Monday, February 28, 2011

Moving from Pensions to 401(k)s

The corporate world figured-out long ago that pension plans are untenable. It's simply not realistic to make promises 30-50+ years into the future. 'course, they didn't completely figure that out on their own. The Pension Benefit Guaranty Corporation was set up to guarantee pension promises made by corporations after a bit of a pension crisis in the 1970s. Companies which have pension plans must pay insurance premiums to the PBGC. The PBGC in turn pays pensions for bankrupt companies. That forced insurance premium payment was likely the tipping point. Why pay an extra tax on employee benefits when there are many ways to attract and retain talented employees? Anyone who thinks pensions are a great idea should look at the PBGC's finances. As of fiscal year 2010, they have $102.5 billion in obligations versus $79.5 billion in assets. 'course, it's possible that investment returns will make up the gap, but, if not, the US Taxpayer will likely be on the hook to make up the difference, as was the case with Freddie Mac and Fannie Mae.

The New York Times is currently running a "debate" on the Pension/401(k) issue. I'm amazed at some of the "arguments." Teresa Ghilarducci argues that 401(k) plans are bad for employees since

...401(k) management and investment fees are three times higher. And professionals who manage money in pooled pension funds usually get higher returns than workers who manage their own 401(k) accounts.
But, this is side-stepping the main issue which is defined-benefit versus defined-contribution. If governments and employees are concerned about this issue that Ghilarducci raises, then the government can simply continue it's pension management, re-branded as a 401(k) plan. This would eliminate fee/return issues while eliminating the defined-benefit aspect.

Ghilarducci also claims that pensions are better for managing talent:

Want an old cop to retire? Want to offer a career path to a young, earnest would-be teacher? Use a traditional plan. Risk seekers and high turnover workers tend to prefer 401(k) plans; but do taxpayers prefer those characteristics in a public employee?
If the old cop can't do his/her job any more, he should be demoted or fired---(s)he shouldn't be given a boat-load of taxpayer money. Use that extra money to pay top-dollar for the best new teachers so they don't all go to private schools.

Finally, Ghilarducci claims that "...401(k) plans fuel bubbles and make recessions worse." If anything, history seems to invalidate her claim. The Early 2000s recession was one of the mildest ever and the so-called Great Recession was barely worse than the Early 1980s recession and downright gentle compared to just about every recession before 1948. For easy to compare length, unemployment and GDP drop numbers, see Wikipedia's list of Free Banking to Great Depression and Great Depression onwards era recessions. Furthermore, 401(k) plans and pension plans invest in similar pools of equities and bonds and pensions tend to make (much) larger investment moves whereas many people barely touch their 401(k) plans.

A final flaw in Ghilarducci's logic is the assumption that a retirement opens the door for others:

At least now public sector workers can retire with a guaranteed pension, making way for other people to get jobs.
While this might be true in a very narrow sense, economies don't work like this. More jobs create more spending which, in turn, create more jobs. In fact, letting people retire earlier than they could on a defined-contribution plan just makes things worse for the new worker since he or the taxpayers will have to help pay for the retiring-too-early worker in the form of lower salary/benefits (for the new worker) or higher taxes (for the taxpayers).

Currently, many government pension plans are strikingly similar to ponzi schemes---retirees take out more than they effectively put in (considering government contributions plus investment returns). Now that baby-boomers are retiring and taking advantage of these generous pension terms, governments are finding it difficult to balance the books. It's only a matter of time before something has to bend.

Update (3/2/11): See David Leonhardt's Union Contracts, Not Pay, Are States’ Problem article for a good discussion of the real problems with public workers' contracts.

Friday, February 25, 2011

I Hate eFile

Massachusetts is strongly promoting their e-file income tax system. I should love it, right? I spend much of my time in front of a computer. I keep much of my tax information on my computer. What isn't there to love?

Let's start with a bug. It's trying to tax me on a qualifying indirect IRA-to-IRA rollover. The Form 1 instructions and this letter clearly state that the distribution is not taxable for Massachusetts income purposes if it is not taxable for Federal income purposes. In order for the rollover be Federally nontaxable, the money has to be deposited in a qualifying IRA within 60 days of receiving the distribution. We did this. Yet, there's nowhere in the WebFile for Income system to indicate so or to override the WebFile determination.

Is that the only complaint? No. Instead of helping me to make this determination, the WebFile for Income documentation only hindered my search. The "Help Library" included useless (to me) entries on rollovers and didn't even provide the relevant text from the Form 1 Instructions (!)

The only plus of the WebFile for Income system is that they caught a mistake I made in filling-out the dependent care expense worksheet. In incorrectly interpreted "qualifying expenses" as being the total paid for dependent care whereas part of the instructions clarify that line 1 of the worksheet should be line 31 of a pro-forma Federal 2441 with the Massachusetts limit entered into line 27.

In principle, I like the idea of electronic filing. It has the potential to be much simpler, easily eliminating 80%+ of the fields I have to fill-in with a traditional form. However, people always underestimate how difficult it is to get software right, especially for something as complex as taxes. I hope that the Massachusetts DOR keeps trying as the current version is a valiant effort.

Update (2/28/11): The Mass. DOR provided me with a speedy clarification: non-taxable rollovers should not be entered into WebFile for Income. I hope they improve their wording in future years as the system indicated that any 1099-R showing income should be entered into the system.

Wednesday, February 23, 2011

Rich Pay Only 14.7% Federal Income Tax

The NYTimes just posted an article entitled The Little People Pay Taxes. Also see the original article, At the Helmsley Building, the Little People Pay the Taxes. I think it's fascinating that it's so easy to identify a super-rich segment of the U.S. population since The Helmsley Building has its own zip code, 10169. Comments on the NYTimes article exhibit the usual outrage at the rich. But, it seems that many comment-ers didn't understand that the low tax rate paid by those rich residents of the Helmsley Building is probably just a simple result of the tax system we've made for ourselves. Here are some facts to consider:

  • The year considered was 2007, the end of a bull market (in both stocks and real estate). The "poor" and "middle class" tend to have little money invested in stock and real estate whereas the "rich" tend to have large amounts of money invested in such capital-gains-vehicles. Long-term capital gains are taxed at 15% for high incomes.
  • State and municipal bond income is exempt from federal tax. However, this income is excluded from Federal AGI and so is irrelevant for the referenced tax rate calculation. (It is entered into line 8b of the 1040).
  • AGI excludes business expense deductions. Martin A. Sullivan notes that Helmsley frequently wrote off home improvements as business expenses. While there are cases where such expensing is legitimate, it sounds like Helmsley's was not, as she served 18 months for fraud and tax evasion.
Personally, I'd like to see more summarized details from these tax returns. In fact, it'd be great to see an average 1040 for the residents of the Helmsley building. It would also be quite useful to see the numbers for a year where there were few-if-any capital gains, such as 2009. I bet the federal tax rate as a function of AGI for the Helmsley residents would be quite a bit higher for 2009.

I wish more people would direct their outrage toward the convoluted tax system rather than at the people who manage to play it to their advantage. Here are some questions I think people should be asking:

  • Why are long-term capital gains taxed at only 15%?
  • Why is mortgage interest deductible?
  • Why is state and municipality bond interest tax-free?
  • Why do we allow the tax system to become more-and-more complex? The more complex it is, the more money you need to take full advantage of the system, and the less likely the IRS is able to enforce the law.

Monday, February 21, 2011

Enterprise Value

One valuable lesson I learned from The Little Book that Beats the Market is that market capitalization (of a stock) is only useful as a component in calculating enterprise value. Two companies with identical market capitalizations can have drastically different "values". Market capitalization just tells you (# of shares) x (current share price). Enterprise value tells you the (net) cost of buying the entire company at the current share price---when you buy, debt needs to be paid off and cash goes into your pocket. So, valuation metrics based on market capitalization miss an important aspect of valuation.

Thursday, February 17, 2011

Are Mass Transit Systems Really More Efficient than Cars?

Some would have you believe that mass-transit systems are always more efficient than cars. But, it doesn't take much critical thinking to realize that this isn't always the case. Consider that mass-transit vehicles:

  • are much heavier than cars
  • must stop (and hence accelerate) frequently
  • carry relatively few passengers during non-peak times and when traveling in non-peak directions
I'm not going to do a full analysis here since someone has already done that work for me. I encourage you to read Brad Templeton's mass transit analysis. His is one of the few, if not the only, analysis I've seen that is fair and reasonable. He notes that the US would be better off promoting fuel-efficient cars (increase the gas tax, anyone?) than building public transit where the benefits are murky. The Toyota Prius's 50 miles-per-gallon combined rating beats the average commuter rail efficiency and one of the more efficient subway systems (NYC). Of course, Brad fairly notes that at an individual level, mass transit is more efficient from a marginal perspective since the buses and trains are running no matter whether you use them or not.