Removing Pension Dollars from the RI Economy

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Rhode Island’s pension system sent $142,159,475 directly out of state, in 2010, to the 4,575 public-sector retirees who live elsewhere. That’s according to the RI Center for Freedom & Prosperity’s new RIOpenGov.org section on pensions. Overall, government pension payouts amount to approximately 1.7% of Rhode Island’s gross state product (GSP), and 17.2% of them support the economies of other states, with the following top 10:

 

The pension dollars lost to Rhode Island’s economy are of particular concern during this era of high unemployment and sluggish economic activity, when it seems as if political actors feel they must couch every argument about public policy in terms of economic stimulus. In the debate over pension reform in Rhode Island, National Education Association Government Relations Director Pat Crowley got ahead of the pack by telling GoLocalProv on October 21 that freezing cost of living adjustments (COLAs) would “be a major drain on the Rhode Island economy.” The following week, the Brown Daily Herald noted the point being made in the wave of Finance Committee testimony. The assertion, in brief, is that if retirees’ pensions do not match or exceed inflation, they will have less cash to spend, which means that less money will cycle through the local economy.

The broadest response to such claims is that every dollar paid into the public sector pension system has to come out of the economy in the first place, most of it reducing local buying power in order to fund national and international investments. In that light, General Treasurer Gina Raimondo’s proposed reform — any reform — would count as stimulus. The state’s pension actuaries, Gabriel Roeder Smith & Company, estimate that the retirement system will require state and local governments to contribute $659 million in fiscal year 2013 without reforms, but only $383 million with the proposed reforms. That’s a difference of $276 million that taxpayers could use to pay bills, purchase goods and services, and make investments.

Meanwhile, additional data from RIOpenGov.org shows that the pensions paid out in 2010 were augmented by $176.0 million for total COLAs already applied to base pensions. In other words, while special interests are arguing that freezing COLAs at their current level would harm Rhode Island’s economy, the state could erase COLAs from the pension system entirely and the economic harm still wouldn’t amount to two-thirds of the economic benefit that the current (arguably too restrained) reform would represent for local economic activity.  (All of this leaves aside, of course, the additional benefit of proving that the state is interested in securing its future.)

And as the total pension dollars sent out of state show, that’s not the whole picture. If COLAs are distributed equally among retirees in state and out of state, $149.6 million of the money paid to retirees who live in Rhode Island is attributable to the adjustments. That means that completely eliminating every penny of current COLA payments would have about the same economic impact, in Rhode Island, as paying for the retirements of people who don’t live here.

Whether these amounts are significant in a $47.6 billion state economy is a matter of opinion. So, too, is the legitimacy of various changes and restrictions that the state could consider imposing on pensions. When assessing the impact of reform, however, it is critical to consider the many ways in which Rhode Island’s public-sector pension system interacts with the economy.

Later Retirement Doesn’t Harm School Districts’ Payroll Costs

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National Education Association of Rhode Island President Larry Purtill is gaining some traction with his claim that having teachers retire later will hit local communities in the payroll. As described in an October 25 Providence Journal story by Kathrine Gregg (not online):

Sen. Walter Felag, D-Warren, asked the question that Larry Purtill, president of the National Education Association of Rhode Island, has asked on YouTube and elsewhere: how will city and town taxpayers be able to afford all of the top-scale teachers who would now be forced to work until they are 67 years old?

A top-step teacher averages $70,764 a year in Rhode Island; a first-year teacher averages $39,087, according to Purtill.

Purtill has not yet had his turn to testify before the legislators, but in other venues he argues: “If a teacher is forced to go from 62 to 67 to retire and would have been replaced by someone on Step 1, that is an additional $130,479 for one teacher over that five-year period. Has anyone thought about this, and figured it into the actuarial studies? I am assuming that unless state aid increases by a drastic amount, this cost will go directly to the cities and towns.”

There’s a reason Purtill stops his cost clock at five years: because after that point, the older teacher retires and a replacement is hired at step one. Obviously, that teacher will be making less, to start with, than a teacher hired five years earlier, so the scenario of a later retirement actually begins to save the district money. And the district continues to save money for the ten years it takes the new teacher to reach step ten, herself.

To put a number on this dynamic, I averaged all of the salary steps compiled by the Rhode Island Association of School Committees for the 2011/2012 school year. For easier comparison, I then removed the few districts that spread their steps over more than ten years, leaving me with 14 cities and towns. (To check for any distortion, I compared these districts to the broader average available for 2010/2011 and found them to be about 0.1% higher, overall.) Using these averages, I figured out the year-to-year step raises and factored in the 4% increase that the pension actuaries estimate that the overall step system receives each year, on average (inflation plus general increase). By this method, I found step one to be $39,175 and step ten to be $72,393.

It is true that a local district will therefore pay an extra $141,475 for five more years of the older teacher’s salary, compared with a replacement starting at step one. However, seven years after the delayed retirement, the savings in waiting to hire her replacement have erased the extra costs. By the time the later replacement reaches step ten, the district turns out to have saved $44,990, and that number holds for decades, until the year that the earlier replacement would have retired.

Remember that this is savings to the district on salary alone. Most districts offer retirees some sort of health benefit, which will erode the initial salary savings of earlier retirement. What’s more, a good number of districts only pay retiree healthcare until Medicare age, so pushing retirement beyond that point would eliminate the healthcare portion of districts’ other post-employment benefits (OPEB) liability completely.

An important note arises if we expand the inquiry to figure out the cost/savings of later retirement in terms of the older teacher’s pension. Such an analysis is difficult to perform, because changes to the retirement system over time have left a number of categories into which employees can fall; moreover, teachers can retire at various ages, with varying years of service, so an accurate comparison would require teacher-by-teacher analysis.

For illustration purposes, however, I assumed normal retirement at age 62 with 29 years of service on a non-grandfathered Schedule A. (That means the teacher receives the more generous percentage of pay that Schedule A provides but has the retirement benefit calculated as an average of his or her highest five years, not three years, as would be the case for a grandfathered Schedule A pension.) For the second scenario, I added five years to this teacher’s career, but followed the proposed pension reform such that the teacher only accrues an additional 1% of salary for each additional year of work. I did factor in cost of living increases for both scenarios, but I used the reformed rate, which ties increases to pension fund performance.

The upshot is that the later retirement saves the retirement system about $54,000 over the life of an individual teacher. But those savings only materialize under the terms of the proposed reform. Applying a later retirement to the current system, without other reforms, winds up costing money in the scenario I’ve described, because the starting pension rate and higher cost of living adjustments (COLAs) increase the total benefit by so much.

Whatever the case, under the current system, the teacher is working for 29 years and retiring for 25. Under the reform, he or she is working for 34 and retiring for 20. Put differently, under the current system (with all of my assumptions), the older teacher will be collecting retirement for almost the entire career of his or her replacement. Essentially, for just four years will the system be paying for only one teacher for one teaching job. Under the reform plan, that differential increases almost fourfold, leaving fifteen years of the replacement’s career unburdened by pension costs for the older teacher.

One needn’t run the numbers to get a sense of just how quickly Rhode Island and its cities and towns — collectively and individually — will save money.

Task Force Commentary: R.I.’s pension debt worse than admitted (by Jagadeesh Gokhale)

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As part of the national task force that our Center has assembled, Jagadeesh Gokhale, from the Cato Institute, published the OpEd below that appeared in the Providence Sunday Journal, Oct. 23, 2011.

R.I.’s pension debt worse than admitted

JAGADEESH GOKHALE

WASHINGTON, DC -Rhode Island’s pension crisis reminds one of Greece, now slaving under externally imposed austerity — the fruits of engaging in systemic deceit.

Lavish retirement benefits, including automatic inflation adjustments, awarded to state employees have resulted in future pension obligations of $11.5 billion in today’s (2010) dollars. But the state has assets worth only $6.8 billion on hand to cover these obligations, implying a funding ratio of less than 60 percent.

In addition, the state provides other post-employment benefits (OPEB) to its employees (general employees, teachers, police, judges, legislators, and so on) — whose present valued obligation amounts to $8 billion. This obligation is completely unfunded — that is, benefits are paid out of current revenues each year.

Adding it all up, the official measure of total pension and OPEB liabilities as of 2010 is $12.3 billion and the unfunded component is $5.5 billion.

Taking the numbers at face value, the state must make up this $5.5 billion shortfall in retiree pension and OPEB programs by increasing the share of general fund budget devoted to covering accruing pension obligations and amortization costs.

State general fund revenues amounted to $5.5 billion in 2010, of which 4.2 percent is contributed to meeting current benefit accruals and amortization costs. The state’s pension obligation amortization schedule extends to about 20 years, but OPEB obligations will remain unfunded.

Unfortunately, the reality that is most likely to unfold in the future is much worse. The accounting methods used by the actuaries amount to sugarcoating the situation. The true magnitude of the Rhode Island’s pension and retiree health underfunding problem is larger by billions of dollars.

As economists have repeatedly asserted, because pension benefits are guaranteed, they should be evaluated by discounting future benefit flows using a relatively safe rate of return — on the order of 3 percent per year in inflation-adjusted terms. Pension actuaries, instead, use the much higher rate of return they expect on the pension fund’s assets — which are usually invested in risky private equities and bonds.

This accounting treatment undervalues (ignores) the risk that the relatively fixed and certain benefit obligations would have to be paid out of additional taxpayer funds because the pension fund’s asset portfolio suffers losses from a market downturn precisely when it must be drawn upon (sold) to fund benefit obligations coming due.

Discounting future benefit flows at a risk-adjusted rate of interest, however, is politically unpalatable because it results in a much higher measure of pension liabilities and increases the current funding burden on the state’s budget.

In the case of Rhode Island, the state’s Comprehensive Annual Financial Report for 2010 (the most recent available) specifies an expected return on pension assets of 8.25 percent. The present valued pension and retiree health liability reported earlier are calculated using that discount rate.

However, using a risk-adjusted rate of return in evaluating the pension liability, and incorporating a 2 percent annual growth rate of the retiree population, shows that the total accrued pension and health liability would be 56 percent larger — or $18.7 billion instead of the official total of $12.3 billion. And the unfunded liability component would be $11.9 billion instead of the officially reported $5.5 billion.

There are other concerns, as well, regarding the level of contributions being made by Rhode Island to amortize this liability and the management of the pension fund’s investment portfolio. Ongoing reform efforts are likely to affect current and future state employees, but the understatement of pension liabilities hides the size of taxpayer exposure to future pension funding shortfalls.

A thorough exploration of feasible pension reform alternatives in Rhode Island is urgently needed. Unfortunately, the underlying data on historical earnings, job tenure and other information on state pension plan participants has been kept under wraps by the authorities.

This impedes transparency and the ability of state lawmakers to analyze and draw upon new ideas on how to resolve the state’s pension funding dilemma and improve the programs’ financial condition over time. That has to change soon if there is to be any hope of dealing with this crisis.

Jagadeesh Gokhale is a senior fellow at the Cato Institute in Washington D.C.

Hybrid Savings Mean System Failure

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The only argument that I’ve heard against my suggestion that the proposed hybrid pension system will be more expensive than the current system is that the hybrid offloads market risk onto the employee, alleviating the risk to the employer (i.e., us, the taxpayers). Moderate Party founder and gubernatorial candidate Ken Block made the point on Anchor Rising, and Gary Morse, pension adviser to the Republican who was almost governor, John Robitaille, called in when I was on Friday’s Dan Yorke Show to make a similar point.

My response has been to suggest that, while the objection may be true, the entire pension reform relies on the 7.5% rate of return that the state’s actuaries have assumed. As a reminder, the current system is a defined benefit plan, which promises employees a certain retirement package; the hybrid system would decrease that benefit but put money into a 401(k)-style plan for each employee to fill in the gap. Right now, the major problem is the liability for defined benefit promises already made, and the hybrid doesn’t make those go away.

Unfortunately, I haven’t come across “what if” data from the actuaries that allows a real comparison of the system’s health with different rates of investment return. One can, however, infer the effect of the Retirement Board’s recent lowering of the return rate assumption from 8.25% to 7.5% from the latest actuarial report. Specifically, the Board dropped the rate of return by 9%, and the normal cost of an active employee’s pension (that is, the percentage of payroll that must be put aside to fund an individual employee’s retirement) went up by 22% for state workers and 18% for teachers.

For an accurate “what if” scenario, the actuaries would have to apply the different assumptions to their models, but purely for the sake of illustrating my point about the cost of the hybrid plan, I’ve assumed that same return-rate-to-normal-cost ratio applies consistently to the equation. If that’s accurate, then the hybrid plan doesn’t cost the taxpayer less than the current system unless the market returns less than 5% on investment:

The solid lines show the effects of an under-performing market on the current defined-benefit plan; the dotted lines show its effects on the hybrid plan. And, yes, the lines do cross eventually. However, under those circumstances, the total cost for the pension system to the employer, even under the reform, will be well above the annual cost that currently has everybody in a panic — over 60% of payroll for teachers and nearing 80% of payroll for state workers:

Of course, the solid lines, which track the current system, show just how scary the situation will be if the General Assembly does nothing, and a defined contribution component ought to be part of the solution (if not all of it). That doesn’t mean, though, that reformers should take the system on the table just because it incorporates some worthwhile concepts. If this reform passes, it’ll be years before the panic level rises sufficiently for further action by elected officials, and by that point hundreds of millions of dollars will have been siphoned into untouchable defined-contribution accounts.

RI energy policy questioned in three national articles

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Two recent articles from nationally recognized sources – the Washington Examiner and Town Hall – referenced the Deepwater project and Rhode Island’s energy landscape and strongly hinted that we are harming our citizens and businesses via our costly state energy policies and bypassing the traditional approval process.

In the article, four important points were made that RI citizens and public officials should consider:

  1. State energy policies that dictate that RI take a part in the floundering Regional Greenhouse Gas Initiative (RGGI) and mandating the we comply with a Renewable Portfolio Standard (RPS) requiring cuts in carbon emissions and increases in renewable energy … both serve to raise energy costs to consumers.
  2. Robbing Peter to pay Peter: citing the Toray Plastics example, the folly and unfairness is pointed out of the government causing energy rates to rise (taking from Toray), then implementing a special deal to subsidize a solar farm at Toray’s plant (paying to Toray) to keep them in RI; our government forced to get in the business of picking winners and losers because of its own failed policies in the first-place.
  3. Eating from the public trough: the disturbing image of vendors “securing a place in the supply chain of Northeastern Offshore Wind projects”. That’s right, there was actually a kind of ‘trade-show’ where businesses were openly invited to line-up to grab some of our money, whether taxpayer or ratepayer, that subsidized some of these wind projects.
  4. The original premises of renewable energy as a near-term panacea are under increasing question. A) The entire man-made climate change debate has lost much of its credibility; B) An immediate jobs boon was never realized for the renewable energy industry; C) Consumer demand for renewable energy is much lower than projected, because renewable energy costs are currently higher – not lower – than fossil fuels; D) There is no immediate shortage of fossil fuels.

In the Ocean State, our public policies, have raised the cost for energy for households and businesses … and we based those policies on what many now consider as false premises.

Reality is not negotiable: during these difficult economic times, should we be dealing with reality … or should we continue taking risks on politically-correct theory?

To read the first Town Hall article by Marita Noon, click here …

To read the Washington Examiner article by Ron Arnold, click here …

To read the most recent Deepwater related article by Martia Noon, click one of the links below:

http://www.globalwarming.org/2011/10/25/why-resort-to-shenanigans-to-make-green-energy-a-reality/

http://finance.townhall.com/columnists/maritanoon/2011/10/23/going_green_with_shady_deals

In the coming months, the RI Center for Freedom & Prosperity will recommend changes to our state energy policies, as part of larger, more comprehensive set of economic and educational reform items.

As with Cars, a Hybrid Pension System Will Cost More

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The complexity of the pension problem comes in the multiplicity of angles from which the numbers can be presented. When it comes to the cost of current employees’ pensions, General Treasurer Gina Raimondo’s hybrid pension system will cost more than the system that’s already strangling Rhode Island.

The headline grabber — because it’s such a large figure — has been the unfunded liability. Essentially, that’s the difference between the benefits promised over the amortization period and the accumulated resources expected to be available to pay them.

It’s critical to realize that both sides of that equation are predictions. General Treasurer Gina Raimondo induced her recent shock to the pension system by leading the Pension Board in a reduction of the predicted annual market return on the system’s investments of just 0.75%, from an 8.25% expected return to a 7.5% expected return. In tweaking its assumptions, the board effectively increased the unfunded liability of state worker and teacher pensions from $5.40 billion to $6.83 billion, according to the most recent actuarial report. The overall problem, however, requires predictions about everything from a female desk clerk’s life expectancy upon retirement in twenty years to the average raise that RI school committees will give to their teachers over the next several decades.

Although interested parties like to pick and choose from among them, various factors have contributed to the existence of the liability. Given the lag time between a particular year’s pension payments and its full effects on the system, elected officials have had plenty of incentive to promise future benefits that outstripped the budget dollars that they were actually willing to put aside in the present, and union leaders have been happy to play along, expecting those promises to be fulfilled somehow, someway.

Another factor has been the market. Even responsible officials, who put aside every penny that the actuaries called for would have wound up underfunded, because the actuaries were basing their predictions on an 8.25% return, when the system has only realized 2.51% per year, considered over the past five years, 2.28% over the past 10 years, and 6.57% annually since 1995.

And then there are all those predictions. The actuaries currently expect a female teacher who retired last year to live for 24.2 more years. They predict that the same teacher retiring in 2030 will only expect an additional 1.1 years of life,  or 25.3 years of retirement. With the rate of advancement in medical technology, does that really seem plausible?

The incentives and unpredictability of pension planning are what make defined-contribution option so attractive. With a defined benefit, the employer promises employees a certain amount of future income, and it is up to the employer (or, in the public sector, the taxpayer) to make sure that the money is there; with a defined contribution, the employer promises to put a certain amount of money aside, and future income will depend on the plans and investment returns of the specific employee. The dollar amounts may turn out to be exactly the same, but it isn’t a “liability” in that the employer hasn’t pledged to make up the difference for unmet expectations.

Leading up to the release of Treasurer Raimondo’s pension reform proposal, advocates for public workers and retirees have been downplaying the importance of reducing this liability by separating the theoretical cost of pensions for current employees from the amount that municipalities and the state have to put aside to catch up on the current debt. The mechanism for this argument is the “normal cost” of a current employee’s pension — that is, the percentage of payroll that must be invested in order to fully fund pensions as if the past liability did not exist.

For teachers, the “normal cost” is now pegged at 11.82% of payroll, and since the teachers contribute 9.5% from their own paychecks, the city and state combined only have to put in another 2.32%. That’s what NEA-RI Executive Director Robert Walsh meant when he wrote in the Providence Journal that “for the vast majority of existing employees, the facts support no further changes” to the pension system. Get over the liability hump, in other words, and it’ll be clear sailing for public-sector retirees.

The question that hasn’t been asked, yet, is what Raimondo’s hybrid defined-contribution/defined-benefit plan will do to public costs when calculated in these terms. The answer is that it will actually increase them, as the following table shows.

RI State Pension Employee and
Employer Contribution Rates (% of Payroll)
Current Employees Defined Benefit
Current Employees Defined Contribution
 Liability Amortization
Subtotal
Total
Employee
Employer
Normal Cost
Employee
Employer
Employee
Employer
Employee
Employer
State workers – current system
Prior assumptions
8.75
0.60
9.35
0
0
0
25.95
8.75
26.55
35.30
Assumptions in effect July 2012
8.75
2.64
11.39
0
0
0
33.70
8.75
36.34
45.09
After 2029 amortization
8.75
2.64
11.39
0
0
0
0
8.75
2.64
11.39
State workers – proposed system
2029 amortization
3.75
5.44
9.19
5
1
0
18.94
8.75
25.38
34.13
2035 amortization
3.75
5.44
9.19
5
1
0
14.91
8.75
21.35
30.10
After 2029 amortization
3.75
2.49
6.24
5
1
0
0
8.75
3.49
12.24
After 2035 amortization
3.75
2.49
6.24
5
1
0
0
8.75
3.49
12.24
Teachers – current system
Prior assumptions
9.50
0.50
10
0
0
0
25.71
9.50
26.21
35.71
Assumptions in effect July 2012
9.50
2.32
11.82
0
0
0
32.93
9.50
35.25
44.75
After amortization
9.50
2.32
11.82
0
0
0
0
9.50
2.32
11.82
Teachers – proposed system
2029 amortization
3.75
4.84
8.59
5
1
0
16.34
8.75
22.18
30.93
2035 amortization
3.75
4.84
8.59
5
1
0
13.27
8.75
19.11
27.86
After 2029 amortization
3.75
2.42
6.17
5
1
0
0
8.75
3.42
12.17
After 2035 amortization
3.75
2.42
6.17
5
1
0
0
8.75
3.42
12.17
Notes
1) Prior and current data from Employees’ Retirement System of Rhode
Island Actuarial Valuation Report as of June 30, 2010
2) Proposal data from “Actuarial Analysis of the Rhode Island Retirement
Security Act of 2011”
3) Amortization is currently scheduled for 2029; 2035 represents reamortization.
4) The proposed system continues the assumptions that will be in effect
as of July 2012.
5) Liability amortization includes current retirees’ pensions and the portion of current employees’ pensions not covered under normal costs.

Reformers should be wary of two facts that emerge from these eye-glazing numbers:

  1. Five percent of current retirees’ contributions will be entirely insulated from any problems that might arise with the defined-benefit component of the system — whether they be low investment returns, proof of unrealistic predictions, or a failure to meet recommended funding.
  2. Combining the defined-benefit and defined-contribution payments, the amount of money that state and local governments will spend on the retirements of current employees every year will increase — more than doubling until such time as grandfathered employees leave the system and continuing on at a higher rate even then.

This means that the savings of the overall pension reform rely entirely on changes to the existing system (e.g., COLAs and retirement age), because the hybrid will cost tens of millions of dollars more every year… even when the “pension crisis” is completely resolved and even if the assumptions prove accurate. And changes to the existing system are precisely the controversial elements that have battle lines being drawn.

With all the lines on the field and the questionable allegiances, taxpayers should be sure that somebody is defending their interests.

Hybrid Pies

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As much as I love text and tables, they do require quite a bit of background consideration before their more interesting revelations are truly visible. So, herewith, some pie charts to illustrate my core point on the matter of General Treasurer Gina Raimondo’s hybrid pension proposal.

The first chart shows state workers’ arrangement currently in place for fiscal year 2012.  Of total state worker payroll, each employee will contribute 8.75% of his or her salary to the defined benefit plan (the light-blue wedge), and the state will add in another 2.64% of payroll (the dark blue wedge).  The larger part of the state’s pension expenditure, accounting for 33.7% of payroll, is the brown wedge, which will go toward amortization of the unfunded liability.  In total, 45.09% of state worker payroll goes toward pensions.


Under the new pension system that General Treasurer Gina Raimondo and Governor Lincoln Chafee have proposed, state workers will put 3.75% of their salaries into the defined benefit plan (light blue) and 5% toward a defined contribution plan (leaving their total contribution the same). These amounts will be supplemented with 5.44% of payroll from the state toward the defined benefit program (dark blue) and 1% toward the defined contribution program (dark green).  The amount to be put toward the unfunded liability (brown) is 14.91%, bringing the overall cost of pensions to 30.1% of payroll.

The current arrangement in place for fiscal year 2012 for teachers calls for each employee will contribute 9.5% of his or her salary to the defined benefit plan (the light-blue wedge), to which the state and local governments combined add another 2.32% of payroll (the dark blue wedge).  Again, the larger part of the state’s pension expenditure, accounting for 32.93% of payroll, is the brown wedge, which will go toward amortization of the unfunded liability. In total, 44.75% of teacher payroll goes toward pensions.

Under the proposed pension system, teachers, will put 3.75% of their salaries into the defined benefit plan (light blue) and 5% toward a defined contribution plan (reducing their total contribution by 0.75% of salary). These amounts will be supplemented with 4.84% of payroll from the state toward the defined benefit program (dark blue) and 1% toward the defined contribution program (dark green).  The amount to be put toward the unfunded liability (brown) is 13.27%, bringing the overall cost of pensions to 27.86% of payroll.

Negotiating Points in the Pension Proposal

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Underlying the policy complexities of the pension issue is the background give and take of financial interests and political careers. General Treasurer Gina Raimondo, for example, is free to propose pretty much anything and let the General Assembly take the heat for actual changes. As long as she stays off the unions’ “not with a 10-foot pole” list, she can run for higher office as the stern-chinned pragmatist.

Similarly, Governor Lincoln Chafee can seek to burnish his “fiscal conservative” bona fides by publicly endorsing a plan more generally seen as Raimondo’s handiwork. For their part, legislative leaders can play off the treasurer’s supposedly objective calculations and the governor’s veto power. What the public is seeing and what elected officials are planning can be two very different policies.

An October 10 Providence Journal op-ed by National Education Association Rhode Island Executive Director Robert Walsh fits neatly into that interpretation:

The only equitable option presented to the pension advisory group was to make current retirees subject to the “Plan B Cost-of-Living Adjustment.” The Plan B COLA, already in place for current teachers and state employees, bases the COLA on the lesser of the rise in the Consumer Price Index or 3 percent, and it is further capped at the first $35,000 in pension earnings, which is also indexed to inflation. (The CPI is also used to calculate Social Security increases.) When combined with a more modest 25-year reamortization of the pension fund, the Plan B COLA option for retirees solves a significant part of the pension dilemma, unless the courts rule otherwise.

General Treasurer Gina Raimondo, to her credit, has allayed some fears already by strongly stating that no earned benefits would be cut, and that the debate regarding retirees would focus on the COLA. She has also wisely shown more openness to reamortization as part of a comprehensive solution to the pension issue.

Obviously, Treasurer Raimondo’s proposal (onto which the union-backed Governor Lincoln Chafee has signed) goes a bit farther than that, mainly in that it completely suspends COLAs pending the pension system’s healthy recovery, it introduces a hybrid defined-benefit/defined-contribution plan, and it adjusts the retirement age upwards to Social Security standards.  (Keep in mind, by the way, that various categories of employees — teachers, public safety, and so on — receive differing treatment.)

Several components of the proposal are subject to basic mathematical negotiation, meaning that the sides will trade dollar amounts in order to secure principles that they want to protect. It’s useful, therefore, to consider COLAs, retirement age, and amortization in this context.

The “Plan B” COLA calculation to which Walsh refers follows the Consumer Price Index and is capped at 3%; it also applies only to $35,000 of the pension benefit (although that number adjusts upwards every year by CPI-to-3%, as well).  Raimondo’s proposal replaces the CPI with the pension’s annual net return (over a five-year average), with the cap at a 4% increase.  In terms of the actuarial calculations, the upshot is that this move reduces the predicted annual COLA from 2.35% to 2%.  The sticking point is that the new proposal would withhold COLAs in any year that the system is less than 80% funded, which could mean a decade or more of no increases.

That aspect of the proposal, along with the increase in retirement age, are likely to be hotly contested.  And since Raimondo has crossed the Rubicon of reamortization (thus extending the number of annual state budgets until the plan is fully funded, reducing the hit each year, but also reducing investment returns), it will appear more reasonable to extend the amortization period even farther in order to “buy back” reduced benefits.  So, for example, advocates for retirees might accept the later retirement age but insist that the COLA pinch be eased, with the difference in costs made up with a few more years of amortization.

But this is all a numbers game.  The interesting wild card is the hybrid plan, which reformers rightfully like as a means of shifting market risk away from taxpayers and toward retirees, but which contains details that ought to make them wary.  Given the complexity of that topic, I’ll take it up in a separate post.

Bank of America Debit Card Tax: a Result of Bad Legislation?

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In mis-understanding their role to ‘regulate’ commerce, federal officials have once again taken a bite out of the pockets and liberties of US consumers and businesses.

The consequences are apparently over-whelmingly negative for Bank of America after they announced a new $5 debit card monthly usage fee.  In trying to login to their website, it was down, citing slower than usual operations. Whether this is because the Bank is trying to stop protesting customers from withdrawing their funds online … or whether it’s the work of angry hackers … the real question is:

Should Bank of America take all the blame for this highly unpopular, anti-consumer new fee?

The Heritage Foundation says “No”. That this is is simply another example of federal government regulations interfering with (as opposed to regulating) normal free-market activity.

It is a gross mis-understanding of our US Constitution for the federal government to believe it has the duty to intervene in commerce via the levy of unnecessary restrictions and costly regulations.

Article I, Section 8 of the Constitution gives Congress the power to regulate commerce, so as to ensure that commerce among the states would take place under clear and predictable rules. According to Georgetown law professor Randy Barnett, our framers granted Congress the power to regulate domestic commerce in order “to make commerce regular.” Today, far too many public officials mistake the term “regulate”  to mean “intervene”.  And the results are predicatably bad for consumer freedom.

In the Bank of America debit card case, the Bank is imposing the new fee in anticipation of a $2 billion annual loss brought about by the “Durbin Amendment” — a provision of last year’s Dodd-Frank Wall Street financial reform bill. The measure was intended to protect America from another financial meltdown, but in reality it placed a boatload of new burdens on financial institutions and their customers. The results? Increased risks to the financial system, increased regulations, and in this case, increased costs to anyone who uses a debit card.

This fee would not likely have occured if Congress had not interevned where it does not belong.

Read the full Heritage post here …

 

Selfishness as the means to Restore Prosperity?

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I attended a very interesting and thought provoking lecture at Brown University Wednesday evening (9/28/11) , featuring Dr. Yaron Brook, President of the Ayn Rand Institute. Dr. Brook, a free-market activist, provided a 30-40 minute lecture, entitled “Capitalism Without Guilt”, then took questions from the over 100 or so people in attendance, with a fair portion of them being students from Brown and other local colleges.

Here, based on my notes and personal paraphrasing, is a synopsis.

Initiating the discussion, Yaron Brook, rhetorically thanked President Obama for his plan to “fundamentally change America”. Obama’s resulting policies, he claims, have kicked off a vigorous national debate about the proper role of government, how to best create jobs, and what are free-markets and capitalism, in reality? He believes the debate will end up benefittng our country.

Brook talked about how our country is currently struggling with jobs and who creates them – the government or the private sector? He states that this issue was settled over 60 years ago; that “consumption” (as the liberals wants us to believe) is not the root of economic growth, but rather that it’s “production” and “investment”. Government stimulus programs, he says, are geared to stimulate consumption … and says this is the reason why they have never worked … anywhere, anytime for anyone. He cites the recent failed US stimulus programs that resulted in fewer jobs, and pointed to Japan, where the government re-distributed massive amounts of wealth, with the result being predictably disastrous for that once proud country.

Most stimulus created government jobs mean only in increased consumption.  They are paid for by taking money away from potential investors where the money otherwise could be used to create production as well as privae sector jobs that would also result in consumption. The beaurocracy also bleeds off its share when redistributing money. Dr. Brook claims that 2-4 private may be lost for every 1 stimulus job.

Brook then spoke about the philosophy of “free” markets … that this means, barring force or fraud, that they are  free to conduct business without excessive government regulation and that the matching of products and services with consumer demand is the best way to ensure a quality product at the lowest possible price, and to provide for steady economic activity and growth.

Excessive regulations and taxes, he claims, destroy free-markets and are the reason certain industry sectors can fail. He cited the 3 major sectors that collapsed in the US leading up to the 2009 recession – housing, banking, and automobiles. The common mantra was “See, capitalism failed, so government must step into to lend a helping hand”. WRONG says, Brook.

He asked: ‘What are the 3 most regulated industries and sectors in the US economy’? His answer: housing, banking, and automobiles. That it was because of over-regulation and government intervention that these industries failed. Fannie Mae (a government created, semi-private entity), he said, experienced the largest financial collapse of any entity in the history of the United States.

Each of these 3 industries, he stated, have their very own governmental Regulatory Agencies … proof positive that these sectors were not “free market” sectors; that it wasn’t the free-market (or capitalism) that failed, but rather government regulated markets that failed.

Government intervention interferes with normal market forces, by messing with the supply & demand mechanism, and more importantly, by removing the “risk” factor that is so important in regulating normal market activity. The risk of failure and loss of capital is a major incentive to behave prudently. With the current bailout/stimulus mentality, it is only natural that companies and industries would take on more risk than they normally would, knowing that the government will come to their rescue. This leads to economic bubbles, and then, economic collapse when these excessive risks begin to fail.

Brook then spoke about the creation of wealth as the primary measure of a successful economy. He asked us to think about the economic contrast of East vs West Berlin; or China (decades ago) vs Hong Kong … dramatic instances where capitalistic vs socialistic forces were at play, and the economic results were so dramatically opposite.

He then moved into the main theme of his lecture, the morality of capitalism. We have to overcome a psychological and emotional hurdle if we want to have a successful economy again.

GET OVER IT … BE SELFISH. He avers that markets exist for people to enhance their lives, meaning some people will make money – lots of it – and consumers will receive, in return, products and services that will make their lives better. He offers this as the definition of “selfishness” … a natural , self-preserving kind of attitude vs the evil connotation that we too often place on the term. That this is a human thing … a good thing. That in a true free-market, mutual selfishness and mutual profit transaction we choose to make. Even that “naked selfishness” is in everyone’s best self-interests.

Dr. Brook then stated what I felt was the crux of his provocative lecture: that our evolved and perverse sense of morality is what is destroying the American free-enterprise system. That in being politically correct, that people are viewed in positive way only when they put others first, instead of prioritizing their own rational self-interests. That philanthropists, for example, hold a much higher esteem in today’s society, than the wealthy. That the only way the wealthy, like Bill Gates for example, can obtain a positive public image is by giving away their money … not for risking their own capital, conceiving and producing a product that consumers demand, hiring lots of people, and yes, making a ton of money. That Bill Gates was initially derided publicly for being a successful businessman (the scorned capitalist), but is now more loved and accepted because of his Foundation (the beloved philanthropist). That if he gave up ALL of his fortune, and lived in a hut, we might even consider him a saint.

This standard of judgment, Brook says, is far too high a bar if we want free-markets to work effectively. That we must accept being “rationally selfish” and encourage risk and success for the greater public benefit.

What about Bernie Madoff? Wasn’t that selfishness? NO, says Brook. How could it possibly be in his long-term self interest to rip off his family, his friends, and many others, knowing all along that he would be caught someday? Brook referred to Madoff’s Ponzi-scheme as more of a delusional kind of near-term emotionally driven action vs a well thought-out plan to pursue self-happiness. It is this latter kind of selfishness that Brook promotes.

That pursuit of one’s own self-interests, or happiness, via mutually beneficial transactions, is a positive and necessary economic stimulus on its own. Conversely, what many believe as selfishness “at the expense” of others … is a very different thing.

He then asked us to consider the uniqueness and individuality of every single person. In what environment would a person with some wealth best be able to invest and prosper even more? In what environment could underprivileged people best find a way to climb out of the morass and pursue whatever might make them happy? A government controlled environment, where everyone is considered homogenous, and incentivized against acting on their own best judgment; or a free environment where people can determine their own futures based on their own unique dreams and capabilities?

Free-markets, Brook strongly contends, are the only way for each person to achieve their highest level of self-interest, or happiness. Happiness is not purely materialistic; it’s whatever rationally chosen goal we want it to be.

That this pursuit of self-interest is NOT immoral. That “sacrifice” is not the only way to be moral, as our society now seems to believe.

That our nation’s founding fathers wrote about pursuit of individual happiness: They did not write about sacrifice or being responsible to others; that charity is an individual choice, and that it should not be the role of our government to legislate economic equality, or even to have a position on whether or not that is a good thing.

That sacrifice, can actually be a bad thing, especially when government mandates it, by taking wealth or property from one person and giving it to another.

What is sacrifice, he asks? The act of sacrifice is giving something (time or money, for example) and getting something less in return; a win-lose scenario.

Alternatively, free-markets encourage win-win scenarios. People trade for something that has equal or greater value than what they give up. When we buy a car for $20,000, we get a car we believe has more than that much value. The car-dealer gives up a product that cost him less than that much to sell. Both sides win.

Why would our society value win-lose propositions over win-win propositions?

At this point, Dr. Brook ended his lecture and accepted questions from the crowd. Most of the questions, especially from the student attendees, challenged many of Brook’s premises with the expected angles: Why are the top-7 rated cities in terms of standard of living based in what Brook would call ‘socialist’ Europe, not the US? Didn’t the founding fathers allow slavery? Isn’t sacrifice a good thing, for instance, for our children? Didn’t the founders talk about equality for all? What about individual property rights, shouldn’t there be more of collective, common ownership? Doesn’t industry and pollution infringe on another person’s property and rights? What about the Christian values of loving your neighbor as yourself … vs Dr. Brooks’ selfishness philosophy? What about welfare, don’t we have an obligation to help the disadvantaged?

While Brook struggled for responses to only one or two very pointed questions, he provided fascinating responses to most of these queries.

Europe, he said, is a dying region. That what the economic crisis there now will only get worse as more and more of the unsustainable promises that have been made to too many workers and retirees grows in the coming years. While he questioned the standards by which those cities were rated, he also admitted that America, in his view, is no longer a true free-market economy, and that our cities and national standard of living is slowly being destroyed by the big government, anti capitalistic economy. He does not understand why many look at Europe with such admiration. It’s the past, he says, full of rich history – yes, but a doomed society. Asian economies (even China to some extent) are the future, where certain capitalistic principles have been embraced and where wealth is growing in enormous strides. America must choose which way to go.

Regarding slavery, he stated that it was the way of the world 250 years ago. That America was not alone, that the slave trade thrived in Africa, that Europe had serfs, etc

He argued THAT IS WAS INDEED THE VERY PRINCIPLES OF ‘FREEDOM’ IN OUR OWN U.S. FOUNDING DOCUMENTS THAT INVITABLY LED TO THE ABOLITION OF SLAVERY IN AMERICA! That our founders were not always perfect in practice, but they were much more so in theory.

Regarding sacrifice, Brook, said that he doesn’t sacrifice for his children. That staying home with his kids, instead of going out with his friends, is not a sacrifice, but rather, a free-market choice that enhances both him and his kids by spending time together, worth more to him (and to them) than spending time apart. Providing money or material goods to his kids is not considered a sacrifice either, any more than buying a car is a sacrifice. Why would we call something a sacrifice if we invest in our kids (with their well-being as what we receive in return), yet not consider investing in a car a sacrifice?

On the constitutional question of equality, Dr. Brook states that equality was intended only in terms of the law. That in the eyes of the law, unlike in Europe, from whence our forefathers fled, that everyone would be treated equally. That it wouldn’t matter what your race, creed, gender, status, or wealth was … that the law would treat everyone the same. This has nothing to do with equal outcomes among citizens.

Protecting individual property rights, he said is a critical component of a free-economy. That via a just court-system, that disputes and infringements of rights would be settled in a natural and moral kind of way. That contingency legal fees were created so that the poor could also have a way to bring suit if they were wronged. That the proper role of government is not to create massive amounts of new regulations in an attempt to restrict property rights so as to not potentially harm someone else or some fuzzy common good, but rather to protect property rights, and institute only those few common-sense laws that serve this purpose.

Regarding pollution of common items such as water or air, Brook gave perhaps his most provocative response: that POLLUTION SHOULD BE CELEBRATED! Pollution is a by-product of industrial progress, that it is a necessary cost to moving a society forward. He posed this scenario: think of London in the 1800’s and the huge particles of ash that most citizens inhaled from coal-powered factories. That if we applied today’s conventional solutions to that problem, we would have shut down those factories … and the INDUSTRIAL REVOLUTION WOULD NEVER HAVE OCCURRED! All of the advances in transportation and construction would never have happened.

Pollution, once industry advances and becomes wealthy enough and technologically capable of dealing with it, can be solved. Then, the next technological innovation produces a new pollution concern, which should be tolerated for a while before being solved … repeating this cycle which goes on and on. This is merely progress. And, society only improves with each cycle. He asked us, with all of our talk of pollution ruining our planet and our lives, to think about life expectancy progress: In the 1800’s, humans were expected to live not much past their forties-fifties. In the 1900’s it was sixties-seventies. Now it is seventies-eighties.

Continuing with the pollution issue, he said, people decide where to live and work, and that it’s their personal choice whether or not to put up with pollution, traffic, or any other problem in any given area. Look how many millions choose to live in LA, despite these issues. He talked about Simi Valley, right outside of LA. Before the hi-tech industry, it was nothing, just land. But because of the great job opportunities created, thousands migrated there from all over the country, putting up with LA smog and traffic, because overall, it offered them a better chance at life than where they came from. The free-market at work.

Finishing up the pollution issue, Brook asked us to think about Cambodia, for example, a country he had visited in recent years. Most of their citizens live in abject poverty, in huts in swamp areas. Brook proclaimed that the only way that Cambodia could raise itself into prosperity would be to bring on industry, and yes, the pollution that goes with it. That pollution in this case should be welcomed, if not celebrated … as a necessary transitional phase and as a sign of progress!

He dismissed the so-asked premise of Christian love for thy neighbor as thyself. He said this is unrealistic, that everyone loves themselves and their own families more than thy neighbor, and that it is nothing more than religions trying to impose “guilt” on people, as a way to have them conform with the impossible goal of ‘equal outcomes’ for everyone. He said none of us should feel guilt for loving ourselves more than our neighbors; that this kind of selfishness is natural and healthy for humans and for our economic well-being. I would personally add, that individuals freely choosing to help their neighbors, is a noble thing … but that government forcing people to help others is nothing short of tyranny.

The final session I participated in, dealt with welfare – a kind of an extension of the love thy neighbor theme. It was discussed that the way taxes and subsidies work in the real world is not a matter of debate. Laws of economics dictate that when we tax something, we get less of it (the premise behind taxing cigarettes, because society believes it is a bad thing to smoke, so therefore we should craft tax policies that discourage the activity). Conversely, when we subsidize something, we get more of it, like tax-deductions for buying a home (a good thing, society says). So, if this is the case, why do we tax work and investments when it means we will get less of each? … while at the same time we subsidize unemployment and idleness, which means we will get more of each of those?

Dr. Brook went on to claim that the biggest victims of the big government, forced responsibility for thy neighbor mentality, are the very people that the policies portend to serve. Only true freedom – to pursue their own dreams – can allow them to prosper. Welfare and other entitlement type programs condemn them to dependence and low expectations; in a way, institutionalizing them. This is not the America our founders envisioned.

In fact, Brook claims, it is IMMORAL to consider the poor as a homogeneous lot that is incapable of raising itself out of whatever morass they may be in. IT IS INSULTING!  He went on to say that all people, including the underprivileged, will be more content when they achieve something based on their own merit and work …that selfishness and the resulting self-esteem is the true measure of happiness … and the only way to achieve prosperity!

***

This was a fascinating 90-minute program, which continued after I had to leave. A few of the students were appalled at some of Dr. Brook’s assertions, while many of the adults were part of the choir. No matter your views, the issues discussed are indeed at the core of the critical debate now underway throughout our nation.

I encourage every single American to take the time and effort to think through these issues, with the goal of arriving at some economic/political philosophy that rings true to you, whether or not you agree with Mr. Brook. Then remain vigilant, stay involved, speak out, support whatever cause you believe in, and adjust your views, as necessary.

“The price of freedom is eternal vigilance” … Thomas Jefferson

Citizens vigilance is the only way our uniquely American form of government can best protect the freedoms of our citizens and allow us to pursue our own idea of happiness and to achieve prosperity.

Mike Stenhouse is the CEO for the Rhode Island Center for Freedom, the leading free-enterprise think-tank in Rhode Island.