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Lucy Burns Institute Launches Policypedia

At the end of June 2014, the Lucy Burns Institute, a nonpartisan and nonprofit organization dedicated to fairness and openness in politics headquartered in Madison, Wisconsin, launched Policypedia. Under the auspices of Ballotpedia, the popular wiki-source for state and local election information with the goal of eventually covering over 507,000 elected officials across the country, Policypedia will be a series of encyclopedia entries consisting of hundreds of articles to inform voters on major policy issues at the national, state and local level. Karen Danford, Policypedia Director, reaffirms their interest in making government transparent and accessible to the public. “Policy decisions made in government affect citizens in many ways, especially economically, legally and socially. We aim to enlighten voters by focusing on the tradeoffs involved so that they can participate in the public discussion of policy issues, and vote for candidates and initiatives aligned with their beliefs and interests.”

One of Policypedia’s four main policy areas will be public pensions and will have articles describing the status of public pensions in each of the 50 states. Readers can find detailed information such as pension funding history, proposed reforms, rate of return and unfunded liabilities. These pages will provide non-experts and regular voters with a road map into what the pension situation is along with some comparative figures.  

Geoff Pallay, Director of Strategic Projects at the Lucy Burns Institute comments, “Policy is a complicated subject. White papers and long studies are a necessary aspect of the policy discussion, but the vast majority of voters want things in plain English in an easy-to-digest format. Our wikis are a proven mechanism for delivering high-quality information to a large audience of voters.” 

With all the projects that the Lucy Burns Institute is taking on to bring transparency and accessibility to government and politicians, they look forward to collaborating on bringing comprehensive, detailed research to their audience.

To learn more about their organization, visit the website for the Lucy Burns Institute. [http://www.lucyburns.org/about/our-story/

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How to Structure a Good Defined Contribution Plan

A good public pension plan should balance the interests of three major stakeholder groups: taxpayers, employers and employees. Corresponding to these interests are three criteria: fiscal sustainability, workforce productivity and retirement security. In other words, a good pension plan should not impose excessive burden on taxpayers (fiscal sustainability), should improve worker retention and recruitment (workforce productivity), and should provide some reasonable level of retirement income (retirement security).

Defined contribution (DC) plans, by definition, are fiscally sustainable because they do not create or perpetuate unfunded liabilities for government pension plans and they have predictable contribution levels. Unlike defined benefit (DB) plans, DC plans do not shift investment risks to taxpayers and produce no lag between benefit promises and payments. In terms of workforce productivity, DC plans are an attractive retirement vehicle for the modern mobile labor force due to their portability, transparency and freedom of choice. Having a three- or five-year vesting requirement for the eligibility for employer contributions may further improve the retention of quality employees.

Retirement security may not be a strong aspect of traditional DC plans, not because of any inherent feature of the DC structure, but because of workers’ financial choices. Many individuals who are offered 401(k) plans fail to save early in their career, or simply do not know how much to save and/or how to invest. Many also fail to properly diversify their investments, exposing their retirement funds to excessive market risk. A number of modifications can significantly improve a DC plan’s performance in this area:

- Automatic enrollment: Workers, by default, would automatically be enrolled in the pension plan and have the option to opt out. This would prevent procrastination in investments, while still allowing for flexibility.

- Index funds: While the majority of ordinary workers do not possess advanced financial knowledge, and thus may not know how to optimally allocate their investment portfolios, these skills aren’t necessary for a successful retirement. Most professional investors (even “superstar” investors and mutual funds) do not beat the market. This means that non-expert individuals could outperform most active fund managers by simply putting their pensions in passive index funds. Having index funds as default investment options is a good way to make sure that workers’ pension funds not only are well diversified but also generate greater returns than what an average professional investor could deliver. These investment vehicles are also low-cost, and thus would not chip away too much at the pension savings. A simple 60-40 stock-bond index portfolio composed of domestic stocks, foreign equity and municipal bonds could be set as the default asset allocation, which workers would be able to modify as they wish.

- Target-date funds: While younger individuals can pursue more aggressive investment strategies, those approaching retirement should have more conservative portfolios. A target-date fund does exactly that, by automatically adjusting the pension asset mix according to a selected time frame. This should be a default feature offered to workers, as many neglect to alter their pension portfolios over time. Again, workers should be allowed to opt out of this arrangement.

- Collective DC plans: By pooling individual accounts together and having them managed collectively by professional money managers, a collective DC plan  would reduce administrative costs, improve investment decisions, and enable “intergenerational risk sharing,” allowing different age groups of employees to share risk and returns over time. While this DC design has certain advantages over traditional DC plans, it strips individual workers of the control of investment strategies and may allow for the politicized management and policies that have plagued some traditional defined benefit systems. These downsides should be considered if the plan is to be adopted. 

- Annuity: DC plans should provide individuals with an option to convert their account balances into an annuity when they retire.

When looking for public pension reform, properly structured DC plans can balance the interests of taxpayers, employers and employees while being fiscal sustainability, increasing workforce productivity and providing retirement security.

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New Landowner-friendly Endangered Species Policy: Not so New, Not so Friendly

The U.S. Fish and Wildlife Service recently announced a proposed new initiative, called the Prelisting Conservation Policy, that appears to make the Endangered Species Act more landowner-friendly.  In reality, the Policy, like other purportedly landowner-friendly initiatives that preceded it, does little of substance to lessen the regulatory burden on landowners because it leaves untouched the Act's draconian penalties ($100,000 fine and/or 1 year in jail for harming a single species or even its habitat).

On the surface, the Prelisting Conservation Policy looks like a good deal.  According to the Fish and Wildlife Service:

"Under the proposed policy, landowners could obtain credits for current efforts that benefit declining species. These conservation credits could later be redeemed to offset or mitigate actions that are detrimental to a species were it to subsequently be listed under the Act. The credits may also be traded or sold to a third party."

And based on how Fish and Wildlife's leadership is enthusiastically pitching the proposed policy, it appears to move the conflict-ridden Endangered Species Act in a positive direction.  Dan Ashe, Director of the Fish and Wildlife Service, said:

“The proposed policy is a win-win for people and for wildlife species that are in decline but not yet listed as threatened or endangered.  This smart approach expands on our existing efforts to work cooperatively with landowners to save the great landscapes of America and both the wildlife and the way of life of Americans that depend on them. By incentivizing early voluntary conservation efforts, this policy demonstrates our continued commitment to innovation and flexibility in implementing the Endangered Species Act.”

So, what's the problem?  After all, this looks like a good deal for species and landowners: species get additional conservation, and landowners potentially avoid getting whacked by the Endangered Species Act.

The problem is that the proposed Prelisting Conservation Policy is another in a long line of so-called landowner-friendly reforms (such as No Surprises, Candidate Conservation Agreements and Safe Harbors) that mask the central problem with the Endangered Species Act by leaving intact the Endangered Species Act's massive penalties.  These penalties create strong incentives for landowners to destroy habitat in efforts to deny refuge to species, and as a result the Act may well be doing more harm than good.  Another problem is these superficial reforms have been done administratively, not codified in to law, and so can be altered at the whim of Fish and Wildlife.

Some of the country's leading legal scholars provide some much-needed insight in to the true nature of these reforms.  Barton Thomson of the Stanford University Law School commented on the No Surprises Policy (which was unveiled in the mid-1990s by then-Interior Secretary, Bruce Babbitt):

"Through its no surprises policy, the FWS tries to create a form of property right to insure property owners against future regulatory activities…Absent explicit statutory (and preferably constitutional) guarantees, however, property owners will be wary of the promised insurance. Even if property owners trusted the government and its no surprises policy, they would still have grounds for unease. Under the no surprises policy, the FWS reserves the right to require additional mitigation in “extraordinary circumstances” (although the mitigation cannot involve additional payments or involve land parcels set aside for development or land management under the original terms of the HCP)."

As Professor Thompson alludes to, “extraordinary circumstances” can apply to species and land not covered in the Habitat Conservation Plan (federally approved mitigation schemes in which landowners put off limits some of their land in order for permission to use the rest of their land for activities such as farming and cutting trees). Given the ever-growing list of endangered species, the prospect of an extraordinary circumstance is very real for landowners who have signed Habitat Conservation Plans.

Professor Thompson had this to say about Safe Harbors, another of Secretary Babbitt's reforms:

“While a growing number of property owners are finding safe harbor agreements attractive, the uncertainty and distrust created by prior ESA implementation has hindered the government’s attempts to market the safe harbor concept."

"A proactive regulatory scheme is not, however, a substitute for compensation. Absent broader compensation than is provided today, even a proactive scheme is likely to encounter evasive habitat destruction, since such a scheme would not eliminate the incentive to destroy habitat, but simply narrow the window of opportunity."

Richard Epstein, of New York University and the University of Chicago, commented on landowner-friendly initiatives, which he refers to as "covenants":

"[T]hese covenants are not universal in scope, and they require confidence that they will be respected over time when the remedies for government breach are uncertain at best. Absent strong ownership rights, the unmistakable incentive remains: destroy habitat now in order to preserve freedom of action later."

Jonathan Adler, of Case Western University, who has written extensively on the Endangered Species Act’s adverse effects on species, has the following observation about reforms touted as landowner-friendly:

"Recent administrations have sought to offset these effects through various programs and initiatives designed to encourage voluntary conservation efforts and provide landowners with greater regulatory certainty. Yet such regulatory assurances and 'safe harbors' can only go so far to reduce the economic consequence of species listings for private landowners, and there is only so much flexibility in the law itself. Such reforms may ameliorate the anti-environmental incentives created by the Act, but they do not eliminate them."

Which brings us back to the latest of these reforms, the proposed Prelisting Conservation Policy.  As is clear from the analysis of these three legal scholars about previous reforms, the reality of the Prelisting Conservation Policy is far different from how it's being touted for a very simple reason: the Policy leaves untouched the Act's massive penalties, which create overwhelming disincentives for landowners to harbor species.

Layering incentives, and so-called landowner-friendly initiatives like the Prelisting Conservation Policy, on top of the Endangered Species Act’s existing highly punitive structure is like putting a shiny, new facade on a house with an unsound foundation and then claiming the house is as good as new. Any serious discussion of reforming the Endangered Species Act must distinguish between disincentives and incentives, and fix the disincentives before adding incentives. The central problem with the Endangered Species Act is not a lack of incentives, but rather the presence of overwhelming disincentives

 

 

 

 

 

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Survey of States Pension Debt

In a paper released earlier this month by the Competitive Enterprise Institute, former Virginia Libertarian gubernatorial candidate Robert Sarvis explains how state governments have understated the underfunding of their pension systems for years through the use of dubious accounting methods. Namely the use of a discount rate—the interest rate used to determine the present value of future cash flows—that is too high. As a result, state pension systems are likely in even worse shape than government data suggests and without reform, state government debt could burden labor markets and worsen state’s business climate.

In his paper, Sarvis aggregates several estimates of states’ pension debts and ranks the states from best to worst in terms of unfunded liability compared to state GDP.  Included in his composite ranking are unfunded liability estimates calculated using fair market value techniques by Naughton, Petacchi, and Weber in their recent paper “Economic Consequences of Public Pension Accounting Rules”,  by Novy-Marx and Rauh in their 2011 paper “Public Pension Promises: How Big are They and What are They Worth”, by Cory Eucalitto in “Promises Made, Promises Broken—The Betrayal of Pensioners and Taxpayers”, by Moody’s Investor Service, and unfunded liability estimates based on each states official assumed rate of return. Below are the five best funded states and the five most underfunded based on Sarvis’ aggregation of the rankings:



The Five Best Funded

The Five Worst Funded 

Nebraska

New Mexico 

North Carolina

Illinois

Tennessee 

Mississippi

Delaware 

Kentucky

South Dakota

Ohio

 

In determining whether a pension fund’s assets are sufficient to meet future liabilities, one must compare the valuation of assets in the pension fund with the calculated net present value of future payments to retirees. The net present value of future liabilities is calculated using a discount rate that represents that represents the risk and timing of those liabilities. Sarvis argues that the discount rate used by public pension systems should be a low risk rate, ideally as low as the rate on Treasury bonds (around 2 percent), but at least as low as other government bonds (municipal bonds return about 5 percent) or high-quality corporate bonds. 

However, state pension system discount rates average around 7.7 percent, and are often as high as 8 percent or 8.5 percent. As a result of these high actuarial assumptions, states understate their unfunded pension liabilities. For example from 1990-2009, as a percentage of state GDP, New Mexico officially reported underfunding their pension system by 5.3 percent over 20 years, but when one reestimates the numbers using the fair market discount rate used by Naughton, Petacchi, and Weber, it turns out New Mexico’s pension system has averaged being underfunded by 20.9 percent of state GDP from 1990-2009.

Sarvis explains that under defined benefit pension systems (the most common type of public pensions) the amount of benefits to be paid out to future retirees is determined by a formula and legally guaranteed, so public pension systems that are underfunded may require further infusions of cash to remain solvent. Often times, it is politically and legally easier to shore up a pension system by either raising taxes or shifting spending from somewhere else in the budget than by increasing contributions from public employees. According to Sarvis, the fact that so many pension systems are underfunded beyond what the government data reveals creates the expectation of future policy changes (like raising taxes or budget cuts) which affects the business climate and labor market within a state. 

For a plain language guide on unfunded pension liabilities see Reason’s piece from June, “The Public Employee Pension Crisis Explained.”

 

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How Pension Reform Can Help the City of Omaha

Facing a $700 million unfunded pension liability, in September 2013 Standard & Poor’s Rating Service downgraded the City of Omaha’s bond rating from AAA to AA+ marking the first time in 30 years that Omaha has had anything less than a AAA rating. Standard & Poor’s cited “the city’s high net direct debt and underfunded pension obligations” as part of the reason for the downgrade. In a new study released by the Platte Institute for Economic Research, pension expert Andrew Biggs describes how Omaha’s deteriorating pension system is putting the fiscal stability of the city at risk, and how switching to a defined-contribution system can help.

Annual required contributions to Nebraska’s Cash Balance pension system for state and county employees’ and the City of Omaha’s Police and Firefighters Retirement System have dramatically increased in the last 10 years. These payments are taking up a larger percentage of the city’s budget and making it more difficult for the city to fund other services. For instance, annual required contributions to the state’s cash balance plan increased from $14.2 million in 2003 to $56.7 million in 2013. Required contributions to Omaha’s civilian and uniformed (police and fire) employees’ plans have also increased from about $6 million in 2004 to $15.6 million in 2012 for the civilian plan, and from about $22 million in 2004 to $54 million in 2012 for the uniformed officials plan.
Omaha has not been able to keep up with these increasing annual required contributions (ARC), and as a result, both of the city’s defined-benefit (DB) pension plans are poorly funded. Beginning in 2003 Omaha began underpaying its ARCs. The city went from making 120 percent ARC payments to the uniformed officials plan in the late 1990’s and early 2000’s to just 65 percent in 2013. The city also skimped on payments to civilian plan, making just 46 percent of the ARC in 2012. As a result, both systems funding ratios are now dangerously low—the uniformed officials plan is 45 percent funded and the civilian employee plan is 56 percent funded.

As Andrew Biggs explains in the study, many states and municipalities have started to switch from defined-benefit plans to 401(k) style defined-contribution (DC) plans. For Omaha, switching to DC plans would have several advantages:

  • Reduced Benefit Costs: Typical private sector 401(k) plans cost employers 3 percent of wages. By contrast, Omaha’s Police and Firefighters Retirement System has a normal cost of over 23 percent of payroll. When employee contributions are subtracted from the normal cost (17 percent), Omaha’s system is still more costly than a 401(k) style system. Making the change would significantly reduce the costs to the city’s budget and the risks taxpayers face in paying for a defunct system should the city be required more interest on their debts.
  • Lower Budgetary Risks: Normal costs do not account for the full cost of pensions for employers; there are also the costs of servicing the existing pension debt (amortization costs). Amortization costs equal 39 percent of payroll in Omaha, and the city is not making its full amortization payments. The city’s latest actuarial report shows the city contributed $39 million to pay down the city’s unfunded pension liabilities, short $13 million they needed to make a full payment. A switch to a DC system caps the unfunded liabilities at the amount they are now, making it easier to draw down the debt while keeping amortization costs from rising (unless the city wants to speed up the amortization process to pay the debt down faster to avoid higher interest payments). Since defined-contribution plans don’t generate unfunded liabilities, once the Omaha’s current debt is paid off a switch to a DC system would eliminate ARC payments. The city would still have to make its full employer contribution into the DC plans every year, but eliminating ARC payments would be another significant source of budgetary savings. 
  • Improved Ability to Attract and Retain Employees: DB plan benefits do not accrue evenly over a public worker’s career. They are back loaded, favoring employees in the later stages of their careers rather than those in the early to middle stages. As a result, employees that only work half their careers in the public sector receive a disproportionally smaller benefit than career public sector workers. In contrast, DC plan benefits accrue smoothly and regularly over a worker’s entire career. Slow initial accruals will not attract talented young workers who do not plan on spending their entire careers in the public sector. Recognizing that DB plan benefits accrue unevenly, favoring those who stick it out for long careers in government likely creates a perverse incentive for longer serving public workers to work longer for the sake of their pensions rather than working because they enjoy their job. Employees who do not want to have a lifelong career in the public sector would do better – benefit wise – with a DC plan.

In the study Biggs also addresses the “transition cost” myths that pension reform opponents often bring up.

  • Accounting Based Transition Costs: Biggs dispels the myth that GASB requires a switch from level percent of payroll amortization to level dollar once a DB plan is closed. Level dollar amortization increases initial payments (decreasing the amount of payments in the long run), but GASB does not require a switch to amortizing the unfunded liability in this manner. Nothing prevents Omaha from amortizing the same way that they have been doing prior to switching to a DC plan, if they so choose.
  • Investment Based Transition Costs: Perpetuators of this myth argue that closing a DB plan would require investing in more liquid and lower risk (thus lower yielding) assets because of the shorter time frame in which benefits need to be paid out. Since these investments would be lower yielding, it is argued that contributions will need to be increased to fully fund the plan. Biggs counters that there is no evidence to support that public pension plans have ever had to do this, noting that there is evidence of the opposite actually occurring. Indeed, public pension plans take on more risk as the participant population has aged. It could be argued that plan sponsors have sorely underfunded their ARC payments knowing that assumed rates of return were far too high. Further, by keeping a DB pension plan open to newer workers, it is easy to hide the underfunding, where the future workers continue to subsidize current retiree costs. Biggs also argues that if Omaha used more accurate assumed rates of return in their current DB plans, any costs related to a reform to DC plans would be fairly insignificant. Moving to safer assets is not necessarily a cost if you factor in the “cost of risk”. In the event that plans are not liquid, the fact that they are investing in relatively safe assets means that a line of credit could be offered to fund the DB plan if needed, at a low cost to the sponsoring government. 

Switching to a DC system for the city of Omaha’s retirement plans would be a great way for the city to get its fiscal house in order and restore its credit rating. Cities and states that have tackled pension reform have usually seen their credit ratings improve. Additionally, switching to a DC system would make Omaha’s pension systems (which have seen a steady decline in their funding) more sustainable in the long term.

For more on common objections to pension reform and how pension reform can be achieved see Reason Foundation’s “Addressing Several Common Objections to Shifting from Defined-Benefit Pensions to Defined-Contribution Pensions” and Reasons pension reform case studies on Rhode Island, Michigan, San Jose.

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Endangered Species and the Export-Import Bank

In an interesting twist, the Endangered Species Act may prevent the U.S. government from subsidizing an iron ore mine in Australia.  Three U.S. environmental pressure groups are challenging the decision by the U.S. Export-Import Bank to provide a loan to the Roy Hill iron ore mine project in Western Australia.  If the challenge is successful, the loan may be withdrawn.

The link between the Endangered Species Act and the Export-Import Bank is that under the Act federal agencies are required to assess whether their actions will negatively impact endangered and threatened species, including the 628 foreign species currently listed.  If there are negative impacts, then the proposed action, such as loan for the iron mine, can be terminated for being in violation of the Act.  Several environmental pressure groups claim the port being built by the mine's owners to export the iron ore will negatively impact a number of endangered species, including sea turtles, the saltwater crocodile and dugong (a relative of the manatee).

The Export-Import Bank approved the loan because the mine's owners have agreed to purchase U.S. mining equipment, such as giant dump trucks from Caterpillar and rail equipment from General Electric, and this is supposedly good for the U.S. economy.  In reality, the Export Import Bank is a prime example of corporate welfare, as Reason has detailed here and here, as well as cronyism because powerful, politically connected companies tilt the process in their favor to the detriment of less powerful companies.  In the case of the Australian mine, Cliffs Natural Resources, which owns four iron ore mines in Minnesota and Michigan, opposed the Export-Import Bank loan because it would undercut their operations and cost an estimated $1.8 billion to the U.S. iron ore industry over the eight-year life span of the loan.  Such is the zero-sum game of the Export-Import Bank and the government picking winners instead of the marketplace.

If projects like the Australian mine are such good opportunities for U.S. corporations to make money, then let them assume the risks, not U.S. taxpayers who are on the hook if Export Import Bank loans go bad.  It's also strange that the $694 million Export Import Bank loan is being portrayed by mine proponents as jeopardizing the future of the mine, when it's only a relatively small part of the $7 billion the mine's owners are trying to raise.

With the Export Import Bank's charter due to expire in September, there is increasing pressure to abolish the Bank from across the political spectrum, including Republicans like Representative Jeb Hensarling of Texas and Senator Mike Lee of Utah,  to Democrats such as Senator Elizabeth Warren of Massachusetts, and Senator Bernie Sanders of Vermont, who is an Independent but usually votes with Democrats.  While opposition to the Export-Import Bank tends to come from those against of corporate welfare, such as Ralph Nader, and fiscal conservatives, including a coalition led by Americans for Prosperity, the loan for the Australian iron mine shows that opposition can come from unusual sources, including environmental pressure groups wielding the much-feared Endangered Species Act.

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