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
No comments:
Post a Comment