEC or MSRB before the securities are sold.
Another study, due within 18 months, requires the GAO to provide an analysis of the mechanisms for trading, quality of trade executions, market transparency, trade reporting, price discovery, settlement clearing, and credit enhancements in the municipal bond market. The GAO is also to assess the needs of the markets and investors and the impact of recent innovations, and make recommendations on possible improvements in the transparency, efficiency, fairness, and liquidity of trading in the municipal securities markets. Finally, the study asks for information about the potential uses of derivatives in the municipal securities markets.
GAO Study of GASB
A third GAO study requires the agency to examine the role and importance of GASB in the municipal securities markets and to study the manner and the level at which GASB has been funded. This study must be completed by January 17, 2011, and the GAO must “consult with the principal organizations representing State governors, legislators, local elected officials, and State and local finance officers” in developing its report.
This GAO study of GASB should be of particular interest and concern to public pensions for a number of reasons. First, by way of background, GASB is recognized by the American Institute of Certified Public Accountants (AICPA) as the body that sets generally accepted accounting principles (GAAP) for State and local governments. Its funding currently comes “in part from sales of its own publications and in part from state and local governments and the municipal bond community,” according to GASB.
Even though compliance with GASB standards is often required by the laws of some States and through the audit process (whereby auditors render opinions on the fairness of financial statement presentations in conformity with GASB’s GAAP), there are no Federal statutory or regulatory requirements that State or local governments -- even those with public securities outstanding -- must comply with GASB standards. Finally, unlike the generally accepted accounting principles produced for private-sector entities by the Financial Accounting Standards Board (FASB), neither the SEC nor any other regulator has oversight over GASB’s standards.
This drives the SEC nuts.
The SEC and GASB
For years now, and on a bipartisan basis, the Commission has therefore been intent on gaining control of GASB. Most recently, SEC Commissioner Elisse Walter has urged that Congress should provide for an independent and more reliable funding mechanism for GASB as well as SEC oversight. Although Dodd-Frank did not authorize such oversight, it did provide that the SEC may, in consultation with the principal organizations representing State governors, legislators, local elected officials, and State and local finance officers, require the Financial Industry Regulatory Authority (FINRA) to impose “a reasonable annual accounting support fee to adequately fund the annual budget” of GASB. However, there is no requirement as to when or even whether the SEC must exercise this authority.
Nevertheless, Commissioner Walter sees this as an important move in the right direction. As she recently put it, “the first step of independent funding is crucial. It should help to ensure GASB’s independence as a standard setter that is able to develop high-quality governmental accounting standards without undue pressure.”
Is the SEC effectively suggesting that GASB lacks independence; that its current governmental accounting standards are not “high-quality;” and that these standards have been developed under undue pressure – presumably from the entities who fund GASB? Some would suggest that the recent SEC settlement with the State of New Jersey confirms just that very kind of reading of her statement.
While the SEC New Jersey settlement primarily deals with New Jersey’s failures to adequately disclose pension underfunding and its potential effects on the state’s financial health, some of the findings in the SEC’s cease and desist order suggest that certain accounting methodologies—such as the smoothing of asset values, currently permissible under existing GASB standards—are nevertheless problematic. For example, the SEC found that New Jersey’s bond offering documents did not provide asset and funded ratio information on a market value basis, although it noted they were available in the state plans’ actuarial reports. Due to the significant difference between the smoothed actuarial value and market value of plan assets, the SEC found “the actuarial value did not accurately present the current value of the pension plans.”
The SEC has nevertheless insisted that the problem in New Jersey with the use of smoothed asset valuations and other GASB-approved accounting practices was a lack of their disclosure in the bond offering documents, and not with the actual numbers themselves.
The SEC and Public Pensions: the Road Ahead
Commissioner Walter, in a speech on October 29th of this year before the 43rd Annual Securities Regulation Seminar, discussed the new SEC focus on expanding its enforcement presence in the municipal area, building a comprehensive program that will develop case law and legal precedent through “high-impact cases.”
According to her, the new Municipal Securities and Public Pensions Unit “is focusing its efforts on investigating and pursuing enforcement actions in specific categories of misconduct, including: (1) offering and disclosure fraud; (2) tax or arbitrage-driven fraud; (3) pay-to-play and public corruption violations; (4) public pension accounting and disclosure violations; and (5) valuation and pricing fraud.”
Clearly, Commissioner Walter has distinguished “offering and disclosure fraud” from “public pension accounting and disclosure violations.” This would suggest that the SEC’s interest in this area is not just about disclosures of pension information contained in the official statements accompanying bond offerings, but rather that the SEC also feels it has the authority to investigate public pension accounting practices to determine if they violate the SEC’s anti-fraud laws.
Therefore, the GAO study of GASB’s role in the municipal securities market takes on added importance, as it could serve as the basis to argue for further SEC involvement in pension accounting practices and be used to document the need for SEC oversight of GASB. Furthermore, a GAO report critical of GASB could also serve to bolster arguments of opponents of public plans who claim that the accounting practices are outdated , rarely enforced, and designed to primarily serve the interests of pension plans and not of the users of their financial information, such as muni bond investors.
In short, it would provide significant support for the ideas behind the Nunes/Ryan/Issa legislation, discussed above.
So what is the status of this GAO report? A meeting with the various required national organizations was held with the GAO in early November in Washington, DC. Participants included GASB; the SEC; NASRA; the Government Finance Officers Association (GFOA); the Association of Local Government Auditors; the Association of Government Accountants; the Securities Industry and Financial Markets Association (SIFMA); the National League of Cities (NLC); the American Institute of Certified Public Accountants; Standard & Poor's; the Maryland State Treasurer's Office; the Association of School Business Officials;, the National Association of College and University Business Officers; the Investment Company Institute; T. Rowe Price; the International City/County Management Association (ICMA); the National Association of State Budget Officers (NASBO); the Financial Accounting Foundation (FAF); the National Association of State Auditors, Comptrollers and Treasurers (NASACT); the National Governors Association (NGA); the National Federation of Municipal Analysts; Insurance Industry Investors; the American Association of Individual Investors; the Native American Finance Officers Association; Moody's Investors Service; Fitch Ratings; the National Association of Counties (NACo); the National Conference of State Legislatures (NCSL); and the Council of State Governments.
The agenda included a discussion of the following questions, which suggest the focus of the GAO’s investigation and a possible outline of its report:
1. What are your perspectives on the extent of GAAP use by municipal issuers?
2. What are the characteristics of governments that are most likely and least likely to use GAAP in preparing financial statements?
3. What are the incentives and disincentives for governments to use GAAP for financial statement reporting?
4. To what extent does GAAP-basis financial reporting meet the needs of market participants, such as securities analysts, rating agencies, and investors, in comparison with other bases of accounting?
5. Are there particular types of municipal securities or issuers for which GAAP basis financial statements provide the most benefit?
6. How does a municipal issuer's use of GAAP-basis financial statements impact its ability to issue debt or lower its borrowing costs in contrast to non-GAAP financial statements?
7. Are there current limitations in GAAP that affect the use of GAAP-basis financial statements for assessing the quality of a municipal security?
8. Are there differences in cost for municipal issuers preparing GAAP-basis financial statements compared to financial statements prepared on another basis?
9. Has market participants' perception of the usefulness of GAAP-basis financial statements changed as a result of the credit crisis or the subsequent increased demand for municipal securities?
10. How does the level of importance that recent investors in the taxable securities markets place on GAAP-basis financial statements compare to that of conventional investors in the tax-exempt securities markets?
11. How has the recent decrease in bond insurance for newly issued municipal securities affected the desirability of GAAP-basis financial statements?
12. How have recent changes made by GASB to GAAP affected the role and importance of GAAP?
13. How does GASB respond to the evolving needs of the municipal markets?
14. What is the role of municipal market participants in the development of new GASB standards?
15. Are there steps GASB could take to improve the usefulness and timeliness of financial reporting?
The SEC has also been holding field hearings to examine the municipal securities markets, with the second to be held at its Headquarters in Washington, D.C., on December 7th. Topics will include market stability and liquidity, investor impact, accounting and self-regulation; one of the scheduled witnesses will be David Bean, GASB’s Director of Research and Technical Activities. Following the hearings, the Commission will release a staff report addressing information learned, including their recommendations for further action the Commission should pursue, which may include rulemaking, recommendations for changes in industry “best practices,” or legislation.
Once again, the SEC appears concerned that there are public pension accounting and disclosure violations of the Securities anti-fraud laws and that, depending on what the GAO study finds, the SEC and Congress may need to take further action to ensure that investors in municipal bonds are being adequately protected from false and misleading actions involving pension plan funding.
And you thought we only had the IRS to worry about!
• Walter Speech Discussing SEC Municipal Securities Efforts
• SEC Field Hearing on Municipal Securities Markets Agenda
Snapshots
GASB Review of Governmental Pension Accounting, Disclosure Rules Continues
The Governmental Accounting Standards Board (GASB) logged in almost 200 individual letters in response to its request for comments on its Preliminary Views (PV) on major issues related to pension accounting and financial reporting by employers. The letters came from individuals, businesses, associations, public pension systems, groups of pension plan representatives, individual employers, public sector unions and national public sector organizations.
The PV was released on June 16, 2010, and written comments were due by September 17, 2010. GASB subsequently held three public hearings on October 13th in Dallas; October 14th in San Francisco; and October 27th in New York City, where dozens of individuals appeared to testify and respond to questioning by the GASB members.
NCTR joined with NASRA and NCPERS in drafting a comment letter which was signed by fiduciaries, administrators and plan members of more than 80 public retirement systems, including 39 NCTR member plans. Furthermore, 20 NCTR member systems and several other NCTR commercial members also sent individual comment letters to GASB. Several NCTR members also testified in person at the GASB public hearings.
Finally, NCTR joined with NASRA, NCPERS and 14 other national organizations, including the National Education Association (NEA), the American Federation of Teachers (AFT), the American Federation of State, County and Municipal Employees (AFSCME), the National Association of Counties (NACo), the National League of Cities (NLC), and the U.S. Conference of Mayors, in sending a group letter to GASB.
NCTR also adopted a resolution concerning the GASB PV at its annual convention in October which reiterated the concerns expressed by many individual NCTR members that:
1. GASB should maintain its current view that the basic discount rate for governmental plans’ unfunded pension obligation should remain the long-term expected rate of return on plan investments;
2. The Annual Required Contribution (ARC) should not be eliminated;
3. The cumulative difference between an employer’s ARC and its actual contributions (known as the employer’s “Net Pension Obligation,” or NPO) should not be replaced on the employer’s balance sheet with a new number, referred to by GASB as the “Net Pension Liability,” or NPL;
4. For single employer and agent plans, an employer’s unfunded pension obligation should continue to be subject to disclosure in the required supplementary information section of employer’s financial statements, and that for cost-sharing plans, an employer’s pension liability should continue to be the difference between the employer’s contractually required contribution and the employer’s actual contributions;
5. The current GASB standards, permitting public pension plans, in consultation with their actuaries, to defer recognition of all asset gains and losses over a responsible period of time, are reasonable and that the GASB PV’s proposed change in this area is needlessly complex, would diminish transparency and understanding for users of public retirement plan financial information, and would adversely impact the predictability and stability of required contributions;
6. GASB’s current disclosure requirements regarding cost-sharing plans adequately express employers’ obligations to the plan, and such pension plan costs should be distributed evenly across the entire group of employers, generally regardless of individual employer characteristics; and
7. Should changes be made, GASB should phase them in over time so as to avoid confusion on the part of the user community and unnecessary disruption of the consistency of public pension reporting.
The next step in the GASB process will likely be the issuance of an exposure draft of the final form any revisions will take, probably in the middle of 2011.
• Group Letter from NCTR/NASRA/NCPERS Member Systems
• Letter from NCTR and 16 other National Public Sector Associations
• Links to all GASB PV Comment Letters
• NCTR Resolution on GASB PV (see page 10)
New GAO Study of Public Pensions Requested
The Government Accountability Office (GAO) has been asked to produce yet another report on public pensions. This time, the request came from the Senate Committee on Aging and the Senate Committee on Health, Education, Labor, and Pensions (HELP). The study will examine “pension issues in the state and local government sectors,” according to the GAO. (Based on Hill sources, the request was from Senator Herb Kohl (D-WI), Chairman of the Aging Committee, and Senator Mike Enzi (R-WY), the Ranking member of the HELP Committee.)
Specifically, the GAO is interested in:
• Current issues and challenges with state and local pension systems;
• State and local government strategies for funding their pension obligations;
• Data and sources of information on state and local pension systems; and
• Selecting case examples of state and local pension systems for study.
The number of GAO studies examining various issues related to public pensions has increased over the last few years, reflecting both increased media attention to governmental plans as well as a growing interest (and concern, in some cases) by Congress in their activities and overall health. The most recent report, dealing with investments, was released in August of this year, and was entitled “State and Local Government Pension Plans: Governance Practices and Long-term Investment Strategies Have Evolved Gradually as Plans Take On Increased Investment Risk.”
To date, most of the GAO reports on public pensions have been relatively favorable, and have not generated a high degree of controversy, nor been used as tools to advance adverse Federal actions.
Not yet, at least.
Hopefully, this latest report will be similar in nature, although its focus on funding could prove to be problematic. NCTR and NASRA will be interviewed by the GAO during December as part of their research efforts. So if you would like to be volunteered as a “case example” for their study, be sure to let us know!
Seriously, it will be important for the GAO to appreciate the great effort that many NCTR member systems have devoted to addressing the current challenges confronting our community. We have a good story to tell about the manner in which public pensions have responded to the economic crisis, so it would truly be very helpful to know if your system would be interested in working with the GAO staff on what could be a very important – and hopefully, very positive – report.
• GAO Report on Public Pension Governance and Investments
Aspen Institute: Private Industry + Social Security Administration = “Starter” Life Annuities
The Aspen Institute’s Initiative on Financial Security (Aspen IFS) has developed a proposal to provide Americans who do not have access to a defined benefit plan with a new option to obtain retirement income that lasts their lifetime. The “Security Plus Annuities,” in the words of its developers, “partners private industry with the Social Security Administration to offer low-cost, inflation-protected, ‘starter’ life annuities.”
It is described as being designed to particularly address the needs of low- and moderate-income workers who often have not had access to a 401(k) plan at their jobs, and workers near retirement whose employer-provided pension plans do not offer lifetime income products. It is premised on two main conclusions: (1) the current 401(k) universe of plans is virtually annuity-free, primarily because employers who do offer them “must undertake rigorous analysis before adding an annuity provider to a plan or face additional fiduciary liability if the provider later becomes insolvent” according to Aspen IFS; and (2) it will likely take years of “building a consensus, crafting and passing legislation, and issuing regulations before lifelong income products become routinely available in 401(k) plans and IRAs,” the Aspen IFS explains.
The key features of the Security Plus Annuity are described as being:
• Retirees would have a one-time opportunity in their first year of receiving Social Security benefits to buy a Security Plus Annuity, capped at $100,000 in purchase amount.
• For married retirees, Security Plus Annuities would offer spousal benefits.
• Security Plus Annuity payments would be automatically added to monthly Social Security checks.
• Through a competitive bidding process, the Federal government would pre-select a private market annuity provider or providers (depending on the volume of purchases) to underwrite Security Plus Annuities on a group basis.
• The Federal government would provide record-keeping, marketing, distribution and other administrative services.
The Aspen Institute is an international nonprofit organization founded in 1950. According to its President and CEO, Walter Isaacson, its “core mission is to foster enlightened leadership and open-minded dialogue. Through seminars, policy programs, conferences and leadership development initiatives, the Institute and its international partners seek to promote nonpartisan inquiry and an appreciation for timeless values.” The Aspen Institute is largely funded by foundations such as the Carnegie Corporation, The Rockefeller Brothers Fund and the Ford Foundation, by seminar fees, and by individual donations.
• Aspen IFS: The Case for Security Plus Annuities
• Retirement Savings: Confronting the Challenge of Longevity
The Failure of the 401(k): New Report Supports Guaranteed Retirement Accounts
Demos , a non-partisan public policy research and advocacy organization, has released a new report in early November that discusses the current state of the U.S. private retirement system, and why reform is necessary. The report argues that “[t]he shift from traditional pensions to individual plans has significantly endangered the gains our country has made in reducing old-age poverty since the introduction of Social Security.”
The report also looks at proposed policies to reform the retirement system in the past “from all sides of the political spectrum,” specifically the Urban Institute’s “Super Simple Savings Plan”, the ERISA Industry Committee’s “New Benefit Platform for Life Security”, the Obama administration’s “Automatic IRA” proposal, and the Economic Policy Institute (EPI) and Bernard Schwartz Center for Economic Policy Analysis at the New School (SCEPA)’s “Guaranteed Retirement Account (GRA).”
While it finds all four proposals represent improvements over the current retirement system, it concludes that only one proposal—Guaranteed Retirement Accounts—“could serve as a true successor to the traditional pension as workers’ second tier of retirement savings.”
The GRA concept was developed by Teresa Ghilarducci, an economics professor at The New School in New York City and serves as the Bernard L. and Irene Schwartz Chair in economic policy analysis and director of SCEPA, the Schwartz Center for Economic Policy Analysis that focuses on economic policy research and outreach. She joined The New School in 2008 after 25 years as a professor of economics at the University of Notre Dame.
A GRA is essentially a mandatory Government-administered guaranteed individual retirement plan. Mandatory minimum contributions from workers and employers of 2.5 percent each would be required, and the Federal government would contribute $600 for all workers, regardless of income. There would be a guaranteed minimum 3 percent real return on the account; the Federal government through the Social Security Administration would administer the plan; and the Federal Thrift Savings Plan would manage the pooled assets. Workers would receive an annuity based on their account balance at retirement. The Federal cost of the program would be paid for by removing the tax deferral for contributions to an IRA or 401(k) that exceeded $5,000 per individual, per year.
• Demos Report: The Failure of the 401(k)
• Description of Guaranteed Retirement Account
Should States be Permitted to Go Bankrupt?
David Skeel, a law professor at the University of Pennsylvania, writes in the November 29th issue of The Weekly Standard that Congress should consider creating a new chapter for states in U.S. bankruptcy law. According to Skeel, “Although bankruptcy would be an imperfect solution to out-of-control state deficits, it’s the best option we have, at least if we want to have any chance of avoiding massive federal bailouts of state governments.”
Skeel argues that the constitutionality of bankruptcy for States is “beyond serious dispute.” He also points out that, with more than 70 years of experience with Chapter 9, which permits cities and other municipal entities to file for bankruptcy, this “shows how bankruptcy-for-states might work, what its limitations are, and why we need it now.”
Such a State bankruptcy law would give debtor states power to rewrite union contracts, with court approval, and Skeel also points out that it is “possible that a state could even renegotiate existing pension benefits in bankruptcy, although this is much less clear and less likely than the power to renegotiate an ongoing contract.”
But would governors, particularly those with union supporters, be willing to take full advantage of such powers? While Skeel recognizes the political realities involved, he insists bankruptcy “would give a resolute state a new, more effective tool for paring down the state’s debts,” particularly if a governor thought he could shift blame onto a bankruptcy court.
However, Skeel believes that perhaps the best reason for Congress to give this new power to the States is that “it would give the federal government a compelling reason to resist the bailout urge.” State bankruptcy would offer what he calls “a credible, less costly, and more effective alternative.” “Bankruptcy isn’t perfect,” he writes, “but it’s far superior to any of the alternatives currently on the table.”
• Skeel: “Give States a Way to Go Bankrupt”
New CII White Paper on Wall Street Pay
The Council of institutional Investors (CII) has recently released a new white paper entitled “Wall Street Pay: Size, Structure and Significance for Shareowners.” The new study, written by Paul Hodgson, senior research associate at The Corporate Library, found that the pay practices of major Wall Street banks encouraged excessive risk-taking by executives that helped bring financial markets to the brink of collapse in 2008. While banks’ executive compensation has improved somewhat since then, Hodgson finds that banks still are not tying compensation to long-term gains in performance.
CII believes that the new report “may help inform shareowners’ decisions about how to cast advisory votes on executive compensation—‘say on pay’—at U.S. public companies next year, a requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act.”
Key findings of the CII white paper include:
• Total CEO compensation at major Wall Street institutions in 2003-2007 was two to three times the level of pay at other Fortune 50 companies during the same period. The differential was driven mainly by big dollops of time-restricted stock in Wall Street pay packages.
• Pay at these banks was structured to incentivize executives to deliver strong performance—over the short-term. But lavish cash bonuses, high absolute levels of pay and excessive focus on short-term annual growth measures had damaging consequences for shareowners over the long-term.
• Compensation structure on the Street has improved since 2008, but the banks still are not tying compensation to long-term performance metrics.
The report recommends that shareowners press for long-term performance measures, “commitments to ensure that a large portion of compensation is tied to long-term value growth and that deferment and forfeiture elements are retained.”
• New CII “Wall Street Pay” White Paper
NCTR/NASRA FY 2009 Public Fund Survey Now Available
The Public Fund Survey (PFS), an online compendium of key characteristics of most of the nation’s largest public retirement systems, is sponsored by NCTR and NASRA and conducted by Keith Brainard, NASRA’s Director of Research. It contains data on 101 public retirement systems and 126 plans whose membership and assets comprise approximately 85 percent of the entire state and local government retirement system, providing pension and other benefits for 13.4 million active members and 6.9 million annuitants (including retirees, disabilitants and beneficiaries). As of FY 09, systems in the Survey hold assets of $2.1 trillion.
The primary source of Survey data is public retirement system annual financial reports. Data also is taken from actuarial valuations, benefits guides, system websites, and input from system representatives. This latest report focuses on fiscal year 2009, which is reported for 98 of the systems in the survey.
The FY 2009 survey shows that aggregate public pension funding levels declined in FY 09 from 85.0 percent to 79.9 percent, due primarily to the 2008-09 market drop. However, improving capital markets since March 2009 are helping to offset the effects of these losses.
The increased unfunded liabilities resulting from the market decline are causing required contribution rates to rise. Median employer contribution rates for workers who participate in Social Security rose to 9.4 percent of pay, and to 12.7 percent of pay for employers whose participants do not participate in Social Security. The median employee contribution rates remained five percent of pay for Social Security-eligible workers, and eight percent for non-Social Security-eligible.
The overall average ARC paid by public plan sponsors in FY 09 was 88 percent, consistent with the levels of the previous six years. Through FY 09, the percentage of plans receiving at least 90 percent of their ARC held steady at just above 60 percent.
The new survey found that the predominant investment return assumption among funds in the Survey remains at 8.0 percent, although in recent months, some funds have reduced this assumption, and other plans are considering doing so.
Public Fund Survey data is made available to public retirement system staff and trustees as well as corporate members of NASRA and NCTR. Registration is required to access most of the PFS website.
• Public Fund Survey Website
GFOA Issues New Advisory on Responsible Management and Design Practices for DB Plans
The Government Finance Officers Association (GFOA) has recently approved a new Advisory that discusses what GFOA believes are responsible management and design practices for defined benefit governmental pension plans.
The Advisory recommends that “under no circumstance should state and local government plan sponsors engage in pension contribution holidays or make insufficient contributions. “ The Advisory also makes comments in specific areas:
1. Spiking of final pensionable compensation.
2. Sustainable full-retirement ages
3. Retroactive benefits increases
4. Deferred Retirement Option Plans (DROPs)
5. Ad hoc cost-of-living allowances (COLA) for existing retirees
6. Investment assumptions
7. Non-contributory plans
8. Prior service credits
A GFOA Advisory identifies specific policies and procedures necessary to minimize a government’s exposure to potential loss in connection with its financial management activities. This Advisory was approved by the GFOA’s Executive Board on October 15, 2010.
• New GFOA Advisory on Responsible Management and Design Practices for DB Plans
The Governmental Accounting Standards Board (GASB) logged in almost 200 individual letters in response to its request for comments on its Preliminary Views (PV) on major issues related to pension accounting and financial reporting by employers. The letters came from individuals, businesses, associations, public pension systems, groups of pension plan representatives, individual employers, public sector unions and national public sector organizations.
The PV was released on June 16, 2010, and written comments were due by September 17, 2010. GASB subsequently held three public hearings on October 13th in Dallas; October 14th in San Francisco; and October 27th in New York City, where dozens of individuals appeared to testify and respond to questioning by the GASB members.
NCTR joined with NASRA and NCPERS in drafting a comment letter which was signed by fiduciaries, administrators and plan members of more than 80 public retirement systems, including 39 NCTR member plans. Furthermore, 20 NCTR member systems and several other NCTR commercial members also sent individual comment letters to GASB. Several NCTR members also testified in person at the GASB public hearings.
Finally, NCTR joined with NASRA, NCPERS and 14 other national organizations, including the National Education Association (NEA), the American Federation of Teachers (AFT), the American Federation of State, County and Municipal Employees (AFSCME), the National Association of Counties (NACo), the National League of Cities (NLC), and the U.S. Conference of Mayors, in sending a group letter to GASB.
NCTR also adopted a resolution concerning the GASB PV at its annual convention in October which reiterated the concerns expressed by many individual NCTR members that:
1. GASB should maintain its current view that the basic discount rate for governmental plans’ unfunded pension obligation should remain the long-term expected rate of return on plan investments;
2. The Annual Required Contribution (ARC) should not be eliminated;
3. The cumulative difference between an employer’s ARC and its actual contributions (known as the employer’s “Net Pension Obligation,” or NPO) should not be replaced on the employer’s balance sheet with a new number, referred to by GASB as the “Net Pension Liability,” or NPL;
4. For single employer and agent plans, an employer’s unfunded pension obligation should continue to be subject to disclosure in the required supplementary information section of employer’s financial statements, and that for cost-sharing plans, an employer’s pension liability should continue to be the difference between the employer’s contractually required contribution and the employer’s actual contributions;
5. The current GASB standards, permitting public pension plans, in consultation with their actuaries, to defer recognition of all asset gains and losses over a responsible period of time, are reasonable and that the GASB PV’s proposed change in this area is needlessly complex, would diminish transparency and understanding for users of public retirement plan financial information, and would adversely impact the predictability and stability of required contributions;
6. GASB’s current disclosure requirements regarding cost-sharing plans adequately express employers’ obligations to the plan, and such pension plan costs should be distributed evenly across the entire group of employers, generally regardless of individual employer characteristics; and
7. Should changes be made, GASB should phase them in over time so as to avoid confusion on the part of the user community and unnecessary disruption of the consistency of public pension reporting.
The next step in the GASB process will likely be the issuance of an exposure draft of the final form any revisions will take, probably in the middle of 2011.
• Group Letter from NCTR/NASRA/NCPERS Member Systems
• Letter from NCTR and 16 other National Public Sector Associations
• Links to all GASB PV Comment Letters
• NCTR Resolution on GASB PV (see page 10)
New GAO Study of Public Pensions Requested
The Government Accountability Office (GAO) has been asked to produce yet another report on public pensions. This time, the request came from the Senate Committee on Aging and the Senate Committee on Health, Education, Labor, and Pensions (HELP). The study will examine “pension issues in the state and local government sectors,” according to the GAO. (Based on Hill sources, the request was from Senator Herb Kohl (D-WI), Chairman of the Aging Committee, and Senator Mike Enzi (R-WY), the Ranking member of the HELP Committee.)
Specifically, the GAO is interested in:
• Current issues and challenges with state and local pension systems;
• State and local government strategies for funding their pension obligations;
• Data and sources of information on state and local pension systems; and
• Selecting case examples of state and local pension systems for study.
The number of GAO studies examining various issues related to public pensions has increased over the last few years, reflecting both increased media attention to governmental plans as well as a growing interest (and concern, in some cases) by Congress in their activities and overall health. The most recent report, dealing with investments, was released in August of this year, and was entitled “State and Local Government Pension Plans: Governance Practices and Long-term Investment Strategies Have Evolved Gradually as Plans Take On Increased Investment Risk.”
To date, most of the GAO reports on public pensions have been relatively favorable, and have not generated a high degree of controversy, nor been used as tools to advance adverse Federal actions.
Not yet, at least.
Hopefully, this latest report will be similar in nature, although its focus on funding could prove to be problematic. NCTR and NASRA will be interviewed by the GAO during December as part of their research efforts. So if you would like to be volunteered as a “case example” for their study, be sure to let us know!
Seriously, it will be important for the GAO to appreciate the great effort that many NCTR member systems have devoted to addressing the current challenges confronting our community. We have a good story to tell about the manner in which public pensions have responded to the economic crisis, so it would truly be very helpful to know if your system would be interested in working with the GAO staff on what could be a very important – and hopefully, very positive – report.
• GAO Report on Public Pension Governance and Investments
Aspen Institute: Private Industry + Social Security Administration = “Starter” Life Annuities
The Aspen Institute’s Initiative on Financial Security (Aspen IFS) has developed a proposal to provide Americans who do not have access to a defined benefit plan with a new option to obtain retirement income that lasts their lifetime. The “Security Plus Annuities,” in the words of its developers, “partners private industry with the Social Security Administration to offer low-cost, inflation-protected, ‘starter’ life annuities.”
It is described as being designed to particularly address the needs of low- and moderate-income workers who often have not had access to a 401(k) plan at their jobs, and workers near retirement whose employer-provided pension plans do not offer lifetime income products. It is premised on two main conclusions: (1) the current 401(k) universe of plans is virtually annuity-free, primarily because employers who do offer them “must undertake rigorous analysis before adding an annuity provider to a plan or face additional fiduciary liability if the provider later becomes insolvent” according to Aspen IFS; and (2) it will likely take years of “building a consensus, crafting and passing legislation, and issuing regulations before lifelong income products become routinely available in 401(k) plans and IRAs,” the Aspen IFS explains.
The key features of the Security Plus Annuity are described as being:
• Retirees would have a one-time opportunity in their first year of receiving Social Security benefits to buy a Security Plus Annuity, capped at $100,000 in purchase amount.
• For married retirees, Security Plus Annuities would offer spousal benefits.
• Security Plus Annuity payments would be automatically added to monthly Social Security checks.
• Through a competitive bidding process, the Federal government would pre-select a private market annuity provider or providers (depending on the volume of purchases) to underwrite Security Plus Annuities on a group basis.
• The Federal government would provide record-keeping, marketing, distribution and other administrative services.
The Aspen Institute is an international nonprofit organization founded in 1950. According to its President and CEO, Walter Isaacson, its “core mission is to foster enlightened leadership and open-minded dialogue. Through seminars, policy programs, conferences and leadership development initiatives, the Institute and its international partners seek to promote nonpartisan inquiry and an appreciation for timeless values.” The Aspen Institute is largely funded by foundations such as the Carnegie Corporation, The Rockefeller Brothers Fund and the Ford Foundation, by seminar fees, and by individual donations.
• Aspen IFS: The Case for Security Plus Annuities
• Retirement Savings: Confronting the Challenge of Longevity
The Failure of the 401(k): New Report Supports Guaranteed Retirement Accounts
Demos , a non-partisan public policy research and advocacy organization, has released a new report in early November that discusses the current state of the U.S. private retirement system, and why reform is necessary. The report argues that “[t]he shift from traditional pensions to individual plans has significantly endangered the gains our country has made in reducing old-age poverty since the introduction of Social Security.”
The report also looks at proposed policies to reform the retirement system in the past “from all sides of the political spectrum,” specifically the Urban Institute’s “Super Simple Savings Plan”, the ERISA Industry Committee’s “New Benefit Platform for Life Security”, the Obama administration’s “Automatic IRA” proposal, and the Economic Policy Institute (EPI) and Bernard Schwartz Center for Economic Policy Analysis at the New School (SCEPA)’s “Guaranteed Retirement Account (GRA).”
While it finds all four proposals represent improvements over the current retirement system, it concludes that only one proposal—Guaranteed Retirement Accounts—“could serve as a true successor to the traditional pension as workers’ second tier of retirement savings.”
The GRA concept was developed by Teresa Ghilarducci, an economics professor at The New School in New York City and serves as the Bernard L. and Irene Schwartz Chair in economic policy analysis and director of SCEPA, the Schwartz Center for Economic Policy Analysis that focuses on economic policy research and outreach. She joined The New School in 2008 after 25 years as a professor of economics at the University of Notre Dame.
A GRA is essentially a mandatory Government-administered guaranteed individual retirement plan. Mandatory minimum contributions from workers and employers of 2.5 percent each would be required, and the Federal government would contribute $600 for all workers, regardless of income. There would be a guaranteed minimum 3 percent real return on the account; the Federal government through the Social Security Administration would administer the plan; and the Federal Thrift Savings Plan would manage the pooled assets. Workers would receive an annuity based on their account balance at retirement. The Federal cost of the program would be paid for by removing the tax deferral for contributions to an IRA or 401(k) that exceeded $5,000 per individual, per year.
• Demos Report: The Failure of the 401(k)
• Description of Guaranteed Retirement Account
Should States be Permitted to Go Bankrupt?
David Skeel, a law professor at the University of Pennsylvania, writes in the November 29th issue of The Weekly Standard that Congress should consider creating a new chapter for states in U.S. bankruptcy law. According to Skeel, “Although bankruptcy would be an imperfect solution to out-of-control state deficits, it’s the best option we have, at least if we want to have any chance of avoiding massive federal bailouts of state governments.”
Skeel argues that the constitutionality of bankruptcy for States is “beyond serious dispute.” He also points out that, with more than 70 years of experience with Chapter 9, which permits cities and other municipal entities to file for bankruptcy, this “shows how bankruptcy-for-states might work, what its limitations are, and why we need it now.”
Such a State bankruptcy law would give debtor states power to rewrite union contracts, with court approval, and Skeel also points out that it is “possible that a state could even renegotiate existing pension benefits in bankruptcy, although this is much less clear and less likely than the power to renegotiate an ongoing contract.”
But would governors, particularly those with union supporters, be willing to take full advantage of such powers? While Skeel recognizes the political realities involved, he insists bankruptcy “would give a resolute state a new, more effective tool for paring down the state’s debts,” particularly if a governor thought he could shift blame onto a bankruptcy court.
However, Skeel believes that perhaps the best reason for Congress to give this new power to the States is that “it would give the federal government a compelling reason to resist the bailout urge.” State bankruptcy would offer what he calls “a credible, less costly, and more effective alternative.” “Bankruptcy isn’t perfect,” he writes, “but it’s far superior to any of the alternatives currently on the table.”
• Skeel: “Give States a Way to Go Bankrupt”
New CII White Paper on Wall Street Pay
The Council of institutional Investors (CII) has recently released a new white paper entitled “Wall Street Pay: Size, Structure and Significance for Shareowners.” The new study, written by Paul Hodgson, senior research associate at The Corporate Library, found that the pay practices of major Wall Street banks encouraged excessive risk-taking by executives that helped bring financial markets to the brink of collapse in 2008. While banks’ executive compensation has improved somewhat since then, Hodgson finds that banks still are not tying compensation to long-term gains in performance.
CII believes that the new report “may help inform shareowners’ decisions about how to cast advisory votes on executive compensation—‘say on pay’—at U.S. public companies next year, a requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act.”
Key findings of the CII white paper include:
• Total CEO compensation at major Wall Street institutions in 2003-2007 was two to three times the level of pay at other Fortune 50 companies during the same period. The differential was driven mainly by big dollops of time-restricted stock in Wall Street pay packages.
• Pay at these banks was structured to incentivize executives to deliver strong performance—over the short-term. But lavish cash bonuses, high absolute levels of pay and excessive focus on short-term annual growth measures had damaging consequences for shareowners over the long-term.
• Compensation structure on the Street has improved since 2008, but the banks still are not tying compensation to long-term performance metrics.
The report recommends that shareowners press for long-term performance measures, “commitments to ensure that a large portion of compensation is tied to long-term value growth and that deferment and forfeiture elements are retained.”
• New CII “Wall Street Pay” White Paper
NCTR/NASRA FY 2009 Public Fund Survey Now Available
The Public Fund Survey (PFS), an online compendium of key characteristics of most of the nation’s largest public retirement systems, is sponsored by NCTR and NASRA and conducted by Keith Brainard, NASRA’s Director of Research. It contains data on 101 public retirement systems and 126 plans whose membership and assets comprise approximately 85 percent of the entire state and local government retirement system, providing pension and other benefits for 13.4 million active members and 6.9 million annuitants (including retirees, disabilitants and beneficiaries). As of FY 09, systems in the Survey hold assets of $2.1 trillion.
The primary source of Survey data is public retirement system annual financial reports. Data also is taken from actuarial valuations, benefits guides, system websites, and input from system representatives. This latest report focuses on fiscal year 2009, which is reported for 98 of the systems in the survey.
The FY 2009 survey shows that aggregate public pension funding levels declined in FY 09 from 85.0 percent to 79.9 percent, due primarily to the 2008-09 market drop. However, improving capital markets since March 2009 are helping to offset the effects of these losses.
The increased unfunded liabilities resulting from the market decline are causing required contribution rates to rise. Median employer contribution rates for workers who participate in Social Security rose to 9.4 percent of pay, and to 12.7 percent of pay for employers whose participants do not participate in Social Security. The median employee contribution rates remained five percent of pay for Social Security-eligible workers, and eight percent for non-Social Security-eligible.
The overall average ARC paid by public plan sponsors in FY 09 was 88 percent, consistent with the levels of the previous six years. Through FY 09, the percentage of plans receiving at least 90 percent of their ARC held steady at just above 60 percent.
The new survey found that the predominant investment return assumption among funds in the Survey remains at 8.0 percent, although in recent months, some funds have reduced this assumption, and other plans are considering doing so.
Public Fund Survey data is made available to public retirement system staff and trustees as well as corporate members of NASRA and NCTR. Registration is required to access most of the PFS website.
• Public Fund Survey Website
GFOA Issues New Advisory on Responsible Management and Design Practices for DB Plans
The Government Finance Officers Association (GFOA) has recently approved a new Advisory that discusses what GFOA believes are responsible management and design practices for defined benefit governmental pension plans.
The Advisory recommends that “under no circumstance should state and local government plan sponsors engage in pension contribution holidays or make insufficient contributions. “ The Advisory also makes comments in specific areas:
1. Spiking of final pensionable compensation.
2. Sustainable full-retirement ages
3. Retroactive benefits increases
4. Deferred Retirement Option Plans (DROPs)
5. Ad hoc cost-of-living allowances (COLA) for existing retirees
6. Investment assumptions
7. Non-contributory plans
8. Prior service credits
A GFOA Advisory identifies specific policies and procedures necessary to minimize a government’s exposure to potential loss in connection with its financial management activities. This Advisory was approved by the GFOA’s Executive Board on October 15, 2010.
• New GFOA Advisory on Responsible Management and Design Practices for DB Plans
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