Pension Overpromise Is a Disaster in the Making

The words ‘The government does not have power under the Crown’s prerogative to give notice pursuant to Article 50 for the UK to withdraw from the European Union’ were enough to send the price of sterling higher and the hearts of the 48.1% of Britons who didn’t vote to leave the EU aflutter.

A case of false hope triumphing over reality. It is always dangerous to give absolute certainties in this business, but Britain will leave the EU…otherwise the will of the people counts for nothing. Laws will be changed. Political arms twisted. And, in the end, Article 50 of the Lisbon Treaty will be triggered by March 2017.

On the others side of the Atlantic, the US election (yawn) is getting down to the pointy end.

Will we see a late barrage of claims and counterclaims? What other dirty tapes have the Democrats got on The Donald? Will WikiLeaks release another batch of Hillary’s emails? Does it matter?

The release of more of the same material — Donald is a womanising leech and Hillary is a money grabbing liar — is hardly earthshattering news.

Can you imagine the pressure being bought to bear by the Obama administration, behind the scenes, on the FBI? The pressure within Washington must be close to boiling point.

If the election comes down to a whisker’s difference in votes, what’s the bet it, too, goes to the Supreme Court (the highest court in the US) for a ruling?

Meanwhile, the working stiffs — while being entertained by the legal and political theatre — get on with the day to day issues. The ones that keep roofs over their heads…food on the table…and who try to save a few dollars for their retirement.

Presidents, Prime Ministers, judges and senior bureaucrats do not have to worry about the latter of these issues…saving a few dollars for their retirement.

That’s well taken care of courtesy of the taxpayer, Wall Street, cushy consultancy gigs with lobbyists, and, if you are so inclined, you can even establish your own ‘Foundation’ to enrich (sorry, I mean assist) causes close to your heart…oh like, your own bank balance.

For those who actually work (and don’t deal in graft, corruption and manipulation) for a living, the age pension underwrites the retirement years for the majority of people.

Around 65% of older Australians rely on a government pension or allowance as their main source of personal income at retirement.’ That’s according to the Australian Securities and Investments Commission (ASIC) Money Smart site.

The percentage of age pension dependency is fairly consistent around the developed world.

More — not less — rely on social security to make ends meet in their later years.

But how sustainable is the pension system?

On 25 February, 2015 Laurence J Kotlikoff (Professor of Economics at Boston University) addressed the US Senate Budget Committee. This was his opening statement (emphasis mine):

Chairman Enzi and Other Distinguished Members of the Senate Budget Committee,

I am honoured to discuss with you our country’s fiscal condition. Let me get right to the point. Our country is broke. It’s not broke in 75 years or 50 years or 25 years or 10 years. It’s broke today. Indeed, it may well be in worse fiscal shape than any developed country, including Greece.

This declaration of national insolvency will, no doubt, shock those of you who use the officially reported federal debt as the measuring stick for what our country owes. After all, federal debt in the hands of the public is only 74 percent of the GDP. Yes, this is double the debt-to-GDP ratio recorded a decade ago. But it’s still a far cry from Italy’s 135 debt-to-GDP ratio or Greece’s 175 percent ratio.

Unfortunately, the federal debt is not an economic measure of anything, including our nation’s fiscal position. Instead, the federal debt and its annual change, the deficit, are purely linguistic constructs that reflect how you members of Congress choose to label government receipts and payments.

Nothing like hitting them straight between the eyes!

Kotlikoff told the US Senate committee what those of us with even a passing interest in the economy already knew…the data is BS.

Pure spin, deliberately doctored not to frighten the masses. They want you dumbed down. Keep working. Keep paying taxes. Keep spending. Keep borrowing. Ah, but will the political class keep their promises? Do I really need to answer that for you?

Let’s continue with the Good Professor’s candid address to the (clueless) Senators.

Spending six decades raising or extending transfer payments and cutting or limiting taxes helped members of Congress get re-elected. But it has placed our children and grandchildren under a fiscal Sword of Damocles that gravely endangers their economic futures.

For 60 years, politicians of all persuasions have increased or extended transfer payments — this is economic speak for ‘welfare payments’ — while at the same time reducing the taxes that are needed to fund the increased social security largesse.

Decrease your income and increase your expenses. What idiot thought of this? A politician who wants to get re-elected. To hell with tomorrow, this is all about getting the snout in the taxpayer trough today.

Well, tomorrow has arrived. Our children and grandchildren are expected to pay for this overpromise with higher taxes, longer working lives, and no expectation of ever receiving what their parents and grandparents have come to expect as a given…an age pension.

I’m not so sure future generations are going to take too kindly to honouring an arrangement they had no say in. Here’s Professor Kotlikoff again: ‘…a positive fiscal gap means the government is attempting to spend, over time, more than it can afford…

What’s the size of the financial albatross around the necks (‘fiscal gap’) of future generations in the US?

Professor Kotlikoff has done his own numbers and puts them into context:

The U.S. fiscal gap currently stands at $210 trillion. This figure is my own calculation based on the Congressional Budget Office’s July 2014 75-year Alternative Fiscal Scenario (AFS) projection.

The size of the U.S. fiscal gap — $210 trillion — is massive. It’s 16 times larger than official U.S. debt, which indicates precisely how useless official debt is for understanding our nation’s true fiscal position.

By now you’d hope the Senate Committee is feeling a little uncomfortable about the liability the ‘as-yet-unborn’ are going to inherit due to the decades of political vote-buying shenanigans.

To bring home the enormity of the task confronting those charged with balancing the books, Laurence the Brave hit them with this:

What’s Needed to Close the Fiscal Gap?

Our $210 trillion fiscal gap represents 58 percent of the present value of projected future taxes. Hence, eliminating the fiscal gap via tax hikes requires an immediate and permanent 58 percent hike in federal taxes. Stated differently, the overall federal government is 58 percent underfinanced.

A 58% hike in taxes — TODAY (that was back in February 2015) — is what’s required to finance decades of overpromise.

Needless to say, the tax rates have not increased.

The Australian government’s 2010 ‘Intergenerational Report’ shows we are on the same fiscal gap path as the US.

fiscal gap
Source: Intergenerational Report
[Click to enlarge]

To quote from the report (emphasis mine):

Population ageing will increase spending on health, age-related pensions and aged care.

Escalating health costs associated with technological enhancements, such as new medicines, and increasing demand for higher quality services, will add to fiscal pressures from ageing.

At the same time, slowing economic growth as a result of an ageing population will reduce the capacity of Australia to fund this increasing spending.

Whether Britain leaves the Eurozone, or one of Hillary and Donald occupy the Oval Office, or Bozo the Clown becomes our next PM (and no snide remarks here about that being a quantum leap forward in political leadership), it matters little to what’s important to you…funding your retirement.

The numbers are baked into the cake, irrespective of whose backside shines the ministerial leather.

Either future generations agree to a substantial increase in taxes to pay for something they never had a say in (and will never)…or future generations are going to wrest control of the fiscalSword of Damocles’ and use it to slash age pension entitlements…or we could see a bit of both.

My money is on the age pension being pared back substantially in the coming years and decades. This won’t happen tomorrow, but, after 2020 (only a few years away), tougher measures will be introduced.

Knowing this is coming is why you need to move into retirement with as much capital as possible. Which means that avoiding the next, potentially catastrophic, market correction should be paramount for anyone who’s within 15 years of receiving the gold watch.

What’s building within the system is a social disaster in the making. You need to make your own plans to ensure you are prepared for the time when overpromise is replaced by under-delivery.

For anyone interested in reading Professor Kotlikoff’s address, here’s the link.

Regards,

Vern Gowdie,
For Markets and Money


Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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