NewRetirement’s Advisor Bud Hebeler of AnalyzeNow.com was just featured in a New York Times Article titled “To Retire in This Weak Market, the Magic Word Is ‘Focus’” that discusses some very interesting and important approaches for retirement preparation. There were quiet a few great takeaways from this article of which I will include two below.
While planning for retirement it is always important to set goals for your future, and the article brings up some clairvoyant questions you must ask yourself. “The first question assumes you have all the money you need –how would you live your life today? In the second, you are told that you have five years to live: what would you do with that time? And the final question aims right at the heart. You have 24 hours left on earth –what did you miss? Whom did you not get to be?” These questions allow you to step back for a minute and decide what is vital to your future, which in many cases does not have to do with financial concerns. Once you can decide what you truly want out of life, then you can set out the course for a retirement plan that will help you meet your goals.
Mr. Hebeler’s advice is also very insightful because retirees rarely budget for wear and tear items. If you put in the expenses for replacing or repairing cars, air conditioners, and your home, then you will have a much clearer picture of your necessary retirement finances.
Retirement Revolution, a new series that looks at the stories of everyday people who have found ways not only to survive but thrive in this new retirement reality, premieres on PBS tonight. Our advisor Henry “Bud” Hebeler of Ask Bud fame has an interview on how to have a successful retirement in these tough times with such answers to questions like, Should savings patterns change during inflationary times?. Check out a part of his interview here.
I grew up in the Great Depression and witnessed my parents’ penchant for avoiding risk. I learned my own lessons as well after I started earning my own money and tried to save it. Someone advised me of a “good” stock broker. He wasn’t good to me. I lost money on every stock he sold to me. I think that his firm directed him to sell the stocks in their own inventory that they considered bad investments.Midway through my working career at Boeing, I became head of corporate planning—a job that required parceling out research and new business budgets to the operating divisions and justifying the investments on the the sales prospects to the company’s board of directors. The total of the budget requests were always higher than we could afford to support while the sales projections from the operating divisions were, when totaled, higher than the customers could afford to spend. They reminded me of the always optimistic projections of my first stock broker.Years later, in retirement, I learned a lot about the various retirement planning methods. Almost all of them used optimistic portfolio returns from history and left out many things that influenced retirement spending and income, and no two gave similar answers. Inserting my standard test values for investment returns, pension, Social Security, tax rates, etc., I found they all gave different results. In fact, some said that no additional savings were required while others would impose staggeringly high monthly savings. These results were published in two, full page, articles in The Wall Street Journal.These programs came from well-known financial firms which seemed reluctant to improve their programs. I still find significant shortcomings after all of these years. The majority do not account for the appreciable costs that bring actual returns to values lower than the indexes for returns, nor do the simpler programs account for reverse dollar-cost-averaging shown by my research and described in J. K. Lasser’s Your Winning Retirement Plan.There are more complex statistical programs that purport to predict the future. They don’t. They should really say they are poor representations of what might have happened in the past. Most are based on fake return statistics and don’t correlate with actual historical inflation at the time of the returns.Together with my wife, we offer modest assistance to some people relying only on Social Security. They consumed their savings too early for various reasons, and now are sorry that they weren’t more conservative in their planning, budgeting, investing and spending. Over the years inflation destroyed the value of the pensions some have. Even then, they didn’t realize that they can’t spend all of their fixed pensions in retirement. It’s necessary to save part of each pension payment so they’ll be able to supplement their income later as inflation destroys fixed pensions income.Then there are Unk-Unks, a term for unknown-unknowns, that is, things you are unlikely to think about in advance, such as household emergencies and events in the lives of your adult children or elderly parents. Retirees have told me their biggest Unk-Unks were the divorce of a daughter with children followed by the need to support elderly parents after the parents exhausted their own savings.There are the things that you could have planned using some very detailed planning. Such planning is used by estimators in the construction industry. When an item was forgotten, we called these OSIFs, short for “Oh, shoot, I forgot,” except we had a stronger word than “shoot.” Forgotten items result in a dollar-for-dollar loss. On www.analyzenow.com I include a special event worksheet in the comprehensive programs that encourages people to include the cost of high value items such as to replace a roof, automobiles, etc. Retirees (and older working people) can gain much by first saving for a future purchase rather than paying for it over time.During my working years, I was very successful managing projects and organizations ultimately becoming president of The Boeing Aerospace Company (1980-1985). I attribute much of my success to being conservative both in work and retirement. Being conservative in retirement planning means using inputs that are low for returns, high for taxes, long life spans, etc. It also means having a significant portion of your assets in conservative securities. You can’t afford to retire on lottery tickets in a retirement portfolio.Bud Hebeler, www.analyzenow.com
The Wall Street Journal included an article on 7/20/09, p. A3, that probably won’t get the attention it deserves. It is “Pension Calculus Draws New Scrutiny” by Craig Karmin. It tells about Pete Nowicki, a CA fire chief, who was earning $186k salary and retired in January at age 51. Just before he retired this year, he “spiked” and now will start retirement with a $241k annual pension that will increase with cost-of-living adjustments.I first learned about spiked pensions from a golfing friend who was a minor administrator at a public high school. He told me how he made a handsome increase in his pension by spiking. Many public pensions are based on wages earned in the last year of employment, so the trick is to get those wages as high as possible. To do this, they can cash in their unused vacation, unused sick leave, unused holidays and unused car allowances as well as take on special assignments that add to their pay. In the case of Mr. Nowicki, he went right back to work for the fire department after retiring as a $176k consultant. Not bad: $241k retirement plus $176k consultant at age 51.
This is only the half of it. Practically no private pension plans have a COLA, a cost-of-living-adjustment. In fact, few private sector employees even get a pension although virtually all government people do. Once retired, a fixed pension in the private sector stays at the same collar amount no matter what happens to the value of a dollar. Even at a modest 3% inflation, that fixed pension goes down each year until it has lost almost half its purchasing power after twenty years of retirement when highly inflated health costs peak. But that’s not true of the growing number of government workers due to get COLA pensions. Their actual buying power remains the same. And we pay for it with our taxes.
Government workers can thank their strong labor unions and weak government negotiators. Some people think that the United Auto Workers have obtained inordinately high benefits for their members. The UAW pales in comparison to the unions that wrestle money and benefits from our taxes. Of course the Congress and state legislatures don’t want to make too big a fuss over this. After all, legislatures too gain great retirement benefits. For example, congressional retirement benefits are the same as those of the federal fire fighters.
Let’s not forget the fact that most public employees have retirement savings plans as well–and have very good health insurance benefits. Like pensions, these too are often not available to those in the private sector.
You can use the retirement calculators on www.analyzenow.com to see how much you can spend for your own retirement. It’s unlikely to be the same as Mr. Nowicki, nor have the generous health benefits. But you might want to bump up your estimate of future tax rates. Unlike private sector businesses, the government is not obliged to count retirement obligations as a liability. If the feds did that, technically the U.S. would be bankrupt!
On November 24, President Elect Obama announced that it was necessary to “jolt” the economy with large cash infusions. Both government and industry want us to spend more money fast.They also believe the economy will recover relatively quickly, perhaps in less than a year.Here’s why that’s impossible:
Motivated by political pressures and the need to show a sharp increase in securities markets, the government will be inserting trillions of dollars of borrowed money into the economy.Never mind that this will increase the national debt by 20% or so in less than one year or that commitments will be made for increased entitlements which are already far beyond our ability to pay. The combination of national debt and unfunded obligations for Social Security and Medicare now total to almost $200,000 for every man, woman and child in the country. As if that’s not bad enough, that doesn’t count any personal, mortgage, or commercial debt–all of which we must also pay.
The fact is that, as a nation, we have been living far above our incomes and the need to stash some money away for retirement.Even our children and grandchildren will be unable to pay just the ongoing costs of these obligations unless everyone is subject to staggering tax rates.The tax problem will be exacerbated by the demographics leading to the inevitable increase in the aged relative to the working population.
The problem started to be evident in 1985 when the national savings rate started its precipitous drive from the historical 9% to virtually zero in 2005 and has stayed that way ever since.In order to recover those lost savings and get back to what 9% would have provided over the past twenty years, people would have to save over 20% of their income over the next twenty years.The only time our country has saved that much was in World War II when there wasn’t much to buy, even food was rationed, and Rosie the riveter worked in a defense plant.Everyone invested in Savings Bonds, even school children.
The fact is that people should be saving more than 9% today.The reason is that a lower percentage of people are getting pensions.Further, over 40% of pensions are for government employees.The majority of the people don’t work for the government, don’t have a pension, and have fewer health benefits than government employees.Now we’re promising the equivalent of Congress’ health insurance to over 40 million uninsured people even though they now get free medical care, and those of us who pay for our health insurance don’t have benefits as good as Congress.
After the decline in savings became apparent, the financial firms discounted the importance of the national savings rate. One argument was that savings rate wasn’t important because the next generation was going to inherit so much.When people found they wouldn’t get any of Bill Gates or Warren Buffet’s money, financial firms said the value of stocks had increased so much that people didn’t have to save anymore.After the stock boom ended financial firms said that the best investment people had was their house which would provide much of their retirement needs.Right now, the government and industry say what’s important is to preserve jobs and keep spending up so that businesses can thrive.Forget savings.
Come on!At some point we have to take our medicine for such imprudent spending.As individuals we should be living within our income.So should our government. Hasn’t anyone heard about cutting expenses?I’ve gone through a number of Boeing financial crises.You learn that there are many things you really don’t need.Congress recently, and correctly, criticized the auto and union representatives for coming to their hearings in private jets.Yet Congress itself is bloated with all kinds of perks and overmanned with aides.There comes a time when Congress and the Administration must lead by example, then slash the spending of every government department severely. Just like Social Security and Medicare are entitlements, the lavish cost-of-living-adjusted government pensions are entitlements and will last as long as government employees live.
If we want change, let the change come from more prudent spending individually and by the government.Are we ever going to get away from politics where those running for office say they are going to give more benefits if elected?I’d like to see politicians give an honest and verifiable cash statement that would not only end deficits but reduce the horrible obligations that we’ve already left to our children and grandchildren. How about a twenty year plan to pay off the national debt and a fully funded trust for Social Security and Medicare?
The “Jolt” is more of the same shortsighted view that we’ve had for a long time.It may get us to spend more for a short while, but the reckoning will come.My thought is that the reckoning will be led by the baby boomers who have to learn relatively soon that they can’t retire without savings.As that reckoning comes, industry and the government will have to be smaller, but we’ll still be stung with a huge income tax burden because there will be fewer workers, even more people begging for handouts and the need to fund overly generous entitlement programs.
If you are expecting a quick recovery from the market problems that began in 2000 and have brought both losses and great volatility, don’t count on it!Those financial firms selling securities would have you believe otherwise.Without security sales, their income is zip, a big zero!
So what will really happen?
First, the government will have to stabilize the credit markets.This could easily take several years because foreclosures will be spread out in time.Even though home prices may be less than mortgage values, people do not decide to abandon a home on quick notice.They have to carefully consider their alternatives including whether the housing market will recover and the desirability to move to a different location.This is extra tough when people can’t qualify for new mortgage because their credit rating was destroyed by abandoning a mortgage.
It can’t be long before credit card defaults hit the banks really hard thereby aggravating the situation.The top six credit card companies hold $639 billion credit card debt.Then there are $365 billion securities backed by that debt.These are bundled into groups of credit-card receivables and sold to investors, insurers and hedge funds which likely find their way into other derivatives.It’s the mortgage problem all over again because about 30% of credit card debts are from low-credit-score people.Business Week (10/20/08) predicts that this is the next big blowup ahead.
In the meantime, people should develop a better appreciation for the fact that they should be saving.The decline of savings started two decades ago from 9% national savings rate to minus numbers today.Failure to increase savings rates is surprising because of the large number of baby boomers who are starting to reach retirement age and the long-term trend of industry to go from pension plans to savings plans.
As a consequence of saving too little, incurring large debts and losing conventional pensions, people will have to save more—lots more and start quickly.
When the savings rate finally increases to the extent necessary, much of the resulting investment would help the stock market. It would also bring back some of the national debt from overseas, thereby strengthening the dollar and reducing the cost of imports.But this will take years, not days or months and will be softened by slower business growth.
By necessity, many are going to have to retire much later.This is good news if they still have updated skills and the physical capability, but they will face a difficult labor market.On the one hand, demographics show there will be proportionately fewer young people entering the work force.That would bode well for seniors trying to retain jobs.On the other hand businesses will be facing many difficulties.This is likely to be overwhelming for a number of years.
Businesses will have lower volume when consumerism declines—as it must with increased savings!At the same time, employers will also face higher taxes, at least at the state and local level if not at the federal level.Heavy industries will face costly capital improvements for environmental and energy reasons.All of these things put pressure on labor as well as encourage businesses to look abroad for less expensive sources of materials and components–if not total assembly.Lower market volumes mean less need for commercial real estate, so there will be trimming there as well.
Another new impediment is put on businesses that offer pensions when the stock market falls and shows definite signs of slower growth.As an example, suppose that a pension trust’s securities fall 10%.Then the company has to either come up with 10% more funds (think of a huge number) to add to the trust.If the forecasted growth rate for their securities in the trust drops only 1% point, they will need about 15% additional assets in the trust.Firms like General Motors and Ford are already reeling from pension promises that are beyond their capability to fund.This is also likely true for government pension promises—only more so because most government pensions have cost-of-living-adjustments which require higher reserves than fixed pensions of private enterprise.
Another consideration is that the cost of government itself will go up. More regulation and health insurance administration will add significant government employment.Many government employees enjoy automatic cost-of-living adjustments to their paychecks.And government employees on the average make more than the average employee in the private sector.If the business share of higher government costs goes up, the product costs go up thereby aggravating inflation.
Some people think that higher corporate taxes reduce will reduce personal taxes.Not so, higher corporate taxes are simply passed on as higher product costs so that everyone pays—just as with a national sales tax.
The net result of reduced consumerism, increased savings and higher taxes will take some time to evolve before business earnings stabilize at a lower level.When that happens, stock price-to-earnings ratios likely will seek lower values than the historical norms for decades.That’s because of at least two factors:(1)People have got to make up a large part of the savings shortages of the last two decades or face poverty in retirement, and that will take many years of cumulative effort.(2) The outlook for growth will be tempered by the consequences of an aging population that has a much different budget distribution than that of the youth.Consumerism is a disease of youth.Lower price-to-earnings ratios combined with lower earnings do not bode well for the stock market for a very long time.
An aging population brings lower national income, more government outlays for entitlements, and a disproportionate increase in the need for services, particularly medical related services.The service industry does not have as great a multiplication factor for support jobs as does manufacturing.Further, it means a significant increase in the number of retired people to the number of workers.In a couple of decades the number of retirees will be one retiree for every two workers compared to one retiree for every three workers today.By itself, that means a 50% increase in individual workers’ burdens and even more with more people on government welfare.
The part of the economy that will continue growing is the government, but it is the least productive part of the service industry.It has virtually no productivity gain.Politicians are reluctant to propose cuts in government payrolls, in part because they are part of it, but also because government workers probably constitute at least 20% of the voting public.Benefits for government workers grow disproportionately as well.Government pensions most often have cost-of-living adjustments, i.e., COLAs, and savings plans too.80% of private sector employees do not have pensions at all, and virtually none have COLA pensions.The number of government employees with pensions is fast approaching the number of people in the private sector that have pensions.That’s because of the double whammy of the private sector reducing the number of pensions while the government’s size is increasing.
The changes from these effects do not occur in days or months.They take years to evolve.To recoup the lost savings of the past twenty years in the next twenty years would require more than a 20% reduction in consumption.This implies savings rates comparable to that only achieved in World War II when most things you could buy were rationed and little else was available.Further, virtually everyone worked and provided income for the family during the war.Saving was politically correct and even school children saved stamps to accumulate savings bonds.
No, don’t look for any rapid improvement in the stock market.There may be spurts as occasional good news is highlighted to improve the economy, but the long-term effects described above will dominate the economy for several decades.There is no quick fix for our past savings deficiencies, record borrowings, unstoppable government growth, automatic entitlement growth and inevitable demographic creep to an aging population with greater demand for services, not hard products.
At the same time, even though stock prices will seek a lower level and grow more slowly in real terms, stocks may still be one of the better hedges against inflation.Inflation will increase the apparent earnings and business assets.Since we are living in a world of ever increasing prices, everything is relative.Inflation is very hard on fixed-income investments because the real value of the principal goes down.Owning a house with a mortgage may be one of the best investments since the value of equity increases disproportionately as the price escalates with inflation and the relative value of the debt goes down.Of course this assumes that we are willing to sell our houses later on, go into smaller homes and invest the savings in something that’s liquid so we can spend it.
As bleak as the picture is as painted above, it can get worse.One of the ways to solve part of the debt problem is for the government to let inflation increase above what we consider to be acceptable levels today.That has happened to numerous other countries and our own as well.Inflation is particularly hard on retirees who are trying to live on fixed incomes.It’s not so bad for government retirees that get a kick upward every year.
It was very poor public policy to pressure lenders to make loans to people who could not afford them.The resulting boom in housing prices made it seem that a home was a great investment and worth some speculation—even by those who could not afford the payments, much less all of the other costs of home ownership.People started to consider their home as their primary retirement resource even though a house is about as illiquid as an investment can be and has negative interest.Further this policy exacerbated the lack of mobility of our work force and made people look furtively for new jobs only close to their homes.
But some good came from the resulting crash.My view is that this mortgage crisis has kick-started us on a better path in the long run. It’s better in that less consumption eventually will help provide more for the aging population and less of a burden on our children than continuing this economic madness for many more years.We’re all going to be poorer, but less poor than we would be otherwise.We may still live more comfortably than most other nations.Hopefully the troubles we suffer in the meantime will bring more economically savvy politicians into office.Perhaps they will reduce government growth and entitlements that otherwise will be an unbearable tax burden on future generations.
This is a contribution from Bud Hebeler who runs Analyzenow.com
To our children and grand children:
These can be good financial times, not bad times!
The stock market is falling.It may be bad for many retirees and those that will lose their jobs as brokers or from bankruptcies but not for many people—IF
·their investments have been widely diversified, and
·they have set a tolerance band for reallocating their investments.
Over my almost fifty years of investing, I have seen markets drop many times.In my first fifteen years I learned the lessons the hard way—by losing money.I followed the market.When it got high, I bought.When it fell precipitously, I sold.Ugggh!I was supposed to do just the opposite.
Eventually, I found a way to do better.I set upper and lower limits to the amount of stock (including stock funds) that I would hold at various ages.The formula was simple:I would not let the stock as a percent of my holdings get below 100 minus my age.That was the bottom side.Then I set a limit for the top side, namely, 110 minus my age.So, at age 40 (about when I first started this) my stock allocations were between 60% and 70% of my investments.
After a while I added real estate investments to my portfolio.I count the equity (price less debt) as a “stock” because, after all, stock is equity as well.I did not count the equity in my home as an investment because I reasoned that I would always need a home.Besides, my home was quite modest.
Now, at 75, my equity limits are much lower:between 25% and 35% of my investments using the very same formula.The remainder of my holdings are in bonds and money markets.Using these limits over all of these years has given me a portfolio return that is higher than if I had steadfastly held to an equity limit of 105 minus my age.That’s because I bought stock when prices were low and sold them when prices were high.I described the performance differences in my book, “Getting Started in a Financially Secure Retirement.”
Not long ago I was on a radio talk show in New England.I talked about my allocation limits.The talk show host said I was old fashioned and dismissed my conservatism.He felt, as do many, that even retirees should have much larger stock allocations.I thought to myself, “He’ll learn!”
I can’t see the future any better than anyone else, so my conservative bent could be wrong.I base my stance now on something very simple indeed.That’s the deplorable decline in savings rates over the past 20 years and the almost inevitable changes in demographics.These embody the effects of overdone consumerism, excessive debt and the forthcoming reduction in the ratio of workers to those who will be retired or trying to retire.
In “Getting Started in a Financially Secure Retirement” I show that it will be impossible for the average person to save enough over the next 20 years to be comparable to what the 9% historical savings rate yielded.We would have to equal the kind of savings we had in World War II when virtually everything was rationed, there was nothing on the store shelves to buy, everyone worked, and buying savings bonds was the politically correct thing to do.
My simple analysis of necessary savings rates does not count the great reduction in the percentage of workers who will get pensions over the past 20 years.The only major segment of our society where the pension benefits are increasing is the government sector which not only is increasing as a percent of our labor force but also has cost-of-living-adjusted (COLA) pensions that are backed by a sovereign power with the ability to tax.
On the demographics side, the ratio of workers to those over 65 will go from 3 now to 2 in the next few decades.Again, the effects are very simple to visualize.That part of our taxes (the largest part) used to support the elderly will have to increase 50% for working folks.That by itself will be debilitating for the economy unless government benefits are trimmed with a meat ax.
On the debt side, by the end of this year every man, woman and child will have a federal debt obligation of over $180,000.This includes only the national debt, Social Security and Medicare.It does not include mortgage and personal debts nor state debts and unfunded obligations.A family of four could easily have an equivalent debt approaching $1 million including mortgage and personal debt obligations.At an average interest rate of 5%, that would be equivalent to an annual cost of $50,000, just to pay the interest without retiring any of the debt.The median family now earns about $70,000.That leaves about $20,000 for living expenses, state taxes and retirement savings.
Of course that assumes that income and taxes are evenly distributed.Since 40% of workers pay no income taxes at all, the burden will be 67% more on those who do pay income tax.
So, what do I think will happen?I believe that not only will income taxes go way up, so will every other form of taxes go up including ones that haven’t yet been invented.As has already happened in several places in Europe, the government will also have to reduce benefits.
Further adding to the problem will be increased inflation.That’s because I believe that the demands for higher wages will increase as will the price for goods both because of higher industrial taxes and higher labor rates.Productivity growth will slow because of increased demand for U.S. labor content.Finally, the feds will silently applaud inflation growth because it will, as always, reduce the apparent size of the national debt relative to GDP.
So why then wouldn’t I advocate holding any stock if the economic future is so bleak?The reason is that stock represents owning something tangible that will increase eventually with inflation.The same is true of investment real estate.If you have been following my past recommendations, you might be buying stock now, not selling it.
Do I think that things can get worse?Absolutely.That’s why I do things incrementally.When in doubt I go half way.That gives me an opportunity to talk about the part that did well and ignore the part that didn’t.After all, isn’t that way the finance industry promotes its performance achievements?(Smile!).
Caution:I can’t see the future any better than anyone else.But I can testify that (1) if you don’t save anything, you won’t have any savings, (2) that regular savings grow faster because of reverse-dollar-cost-averaging, (3) that diversifying investments helps savings growth over the long-term, and (4) that allocation control really pays.
This is a contribution from Bud Hebeler who runs Analyzenow.com
Last night I went to the movie I.O.U.S.A. followed by live commentary from Warren Buffett, Pete Peterson, Dave Walker (headed GAO and was Controller General), William Novell from AARP, William Niskanen from the CATO Institute and an Economist whose name I can’t remember. You’ll have to pardon the errors in this because I was taking notes in the dark and found later that it’s almost impossible to read them.
The commentary that followed was handled by Becky Quick from CNBC’s Squawk Box show who fielded questions from the audience.The movie was loosely based on the book, Empire of Debt, and was actually exciting—quite a surprise for a financial show.It even got our local movie audience clapping and laughing.The show was financed by the Peterson Foundation and starts out with a lot of material from the Concord Coalition.It was non partisan.
The more I think about the conclusions of the experts (Buffett, Walker, Peterson, et.al.) at the conclusion of the movie I.O.U.S.A., the more I wonder about their almost universal opinion that the main solution would be to increase the federal tax rates and moderate Social Security and Medicare payments to solve the $53 trillion government obligation problem.Nowhere did they mention the other main debt problems:personal debts, business and financial firm’s loans, State obligations including unfunded public employee pensions, and the sorry state of our transportation infrastructure.These have to be satisfied as well.As bad as the national condition was portrayed, our share of the total obligations was far understated.
One position that was mentioned was a mandatory savings program although the small percent cited would do little to solve our huge savings problem.After all, Social Security costs us 6.2% plus another 6.2% from our employer—and that isn’t enough to keep the program solvent.Further, as I have cited in Getting Started in a Financially Secure Retirement, the savings rate (not including Social Security) has to be well over 20% for the next two decades just to make up for the lack of savings in the past two decades of consumerism.
There are those that would only tax the rich, but as much as I dislike the extreme over-compensation of the top executives in major companies, those people eventually have to spend their money, and in so doing enrich the rest of us.They and their children may live what we consider (or wish we could achieve) obscenely ostentatious lives, but their incomes (less taxes) eventually come into the economy.
On the other hand, government spending and wealth redistribution do little to increase productivity.In fact all of the paperwork, additional government employees, even more private sector employees to respond to government regulations, and the imposition on our personal time all hurt productivity.That’s not to say that some innovation doesn’t come from government sponsored research in medicine, military and space activities, but there is lots more that comes from the private sector where competition and necessity are the stimulus for invention.This is well illustrated by the modern examples of nations that have converted from pure welfare states.Russia and China now have booming economies by comparison with their past under totally controlled economies.
Higher taxes and increased savings have to reduce economic activity.Some other alternative solutions are particularly unappealing:Government bankruptcy, revolution, and hyperinflation.Bankruptcy destroys much of the world’s economy with it.Revolution ends the way of life we and few others know.Hyperinflation puts those on fixed incomes into poverty.Yet, in my view, a little of each of these horrible extremes is the medicine that might be necessary to at least end up in some reasonable equilibrium.
How about some real government changes to same money?The Congress should start by setting the example and cutting its overgrown and bloated staffs by 50%.Then it should act to change all federal pensions, including their own, to fixed pensions like all of those in the private sector.(Only one in five private sector employment earns a pension, and they don’t have cost-of-living-adjusted pensions like federal and most state pensions.)Stand up to your unions.Let them strike.That would reduce cash outflows too.Then deny state largess from the federal coffers unless the states do likewise.Don’t stop there.Demand IRS 1040 simplification so that the IRS can cut its work force in half and we don’t have to use accountants and computer programs to do our taxes.Simultaneously, get Medicare to do the same thing so that both government employees and the private medical facilities can cut their own staffs with less paper to handle.Then sell off the excess office buildings.Give up your perks.These are the kind of things we have to do in the private sector in order for a business to survive.You’ve got to save a country—that’s even more important!
This is not “change” as envisioned by current political parties.Current political “change” is aimed at things that increase government spending and control.In my view, change should be moderately more inflation than now considered acceptable, reduced bailouts of industry and financial firms, meat-ax reductions in government personnel, and much increased foresightedness in Congress and personal financial planning –together with some tax increases and entitlement reductions.We all have to consider much longer horizons than hours or days in financial markets or a few years as in elected office terms. We even have to think in terms longer than decades as we did in our Boeing planning. We have to think in terms of generations and life-expectancies, just as in the insurance business.
Everyone is going to get hurt, but we all have to understand that a little pain now is a lot better than a lot of pain if we wait longer to take our medicine.Perhaps the only Congress and Administration people willing to take such long range positions might be those nearing retirement, but certainly not the others and especially their supporting staffs which provide all of the advice and “smarts” on which government officials depend.These all need their jobs to feed their families, and most are terrified of leaving their jobs to seek private sector employment and much lower benefits than the government provides.Further, they have demonstrated that they have no interest in solving the additional problems of personal savings to replace debt, business debt, State obligations including public pensions and the sorry state of our transportation infrastructure.
That said, here are my notes from the movie, I.O.U.S.A., and the comments from some of the more powerful people in financial circles and former government executives.I feel all citizens should hear this message—and consider some of the points I have made above.
Of course, the movie is mostly about debts this country has incurred to date as well as the history leading up to our current situation. Before the movie began, they had a digital display showing the current national debt as it was actually changing.It was increasing by millions as we watched. The only time this country was out of debt was 1830. At the time the movie was made the total unfunded obligations of the country were $53 trillion or $175,000 for every man, woman and child in the US.By 1/1/09, it will be $55 trillion and $184,000 for each person.
$10 trillion of this will be the national debt at the end of the year.44.5% of our debt is owned by foreigners, principally China.The other time the country reached levels of national debt to GDP like we are now was at the end of WWII, but that debt was owed to ourselves, largely as savings bonds.Unlike now, the people were willing to make great sacrifices because they had experienced the Great Depression and had come out of the War where most things were rationed.So much of the debt got paid.
One of the few periods in modern times when the government was not outspending its income was in the Clinton administration supported by a Republican Congress.The movie came down hard on President Bush for not containing spending, especially for approving Medicare drug assistance with Part D.It showed clips of Secretary O’Neill who was very upset about being fired for his disagreements with President Bush.
All commentators agreed that the current problem was largely due to excessive consumption.Our national savings rate is now -2.9%.The graphics showed the highest savings, about 23%, occurred during WWII.Most of the time savings rates in the past have been about 9% to 10% through good times and bad.
There was a considerable amount of material on inflation with laudatory comments about Paul Volker raising the interest rate to 20% to combat what had occurred in the Carter years.There were also clips of Ron Paul railing the government for printing money.
Social Security was highlighted in the movie as well as the commentary.Various solutions were suggested such as raising the full retirement age from 66 to 70 or doubling the Social Security tax on the work force.After 2017, without action, the Social Security Trust Fund will no longer be able to support cash flows for things other than Social Security as it does now because the trust funds won’t be there.As most of us already know, the trust fund is a fiction.It’s full of IOUs from the federal government.One person said that the trust fund is neither a fund, nor can it be trusted.
The movie showed street interviews with ordinary people.It was shocking how little they knew not just about the country’s financial conditions, but even simple financial terms like deficit.The movie and all commentators (except Warren Buffett) felt it was grossly unfair to have our children and grandchildren and following generations have to pay for our current excesses.Buffett felt that the ingenuity of our people would come up with things to solve the problems so that our children would actually have better lives than us.The movie and commentators showed how poor our schools were compared to all other developed countries.We are particularly deficient in math and science.After seeing the movie, I’d add that they are even worse in teaching basic finance and money management.
The movie also made some dramatic points about the trade deficit.It showed a US scrap yard where the manager said the majority of his scrap was being sold to Japan and China who were manufacturing things to be exported back to the US.
Foreigners that hold our debt hold it in dollars, so if they sell it to another foreigner, the other foreigner will have the same debt in dollars.It’s like a tar baby.The risk is not the foreigners dumping the debt; the risk is the interest rate and being able to get them to take on more of our debt.
Walker pointed out that one of the things that made the debt problem so intractable is that 68% of the national budget is on autopilot (e.g., automatically adjusted for inflation) and only 32% is for the things originally intended by our founding fathers to be what the federal government was supposed to do—like defend us.Also, Congress was supposed to be a part-time job where the congressmen went back home to their regular jobs the rest of the year.Now, congressmen work to preserve their congressional jobs and have a very short term perspective directed at whatever it takes to get reelected.
Most of the commentators agreed that the solution to our problem relies on national leadership—and it just isn’t there.Politicians are campaigning with programs advocating more government spending, not less.Medicare is currently the largest single unfunded liability—and it looks like the finance problem not only will not get solved—it will get worse with all of the add-ons.
The $53 trillion debt and unfunded liabilities is made up (as I recall the numbers) with $10 trillion national debt, 7 trillion Social Security, $26 trillion Medicare parts A and B, 8 trillion Medicare part D and some miscellaneous items.I don’t remember how they accounted for the trade deficit, and there was no mention of State debts or industrial debts which must exacerbate the problems.
If you get a chance to see a replay, I’d urge you to see it yourself.It has a very compelling message that should be understood by all citizens including those in high-school.We need better government leadership and we must greatly increase personal savings.
This is a contribution from Bud Hebeler who runs Analyzenow.com
Hidden government costs FAR exceed that which we think we pay in sales and income tax. See the illustrations below:
So you may think you are only paying income, property and sales tax.Wrong!You are paying for the government labor to administer and collect the taxes.You are also paying for all of the taxes on the materials used to get you the final product. And you are paying for the additional effort required by the retailer to administer and collect the taxes.
The additional administrative costs problem may be the worst in the medical field where medical offices now employ many more people than the professional staff in order to handle the bookwork of Medicare patients.Of course the major exceptions to this are those medical professions where Medicare doesn’t cover the costs, i.e., dental, hearing and eye care.Still they require some effort to cover those things covered by private insurance, but they don’t have to provide all of the incremental labor associated with submitting the bills to Medicare, waiting for a reply, resubmitting the result to a Medigap insurer, waiting for the insurer’s reply, and then finally billing the patient for the incremental cost that’s left.
Our family and retired friends have found that many times, the interval between the visit to the doctor’s office and our final bill can exceed a year.Since all of the medical staff and their suppliers must be paid before the doctor’s office finally gets the checks from Medicare and the Medigap insurer, your medical bills have to include the cost of borrowing the money in the interval.Throughout this process we get a number of reports on what’s allowable and what’s not–almost always aggregated with other items still in progress in a mess that’s virtually impossible to untangle.I remember that my father used to just throw all of these reports unread in his top drawer and discard them when the drawer got full. This used to drive my sister nuts, but it probably was the most practical thing to do.
Medical costs may be the least problem to you who are young and healthy.You don’t get off scot free from hidden government costs though.Let’s first look at sales taxes.
We only see the sales tax on the retailer’s bill.However, the retailer must pay sales (or “use”) tax on the goods it sells.The retailer pays sales tax on the goods it buys from the wholesaler.The wholesaler pays sales tax on the goods it buys from the manufacturer.The manufacture pays sales tax on the goods it buys from subcontractors.The subcontractor pays sales tax on the materials it uses.And so on down to the point where the basic material comes from the ground—and property taxes are due.Actually, property taxes are involved in every step of the way, but we’ll leave those out to simplify the results.
In a product area where the labor costs and profit are a small part of the costs, say only 10% of the total cost, then a 9% sales tax like we have in our area really is a 24% sales tax when considering the product passes through only four hands on the way to your home.A 5% sales tax translates to a 13% sales tax in the same situation.
On the other hand, a product that has a high labor content, say 50%, at each of the four steps with a 9% sales tax would really cost you 12%.If the labor content was 50% and the sales taxes were 5%, the net sales tax to you would be 7%.
How do income taxes come into this?You pay income tax on all of the labor that went into the product at each step along the way. Suppose the labor content was 50%.If the average income tax of the workers was 20% and the profit was 10% at each of four steps, you would be paying 14% of the price for income tax along the way.If the income tax was 10%, you would be paying 7% of the price for income tax.Remember that the income tax includes that of the top bosses, administrators, and hands-on labor.Also remember that we haven’t accounted for Social Security and Medicare.
So, leaving out property taxes, Social Security tax and Medicare tax, if the sales tax is 9% and income tax is 20%, we are paying 24% tax for a low labor product and 26% for a product that averages 50% labor and profit at each of four steps.At the other extreme with 5% sales tax and 10% income tax, we are paying 13% tax for a low labor product and 19% for a product with 50% labor and profit at each step.Of course these are just rough figures because everything we buy is going to have different net taxes.
One of the main ways that the federal government has to reduce taxes is to push responsibility down to the state level.Medicaid is a primary example of this, but it also applies to many other areas including education and law enforcement.
The main point is that actual taxes on the things we buy are far greater than that sales tax number we see printed on the receipt. By analogy, the same is true of our property tax rates. So when someone says that the federal government is going to increase its services but not income tax for the average person—Watch out!The average person will pay for it one way or the other.
The other point to keep in mind is that increased government services and regulations can have a far greater effect than the increase in government payroll.This in itself is costly because both the average pay and retirement benefits for government workers far exceed the averages for those in the private sector.But the greatest effect is on the increase in labor needed in the private sector to satisfy the government requirements and administrative effort.The medical profession is a prime example of this, but it’s not the only one.I worked for thirty three years in the military and space fields.For every government oversight person assigned, we had to employ many more of our own employees to respond to the government’s questions.
All of these things are hidden costs.It’s impossible to find out the total, but almost anything we buy has hidden sales tax, income tax, Social Security tax and private sector overhead costs that far exceed that which we think we are paying in that simple sales tax number!
This is a contribution from Bud Hebeler who runs Analyzenow.com
How would you like to have retirement resources that will provide about the same income in retirement as when working and be inflation protected?Answer:Go to work for the government.Oregon has one of the richest pension plans.After 30 years of employment, pensions equal or exceed their working compensation per 1999 rules.(Statesman Journal, April 20, 2003)Add Social Security which may provide another 40%.
The baby boomers with government pensions will exceed the number of baby boomers getting pensions in private industry if current trends continue.Consumer Reports Money Adviser (May, 2008) cites Boston College research showing that while 36% of the private sector employees had defined benefit plans in 1992, only 19% have such plans now.That translates to about 22 million private sector employees (19% of 116 million) who get pensions.Virtually all of the 23 million government employees get pensions.This does not count those in the military who also get pensions, and I believe does not count postal service employees or those in similar government sponsored corporations like the Pension Benefit Guarantee Corporation that’s supposed to save pensions for the rest of us.
Most federal pensions have inflation protected cost-of-living-adjustments, COLAs.Many state pensions also have this rich benefit.Practically no private sector pensions have COLAs. At 65, a pension with a COLA has a funding obligation about 50% more than a fixed pension assuming future inflation is only 3%.So if you’d go to buy an inflation adjusted immediate annuity with regular monthly payments like a pension, a COLA annuity will cost about 50% more than a fixed payment annuity.Said another way, a $1,000 a month COLA pension will pay $1,810 after 20 years of 3% inflation while a $1,000 fixed pension will still pay $1,000.
So we are paying into a pension plan that’s not our own even if we personally will not get a pension.That’s because we are paying for the federal, state and local government retirement plans with our taxes.As government increases in size, we’ll pay more—and even more with the COLA adjustments.Although politicians run for office on the basis of reducing government spending, it practically never means reducing the government payroll.Every addition for oversight or a function adds people.And it’s almost impossible to reduce the staff size in a government job.I can remember when congressmen had only 4 people on their staff while ten times that much is not uncommon today.
That’s not all.The percentage of retired people is increasing relative to the number of working people, perhaps 10% to 20% more in the next couple of decades.That means that an ever smaller working force is going to have to support an ever increasing number of aged people.This is not just for the government pensions.It also covers everyone’s Social Security (also inflation adjusted) and Medicare.Medicare is not only increasing from inflation—it’s increasing because of the increasing number of aged and faster-than-inflation growth of medical expenses of almost every kind.
It also means that over 17% to 20% of the work force will be in the government excluding the military and other quasi government workers and the unstoppable growth of government.That’s a powerful voting block. Government employees will always vote to keep their jobs.
Federal employees have subsidized health insurance in retirement as do many state and local government retirees.Very few private sector employees have this benefit.This is huge.A retired couple from the private sector pays about $700 a month for Medicare and Medigap policies, and that doesn’t cover drugs, uninsured costs and care of eye sight, hearing or dental work.
Government employees have 403(b) savings accounts with provisions similar to the 401(k)s in the private sector.But, in the case of the private sector, these savings plans are rapidly replacing pensions, not in the government sector.The public sector is better subscribed because many of those in the private sector opt out, even when the employer offers matching funds.
The average government employee now makes about 50% more than the average person in the private sector.USA Today (2/1/08) reports that “State and local government workers now earn an average of $39.50 per hour in total compensation …Private workers earn an average of $26.09 an hour. . . From 2000 to 2007, public employees enjoyed a 16% increase in compensation after adjusting for inflation compared to 11% for private workers.” In large part, many government workers can thank their very powerful unions and public shy politicians afraid to confront a large part of their voters.
So there you have it.We’ve grown a government that not only pays its employees better than the private sector, we give them better benefits.We’ll pay for those employees not only while they are working, but at an ever increasing rate while most of the rest of us in private sector retirement see our incomes cut by inflation.
General Motors, move aside.There’s another entity that is going to pay more dearly than you for all the retirement promises it has made.Ah, but it’s a sovereign power that has the ability to tax.Sorry about that GM.You have to manage better to catch up.The government doesn’t.
