New America Foundation paper proposes that California switch to cash balance plans

From the New America Foundation website:

The financial crisis has shaken the foundations of retirement security in both the private and public sectors, and nowhere more than in California. Generous public pension promises are straining the finances of cities and counties while private sector workers have little prospect of secure retirement. The contrast between the guaranteed and increasingly expensive pensions and retiree health benefits enjoyed by most public workers in California and the less secure (and often missing) retirement plans of private-sector workers has touched off pension envy.

In Public Affluence, Private Squalor, Mark Paul and Micah Weinberg examine the roots of California’s pension crisis and the legal obstacles to reform. Change is desperately needed to avoid further overpromising and underfunding of public pensions and to mend the broken social contract for private sector employees with inadequate retirement savings. Although the road to reform will be rocky, Paul and Weinberg suggest that, in the long-term, a cash balance plan can create a stable public pension system while restoring the balance between public and private pensions.

Access the paper here: http://growth.newamerica.net/publications/policy/public_affluence_private_squalor

New York Times: Maine considers shifting into Social Security to alleviate public pension burden

Facing Pension Woes, Maine Looks to Social Security

MARY WILLIAMS WALSH New York Times July 21, 2010

Lawmakers in Maine have found an unusual tool for tackling their state’s pension woes: Social Security.

Just as workers in the private sector participate in Social Security in addition to any pension plan at their companies, most states put their workers in the federal program along with providing a state pension.

Maine and a handful of others, however, have long been holdouts, relying solely on their state pension plans. In addition, most states have excluded some workers — often teachers, firefighters and police — from the national retirement system and its associated costs, 6.2 percent of payroll for the employer and an equal amount for the worker.

Now, Maine legislators have prepared a detailed plan for shifting state employees into Social Security and are considering whether to adopt it. They acknowledge it will not solve their problem in the short term but see long-term advantages.

Some variation on this idea could ultimately appeal to other states grappling with their own exploding pension costs and, in extreme cases, quietly looking for help from Washington. In troubled states, some employees have wondered whether they might be allowed to begin paying in and collecting from the federal system even before they have contributed a career’s worth of taxes.

The potential effect on the Social Security program is hard to estimate. Maine’s proposal would mean new members and a small additional source of payroll tax revenue for the federal system.

Even if it fully embraces the proposal, Maine will have to come up with a considerable sum to sustain its existing pension plan, presumably through some combination of taxes and service cuts. After a phase-in period, Social Security would cover part of state retirees’ benefits, with the state pension as the remainder. Many pension plans in corporate America coordinate their benefits in this way.

The proposal has the advantage of not reducing promised benefits, guaranteed by the constitution in many states. The change would not be cheap, but it would reduce the role of Maine’s pension fund and thus the risk of having to suddenly cover giant losses down the road.

A Social Security spokesman said the agency did not expect many of the holdout states to join, citing the cost of participation. The only other state known to have talked recently about adding Social Security is Louisiana.

More than six million public employees work outside the Social Security system, including roughly 1.7 million teachers in California, Illinois and Texas, and nearly two million employees of all types in Alaska, Colorado, Massachusetts, Nevada and Ohio, as well as Louisiana and Maine. For years, these and other states have insisted they could provide richer pensions at a lower cost, both to workers and taxpayers, because of investments.

Some of those states’ pension plans now have shortfalls so large that they need outsize contributions. Virtually all state pension funds have had big losses in the last two years, but the go-it-alone states appear especially vulnerable.

Not only are these states trying to provide richer benefits with smaller contributions than the payroll tax for Social Security, but they have promised to do it for workers who can retire 10 and sometimes 20 years younger.

With pension costs ballooning and taxpayers lashing out, many workers in states with deeply underfunded plans fear their benefits will be cut. Those being asked to put more into their pension funds complain they feel caught up in Ponzi schemes. Some wish they had been part of Social Security after all.

“Had I known back then, I would not have stayed in Illinois,” said John Gebhardt, a university employee in that state, which keeps teachers and university personnel out of Social Security. He has even offered to pay both his own and his employer’s payroll tax to join Social Security, but was told no.

Maine lawmakers who support shifting state workers into Social Security say they believe it would be fairer. Social Security may not be sexy, but it is portable.

A recent study in Maine underscored the penalty paid by the mobile work force. Only one in five state employees stays around long enough to get a full pension. The majority leave, taking neither a pension nor any Social Security credits with them. This practice, not investment gains, has sustained the state’s pension system.

“The current system is immoral,” said Peter Mills, who, as a state senator, started the push to join Social Security. “It takes younger people and feeds off of them. You can withdraw from teaching at age 40 and realize you’ve got nothing to look ahead to for your old age.”

Dallas L. Salisbury, president of the Employee Benefit Research Institute, said he was surprised by how few public workers ever got pensions in Maine, where he provided advice on a pension overhaul. He said he checked and found similar turnover in other states.

Whether Maine joins Social Security or not, painful choices must be made. The state pension fund lost $2.25 billion in 2008, and taxpayers will have to replace the lost money. But they have less time to do so than most states, thanks to tough financing rules in the constitution. Projections show that Maine will not have enough money to do much else in the coming years if it adheres to those rules.

“It’s going to rip the guts out of our budget,” said Mr. Mills. “I don’t think you can find a budgetary parallel in my lifetime, and I’m 67.”

Unlike laggard states, including Illinois and New Jersey, Maine had in recent years been making its required pension contributions annually, and it avoided the common mistake of sweetening benefits when markets were strong.

Its looming fiscal crisis stems primarily from investment losses, points out Sandy Matheson, executive director of the state plan. “Maine is almost like a petri dish,” she said, showing how things can go awry even if a state is responsible.

Mr. Mills, a Republican, initially envisioned shifting workers into Social Security and a 401(k) plan. But he now views Social Security combined with a traditional pension as a safer option. That puts him on common ground with Democrats in the statehouse.

The proposal may meet resistance, however, because it does not fill the gaping hole in the state’s pension fund.

A shift into the federal program is also hard to plan because Social Security has a financial imbalance — one that will worsen as the population ages. At some point, Congress is expected to either raise taxes or cut benefits.

Still, Social Security’s future is easier to predict than that of a state pension fund, because its pressure stems from broad demographic trends, not the vagaries of the stock market. Social Security keeps its reserves in conservative Treasury securities.

“You’ve got reviews taking place all over the country,” said Mr. Salisbury. Most places are asking painful questions about their investment strategies. But what Maine has discovered, he said, is just how expensive it really is to provide a guaranteed retirement benefit.

Audit finds that Social Security pays ineligible retired public employees

Social Security Loses $50 Million a Year in Benefit Overpayment

MARY WILLIAMS WALSH New York Times July 21, 2010

Social Security is paying roughly $50 million a year too much to people who collect state pensions but fail to declare that income, according to the system’s inspector general.

The overpayments go to retirees who have held state jobs and also worked in the private sector — teachers who worked on their summer breaks, for instance, or police officers who retired young enough to form their own companies.

If the workers do not declare their state pension income, they appear to be low lifetime earners in the Social Security system.

That produces windfalls because Social Security is intended to give the poorest Americans assistance in retirement.

State workers often complain that they are being penalized for working two jobs if they report their full income. But in fact, they are otherwise gaming the system in a way that no one else can, claiming bigger benefits than other retirees with the same income history.

“This is somebody else’s money they’re playing with,” said Andrew G. Biggs, a former deputy commissioner for Social Security, now an economist with the American Enterprise Institute. “The people who are in the Social Security system who don’t get good state pensions, this is taking money away from them.”

The problem does not occur in states whose workers participate in Social Security, because the federal program can see how much workers have earned from the states over the years.

The most recent audit, by Social Security’s inspector general in September 2008, looked at a sample of 235 Social Security recipients, and found 21 who were being paid too much. Extrapolating, the inspector general warned that unless Social Security identified and corrected all such errors, “it will pay about $53.2 million in overpayments annually.”

Missouri Legislature approves changes to state employee pension benefits

Pension Reform Bill Passes in Special Session

Final Version of Bill Does Not Include Previously Proposed Retirement Incentive or Investment Board

Posted on www.mosers.org on 07/14/2010

Please Note: This legislation makes no changes to retirement benefits for existing state employees or current retirees. TAFP/CCS/SCS/HCS House Bill 1 applies only to new state employees hired for the first time in a benefits eligible position on or after January 1, 2011.

Highlights of the bill (Governor's signature pending) for new employees in the new tier of the MSEP 2000 plan include:

Contributions: New employees will be required to contribute 4% of pay to the retirement system. (the plan currently is non-contributory kb)
Vesting period: 10 years. (up from 5 kb)
Normal Retirement Eligibility: At least age 67 and 10 years of credited service or at least age 55 with sum of age and credited service equaling at least 90. ((from 62 or Rule of 80 at any age kb)
Early Retirement: At least age 62 with 10 years credited service with a reduction in the base benefit (Terminated-vested members will not be eligible for early retirement).
Purchased Service: The subsidized purchase of service provisions are eliminated.
BackDROP: Not available to new state employees hired for the first time in a benefit eligible position on or after January 1, 2011.
No Retirement Incentive: The final bill does not contain a retirement incentive.

NCSL posts updated listing of legislative pension enactments

The National Conference of State Legislatures has posted an updated version of its venerable Pension and Retirement Plan Enactments. The file is accessible directly here:

http://www.ncsl.org/?tabid=20836

and is accessible via the NASRA web page, Reports on the Public Retirement System Community, here:

http://www.nasra.org/resources/reports.htm

Report on states’ revenue finds slow growth but no broad recovery

First Quarter 2010 Brings Revenue Gains for States, After Disastrous 2009

No broad fiscal recovery for states yet; collections in second quarter appear weaker

Albany, N.Y. — States’ overall tax revenues rose 2.5 percent in the first quarter of 2010 on a year-over-year basis, marking the first such gain since the third quarter of 2008, according to the latest State Revenue Report from the Rockefeller Institute of Government.

The growth in states’ tax collections, however, does not indicate broad fiscal recovery, according to the report. The overall revenue growth was largely the result of legislated tax increases in two states — California and New York. Compared with two years ago, states’ tax collections declined — by 9.3 percent — from the first quarter of 2008.

Further, preliminary data for April and May indicate that states’ revenues in the second quarter of 2010 will likely be weaker than in the first quarter. Data from 42 early reporting states show tax collections for those two months inched upward less than 1 percent, compared to a year earlier.

“After record tax declines in calendar 2009, the fiscal conditions of the states remain quite fragile,” write Institute Senior Policy Analyst Lucy Dadayan and Senior Fellow Donald J. Boyd, the report’s co-authors.

The data confirm findings the Institute issued last month in its “flash” report, which used preliminary data from early-reporting states. The new report, based on final first-quarter data from the Census Bureau for all 50 states, provides a more complete picture of tax collections for the first three months of the year and some early second-quarter data.

Despite the revenue gains overall, 33 states reported total tax declines during the first quarter, with five states reporting double-digit declines. If California and New York are excluded, overall tax revenues in the remaining 48 states dipped 1.5 percent in January-March 2010, compared to the first three months of 2009.

In a reversal from the last two quarters, local tax revenue declined 1.1 percent, led by drops in property tax and corporate income tax collections.

On a regional basis, the New England, Mid-Atlantic, and Far West regions all saw increases in tax collections, while the remaining regions suffered declines. The Rocky Mountain region reported the largest drop-off at 8.1 percent. Wyoming and Louisiana reported the largest declines in tax revenues, at 30.2 percent and 24.6 percent, respectively. The dips in those states were not surprising, the report notes, as those states’ tax collections were unusually high in previous quarters due to strong growth in taxes paid for oil extraction.

Institute experts continue to forecast a rough road to states’ fiscal recovery. Fiscal year 2010 ended June 30 for 46 states. Many states were forced to take undesirable actions to balance their fiscal year 2011 budgets, the report notes. Those actions include tax increases, spending cuts or reductions in public service. Many states also pushed some of their budgetary problems into subsequent fiscal years with “borrowing, fiscal gimmicks, and other approaches,” according to the report.

“Even if the economic recovery is as rapid as those from prior recessions, it would likely take state tax revenue several years to recover to its previous peak,” Dadayan and Boyd write. “With the expected slow recovery from this recession, state fiscal recovery is likely to take longer.”

For a full copy of the report, visit www.rockinst.org.

Alan Milligan: CalPERS investment return assumption is realistic

Viewpoints: CalPERS uses realistic estimate in calculating pension funding

By Alan Milligan Sacramento Bee Tuesday, Jul. 20, 2010

We are just emerging from the worst economic recession since the Great Depression in which investments of all types have lost significant value, from stocks to real estate. Pension funds, unfortunately, are not immune from global economic forces. It should not be a surprise that the funded status of pension plans has declined.

Unfortunately, several recent studies have muddied the waters by exaggerating pension liabilities. These studies were not conducted by pension experts or actuaries but by academics or think tanks with an ideological bent.

A recent example is the study by Stanford graduate students which was commissioned by the Schwarzenegger administration. The student researchers used a much lower discount rate, or assumed investment return rate, to produce a much higher liability figure.

The lower assumption would be appropriate if the assets of pension funds were invested only in low-yielding Treasury securities, but most pension fund investment portfolios are much more diversified and earn higher returns than Treasury securities alone.

It is interesting to note that even the proposed changes in the Governmental Accounting Standards Board rules would not use these low discount rates for liabilities. In fact, the liability that would be reported under the proposed rules would be the same as CalPERS currently reports.

Not even Stanford University uses these discount rates for its endowment or pension fund. By exaggerating unfunded liabilities, the study implies that higher taxpayer contributions are required. It conjures up a half-trillion-dollar liability and the falsehood that CalPERS and other pension funds are hiding trillions of dollars of liabilities. The funding and accounting of liabilities is, and should be, based on standard actuarial assumptions that reflect how pension plans are actually funded.

For 78 years, CalPERS has been using an accounting method that adheres to governmental accounting standards and is consistent with actuarial best practices. We assume an average annual investment return of 7.75 percent, a target that has been achieved over the last 20 years despite two recession years.

A recent study by Callan Associates found the investment assumptions of public pension plans are consistent with historical experience.

According to the Callan report: "We examined the historical record for implicit real return assumptions for U.S. stocks and bonds and conclude that real return assumptions for public plans are in line with historical experience." The report goes on to say: "Most actuaries are using real return assumptions in line with historical experience, with the distribution marginally skewed toward the conservative end of the spectrum."

Nevertheless, CalPERS is currently engaged in a top-to-bottom review of our asset allocation and our investment return assumptions. Part of that effort includes reaching out to a wide-ranging group of experts with varied opinions on asset allocation and the assumed rate of return.

In November, our board will hold a two-day asset/liability management workshop on the issue. Our assumed rate of return will be considered in February 2011.

As the administrator of retirement plans for more than 3,000 cities, counties, special districts, school districts and the state of California, CalPERS believes a debate over public employee retirement benefits is healthy. But the debate should be based on sound assumptions and facts. Unfortunately, exaggerating pension liabilities to scare the public and policymakers is not.

CalSTRS reports 12.3 percent investment return for year-ended June 30

CalSTRS rebounds with double-digit returns

July 19, 2010

12.3 percent return a positive note, but 2008 declines still impact portfolio.

WEST SACRAMENTO, CA– The California State Teachers’ Retirement System (CalSTRS) investment portfolio posted a solid 12.3 percent return at the end of the 2009-10 fiscal year.

The CalSTRS investment portfolio’s market value at fiscal year’s end was $129.77 billion. The 12.3 percent return rate beat the actuarial rate of 8 percent and brought in more than $10 billion as the 2009-10 fiscal year ended on June 30.

However, because CalSTRS bases its investment portfolio performance on a three-year rolling average, the last two years’ losses of 25 percent and 3 percent, still have an effect.

“We’ve taken steps to position the portfolio for long-term growth, but we’re not out of the woods yet,” said CalSTRS Chief Investment Officer Christopher J. Ailman. “The American economy suffered a near-death experience in 2008, and it’s going to take some time to fully recuperate from that. This year’s performance is a solid start along that road to recovery.”

The CalSTRS Board and investments staff have positioned the fund for ongoing recovery by:

Expanding its target asset ranges to avoid having to sell at a loss.
Temporarily shifting 5 percent of the portfolio from global equities to fixed income, real estate and private equity to take advantage of the distressed market.
Permanently shifting 5 percent of the portfolio from global equities to create a new absolute return asset class for inflation-protection.
Adopting a new asset allocation mix to further diversify the portfolio and reduce its stake in the global stock market.
Launching the Innovations and Risk unit to explore new investments such as a macro global hedge fund strategy, commodities and microfinance.

Returns by asset class were: 14.5 percent for global equities (U.S. equities posted 15.7 percent, non-U.S. 12.1 percent), fixed income at 12.3 percent, private equity with 21.7 percent, and real estate with -12.4 percent.

As of June 30, 2010, the portfolio holdings were: 51.7 percent in U.S. and non-U.S. stocks, 22 percent in fixed income, 14.5 percent in private equity, 10.1 percent in real estate, 0.9 percent in absolute return assets and 0.8 percent in cash.

The California State Teachers' Retirement System is the second largest public pension fund in the United States. It administers retirement, disability and survivor benefits for California's 848,000 public school educators and their families from the state's 1,400 school districts, county offices of education and community college districts.

Maryland State Retirement Agency reports investment return of 14.05 percent for year-ended June 30

Press Release

Maryland State Retirement Agency Earns 14.05% on Investments in FY 2010

Exceeds 7.75% assumed return

Baltimore, MD (July 20, 2010) — The Board of Trustees of the Maryland State Retirement and Pension System has been informed that its portfolio returned 14.05 percent on investments for the fiscal year that just ended June 30, 2010—exceeding the 7.75 percent assumed actuarial return rate. The performance raised the assets of the system to $31.848 billion.

In making the announcement today, Mansco Perry, Chief Investment Officer said, “My staff has worked tirelessly to realize this kind of a return during these challenging economic times. I believe these results demonstrate we have a portfolio headed in the right direction. Though the final numbers aren’t in, I expect that we will have exceeded our policy benchmark by nearly 250 basis points (2.5%).”

	Asset Allocation	Return
Public Equity	51.2%	15.63%
Private Equity	3.2	14.16
Fixed Income	19.0	14.31
Credit	3.4	19.23
Real Return	10.5	12.10
Real Estate	6.3	3.55
Absolute Return	4.4	7.47
Cash	2.0	2.48
Total		14.05%

“The board is very pleased with the fund’s performance, due in no small part to the excellent team headed by Mr. Perry and to the system’s prudently diversified asset allocation that they manage,” said State Treasurer Nancy K. Kopp, Chair of the Maryland State Retirement and Pension System Board of Trustees. “This offers further proof to our more than 367,000 members that they can rely on the professional staff of the State Retirement Agency to look after their interests. We should all be pleased with today’s announcement.”

# # #

The Maryland State Retirement and Pension System is charged with the fiduciary responsibility for properly administering the retirement and pension allowances of more than 116,000 retirees and beneficiaries as well as the future benefits for more than 251,500 active and former members. These groups include state government employees, teachers, law enforcement personnel, legislators, judges and local government employees and fire fighters whose employers have elected to participate in the system.

AIG settles lawsuit led by public pension funds

AIG Settles Investor Lawsuit for $725 Million, May Sell Shares

July 16, 2010

July 17 (Bloomberg) -- American International Group Inc., the bailed-out insurer, agreed to pay $725 million to settle a lawsuit by investors as it seeks to resolve a backlog of litigation and repay the U.S. government.

AIG said it may sell common stock to raise $550 million of the total, according to a regulatory filing yesterday. If the New York-based company is unable to raise that sum, the agreement may be terminated.

“If you had to do it, now would be the time to do it,” Optique Capital Management analyst William Fitzpatrick said, referring to a share sale. Milwaukee-based Optique oversees $800 million and doesn’t own AIG shares. “There are plenty of funds available that want the issue; the question will be under what kind of terms.”

Chief Executive Officer Robert Benmosche is settling with investors who lost money when the insurer’s stock plunged amid a 2004 investigation by then-New York Attorney General Eliot Spitzer into bid rigging and faulty accounting. The insurer agreed in November to settle legal disputes with former CEO Maurice “Hank” Greenberg, who was ousted in 2005. AIG said in a Nov. 6 filing it faced more than a dozen lawsuits and probes.

The suit covered by yesterday’s agreement was filed by plaintiffs including public pension funds in Ohio, New Mexico, Mississippi and California. They claimed AIG fraudulently inflated results, causing the share price to plummet when the deception was uncovered. Under the settlement agreement, AIG will pay $175 million within 10 days of preliminary court approval.

Go Forward

“The key here is for the company to go forward and make money and do business and have issues dealing with supervisors and shareholders all in the past,” said Ernest “Ernie” Patrikis, a partner at White & Case and a former general counsel at AIG. “It’s another major impediment behind them.”

AIG settled with Spitzer and federal regulators in 2006, agreeing to pay $1.64 billion.

The insurer was forced in September 2008 to take a government bailout that swelled to $182.3 billion, giving the U.S. a stake of almost 80 percent. If AIG raises at least $550 million through a share sale to repay the U.S. government, that will trigger a full payment of yesterday’s settlement, according to the filing. Andrew Williams, a spokesman for the Treasury Department, had no immediate comment.

“We are pleased to have resolved this matter,” AIG spokesman Mark Herr said in a statement. “This settlement ends a long-standing lawsuit, allowing AIG to continue to focus its efforts on paying back taxpayers and restoring the value of our franchise for the benefit of all our stakeholders.”

Selling Shares

A share sale would be the first for AIG since May 2008, when it needed funds to cushion losses tied to bad bets on subprime mortgages. The stock has risen 19 percent this year, outpacing the 4.5 percent decline in the Standard & Poor’s 500 Index.

AIG declined $1.74 to $35.64 yesterday in New York Stock Exchange composite trading. That compares with $767.40 on May 12, 2008, when the last offer priced, according to data compiled by Bloomberg.

Ohio Attorney General Richard Cordray said in a separate statement that total damages from AIG will reach $1 billion, including earlier lawsuits. In April, Cordray said AIG would settle allegations it violated Ohio antitrust laws by colluding to restrict the commercial insurance market.

“This historic settlement is an excellent result for all shareholders harmed by AIG’s misconduct, including Ohio’s teachers, firefighters, police officers and public employees,” Cordray said.

In February, the insurer hired Thomas Russo to be general counsel. Russo was the Lehman Brothers Holdings Inc. chief legal officer when the securities firm went bankrupt in 2008. Last month, AIG named former Lehman managing director David A. DeMuro as head of compliance and regulatory affairs.

The case is In re American International Group Inc. Securities Litigation, 1:04-cv-08141, U.S. District Court, Southern District of New York (Manhattan).

GAO testimony on defined benefit plans’ increased investments in hedge funds and private equity

The Government Accountability Office this week provided testimony to a Congressional Subcommittee on the subject of increased investments in hedge funds and private equities by private and public pension funds.

An excerpt from the Summary:

According to a survey of large plans, the share of plans with investments in hedge funds grew from 11 percent in 2001 to 51 percent in 2009. Over the same time period, investments in private equity were more prevalent but grew more slowly--an increase from 71 percent in 2001 to 90 percent in 2009. Still, the average allocation of plan assets to hedge funds was less than 5 percent, and the average allocation to private equity was less than 8 percent. Available data also show that investments in hedge funds and private equity are more common among large pension plans, measured by assets under management, compared to mid-size plans. Survey information on smaller plans is unavailable, so the extent to which these plans invest in hedge funds or private equity is unknown. Hedge funds and private equity investments pose a number of risks and challenges beyond those posed by traditional investments. For example, investors in hedge funds and private equity face uncertainty about the precise valuation of their investment. Hedge funds may, for example, own thinly traded assets whose valuation can be complex and subjective, making valuation difficult. Further, hedge funds and private equity funds may use considerable leverage--the use of borrowed money or other techniques--which can magnify profits, but can also magnify losses if the market goes against the fund's expectations. Also, both are illiquid investments--that is they cannot generally be redeemed on demand. Finally, investing in hedge funds can pose operational risk--that is, the risk of investment loss from inadequate or failed internal processes, people, and systems, or problems with external service providers rather than an unsuccessful investment strategy. Plan sponsors we spoke with address these challenges in a number of ways, such as through careful and deliberate fund selection, and negotiating key contract terms. For example, investors in both hedge funds and private equity funds may be able to negotiate fee structure and valuation procedures, and the degree of leverage employed. Also, plans address various concerns through due diligence and monitoring, such as careful review of investment, valuation, and risk management processes. The Department of Labor (Labor) has a role in helping to ensure that plans fulfill their Employee Retirement and Income Security Act of 1974 (ERISA) fiduciary duties, which includes educating employers and service providers about their fiduciary responsibilities under ERISA. According to plan officials, state and federal regulators, and others, some pension plans, such as smaller plans, may have particular difficulties in addressing the various demands of hedge fund and private equity investing. In light of this, in 2008, we recommended that Labor provide guidance on the challenges of investing in hedge funds and private equity and the steps plans should take to address these challenges.

Access the full summary, along with the full report, here: http://www.gao.gov/products/GAO-10-915T

Girard Miller: A value-added tax could have significant effects on federal and state retirement plans

Going to Bat for a VAT

Tax solutions for Social Security and Medicare could also heal the states.

Governing Magazine July 15, 2010

President Obama's new bipartisan commission on fiscal responsibility is meeting this summer and will report its findings after the November elections. The most important topics it will address are Social Security, Medicare and the financing of them.

In last month's column on "Fixing Social Security and Medicare," I outlined the kind of comprehensive package that will be necessary to fund both systems properly for the 21st century. This month, I'll focus on the revenue and tax side.

The latest reports from trustees for Social Security and Medicare show the two systems to be actuarially deficient by 6 percent of payroll nationwide. If Congress tries to raise payroll taxes by 6 percent, the self-employment tax on individuals would exceed 20 percent -- in addition to the personal income taxes and state and local taxes they also pay. That approaches a taxing level many would call confiscatory. The solution needs to lie elsewhere, so it should not come as a surprise that the commission will dust off a perennial tax topic: the value-added tax.

A VAT is a broad-based consumption tax, which is collected at each stage of economic production. Farmers pay a tax on the wheat they sell, flour mills pay a tax on their flour, bakeries pay a tax on their bread, and restaurants pay a tax on the bread at meals they serve. Each receives a credit for all the taxes paid previously by their suppliers. VATs are common in Europe and Canada.

Some states have also considered a VAT as a replacement for their sales taxes. That's because services compose a greater percentage of the economy every year and most services escape the sales tax. A broad VAT with few exceptions would arguably treat every industry the same and require a lower tax rate than a sales tax. However, businesses that operate nationally would worry that a multistate VAT regime would be ridiculously complex. Uniformity in tax structures across state lines would be an important positive.

To solve the impending Social Security and Medicare crisis, a VAT would serve a broader social purpose: To collect revenues from two generations that failed to fix the fiscal deficits before they started collecting from these underfunded systems. Retirees don't pay much in payroll taxes, but they would pay a VAT on their consumption. Younger generations who will inherit their elders' Social Security and Medicare deficits will consider it more equitable that everybody pays into the solution.

Those who consider a VAT regressive might be mollified if the federal estate tax were also earmarked for Social Security and Medicare. That pairing would cut equitably across all income and wealth levels more fairly than any other alternative or combination.

To win Republican support for the VAT and the earmarking of estate taxes, I suggested last month that the estate tax deductions and rates need to be set at levels that don't penalize successful middle-class families, while making sure that we discourage American aristocracies through inherited wealth. I would also suggest a 12-year limit on capital gains and dividend income taxes at the 20 percent level along with the new Medicare tax on unearned income at no more than 5 percent, to keep American capital formation competitive internationally. Otherwise, Republicans would be crazy to accept a VAT, even as part of a prudent solution to retirement reforms that requires benefits limits, caps on COLAs and higher retirement ages.

I'd also be shocked if any VAT or payroll tax increase were to take effect before 2013. The 2012 presidential election stands in the way, and our fragile economy remains vulnerable to a tax shock -- unless it's just a token increase that will ramp up later to mollify the government bond and global currency markets. One idea is to require the economy as measured by GDP to grow by 3 percent annually before any tax increases are scaled-in prior to 2013.

If Congress ever considers a VAT to fully fund the Social Security and Medicare systems, state and local governments should advance a piggy-back VAT for themselves. Congress could easily add another 2 percent VAT tax to the federal bill to be distributed directly to states where it is collected. A piggyback VAT would be true "revenue sharing" rather than "deficit sharing." States could decline to allow and accept the federal piggyback VAT and its revenues, so that each legislature would decide whether it could properly put the money to good use. California, where constitutional tax limitations apply, would be one state in particular that could make good use of such revenue. States with little pressure on their budgets or with bedrock-conservative anti-tax legislatures could opt out.

To address conservatives' instinctive opposition to new taxes at any level, Congress should attach strings to the piggyback option: All the states' money must be used exclusively for fiscally frugal purposes. No new social programs or operating subsidies. Revenues would be divided between these three categories:

A third should be used to match infrastructure replacement spending, with no more than one-quarter used for public buildings. That way, transportation, decayed public utilities and the economic base of the state and the nation are all improved.
A third should be used for long-term financial stabilization. Half of this money should be earmarked for local governments and schools to fund deficient retirement plan trust funds first and then air-tight rainy-day escrow accounts. That second half should be used to insure that state budget stabilization reserves can withstand a two-year revenue loss comparable to the great governmental recession of 2008-10, and to properly fund previously incurred (not future) retirement plan deficits. This will avoid future federal bail-outs in the next recession.
A third should be used to reduce sales, personal income and residential property taxes.

To win support of local governments and schools, it may be helpful to allocate minimum percentages of all three buckets. However, too much earmarking at the Congressional level will result in gamesmanship somewhere, so I would favor broader discretion for the governors and state legislatures, who must first decide whether such additional taxes are warranted in their states. If they see this as one-sided for localities and schools versus what they could do themselves through a local tax or single-state VAT, they will simply opt out.

State and local leaders and their policy organizations should articulate their interest in this option this summer, before the presidential commission concludes its research and begins to formulate its recommendations. As I see it, this structure offers something to both political parties and deserves bipartisan support at the federal, state and local level.