Category Archives: Government

Fixing the Public Employees’ pension crisis

Public employee pensions are time bombs set to explode.  The State of Illinois finances are in such a state of crisis that its comptroller, Susana Mendoza, has told the legislature that over 90% of its monthly revenue is now being commandeered for court-ordered payments, primarily to pay current pensioners.  If Illinois does not pass a new budget within a few days there will be a financial crisis.

According to Forbes:

Public employee pension plans around the country are facing a shortfall of at least $1 trillion, and some of the largest plans are beginning to radically cut promised benefits because they have not stashed away enough to meet their obligations.

There is only so much money to go around.  Promises that can’t be kept won’t be kept … and that includes pensions.

One sign of things to come is a bill signed by Pennsylvania Governor Tom Wolf.  It reforms the state pension system that makes it more sustainable.

 “Let’s be clear: This plan addresses our liability in the only real and responsible way possible, by changing the structure of pension benefits,” said Mr. Wolf. “The fact is, we cannot accelerate the shrinking of our liability on the backs of our current employees, and this bill recognizes this in a real, concrete way.”

The bill moves new workers not in high-risk jobs such as state police and corrections officers into a hybrid retirement system.   Half of their retirement benefits will come from pensions paid for by the taxpayer and the other half will come from a 401(a) defined contribution plan.  A 401(a) is similar to a 401(k) but for public employees.  There are differences, but both transfer responsibility for retirement income to the employee and away from the employer.

The law is projected to save more than $5 billion and shield taxpayers from $20 billion or more in additional liabilities if state investments fail to meet projections, said a news release issued from the office of Republican Sen. Jake Corman, the bill’s chief sponsor.

We suspect that Pennsylvania is just the first state to adopt a system that transfers the responsibility for public employees’ retirement income away from the taxpayer and toward the employee.  It levels the playing field between public and private employees.

It will also make financial planning increasingly important for everyone.

Click HERE for questions about financial planning.

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The Trump Trade after three months.

The election of Donald Trump was followed by what many called “The Trump Trade.”  Based on the promises made by Trump during the campaign: to lower taxes and reduce regulations – two factors that inhibit economic growth – the stock market rose sharply.  But it’s going to take time and a lot of hard bargaining to actually get to the point where real economic benefits result.

Brian Wesbury, Chief Economist at First Trust:

As we wrote three months ago, it’s going to take much more than animal spirits to lift economic growth from the sluggish pace of the past several years. Measures of consumer and business confidence continue to perform much better than before the election. But where the economic rubber hits the road, in terms of actual production not so much.  It looks like real GDP growth will clock in at a 1.3% annual rate in the first quarter.

He says that we still have a “Plow Horse Economy” and it will take time to unhitch the plow and saddle up the “Racehorse.”

Trump has signed a number of executive orders that will have an impact on regulation, but the bureaucracy is still staffed with the last administration’s appointees and the pace of approving new appointments is glacially slow.

Waiting is the hardest part.

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The Retirement Dilemma Facing American Workers

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The way Americans fund their retirement has undergone a fundamental transformation in the last 30 years. According to the Bureau of Labor Statistics, the percentage of private-sector employees with a traditional defined benefit pension plan has dropped from about 45% in 1980 to a little over 20% in 2011. A defined benefit pension plan is one that provides the retiree with a guaranteed income for the rest of his or her life.

The guaranteed pension has been replaced by a defined contribution plan. Today, about 50% of the private workforce participates in one of these plans, which include 401(k) plans and 403(b) plans and allow the worker to set money from their paycheck aside to grow tax-deferred until they retire, at which point they can start pulling from it to fund their retirement. However, there is no guarantee that the amount saved will be adequate to meet their income needs once they retire.

Most government workers still have access to traditional defined benefit pension plans. However, most of these plans are severely underfunded and questions are being raised about cities and states being able to pay the benefits that were promised. A recent poll of people 25 years and older concluded that “Americans are united in their anxiety about their economic security in retirement.” Over 75% of those surveyed worry that economic conditions might hurt their chances for a secure retirement. (For related reading from this author, see: How Retirees Should Think About Retirement Income.)

Social Security and Medicare Concerns

The federal government provides a basic level of retirement income via Social Security, and provides a basic level of health insurance via Medicare and Medicaid. However, these programs are on shaky ground according to most actuaries. The Social Security Trust Fund will run out of money around 2034 unless it is reformed. That does not mean that checks will not go out to retirees, but it does mean that the amount going out will decrease.

Medicare is in even worse shape and, with the continued rapid rise in medical costs, may face a crisis even sooner. The costs of health care and increasing life spans are major issues for retirees, which explains the reason that so many Americans think they are facing a retirement crisis in the first place. Given the level of debt at the federal level and the rhetoric of the current administration, we do not see the government jumping in to fund the American worker’s retirement at levels above what it does now.

Even Denmark, an icon of the Welfare State, is proposing tax cuts, reducing welfare benefits and raising the retirement age.

“We want to promote a society in which it is easier to support yourself and your family before you hand over a large share of your income to fund the costs of society.”

Funding Your Own Retirement

If the government is not going to come to the rescue, and if corporations are going to continue to unload the financial risks and burdens associated with pension plans, what is the answer? Look to the old saying, “If you want something done, do it yourself.” Going forward, it’s increasingly going to be up to the individual American worker to fund his or her own retirement.

If people begin saving early, a large part of the retirement problem will be solved. The most valuable asset that people have when they are young is time. If workers begin putting money aside at an early age, it will grow and compound for 40 to 50 years until retirement, solving a large part of the problem. The compounding of returns is what makes so much of the difference.

Here is a little math exercise: assume you begin by saving $25 per month—much less than the cost of having one decent dinner at a restaurant—and invest it conservatively so that it grows at 5% per year. At the end of 45 years you will have $50,000. Now assume that you increase your savings by 10% each year—so that in year two you save $27.50 per month (still far less than the cost of just one dinner out)—at the end of 45 years you have $400,000 to use in retirement. These examples go to show that saving a modest sum for retirement does not require much cost or effort, just discipline, time and patience.

Financial Education is Key

The greatest asset that young workers have is time. Unfortunately, people rarely enter the workforce knowing much about saving or investing. That is one reason so many people live paycheck to paycheck. The solution to the retirement crisis is achievable by educating young people and raising awareness. Until schools and colleges begin having mandatory courses for our young people about managing money, parents should be doing this. If they are unsure, they can put their children in touch with a financial planner who will spend time to provide the education. Many financial planners are beginning to offer hourly rates to help people learn to plan and budget.

For most people, the retirement problem is the result of a lack of information. The solution is right in front of us, if we realize that times have changed and people must change with it.

(For more from this author, see: Are You Ready for the Retirement Challenge?)

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Getting ready to file your taxes? Pay attention!

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As we head into tax season, many of you have received tax reports – commonly referred to as “1099s” – from your investment firm.

The IRS requires that 1099-MISC forms must be mailed by January 31st,  but issuers are not required to file copies of all 1099 Forms with the IRS until the end of February.

We frequently advise our clients to delay filing their taxes until March at the earliest.  That’s because the tax code is so complex that errors are inevitable.  As a result, investors often receive “corrected” 1099 forms after the February deadline has passed.  This may result in a change in the tax owed.  Those who use tax preparers or CPA firms may need to have their tax re-calculated, increasing the cost to the investor.

We note that Morgan Stanley has admitted to providing erroneous information to its clients.

Apparently Morgan Stanley’s reporting system sometimes generated an incorrect cost basis for its clients’ stock or bond positions, which threw off capital gains tax calculations following the sales of the securities, the paper reports. The errors affected a “significant number” of the firm’s 3.5 million wealth management clients for tax years 2011 through 2016, according to the paper. But around 90% of the under- or overpayments were less than $300 while more than half were less than $20, a Morgan Stanley spokesman tells the Journal.

It is always a good idea to check the accuracy of the statements you receive from your custodian.  There may be erroneous or missing information.  In many cases where securities were purchased years ago, the custodian does not have the cost basis of stocks or bonds that were sold.  In those cases the investor is responsible for providing that information.  If you do not provide that information, the IRS may assume that the cost basis is zero and tax you on the full amount of the proceeds of sale.

On a final note, many clients have asked us how long they need to keep records for tax purposes.  The primary IRS statute of limitations was three years. But there are many exceptions that give the IRS six years or longer. Several of those exceptions are more prevalent today, and one of them has gotten bigger.  The three years is doubled to six if you omitted more than 25% of your income. “Omitted” can mean to not report at all, or it can mean that the amount of income was under-reported by 25% or more.

If you have questions about your tax forms, or wonder where you can get assistance to determine the cost basis of securities bought or gifted long ago, give us a call.

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The Plow Horse is Dead – Long Live the Race Horse

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We have referred to the economy over the last decade as the “Plow Horse Economy.”  There has been a huge increase in technology available to the economy over that period of time.  “Fracking” has unlocked huge oil and gas reserves in the energy sector.  The “Internet of Things” is tying our appliances together, automating our homes, even allowing us to control them with voice commands.  Self-driving cars are becoming a reality faster than I believed possible.  3D printing is revolutionizing production processes.  Yet despite this dazzling technological revolution, the economy is only managing 1.2% GDP growth.

Why?

Many analysts believe that if we compare the economy to a horse, we have a thoroughbred economy that’s plodding along like a Plow Horse.  The problem is that the rider is too heavy.    That rider is the government.  It’s holding growth down.  In the year 2000 government was 17.6% of Gross Domestic Product (GDP).  In 2016 it was 21.1% of GDP, an increase of 20%.  That’s a big move from the private sector to the public sector.

Keep in mind that government doesn’t manufacture anything.

On top of that, government today regulates virtually everything, generating a hidden cost to producers and consumers.  Some analysts think it’s a miracle that the economy actually grew despite increased borrowing, taxes and regulation.

The incoming Trump administration has a staunchly pro-business agenda.  The focus on jobs and economic growth is front and center.  A new executive order instructs federal agencies to halt the issuance of more regulations, and the new President has indicated a desire to reduce them by 75%.   Another executive order has frozen hiring of federal employees, opening the door to replacing government employees with technology, something that has happened in the private sector.  Yet other executive actions advance the approval of the Keystone XL and Dakota Access oil pipelines – using American steel – creating new high-paying construction jobs and indicating an interest in making America energy independent.  Reducing tax rates, especially the high corporate tax rate, is another Trump administration objective.  It’s the carrot to encourage companies to build here, even as he waves the stick of high tariffs for goods brought in from overseas.  It’s getting a respectful hearing from otherwise skeptical business leaders.

These actions are not going to be enough, but they are indications that the new administration is determined to streamline government and incentivize private industry to grow.  According to Brian Wesbury, Chief Economist of First Trust, the earning per share of the S&P 500 is estimated to be $130, an increase of 20% in 2017.  Growth in earnings of that magnitude can justify an increase in market valuations and add a few percentage points to the annual GDP.

To get back to our horse analogy, it looks as if the jockey riding the horse will be put on a diet.  If that happens the thoroughbred who was a “Plow Horse”  may become a “Race Horse.”

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Greedy Innkeeper or Generous Capitalist?

During the Christmas season we are reminded of the story of Jesus being born in a stable because there was no room in the inn.  We wanted to share this story with our readers because it says something about Christmas and also about the economy.  It comes from Brian Wesbury of First Trust Advisors

The Bible story of the virgin birth is at the center of much of the holiday cheer this time of year. The book of Luke tells us that Mary and Joseph traveled to Bethlehem because Caesar Augustus decreed a census should be taken. Mary gave birth after arriving in Bethlehem and placed baby Jesus in a manger because there was “no room for them in the inn.”

Some people believe Mary and Joseph were mistreated by a greedy innkeeper, who only cared about profits and decided the couple was not “worth” his normal accommodations. This version of the story (narrative) has been repeated many times in plays, skits, and sermons. It fits an anti-capitalist mentality that paints business owners as greedy, or even evil.

It persists even though the Bible records no complaints and there was apparently no charge for the stable. It may be the stable was the only place available. Bethlehem was over-crowded with people forced to return to their ancestral home for a census – ordered by the Romans – for the purpose of levying taxes. If there was a problem, it was due to unintended consequences of government policy. In this narrative, the government caused the problem.

The innkeeper was generous to a fault – a hero even. He was over-booked, but he charitably offered his stable, a facility he built with unknowing foresight. The innkeeper was willing and able to offer this facility even as government officials, who ordered and administered the census, slept in their own beds with little care for the well-being of those who had to travel regardless of their difficult life circumstances.

If you must find “evil” in either of these narratives, remember that evil is ultimately perpetrated by individuals, not the institutions in which they operate. And this is why it’s important to favor economic and political systems that limit the use and abuse of power over others. In the story of baby Jesus, a government law that requires innkeepers to always have extra rooms, or to take in anyone who asks, would “fix” the problem.

But these laws would also have unintended consequences. Fewer investors would back hotels because the cost of the regulations would reduce returns on investment. A hotel big enough to handle the rare census would be way too big in normal times. Even a bed and breakfast would face the potential of being sued. There would be fewer hotel rooms, prices would rise, and innkeepers would once again be called greedy. And if history is our guide, government would chastise them for price-gouging and then try to regulate prices.

This does not mean free markets are perfect or create utopia; they aren’t and they don’t. But businesses can’t force you to buy a service or product. You have a choice – even if it’s not exactly what you want. And good business people try to make you happy in creative and industrious ways.

Government doesn’t always care. In fact, if you happen to live in North Korea or Cuba, and are not happy about the way things are going, you can’t leave. And just in case you try, armed guards will help you think things through.

This is why the Framers of the US Constitution made sure there were “checks and balances” in our system of government. These checks and balances don’t always lead to good outcomes; we can think of many times when some wanted to ignore these safeguards. But, over time, the checks and balances help prevent the kinds of despotism we’ve seen develop elsewhere.

Neither free market capitalism, nor the checks and balances of the Constitution are the equivalent of having a true Savior. But they should give us all hope that the future will be brighter than many seem to think.

Merry Christmas.

 

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Is the Trump Rally Real?

Our favorite financial economist, Brian Wesbury, has some hopeful thoughts about the market following the election.

Since the presidential election, the S&P 500 is up 8.4%, the Russell 2000, a small cap stock index, is up almost 20% and the Dow is closing in on 20,000. Financial stocks have surged.

This “Trump Rally,” just like the entire 2009-2016 bull market – which pushed up stocks more than 200% – has its detractors. We heard it over and over in the past eight years, and now we are hearing it again – “the market has moved too far, too fast.”

Wesbury thinks that there’s a real reason for the market’s rise.  “Hope and faith” has nothing to do with it.  His model indicated that the market was undervalued before the election, and he has attributed that to government policies.

We believe the reason it was undervalued was because government policy was constantly making it more difficult for free markets to operate. Higher taxes, higher spending and more regulation increase the risks to future growth. It’s why we have had a Plow Horse economy. At the least, these policies are now stopped, at best, they will be reversed.

He expects that a Trump administration will be much more market friendly.  At the current rate, perhaps he will soon begin talking about a “Race Horse” economy.

Of course, like any prediction about the future, events can get in the way.  That’s why we are always cautious and focused on protecting our client’s investment assets while participating in the market’s advance within the constraints of prudence, knowing that our vision of the future is never guaranteed.

In the meantime, we are enjoying the ride and are getting ready for a very Merry Christmas.

The New Trump Economy

We have been talking about the “Plow Horse Economy” for quite a while now.  Low interest rates designed to spur economic growth have been offset by other government policies that have acted as a “Plow” holding the economy back.

Market watchers have assumed that the November election would see a continuation of those policies.  The general prediction was for slow growth, falling corporate profits, a possible deflationary spiral, and flat yield curves.

What a difference a week makes.  The market shocked political prognosticators by standing those expectations on their heads.

Bank of America surveyed 177 fund managers in the week following the elections who say they’re putting cash to work this month at the fastest pace since August 2009.

The U.S. election result is “seen as unambiguously positive for nominal GDP,” writes Bank of America Merrill Lynch Chief Investment Strategist Michael Hartnett, in a note accompanying the monthly survey. 

The stock market has reached several new all-time highs, moving the DJIA to a record 18,924 on November 15th, up 3.6% in one week.

Interest rates on the benchmark 10-year US Treasury bond have risen from 1.83% on November 7th to 2.25% today (November 17th), a 23% increase.  Expectations for the yield curve to steepen — in other words, for the gap between short and long-term rates to widen — saw their biggest monthly jump on record.

 WealthManagement.com says that

Global growth and inflation expectations are also tracking the ascent of Trump. The net share of fund managers expecting a stronger economy nearly doubled from last month’s reading, while those surveyed are the most bullish on the prospect of a pick-up in inflation since June 2004.

Investors are now also more optimistic about profit growth than they have been in 15 months.

Whether this new-found optimism is justified is something that only time will tell.  In the meantime to US market is reacting well to Trump’s plans for tax cuts and infrastructure spending.  Spending on roads, bridges and other parts of the infrastructure has been part of Trump’s platform since he entered the race for President.  It’s the tax reform that could be the key to a new economic stimulus.

According to CNBC American corporations are holding $2.5 trillion dollars in cash overseas. That’s equal to 14% of the US gross domestic product.  If companies bring that back to the US it would be taxed at the current corporate tax rate of 35%.  The US has the highest corporate tax rate in the world.  The promise of lower corporate tax rates – Trump has spoken of 15% – could spur the repatriation of that cash to the US, giving a big boost to a slow growth US economy.

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Economic Growth Does Not Kill People – The Opposite is the Case

Brian Wesbury, Chief Economist at First Trust, noted that members of the elite press are telling the people that they had better get used to slow growth.  That economic growth actually kills people.

Two weekend articles, in major US newspapers, left us shaking our heads. The Washington Post wrote that “economic growth actually kills people,” while The Wall Street Journal published a piece saying, ironically, we should get used to slow growth – it’s normal.

Both are ridiculous.

First, The Washington Post cited statistical studies that blame premature death on economic growth (more pollution, more work and more risk).

The statisticians found that pollution and alcohol were the #1 and #2 causes of death as economic growth accelerated. We couldn’t help but think about the Soviet Union, where pollution and alcoholism were rampant in the 1970s and 1980s, but economic growth was non-existent. Economic growth does not cause pollution; to say it does is a red herring. The air in Boston was much worse in the 1800s when wood-burning fireplaces were used to heat homes. Public health was a serious problem before sewage systems and water purification.

 

 The articles in the Post and the Wall Street Journal try to make the case that Americans need to forget about growth.  Rather, the government should focus on making the social safety net bigger, on rule-making, and making everyone more “equal.”  In fact, we are told that growth is a killer.

Evidence of the opposite exists.  Stagnating wages and loss of jobs in this country has been followed by alcoholism and rampant use of heavy-duty drugs like heroin, leading to an increase in premature deaths in America’s heartland.

There is no reason why the American economic engine cannot be revved up to the benefit of all.

Roughly 70% of the US economy depends on consumer spending.  The return of good paying jobs to communities thoroughly the country would result in a significant surge of economic growth.  And by good paying jobs we are not referring to the jobs created by the internet economy on the East or West Coasts.  The jobs produced by companies like Google, Facebook, Twitter and other Internet based “infotainment” companies produce great wealth for their creators but no actual consumer product.  What has surprised many economists – but should not have – is that they have not produced nearly the number of jobs that were predicted.  Meanwhile, industries that produce actual goods that people need to live – food, clothing, housing, fuel, medicine, cars – industries that once produced good paying jobs – are being outsourced or automated.

The country needs to focus on this issue or face increasing unrest among people who feel disrespected and marginalized.  Reviving American industries – in America – can be the spark that leads to a better future for everyone.

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The Public Pension Crisis

Government workers at all levels are likely to have pension plans but there is a big question about the plans’ ability to pay.

According to the Bureau of Labor Statistics (BLS), 92% percent of full-time government employees like teachers and police officers are eligible for pensions, known as “defined benefit plans.”

According to the BLS about 22% of workers in the private sector have pensions, down from 42% in 1990.  In the private sector, retirement plans are much more likely to be 401(k) plans, known as “defined contribution plans.”  Part of the reason for this is that some large companies, like General Motors, accrued huge pension liabilities over the years that they were unable to pay.

Since the Federal Government can print money, federal employees are not worried.  However, states and municipalities depend on their tax base and can’t print money.  That’s where the problem comes in.  Some estimates claim the unfunded liability of public pension plans exceeded $3 trillion dollars.

According to Governing, the city of Chicago’s has an unfunded pension liability of almost $20,000 per capita.  Other cities are somewhat better off, but no big city has a fully funded pension account.  Dallas and Denver, for example are on the hook for between $8,000 and $9,000 per resident.  It’s difficult to even measure the amount of indebtedness because political leaders really don’t want to discuss it.

The problem has been exacerbated by rate-of-return assumptions that are unrealistic.  Most pension funds assume that their assets will grow at rates of seven to eight percent per year indefinitely, a virtual impossibility in this age of low interest rates and sluggish growth.

What does that mean for public employees?   They may want to cast a wary eye on Puerto Rico and some cities in California who have gone into default.  As a wise man once said, “something that can’t go on forever, won’t.”  A little planning ahead won’t hurt.

Whether you are a public employee or work in the private sector we welcome your inquiries.

 

 

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