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Pensions, Politics & Benefits Tax Policy

2008's Top Topics


Girard Miller

Girard Miller is the Public Money columnist for GOVERNING and a senior strategist at the PFM Group.

This will be a pivotal year in the policy arenas that control public pensions and benefits plans. The Great National Debate of 2008 will set the stage for congressional action in 2009. In the state legislatures, bills will be introduced with either helpful or harmful consequences, so state and local leaders must take initiative to assure positive results. Here's what to expect:

Debating points 2008. So far, the presidential candidates have avoided major policy positions on key issues affecting pension plans, as their advisers urge them to stress character and themes -- avoiding specifics this early in the campaign. But by September, candidates and their parties will stake out platforms on Social Security, Medicare, national health care and income tax policy, seeking "mandates" for action once the new president is inaugurated in 2009. Public sector professional organizations will therefore need to point out the flaws in various proposals that are floated during the campaign, so that 2009 policymakers are alerted to unintended public-sector consequences.

Social Security reform will undoubtedly be a campaign issue once the two parties select their nominees. Most Republican candidates continue to favor some limited form of individual accounts while avoiding talk of benefits reductions. Democrats will focus on raising additional revenues by raising the tax caps, to support the promises made under the existing system.

One reform issue that candidates will likely duck is whether the system's current retirement ages are sustainable. Eventually this issue will spill into state-level pension policy debates -- but not until 2009 or later. AARP and unions supporting the Democratic candidate will strongly oppose even modest proposals to raise the retirement age to reflect increasing longevity. Republican candidates will likely stand silent on the eligibility-age issue. Unless the Democrats sweep the elections, a bipartisan commission will likely be formed in 2009 to provide "air cover" for both parties to make needed changes. Don't be surprised if universal coverage including new state and local government employees resurfaces as an issue. A proposed bill to eliminate the Social Security offset for public workers now exempt will only draw attention to that issue.

Although Social Security will take center stage, the costliest elephant on the table in national retirement security policy is Medicare , which will run out of money much sooner than Social Security. Voters remain uninformed and almost nonchalant about Medicare. It's not obvious that this can be a winning issue for either party. Democrats thus far have ducked it by asserting that national health care-reform must come first, because that will shape the nature of longer-term Medicare reform. That's probably true, but the next Congress eventually will need to address this issue soon. Again, a bipartisan commission may be the only way to pass a controversial bill in the Senate -- unless Democrats win by a landslide large enough to break filibusters.

It won't be discussed in the election campaigns, but in 2009 look for fiscal-responsibility proposals to (a) phase-in a Medicare tax rate increase of as much as 1 percent of all payroll income for both employers and employees and (b) align the Medicare eligibility age with the escalating Social Security normal retirement age. Such tax increases would directly impact public-sector employers. The alignment of eligibility ages could ultimately increase state and local government retiree medical costs which are now picked up by Medicare at age 65 for everybody.

Regardless of who wins the nominations, it's likely that both parties' platforms will include a proposal for national health care in some form. Democrats will likely bundle something that looks as universal as feasible, targeting lower- and middle-income voters now without coverage. Republicans will be more likely to suggest tax incentives plus public-private solutions similar to those brokered by Mitt Romney in Massachusetts and Arnold Schwarzenegger in California.

The key issues for state and local governments are whether the current employer-based system will continue, and whether the new national system will absorb more medical-care costs through expanded coverage. That would partly relieve state governments and counties of their fiscal burdens under the Medicaid system plus their costs of funding public hospitals and local health care systems. With the national budget bleeding deficits, it's hard to imagine an increased federal fiscal role. But anything can happen in an election year if this issue gains traction among worried voters.

Themes of consumer-based health care will likely dominate the Republican proposals, but at the state and local government level, those are non-starters because state and local governments receive no employer tax savings for the benefits they now provide employees who are in modest personal tax brackets. Republican leaders will eventually realize that shifting to individual-based health care through tax credits could prove more expensive for public employees. That's why a tax-incentive approach only makes sense in the taxable private sector. This is one area where state and local government coalitions should now be plotting their communications strategies as the candidates' proposals are refined.

For an extensive, objective and independent analysis of candidates' positions on health care by PricewaterhouseCoopers, click here.

Unions. A key factor in the Democratic nomination process will be the role of public-sector labor unions. Senator Hillary Clinton has already locked up much of the labor leadership including AFSCME and the American Federation of Teachers. Firefighters will certainly be represented on the podium at the nominating convention. Labor groups will expect payback in 2009 if Democrats take the White House and strengthen their control of Congress. Success nationally could also carry more labor-friendly Democrats into state and municipal offices where their impact on benefits is much more direct. Traditional employee- and pension-friendly policies would most likely be continued.

Investment tax policy in 2009. The Great National Debate will undoubtedly pit Republicans against Democrats on the issue of income tax rates. Current law schedules the Bush administration's tax cuts to expire in 2010. There will be much fanfare at the Republican convention about extending the current lower rates in the next Congress. Democrats, on the other hand, are emphasizing short-term fiscal stimulus for middle America and would let the 2011 rates increase as now scheduled for wealthier taxpayers. The condition of the economy may drive this issue in 2008, as candidates of both parties are reluctant to talk about a tax increase as the economy weakens.

Whatever happens to individual income tax rates, the most important issue for public pension plans is whether investment incentives now provided for individuals' capital gains and dividend income will continue at the low 15 percent tax rate vs. the top-bracket 35 percent rate. Democrats could commit political suicide if they propose complete elimination of the lower preferential investment tax rates, so they will likely find it necessary to propose a gradual increase to higher levels, such as 20 percent, over a five-year period. Anything faster than that could induce widespread selling on Wall Street in 2009 as investors rush to lock in lower capital gains rates. That could be harmful for pension fund portfolios already invested in stocks. Thus, the smart position for pension associations should be to encourage Congress to scale-in any future tax increases on capital gains and dividend income smoothly over a five-year period.

Divestment legislation. At the state level, the hottest symbolic issue in 2008 will likely be pension-divestment proposals, which continue to float around the state capitals. President Bush recently signed legislation that exempts pension trustees from fiduciary liability if they divest from companies doing business in Sudan. I've written about this before in my previous column on divestment, and encourage pension leaders to confront the state legislatures with facts showing the adverse impact of divestment and the transaction costs that lawmakers thrust onto public employers, taxpayers and younger employees when they target a specific country.

State-level OPEB solutions. For state and local governments to properly finance their retiree health care plans, legislation is needed in many states. Here the issues are more structural than symbolic. These "other post-employment benefits" require funding just like pension funds for $1 trillion to $1.5 trillion of accrued liabilities even if public employers establish less-expensive defined contribution plans for new and younger employees (see my previous column on the UAW and VEBA as a model). Several states lack investment legislation to permit OPEB trust funds to be broadly diversified in all capital markets like pension funds. Those laws must be updated pronto or else the employers must follow cash management statutes resulting in an unfavorably low discount rate in calculating their OPEB liabilities.

State leaders would also be wise to create statewide, voluntary OPEB financing agencies to enable localities to fund their OPEB liabilities through a common fund and to tap the states' superior borrowing capacity to sell OPEB bonds at opportune times. I have developed a comprehensive proposal to this effect (e-mail me if you'd like a copy). Why should every local government in America set up and manage a separate OPEB trust fund when a statewide investment fund can be operated more efficiently? We learned this lesson decades ago in the pension world when fragmented municipal systems were consolidated into statewide plans. I look forward to seeing creative solutions developed by state plan administrators, including the possibility of a nationally marketed OPEB trust fund run by a statewide retirement system that could serve localities everywhere, with home-rule decisions on benefit levels.

States are also better positioned and staffed to issue OPEB bonds at lower interest rates, to establish limits on local government borrowing authority and benefit increases, and to protect local taxpayers from political or naïve leveraged financing strategies. My previous column on local OPEB bonding offers a glimpse of the questions that should be asked. The economy may answer some of these questions for us: If a recession lingers, OPEB bonds could make sense by year-end 2008.

The California pension issue. A final issue to watch closely is the momentum of the taxpayer group in California that crafted a ballot initiative to curb public pensions. I introduced this issue in my previous column on a possible benefits crackdown. Since then, the sponsoring group has regrouped and apparently will re-file a revised petition, but if they collect sufficient signatures to achieve November 2008 ballot status, it's likely that sparks will fly in the Golden State. Public employee unions remain adamantly opposed. Only time will tell whether enough voters can be mobilized to mandate statewide public employee compensation changes when taxpayers' potential pocketbook savings are indirect. The issue is either one of principle or "pension envy," depending on one's perspective. If the issue gains traction in California, however, other states could see similar proposals in 2009.

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