Friday, March 5, 2010

Economics 05/03/2010: More questions on pensions plan

In a recent post (here) I have asked 12 questions concerning the new Government plan for pensions.

Here are more questions to follow. But before we begin, let me state the following:
  • Lack of clarity on any of the questions raised by myself and other observers,
  • The fact that these questions can be raised in the first instance; and
  • Two independent confirmations of my questions validity from the industry sources
show that I am right in suggesting that the entire plan is badly thought through and most likely represents a new tax with no contractually verifiable benefits.

Question 13: Given that the Government will be forcing people of all ages to save 8% of their income per annum for pensions provision, the plan is not even sufficient to provide reasonable pension protection for the 22-year olds who will be enrolled into it. How will it help to defuse the demographic (aging-induced) time bomb the Government is facing?

The Government is hoping to start enrollment in 2014. It is facing pensions system meltdown around 2030-2035, which will cover by then retired generations born between before 1965. These generations by 2014 will be of age 49 or more, with 18 years or more left to go before a pension. This, in turn means that their pension provisions should be in excess of 20% of their income, assuming they are starting anew at 2014. Massively more than 8% the Government has in mind.

At the same time, the younger generations pension savers will be facing a dependency ratio of less than 2 workers per retiree by 2050. This means their total provision for pensions as well should be around 18-20% of their income annually. With 1/4 of this delivered in a promissory Government offer of 35% AE state pension, even assuming the Government will keep its promise, the unfunded contribution required is around 13.50-15% of income annually. Not 8% set by the Government.

Then there is a third sub-component of those who are in the older (pre-1970) cohorts who are currently outside private pensions schemes. They will require savings of more than 25% of their income annually to underwrite reasonable pensions provision. Again, 8% state run pension is not going to cover their shortfalls.

Question 14: If the funds were to go into the NPRF, then the life-span of the cash in the fund is about 5-10 years before the money is spend on some new emergency, e.g. another banks bust or another fiscal crisis (potentially the one induced by the collapse of the public sector pensions scheme). How will the Government protect our money from itself? It was not able to do so with the current NPRF set up and the signs are not good for any future funds security.

Question 15: Given that public sector pensions insolvency is already a known, the best for the Government to do is to reform the Rolls-Royce pensions it provides to its own employees. Why is the Government not leading by example?

Question 16: Anyone who has been outside the state scheme for 2 years will be automatically re-enrolled into the system. In the period of time between the re-enrollment and a new opt-out (which can be months), a taxpayer will be liable to pay into two pensions simultaneously (her own private plan and her state plan). Is this the case? How will the Government compensate such families who will incur overdraft charges due to such double pension provisioning courtesy of the state? How will the state actually monitor the opt-outs and whether people in the opt-out are still in a pension plan?

Question 17: What is the feasibility of the entire proposal ever being implemented, given the logistical nightmares it would entail?
  • The proposal would require massive bureaucracy (and invasion of privacy) to verify - e.g. Revenue data being used by another State agency to generate demand for enrollments, re-enrollments and clear opt-outs. Is this even legal?
  • The proposal will require the state to engage in the areas in which it has no expertise, running an investment undertaking with retail clients. What are the implications of a massive state monopoly with statutory enrollment powers to the market for pensions and financial services in Ireland? How long and how expensive will be the state battle with the EU Competition authorities to clear this scheme?
  • How big will the paper trail be if the state were to require continued monitoring of compliance with the opt-outs? What will be the cost of this to businesses and employees? How many paper pushers will the state need to hire to keep the track of these mountains of evidence?
From the point of conception, to the point of translating the new authority's documents into Irish, the undertaking cannot be envisioned as an efficient and cost-competitive operator.


So why is the Government engaging in the scheme at all?

Since 'resolving the pensions problem' is clearly not on the cards (see above), one possible explanation is to get its hands on more cash through 'borrowing' against the funds raised. Another possible explanation - to raise tax (unimaginable otherwise) on business.

Remember -
  • corporate tax is a sacred cow of the State;
  • personal income tax is already high and will rise again in the next Budget;
  • indirect taxes are crippling and the local authorities will be coming for more of their cut in the next few years.
So the only means for raising new cash is to levy a new charge - on businesses and incomes - that can be called something else other than tax. A promise of a service (new pension) 20-plus years down the road is a fig leaf of decorum, especially since the Government has no contractual obligation to actually honor such a promise and has set no specific target for a return on this undertaking.

This pensions proposal is a tax on employers (+2%) and a tax on people (+4%). And this tax will have the greatest negative impact on smaller businesses and entrepreneurs, since MNCs and larger companies are already offering much better pensions.

The Government might have solved the conundrum it faced courtesy of the EU Competition rules. Unable, since 2003, to charge differential tax rates on domestic and multinational businesses, it now devised a 'pensions' scheme to charge smaller companies more through a new levy. And it didn't have to raise official corporate tax rate to do so...


Of course, there is always a better solution than what our folks in the Government Buildings can deliver. That solution would be -
  1. set a flat income tax rate of 12% on all income and no exemptions except for a generous up front personal tax-free limit (to exclude the real working poor from taxation);
  2. And then tell people - including public sector workers - that they must invest at least 10% of their income in pensions of their choice, provided privately with real international competition in place (my preference would be to avoid compulsion, though);
  3. Make the entire pension contribution, up to 20% of gross income, tax deductible;
  4. Set up self-funded insurance scheme to underwrite pensions providers;
  5. Done. End of story and no need for white papers from over-paid and over-staffed task forces and for bureaucrats, lawyers, mountains of paper and pensions tzars.
Simple, folks. Really simple. Chile did so already.
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