An Idea for Safeguarding Pensioners and Taxpayers

Filed Under (Retirement Policy) by Jeffrey Brown on Dec 10, 2009

In at least one previous post, as well as in other research papers and articles, I have discussed the enormous problems facing the Pension Benefit Guarantee Corporation (PBGC), the government corporation that insures private defined benefit pension plans.  This week, a very talented MBA student at Illinois – Gagan Bhatia – reminded me of a terrific idea that would go a very long way toward providing plan sponsors with economically appropriate incentives for funding their plans.  Right now, plan sponsors lack appropriate and sufficient incentives to fully fund their plan or to choose a portfolio that immunizes the plan funding from market risk.  Sure, the government imposes funding requirements, but they have proven woefully inadequate.

In fairness, while Gagan Bhatia came up with this idea on his own and independently, it is an idea that has been out there, including in some work by Doug Elliot of the Center on Federal Financial Institutions.  Regardless of who gets credit, I think it is a terrific idea.

In a nutshell, the idea is to increase the seniority of pension claims in the event of a bankruptcy.  When a company files for Chapter 11 bankruptcy, the company’s creditors and claimants fall into different pools as per their priority over the company’s assets. PBGC’s obligations fall into the Unsecured Creditors pool which are paid after the Secured Creditors.   

Under this proposal, the PBGC would be moved up the line and be considered a senior, secured claim.  In essence, it would allow the PBGC to get paid first (or at least earlier than under current law) from any assets that the plan sponsor has remaining.

Why does this help?  Currently, creditors have insufficient incentive to consider the funding status of a firm’s pension plan when the firm is issuing debt.  If creditors knew that the PBGC’s claim on the firm’s assets was senior to that of the creditors, then creditors and potential creditors would become powerful enforcers of economically appropriate funding behavior.  Plan sponsors that failed to adequately fund their pension or plan sponsors who failed to engage in asset-liability matching would be considered – appropriately – to be a higher credit risk.  Thus, the firm would have to pay more to borrow.  Firms that funded their pensions and invested them in a manner that mitigated future funding risk would benefit from lower borrowing rates. 

In essence, this approach would harness market forces to achieve a worthwhile public policy goal.  Along the way, both pensioners and taxpayers would benefit. 




An Expected Surprise: The Doubling of the PBGC’s Deficit

Filed Under (Retirement Policy, U.S. Fiscal Policy) by Jeffrey Brown on Nov 17, 2009

Last Friday, the Pension Benefit Guaranty Corporation (PBGC) announced that its deficit had doubled over the past year.  The PBGC is the government agency that insures defined benefit (DB) pension plans in the U.S.  While this doubling of the deficit was widely reported in the press, the only thing surprising about this announcement was that anyone was surprised by it.


Since the PBGC was created through the passage of ERISA in 1974, the basic design of the program has been fundamentally flawed.  As I have discussed in several papers, the PBGC fails to price this insurance properly, fails to provide adequate incentives for funding, and fails to provide adequate information to market participants.  As a result, DB plan sponsors have the incentive – and the legal right – to fund their pensions in a manner that imposes large future obligations on U.S. taxpayers.  (And as for the PBGC experts out there who will quickly point out that the PBGC is not funded by taxpayer dollars, I ask you only one question – given our experience of the past 15 months in which the U.S. government has not only bailed out government sponsored enterprises such as Fannie and Freddie, but also private sector companies such as G.M., do you really think Congress will let millions of pensioners lose their benefits when the PBGC runs out of money?)


Given that the program’s finances have been underwater for years, and given that numerous academics, think-tanks, and government policy experts such as the GAO and the CBO have all pointed out that the PBGC is on an unsustainable course, the latest numbers simply confirm what we already intuitively know – the PBGC’s finances are deteriorating rapidly.


Here are the facts as of September 30, 2009:

-         The PBGC had only $68.7 billion in assets to cover an estimated $89.8 billion in liabilities.

-         The PBGC “acquired” responsibility for an additional 144 plans during the year.

-         27 large plans – with liabilities of over $1.6 billion are now listed as “probably losses” on the PBGC’s balance sheet

-         The PBGC notes that “potential exposure to future pension losses from financially weak companies” is approximately $168 billion.


I do, of course, realize that it is difficult to get people exercised about this issue.  Even $168 billion, let alone $22 billion, no longer seems like a big number coming in a year after trillions have been spent on stimulus plans and TARP-like programs.  Nor does it seem large relative to the tens of trillions in unfunded liabilities facing Social Security or Medicare.  But $168 billion is still real money – even in Washington. 


What needs to change?  One useful first step would be to give the PBGC the authority to charge market-based premiums for the insurance it provides.  It is true that this might hasten the decline of DB plans in some sectors.  But I would submit that if making firms pay the true cost of their pensions means that they no longer find it attractive to offer them, then perhaps the efficient outcome is for them to end the plans before they dig the fiscal hole any deeper.

Should a Proposal “Pay for Itself” (and How do We Know if it Does)?

Filed Under (U.S. Fiscal Policy) by Don Fullerton on Sep 18, 2009

A member of Congress who wants to spend additional money often has to say what tax will be raised to pay for it.  Somebody else who wants a particular tax cut for their favorite lobbyist may have to say what other tax will be raised.  As a general principle, this kind of “budget neutrality” is often a good idea.  In all likelihood, the Tax Reform Act of 1986 only succeeded because it was revenue neutral.  It broadened the tax base and lowered tax rates, to fix the tax system without changing the amount collected.

But how is revenue neutrality calculated?  Politicians on both sides of the aisle call upon the non-partisan Congressional Budget Office (CBO) as the arbiter of budget balance.  If important policy choices must pass the CBO’s litmus test, then we need to understand what test is being administered.  According to its website, the “CBO’s [cost estimate] statement must also include an assessment of what funding is authorized in the bill to cover the costs of the mandates and, for intergovernmental mandates, an estimate of the appropriations needed to fund such authorizations for up to 10 years after the mandate is effective” (  This CBO test has a few major problems that could limit the benefits from a policy, or even prevent enactment of a good policy.

First of all, not every act of Congress must be revenue neutral.  But policymakers may want the restriction of revenue neutrality, in order to “prove” they are fiscally responsible.  Recently, President Obama in his health care policy speech to a joint session of Congress promised that he “will not sign a plan that adds one dime to our deficits — either now or in the future.”  Thus, one general problem is: who decides which projects must be revenue neutral?

Second, of course, a project may generate revenue or cost savings after ten years.  President Obama’s health care reform has initial start up costs, but it may “bend” the long-run cost curve for federal expenditures on Medicare and Medicaid, so that cost savings accrue and accumulate over more than ten years.  In general, the CBO’s ten-year balance sheet could say that a policy adds to the debt over ten years, even though it may save taxpayer dollars in the long-run.  On Wednesday, September 16, 2009, the CBO released its official cost estimate for the Senate Finance Committee’s draft health care bill, stating that it would have a “net reduction in federal budget deficits of $49 billion over the 2010–2019 period” (  However, an additional, unofficial estimate by the CBO concluded that the “the added revenues and cost savings are projected to grow more rapidly than the cost of the coverage expansion”, meaning that over a longer time horizon that the bill further reduces the deficits.

To be clear, the federal debt is a real concern.  Running massive deficits that pile up year after year is unsustainable and irresponsible.  But a strict CBO ten-year cost estimate test may not be the best way to evaluate a potential policy change.

A third problem is that any such test must be somewhat arbitrary, regarding what is counted as “revenue”.  Does it just count actual dollars flowing into government coffers?  What about features of a policy that reduce future outflows?  Some pieces of additional spending in proposed health care reforms are intended to improve future heath and thus to avoid the need for some future medical expenses.  The CBO would count current “preventive care” spending as a cost, but it may not count the fact that this current spending could reduce the need for Medicare and Medicaid to pay for some future medical procedures.

Fourth, and most importantly, even if NOT revenue-neutral, SOME policies are still valuable, important, and worthwhile.  A project may have generalized benefit to everybody in society that exceeds the actual social cost, meaning that it passes a benefit-cost test, even though it requires government spending and is not “revenue neutral”.

Any revenue-neutrality test is a way for policymakers to “tie themselves to the mast” and prevent them from pork spending of the most egregious sort.  Maybe that’s good and worthwhile.  But it may also mean we can’t have some other worthwhile policies either.

Does Social Security Help the ‘Poor’?

Filed Under (Retirement Policy) by Don Fullerton on Sep 11, 2009

Social Security is the largest government program in the U.S., with annual expenditures over $600 Billion.  It is also the single largest source of income for the elderly, accounting for 40 percent of all annual income going to individuals age 65 and above and over 80 percent of income for the poorest quintile of families.

Yet, it is less clear whether the program really redistributes income from those who are truly well-off to those who are truly poor.  Although Social Security has a progressive benefit formula, various features of the program reduce the extent of redistribution in the system.

This question matters for the debate over Social Security reform, because most reform proposals try to maintain Social Security as a progressive program and yet might alter the extent of redistribution.  We’d like to know how much redistribution really occurs through the current system, and which aspects of the program’s design influence this redistribution.  Such information would be useful in order for policy makers to assess the distributional effects of any program change.

Three of us undertake such research in a paper called “Is Social Security Part of the Social Safety Net?”, which you can find on my website at .  My co-authors are Jeffrey Brown and Julia Coronado.  We examine the extent of redistribution in the Social Security system.  To do so, we build a model that categorizes individuals by their lifetime resources, and we calculate the taxes they pay and benefits they receive from Social Security.  Most importantly, we use a number of different definitions of income and of redistribution, in order to obtain a more complete understanding of the issue.

We use 26 years of data from the Panel Study of Income Dynamics to construct complete lifetime earning histories for individuals in the sample.  The use of actual data allows us to incorporate real events and phenomena, such as spells of unemployment, which may be important for the analysis.

We begin by calculating the lifetime net Social Security tax rate for each individual in the sample.  This is the present value of Social Security tax payments minus the present value of Social Security benefits divided by the present value of the individual’s lifetime income.  We then use this tax rate to calculate three different measures of redistribution. The first is a measure of how the Gini Coefficient changes when Social Security is included.  The Gini is a well-known gauge of income inequality that is useful for understanding the overall impact of Social Security on inequality.  The other measures are the average net tax rate in each quintile of the income distribution, and the fraction of individuals in each quintile that receive positive net transfers from Social Security.  The latter two measures are useful for assessing whether the program does indeed benefit those at the bottom of the income distribution.

In addition to the multiple definitions of redistribution, we also employ multiple definitions of income.  The first is the present value of the individual’s actual lifetime earnings.  The second is an individual’s potential lifetime earnings (their earnings if they had worked full-time throughout their adult lives, minus any periods of unemployment).  “Potential earnings” measures the individual’s ability to earn, regardless of how much he or she actually chooses to work.  The third definition pools the earnings of married couples, since their economic well-being depends on total household resources rather than individual earnings.

Here are the major findings.  First, when a more comprehensive income definition is used (potential earnings, or household income), Social Security has virtually no impact on the overall distribution of lifetime economic resources, as measured by the Gini coefficient.  Second, however, while Social Security is not particularly good at flattening the overall income distribution, it nonetheless is at least mildly successful at transferring resources, on average, to the lifetime poor.  Over 85 percent of individuals in the lowest quintile receive positive net transfers from Social Security when the narrowest definition of income is used (individual actual earnings).  As the income definition is broadened, this share falls, but some individuals still receive positive transfers.

Third, transfers through the Social Security system are imperfectly targeted; some high-income individuals receive positive net transfers, particularly when income is defined at the household level, and some low-income individuals do not.  One reason, for example, is that spousal benefits provide more generous payouts to the spouses of high earners.  Finally, we examine whether the extent of redistribution has changed over time and find that the program has become somewhat more progressive on balance, but the direction and extent of the changes depend on the income definition used.

Our research suggests several avenues for future work. The analysis explicitly ignores behavioral responses to Social Security, such as changes in labor supply or savings, which might have an impact on inequality.  Second, our analysis does not incorporate the value of Social Security as an insurance program, for example in providing protection against the risk of disability or unexpectedly long life.  Despite these limitations, the framework we develop could be used to explore the distributional consequences of Social Security reform.

Garbage Has Costs, So You Ought to Pay!

Filed Under (Environmental Policy) by Don Fullerton on Aug 21, 2009

Oh, I’m sure you think you pay for your garbage collection through your property taxes, or through your fixed monthly fee.  But given those payments, you can put out as much garbage at the curb as you want.  Have another party with paper plates and cups, and then you can put out another couple of bags at no extra cost whatsoever.  But those extra bags still have to be collected, and they still use up valuable space in the landfill.  It’s not only “fair” for you to pay your own costs; more importantly, it can help get people to conserve.  (Save the planet!)

In the U.S., this problem is a big one. Americans generate about 4.5 pounds of trash per person per day, 95 percent more than our neighbors in Canada, 64 percent more than Australians, and 37 percent more than the French. This high per-capita rate, combined with our large population, means that the United States generates far more trash each year than other developed countries. The amount is also much greater than it used to be: in 1970, the average American generated only 3.25 pounds per day.

It is only getting worse, considering more economic development combined with population growth in communities across the United States and around the world.

Recycling and composting do make a dent: in 1970, composting was virtually nonexistent and only 7 percent of solid waste generated was recycled. But by 2005, the numbers had risen to 24 percent, for recycling, and 8.4 percent, for composting. These figures have remained relatively unchanged for the past several years, however. And while some materials have relatively high recycling rates – half of all paper and paperboard is recycled – others pose perennial problems. Plastics are difficult and costly to recycle.  As a result, less than 6 percent of them are recycled. Furthermore, products like cell phones and computers are creating new problems.

What are the key problems that government officials and policymakers need to address with respect to solid waste? And what policy instruments do the best job of tackling those problems?

For local communities, three goals seem paramount: trash needs to be managed properly without the high social costs of litter and other forms of illegal disposal; the amount of legally disposed waste should be reduced to a level that accounts for its own social costs; and particularly hazardous or toxic wastes need to be disposed separately, not thrown in the landfill with other trash.

Policymaking inevitably involves tradeoffs, so furthering one goal may reduce progress toward another. For the most part, developed countries have figured out how to manage solid waste to avoid extensive dumping. Local communities provide trash collection and disposal services – usually through government provision, franchises, or contracts with private companies. Although the number of landfills has fallen in the past 15 years or so, landfill capacity has remained steady. Moreover, landfills are safer than they used to be because of requirements for liners, methane control, and monitoring. What is less clear is how best to reduce the volume of solid waste in the first place. Based on economic analysis, empirical research, and years of real-world experience, I believe there is no “one size fits all” solution. An array of policies can best make the tradeoffs for different locations and different waste materials.

The economist’s typical solution to an externality problem is a Pigouvian tax: charge a tax or fee per pound of trash exactly equal to the social damages imposed by that trash. That would reduce waste in landfills, but it raises two questions. The first is whether the social damages can actually be estimated. Even if policymakers know what to charge, however, the second question is whether any such fee can feasibly be administered and enforced.

Some communities charge for each can or bag of trash, under a system commonly called “Pay as You Throw” (PAYT). Households might be charged one monthly amount for one can a week, or a higher monthly amount for a larger can or two cans a week. But not every can gets filled every week, leaving households with no incentive at the margin to reduce that last bag of waste. A better system, closer to true “marginal cost pricing”, requires households to buy a special bag at the grocery store, or a special tag to use on a bag of garbage of a particular size.

EPA estimates that approximately 7,100 communities in the United States use some kind of PAYT, making it available to approximately 25 percent of the country’s population. The number of communities has risen over time and, in some areas of the country, is quite high. Some states (Wisconsin, Oregon and Minnesota) even have a law requiring that communities use PAYT.

Does it work? Results from the economics literature suggest that demand for garbage collection is relatively unresponsive to prices, but PAYT towns have experienced some reductions. And it is important to keep in mind that even if reductions are small, charging the right price may result in the right amount of garbage disposal. Fixed monthly charges – the norm in many places – set a zero price for an additional bag or can and thus provide no incentive for households to conserve.

The big question for PAYT communities, though, is what households are doing with the garbage they no longer place at the curb. To avoid paying the fee, households can reduce their waste by recycling, composting, consuming less in the first place, or disposing illegally – burning, finding a commercial dumpster, or throwing it by the side of the road. Recycling does increase with PAYT but not enough to account for all of the reduction in trash. Clearly, municipalities can help themselves by providing free curbside collection of a wide variety of materials for recycling and yard waste collection for central composting. Towns also must choose how much to spend on enforcement, and how to set penalties.

PAYT is most effective in small cities and suburban areas but has not worked so well in densely populated urban areas where apartment dwellers use chutes and dumpsters for their normal disposal (and might easily use vacant lots for everything else). PAYT is also not as well-suited to very rural areas where illicit dump sites are similarly easy to find. In general, it is most feasible where we can measure and monitor individual households’ weekly trash and recycling.

Even in towns where a PAYT fee works well to reduce waste amounts without increased dumping, it does nothing special for separate handling of hazardous and other troublesome items like batteries, tires, or used electronic equipment. These products, especially, are candidates for some kind of deposit refund system (DRS). Experience has shown great success with a DRS applied to certain products: beverage containers in “bottle bill” states have recycling rates that range from 60-95 percent, significantly higher than in states without such a program; 96 percent of lead-acid batteries are recycled; and tires in states with a DRS are recycled at a 72 percent rate. But the idea can be generalized, in a “two-part instrument,” a general sales tax on everything at the store – all of which eventually becomes waste – along with a subsidy per ton of waste handled at the recycling center. Products like computer monitors could still be specifically targeted with a special fee, but most items could be treated in bulk, without time-consuming transactions to count or weigh individual items.

Thus the “best” policy is not any single policy. PAYT can successfully be employed in at least some communities, and probably in more than are currently doing so. Other towns, however, need a two-part instrument – a general sales tax on new items at the store, plus a subsidy for recycling. And products that pose special problems may need targeted deposits or refunds. Different circumstances therefore call for different policies, PAYTs, DRSs, or two-part instruments. All of these policies have a key feature in common and one that economists invariably seek in all of their policy prescriptions: they provide the proper incentives to consumers and others to generate a socially desirable outcome.