PANC 2013: Tax and Benefit Reform

Alterations both small and large for numerous reforms to the retirement system—both public and private sector—are in play. “What type of pension system this country can afford, and what kind it needs” are at issue, Wagner said, with deficit reduction a catalyst for debate.

The tax-qualified system is expensive because of the length of time of deferrals, which occur over 10-plus years and are thus considered permanent. According to Wagner, estimates of annual cost range from $70 billion to $360 billion over five years in the view of the Office of Management and Budget, which, she said, “even by D.C. standards is real money.”

Wagner detailed a number of the proposals put forward to reform the retirement system, with some of their pros and cons.

In April, President Obama’s proposed budget floated setting a maximum lifetime amount that could be accrued in aggregated lifetime contributions, including individual retirement accounts (IRAs). Wagner called this a recordkeeping nightmare, expensive and difficult to manage.  (See “Budget Proposals for Savings  a Deterrent—or Not?”)

Pension envy, Wagner said, is a funny sounding joke, but a real problem. It occurs when two people, one in a defined benefit (DB) plan and the other in a defined contribution (DC) plan with similar demographics, wind up with very different retirement outcomes. “This is a real problem,” Wagner noted, not so much for state pension systems in general but for the private sector not having a DB plan. One easy solution: Let the private sector buy into public sector DB plans, which can leverage external efficiencies and give a guaranteed rate of return. States are starting to work with this, notably Massachusetts, which has an enactment of DC multi-employer plan for nonprofits. At least other 11 states are reportedly considering plans for private sector employees.

Evolutionary Proposals

Wagner noted that the Brookings Institution favors keeping the current pension system but eliminating the tax deduction – a potential savings of $360 billion and refundable tax credits. The proposal would  take away the current skew that favors highly compensated workers.

Sen. Tom Harkin (D-Iowa) proposed a university retirement system in 2012. (See “Retirement Plan Would Be a Win-Win for Working Families, Employers.”) Features include auto and universal enrollment, privately managed accounts and a regular stream of income starting at retirement age. Funded by money from the government, employees and employers, the plan proposes limited employer involvement and no fiduciary responsibility on the part of employers. Wagner said it is unclear if Harkin’s plan is meant to supplement or replace the Employee Retirement Income Security Act (ERISA). By getting rid of the wage base for Social Security, the plan would have better cost of living adjustments, she added.

Sen. Orrin Hatch (R-Utah) favors the retirement system as it is but has forwarded a proposal that would include some form of annuitization, no discrimination testing, automatic deferrals from 3% to 5% and up to $8,000 participant contributions annually. (See “Bill Would Overhaul Public Pension System.”)

It is likely that bipartisan politics will continue in the short term, “but bipartisan support typically emerges on retirement issues,” Wagner said.

John Bogle, founder of the Vanguard Group, has proposed a unitary DC system controlled by a federal retirement board. Investments would be, unsurprisingly, indexed mutual funds with at least some partial annuity. “When John Bogle talks, people listen,” Wagner said, adding that it seemed surprising people aren’t discussing his proposal more.           

Academic Ideas

Academics suggest improving or changing the retirement system. For example, Teresa Ghilarducci, chair of economic policy analysis at The New School’s New School for Social Research, proposes eliminating current tax breaks; the savings would go to a 5% contribution to all employees. Ghilarducci’s proposed system mandates contributions and a guaranteed investment return, making it similar to a DB plan that supplements Social Security. Participants in existing plans could continue in such plans if they make regular contributions. Other stipulations include no early withdrawals, and a mandatory conversion to annuity upon retirement.

People not in employer-sponsored plans would be placed in guaranteed retirement accounts with mandatory employer and employee contributions; professional management of pooled investments would reduce fees.

Meir Statman, a professor of finance at the Leavey School of Business at Santa Clara University, suggests a DC approach with features common to Australian and British systems: mandatory employer and employee contributions, and account owner control of investments. The proposed system works in conjunction with Social Security.

The U.S. stands at a crossroads between the affordable and the needed, given the aging Baby Boomers’ increasing strain on retirement resources. Said Wagner, “Our current system is a voluntary system, and people are incentivized to be in it through the IRS, among other factors.” She believes the system will narrow in some way but remain a system we recognize. “We have to decide what type of pension system we want,” Wagner said. “The current one we have with tweaks? Or something very different?”